SOLUTION MANUAL FOR Advanced Accounting, 12e Paul Fischer William Taylor Rita Cheng by StudyGuide

CHAPTER 1 UNDERSTANDING THE ISSUES 1. (a) Product extension—manufacturer expands product lines in boating industry. (b) Vertical forward—manufacturer buys distribution outlets (c) Conglomerate—unrelated businesses (d) Vertical backward—manufacturer acquires a supplier (e) Vertical forward—an entertainment company acquires outlets for its products (f) Market extension—companies providing the same services expand their geographic market 2. By accepting cash in exchange for the net assets of the company, the seller would have to recognize an immediate taxable gain. However, if the seller were to accept common stock of another corporation instead, the seller could construct the transaction as a tax-free reorganization. The seller could then account for the transaction as a tax-free exchange. The seller would not pay taxes until the shares received were sold. 3. Identifiable assets (fair value) .. $600,000 Deferred tax liability ($200,000 × 40%)....................... (80,000) Net assets ................................ $520,000 Goodwill Price paid ................................. $850,000 Net assets ................................ (520,000) Goodwill ................................... $330,000 4. (a) The net assets and goodwill will be recorded at their full fair value on the books of the parent on the date of acquisition. (b) An investment account is recorded at the price paid for the interest. 5. Puncho will record the net assets at their fair value of $800,000 on its books. Also, Puncho will record goodwill of $100,000 ($900,000 – $800,000) resulting from the excess of the price paid over the fair value. Semos will record the removal of its net assets at their book values. Semos will record

a gain on the sale of business of $500,000 ($900,000 – $400,000). 6. (a) Value Analysis: Price paid ................................ $800,000 Fair value of net assets ........... 520,000 Goodwill .................................. $280,000 Current assets (fair value)....... $120,000 Land (fair value) .......................... 80,000 Building and equipment (fair value) .............................. 400,000 Customer list (fair value) ............. 20,000 Liabilities (fair value) ................ (100,000) Goodwill .................................. 280,000 Total........................................ $800,000 (b) Value Analysis: Price paid ................................ $450,000 Fair value of net assets ........... 520,000 Gain ........................................ $ (70,000) Current assets (fair value)....... $120,000 Land (fair value) .......................... 80,000 Building and equipment (fair value) .............................. 400,000 Customer list (fair value) ............. 20,000 Liabilities (fair value) ................ (100,000) Gain ........................................ (70,000) Total........................................ $450,000 7. The 2015 financial statements would be revised as they are included in the 2016– 2015 comparative statements. The 2012 statements would be based on the new values. The adjustments would be: (a) The equipment and building will be restated at $180,000 and $550,000 on the comparative 2015 and 2016 balance sheets. (b) Originally, depreciation on the equipment is $40,000 ($200,000/5) per year. It will be recalculated as $36,000 ($180,000/5) per year. The adjustment for 2015 is for a half year. 2015 depreciation expense and accumulated depreciation will be restated at $18,000 instead of $20,000 for the half year. Depreciation expense for 2016 will be $36,000.

1–2 (c) Originally, depreciation on the building is $25,000 ($500,000/20) per year. It will be recalculated as $27,500 ($550,000/20) per year. The adjustment for 2015 is for a half year. 2015 depreciation expense and accumulated depreciation will be restated at $13,750 instead of $12,500 for the half year. Depreciation expense for 2016 will be $27,500. (d) Goodwill is reduced $30,000 on the comparative 2015 and 2016 balance sheets. 8. Fair value of operating unit ...... $1,200,000 Book value including goodwill .. 1,250,000 Goodwill is impaired. Fair value of operating unit ...... $1,200,000 Fair value of net identifiable assets (excluding goodwill) ... 1,120,000 Recalculated goodwill .............. $ 80,000 Existing goodwill ...................... 200,000

(c) Since this agreement is based on issuance of additional shares based on a decrease in value, it is recorded as a liability based on the estimated value. On each reporting date, the liability would be re-estimated. Upon the settlement date, the liability would be extinguished by the issuance of the additional shares. 10. The two major differences are: (a) Goodwill is $100,000. Under U.S. GAAP it would be impairment tested and possibly reduced in future periods. Under IFRS, it would be amortized over some number of future periods. (b) Under U.S. GAAP, the stock issue costs would reduce the amount credited to paid in capital. Under IFRS, the issue costs would be expensed in the period incurred.

Goodwill impairment loss ......... $ 120,000 9. (a) An estimated liability should have been recorded on the purchase date. Any difference between that estimate and the $100,000 paid would be recorded as a gain or loss on the liability already recorded. (b) The estimated amount due would be recorded as a part of the purchase price and would result to a credit to paidin capital, contingent share agreement. There would be no re-estimation of the amount.

1–3

Ch. 1—Exercises

EXERCISES EXERCISE 1-1 (1) Current Assets .......................................................................... Land .......................................................................................... Building ..................................................................................... Equipment ................................................................................ Goodwill .................................................................................... Liabilities .............................................................................. Cash .....................................................................................

85,000 90,000 300,000 275,000 227,000

Expenses (acquisition costs) .................................................... Cash .....................................................................................

15,000

(2) Cash ......................................................................................... Liabilities ................................................................................... Accumulated Depreciation—Building ....................................... Accumulated Depreciation—Equipment ................................... Current Assets ..................................................................... Land ..................................................................................... Building ................................................................................ Equipment ............................................................................ Gain on Sale of Business .....................................................

875,000 100,000 200,000 100,000

102,000 875,000 15,000

80,000 70,000 450,000 300,000 375,000

Note: Seller does not receive the acquisition costs. (3) Investment in Crown Company ................................................ Cash ................................................................................... Expenses (acquisition costs) .................................................... Cash ...................................................................................

875,000 875,000 15,000 15,000

Note: At year-end, Crown would be consolidated with Barstow, as will be explained in Chapter 2.

Ch. 1—Exercises

1–4

EXERCISE 1-2 Cash................................................................................................. Inventory .......................................................................................... Equipment ........................................................................................ Land ................................................................................................. Buildings .......................................................................................... Goodwill* .......................................................................................... Discount on Bonds Payable ............................................................. Current Liabilities ....................................................................... Bonds Payable ........................................................................... Common Stock........................................................................... Paid-In Capital in Excess of Par.................................................

100,000 270,000 220,000 180,000 300,000 515,000 75,000

Acquisition Expense ......................................................................... Paid-In Capital in Excess of Par ...................................................... Cash ...........................................................................................

25,000 10,000

*Total consideration: Common stock (60,000 shares × $18) ....................................... Less fair value of net assets acquired: Cash ..................................................................................... Inventory .............................................................................. Equipment ........................................................................... Land ..................................................................................... Buildings ............................................................................... Current liabilities ................................................................... Bonds payable ..................................................................... Value of net identifiable assets acquired .............................. Excess of total cost over fair value of net assets (goodwill) .............

80,000 500,000 60,000 1,020,000

35,000 $1,080,000 $100,000 270,000 220,000 180,000 300,000 (80,000) (425,000) 565,000 $ 515,000

1–5

Ch. 1—Exercises

EXERCISE 1-3 Accounts Receivable ....................................................................... Inventory .......................................................................................... Equipment for Resale ($200,000 less 10%) .................................... Land ................................................................................................. Building ............................................................................................ R&D Project ..................................................................................... Customer List ................................................................................... Goodwill* .......................................................................................... Current Liabilities ....................................................................... Bonds Payable ........................................................................... Warranty Liability........................................................................ Common Stock........................................................................... Paid-In Capital in Excess of Par.................................................

100,000 210,000 180,000 200,000 450,000 90,000 210,650 879,350

Totals ......................................................................................................................

2,320,000

*Total consideration: Common stock (100,000 shares × $20) ..................................... Less fair value of net assets acquired: Accounts receivable ............................................................. Inventory .............................................................................. Equipment for resale ($200,000 less 10%) .......................... Land ..................................................................................... Building ................................................................................ R&D project .......................................................................... Customer list ($100,000 payment discounted 3 years at 20%) Current liabilities ................................................................... Bonds payable ..................................................................... Estimated liability under warranty ........................................ Value of net identifiable assets acquired ......................................... Excess of total cost over fair value of net assets (goodwill) .............

80,000 200,000 40,000 100,000 1,900,000 2,320,000

$2,000,000 $ 100,000 210,000 180,000 200,000 450,000 90,000 210,650* (80,000) (200,000) (40,000) 1,120,650 $ 879,350

*This amount is arrived at using table and would be 210,648 using financial calculator or Excel.

Ch. 1—Exercises

1–6

EXERCISE 1-4 Accounts Receivable ....................................................................... Inventory .......................................................................................... Equipment ....................................................................................... Brand-Name Copyright .................................................................... Cash ........................................................................................... Current Liabilities ....................................................................... Mortgage Payable ...................................................................... Gain on Acquisition* ................................................................... Acquisition Expense ......................................................................... Cash ........................................................................................... *Total consideration: Cash ........................................................................................... Less fair value of net assets acquired: Accounts receivable ............................................................. Inventory .............................................................................. Equipment ............................................................................ Brand-name copyright .......................................................... Current liabilities ................................................................... Mortgage payable ................................................................ Value of net identifiable assets acquired .............................. Excess of total fair value over cost of net assets (gain) ...................

200,000 270,000 40,000 15,000 160,000 80,000 250,000 35,000 25,000 25,000 $160,000 $ 200,000 270,000 40,000 15,000 (80,000) (250,000) 195,000 $ (35,000)

1–7

Ch. 1—Exercises

EXERCISE 1-5 (1) Adjustments: Final value of manufacturing plant ............................................................. Provisional value of manufacturing plant ................................................... Total increase ............................................................................................ Depreciation adjustment: Depreciation on final cost ($700,000/10 years) .................. Depreciation based on provisional cost ($600,000/10 years) Annual increase in depreciation..........................................

$70,000 60,000 $10,000

Adjustment for half year ......................................................

$5,000

Journal Entries: Plant Assets ........................................................................ Goodwill..........................................................................

100,000

Retained Earnings (increase depreciation for half year)..... Plant Assets (because they are shown net of depreciation)............................................................ (2)

$700,000 600,000 $100,000

100,000 5,000 5,000

Balance Sheet December 31, 2015 (revised) Current assets ............... Equipment (net) ............. Plant assets (net) ........... Goodwill .........................

$ 300,000 600,000 1,695,000 200,000

Total assets ...................

$2,795,000

Current liabilities ................... Bonds payable ...................... Common stock ($1 par) ........ Paid-in capital in excess of par Retained earnings ................ Total liabilities and equity .....

$ 300,000 500,000 50,000 1,300,000 645,000 $2,795,000

Summary Income Statement For Year Ended December 31, 2015 (revised) Sales revenue ........................................................................... Cost of goods sold .................................................................... Gross profit ............................................................................... Operating expenses.................................................................. Depreciation expense ............................................................... Net income................................................................................

$800,000 520,000 $280,000 $150,000 85,000

235,000 $ 45,000

Ch. 1—Exercises

1–8

EXERCISE 1-6 Machine = $200,000 Deferred tax liability = $16,800 In this tax-free exchange, depreciation on $56,000 [($200,000 appraised value) – ($144,000* net book value)] of the machine’s value is not deductible on future tax returns. The additional tax to be paid as a result of Lewison’s inability to deduct the excess value assigned to the machine is $16,800 ($56,000 × 30%). Goodwill = $800,000 – ($700,000 – $16,800) = $116,800 *$180,000/10 yrs. × 2 prior years = $36,000 accumulated depreciation $180,000 – $36,000 = $144,000 net book value

EXERCISE 1-7 Current Assets ................................................................................. Equipment ........................................................................................ Building ............................................................................................ Deferred Tax Asset .......................................................................... Goodwill* .......................................................................................... Current Liabilities ....................................................................... Cash ........................................................................................... Price paid ......................................................................................... Less fair value of net assets: Current assets ............................................................................ Equipment .................................................................................. Building ...................................................................................... Recorded (current) liabilities ...................................................... Excess ............................................................................................. *Tax loss carryforward consideration: Deferred tax asset ($300,000 × 30%) = the value of the remaining carryforward ........................................................ Goodwill ..........................................................................................

100,000 200,000 270,000 90,000 350,000 60,000 950,000 $ 950,000 $100,000 200,000 270,000 (60,000)

510,000 $ 440,000

(90,000) $ 350,000

1–9

Ch. 1—Exercises

EXERCISE 1-8 (1) Estimated Liability for Contingent Consideration (original account) Loss on Estimated Contingent Consideration........................... Cash ................................................................................... 2 × (average income of $55,000* – $25,000) – (2 × $30,000)

40,000 20,000 60,000

* average of $50,000 and $60,000 Two years at $30,000 = $60,000 payment (2) Paid in Capital, Contingent Share Agreement (original account) Common stock, $1 par........................................................ Paid-In Capital in Excess of Par .........................................

40,000 12,000 28,000

Value of amount due is $60,000 (2 × $30,000 for two years) Divide $60,000 amount due by $5 value per share = 12,000 shares No adjustment is made for the change in value. (3) Estimated Liability for Contingent Consideration (original account) Loss on Estimated Contingent Consideration..................... Common Stock, $1 par ....................................................... Paid-In Capital in Excess of Par .........................................

40,000 60,000

Deficiency [($6 – $5) × 100,000 shares] ................................... Divide by fair value ................................................................... Added number of shares ..........................................................

$100,000 ÷ $5 20,000

20,000 80,000

EXERCISE 1-9 (1) Purchase price ................................................................................................. Fair value of net assets other than goodwill .................................................... Goodwill ...........................................................................................................

$600,000 400,000 $200,000

The estimated value of the unit exceeds $600,000, confirming goodwill. (2) (a) Estimated fair value of business unit ......................................................... Book value of Anton net assets, including goodwill ...................................

$520,000 $500,000

No impairment exists. (b) Estimated fair value of business unit ......................................................... Book value of Anton net assets, including goodwill ...................................

$400,000 $450,000

Goodwill is impaired. Estimated fair value of business units ....................................................... Fair value of net assets, excluding goodwill .............................................. Remeasured amount of goodwill ............................................................... Existing goodwill ........................................................................................ Impairment loss .........................................................................................

$400,000 340,000 $ 60,000 200,000 $140,000

Ch. 1—Exercises

1–10

APPENDIX EXERCISE EXERCISE 1A-1 (1) Calculation of Earnings in Excess of Normal: Average operating income: 2011 ........................................................................ 2012 ........................................................................ 2013 ........................................................................ 2014 (subtract $40,000).......................................... 2015 ........................................................................ Less normal return on assets at fair value: Accounts receivable ........................................... Inventory............................................................. Land ................................................................... Building............................................................... Equipment .......................................................... Fair value of total assets ......................................... Industry normal rate of return ................................. Normal return on assets ..................................... Expected annual earnings in excess of normal ............

$ 90,000 110,000 120,000 100,000 130,000 $550,000 ÷ 5 years = $110,000 $100,000 125,000 100,000 300,000 250,000 $875,000 × 12% 105,000 $ 5,000

(a) 5 × $5,000 = $25,000 Goodwill (b) Capitalize the perpetual yearly earnings at 12%: Goodwill

Yearly Excess Earnings Capitalization Rate

$5,000 0.12

= $41,667 (c) Present value of a $5,000 annuity capitalized at 16%. The correct present value factor is found in the “present value of an annuity of $1” table, at 16% for 5 periods. This factor multiplied by the $5,000 yearly excess earnings will result in the present value: 3.2743 × $5,000 = $16,372 (2) The goodwill recorded would be $15,000. The journal entry (not required) would be as follows: Accounts Receivable ................................................................ Inventory ................................................................................... Land .......................................................................................... Building ..................................................................................... Equipment................................................................................. Goodwill .................................................................................... Cash ................................................................................... Total Liabilities ....................................................................

100,000 125,000 100,000 300,000 250,000 15,000 690,000 200,000

1–11

Ch. 1—Problems

PROBLEMS PROBLEM 1-1

(1) Acquisition price

$540,000

Total consideration: Cash ..................................................................................... Less fair value of net assets acquired: Accounts receivable ............................................................. Inventory .............................................................................. Other current assets ............................................................. Equipment ............................................................................ Trademark ............................................................................ In-process R&D .................................................................... Current liabilities ................................................................... Bonds payable ..................................................................... Value of net identifiable assets acquired ........................ Excess of total cost over fair value of net assets (goodwill) ..... Journal Entry: Accounts Receivable ............................................................ Inventory .............................................................................. Other Current Assets ........................................................... Equipment ............................................................................ Trademark ............................................................................ R&D ..................................................................................... Goodwill ............................................................................... Cash ............................................................................... Current Liabilities............................................................ Bonds Payable ............................................................... Dr. = Cr. Check Totals

$540,000 $ 79,000 98,000 55,000 340,000 30,000 20,000 (125,000) (100,000) 397,000 $143,000 79,000 98,000 55,000 340,000 30,000 20,000 143,000 540,000 125,000 100,000 765,000

765,000

Ch. 1—Problems

1–12

Problem 1-1, Concluded

(2) Acquisition price

$350,000

Total consideration: Cash ..................................................................................... Less fair value of net assets acquired: Accounts receivable ............................................................. Inventory .............................................................................. Other current assets ............................................................. Equipment ........................................................................... Trademark ............................................................................ In-process R&D .................................................................... Current liabilities ................................................................... Bonds payable ..................................................................... Value of net identifiable assets acquired ........................ Excess of fair value of net assets over cost (gain) ................... Journal Entry: Accounts Receivable ............................................................ Inventory .............................................................................. Other Current Assets ........................................................... Equipment ............................................................................ Trademark ............................................................................ R&D ..................................................................................... Gain on Business Acquisition ......................................... Cash ............................................................................... Current Liabilities............................................................ Bonds Payable ............................................................... Dr. = Cr. Check Totals

$350,000 $ 79,000 98,000 55,000 340,000 30,000 20,000 (125,000) (100,000) 397,000 $ (47,000) 79,000 98,000 55,000 340,000 30,000 20,000 47,000 350,000 125,000 100,000 622,000

622,000

1–13

Ch. 1—Problems

PROBLEM 1-2

Total consideration for Vicker: Common stock (30,000 shares × $40) ....................................... Less fair value of net assets acquired: Accounts receivable ................................................................... Inventory .................................................................................... Land ........................................................................................... Buildings..................................................................................... Current liabilities......................................................................... Bonds payable ........................................................................... Value of net identifiable assets acquired .............................. Excess of total cost over fair value of net assets (goodwill) ............. Bar entry to record the purchase of Vicker: Accounts Receivable.................................................................. Inventory .................................................................................... Land ........................................................................................... Buildings..................................................................................... Discount on Bonds Payable ....................................................... Goodwill ..................................................................................... Current Liabilities ................................................................. Bonds Payable ..................................................................... Common Stock (30,000 shares × $10 par) .......................... Paid-In Capital in Excess of Par ........................................... Dr. = Cr. Check Totals

Acquisition Expense ......................................................................... Cash ...........................................................................................

$1,200,000 $ 200,000 190,000 300,000 450,000 (160,000) (90,000) 890,000 $ 310,000 200,000 190,000 300,000 450,000 10,000 310,000 160,000 100,000 300,000 900,000 1,460,000

1,460,000

5,000 5,000

Ch. 1—Problems

1–14

Problem 1-2, Concluded

Total consideration for Kendal: Common stock (15,000 shares × $40) ....................................... Less fair value of net assets acquired: Accounts receivable ................................................................... Inventory .................................................................................... Land ........................................................................................... Buildings..................................................................................... Current liabilities......................................................................... Bonds payable ........................................................................... Value of net identifiable assets acquired .............................. Excess of total cost over fair value of net assets (goodwill) ............. Bar entry to record the purchase of Kendal: Accounts Receivable.................................................................. Inventory .................................................................................... Land ........................................................................................... Buildings..................................................................................... Discount on Bonds Payable ....................................................... Goodwill ..................................................................................... Current Liabilities ................................................................. Bonds Payable ..................................................................... Common Stock (15,000 shares × $10 par) .......................... Paid-In Capital in Excess of Par ........................................... Dr. = Cr. Check Totals

$600,000 $ 80,000 100,000 80,000 400,000 (55,000) (95,000) 510,000 $ 90,000 80,000 100,000 80,000 400,000 5,000 90,000 55,000 100,000 150,000 450,000 755,000

Acquisition Expense ......................................................................... Cash ...........................................................................................

4,000

Paid-In Capital in Excess of Par ...................................................... Cash ........................................................................................... To record issue and acquisition costs.

15,000

755,000

4,000 15,000

1–15

Ch. 1—Problems

PROBLEM 1-3

(1) Total consideration for Yount: Cash ..................................................................................... Less fair value of net assets acquired: Cash equivalents .................................................................. Accounts receivable ............................................................. Inventory .............................................................................. Depreciable fixed assets ...................................................... Current liabilities ................................................................... Long-term liabilities .............................................................. Value of net identifiable assets acquired ........................ Excess of total cost over fair value of net assets (goodwill) ..... Acquisition entry: Cash Equivalents ................................................................. Accounts Receivable ............................................................ Inventory .............................................................................. Depreciable Fixed Assets .................................................... Goodwill ............................................................................... Current Liabilities............................................................ Long-Term Liabilities ...................................................... Cash ...............................................................................

$730,000 $ 100,000 120,000 70,000 400,000 (30,000) (165,000) 495,000 $235,000 100,000 120,000 70,000 400,000 235,000 30,000 165,000 730,000

Dr. = Cr. Check Totals

925,000

Acquisition Expense ................................................................. Cash .....................................................................................

20,000

925,000

20,000

(2) Pro Forma Income: Sales ..................................................................................................... Less: Cost of goods sold ($120,000 + $20,000 additional for inventory valuation) .................................................................................... Other expenses .............................................................................. Depreciation (1/20 of $400,000 market value) ................................ Net income............................................................................................

Combined Income $ 200,000 (140,000) (25,000) (20,000) $ 15,000

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Ch. 1—Problems

1–16

PROBLEM 1-4

(1) $500,000 consideration Total consideration for Williams: Common stock (20,000 shares × $25) ................................. Less fair value of net assets acquired: Accounts receivable ............................................................. Inventory .............................................................................. Land ..................................................................................... Building ................................................................................ Accounts payable ................................................................. Value of net identifiable assets acquired ........................ Excess of total cost over fair value of net assets (goodwill) ..... Kiln Corporation journal entries: Accounts Receivable ............................................................ Inventory .............................................................................. Land ..................................................................................... Building ................................................................................ Goodwill ............................................................................... Accounts Payable........................................................... Common Stock ............................................................... Paid-In Capital in Excess of Par ..................................... Dr. = Cr. Check Totals

$500,000 $ 50,000 250,000 40,000 120,000 (40,000) 420,000 $ 80,000 50,000 250,000 40,000 120,000 80,000 40,000 200,000 300,000 540,000

540,000

(2) $385,000 consideration Total consideration for Williams: Cash ..................................................................................... Less fair value of net assets acquired: Accounts receivable ............................................................. Inventory .............................................................................. Land ..................................................................................... Building ................................................................................ Accounts payable ................................................................. Value of net identifiable assets acquired ........................ Excess of fair value of net assets over cost (gain) ................... Kiln Corporation journal entries: Accounts Receivable ............................................................ Inventory .............................................................................. Land ..................................................................................... Building ................................................................................ Gain on Acquisition ........................................................ Accounts Payable........................................................... Cash ............................................................................... Dr. = Cr. Check Totals

$385,000 $ 50,000 250,000 40,000 120,000 (40,000) 420,000 $ (35,000) 50,000 250,000 40,000 120,000 35,000 40,000 385,000 460,000

460,000

1–17

Ch. 1—Problems

PROBLEM 1-5

Total consideration for Jack: Common stock (18,000 shares × $270) ..................................... Less fair value of net assets acquired: Investments ................................................................................ Accounts receivable ................................................................... Inventory .................................................................................... Prepaid insurance ...................................................................... Land ........................................................................................... Machinery and equipment ($1,473,500 × 1.3) ........................... Current liabilities......................................................................... Value of net identifiable assets acquired .............................. Excess of total cost over fair value of net assets (goodwill) ............. Journal Entry: Investments ................................................................................ Accounts Receivable.................................................................. Inventory .................................................................................... Prepaid Insurance ...................................................................... Land .......................................................................................... Machinery and Equipment ........................................................ Goodwill ..................................................................................... Current Liabilities ................................................................. Common Stock (18,000 × $10) ............................................ Paid-In Capital in Excess of Par [(18,000 × $270) – $180,000]

$4,860,000 $

400,500 925,000 1,200,000 18,000 70,000 1,915,550 (1,475,000) 3,054,050 $1,805,950 400,500 925,000 1,200,000 18,000 70,000 1,915,550 1,805,950 1,475,000 180,000 4,680,000

Dr. = Cr. Check Totals

6,335,000

Acquisition Expense ......................................................................... Cash ...........................................................................................

12,000

6,335,000

12,000

Ch. 1—Problems

1–18

PROBLEM 1-6

Total consideration for Sylvester: Cash ........................................................................................... Less fair value of net assets acquired: Notes receivable ........................................................................ Accounts receivable ................................................................... Inventory .................................................................................... Other current assets................................................................... Investments ................................................................................ Land ........................................................................................... Building ...................................................................................... Equipment .................................................................................. Patents ....................................................................................... Trade names .............................................................................. Accounts payable ....................................................................... Payroll and benefit-related liabilities—Current ........................... Debt maturing in one year .......................................................... Long-term debt ........................................................................... Payroll and benefit-related liabilities—Long-Term ..................... Value of net identifiable assets acquired .............................. Excess of total cost over fair value of net assets (goodwill) ............. Journal Entry: Notes Receivable ....................................................................... Accounts Receivable.................................................................. Inventory .................................................................................... Other Current Assets ................................................................. Investments ................................................................................ Land ........................................................................................... Building ...................................................................................... Equipment .................................................................................. Patents ....................................................................................... Trade Names ............................................................................. Goodwill ..................................................................................... Accounts Payable ................................................................ Payroll and Benefit-Related Liabilities—Current .................. Debt Maturing in One Year .................................................. Long-Term Debt ................................................................... Payroll and Benefit-Related Liabilities—Long-Term ............ Cash .....................................................................................

$580,000 $ 24,000 56,000 30,000 15,000 63,000 55,000 275,000 426,000 20,000 15,000 (45,000) (12,500) (10,000) (248,000) (156,000) 507,500 $ 72,500 24,000 56,000 30,000 15,000 63,000 55,000 275,000 426,000 20,000 15,000 72,500 45,000 12,500 10,000 248,000 156,000 580,000

Dr. = Cr. Check Totals

1,051,500

Acquisition Expense ......................................................................... Cash ...........................................................................................

20,000

1,051,500

20,000

1–19

Ch. 1—Problems

PROBLEM 1-7

(1) Total consideration for Sambo: Cash ..................................................................................... Stock issued (15,000 shares × $20)..................................... Contingent liability ($50,000 × 60%) .................................... Total consideration ......................................................... Less fair value of net assets acquired: Notes receivable .................................................................. Inventory .............................................................................. Prepaid expenses ................................................................ Investments .......................................................................... Land ..................................................................................... Buildings ............................................................................... Equipment ............................................................................ Vehicles ................................................................................ Franchise ............................................................................. Accounts payable ................................................................. Taxes payable ...................................................................... Interest payable .................................................................... Bonds payable ..................................................................... Value of net identifiable assets acquired ........................ Excess of total cost over fair value of net assets (goodwill) ..... Journal Entry: Notes Receivable ................................................................. Inventory .............................................................................. Prepaid Expenses ................................................................ Investments .......................................................................... Discount on Bonds Payable ................................................. Land ..................................................................................... Buildings ............................................................................... Equipment ............................................................................ Vehicles ................................................................................ Franchise ............................................................................. Goodwill ............................................................................... Accounts Payable........................................................... Taxes Payable................................................................ Interest Payable ............................................................. Bonds Payable ............................................................... Cash ............................................................................... Common Stock (15,000 shares × $2) ............................ Paid-In Capital in Excess of Par ..................................... Estimated Contingent Liability ........................................ Dr. = Cr. Check Totals

$225,000 300,000 30,000 $555,000 $ 33,000 80,000 15,000 55,000 90,000 170,000 250,000 25,000 70,000 (63,000) (15,000) (3,000) (220,000) 487,000 $ 68,000 33,000 80,000 15,000 55,000 30,000 90,000 170,000 250,000 25,000 70,000 68,000 63,000 15,000 3,000 250,000 225,000 30,000 270,000 30,000 886,000

886,000

Ch. 1—Problems

1–20

Problem 1-7, Concluded

(2) Revised estimate of contingent payment ($50,000 × 90%) ...... Original estimate ($50,000 × 60%) ........................................... Net increase..............................................................................

$45,000 30,000 $15,000

Journal Entry: Loss on Estimated Contingent Liability ................................ Estimated Contingent Liability ........................................

15,000 15,000

PROBLEM 1-8

Total consideration for Heinrich: Cash ........................................................................................... Less fair value of net assets acquired: Accounts receivable ................................................................... Inventory .................................................................................... Other current assets................................................................... Equipment .................................................................................. Vehicles...................................................................................... Mailing list .................................................................................. Accounts payable ....................................................................... Accrued liabilities ....................................................................... Notes payable ............................................................................ Value of net identifiable assets acquired .............................. Excess of fair value of net assets over price paid (gain) .................. Journal Entry: Accounts Receivable.................................................................. Inventory .................................................................................... Other Current Assets ................................................................. Equipment .................................................................................. Vehicles...................................................................................... Mailing List ................................................................................. Accounts Payable ................................................................ Accrued Liabilities ................................................................ Notes Payable ...................................................................... Gain on Acquisition of Business ........................................... Cash ..................................................................................... Dr. = Cr. Check Totals

$150,000 $ 90,000 30,000 8,000 80,000 50,000 10,000 (56,000) (14,000) (30,000) 168,000 $ (18,000) 90,000 30,000 8,000 80,000 50,000 10,000 56,000 14,000 30,000 18,000 150,000 268,000

268,000

1–21

Ch. 1—Problems

PROBLEM 1-9

(1)

Reported Income for 2015 Combined Income Statement For the Period Ending December 31, 2015 Sales revenue ........................................................................... Cost of goods sold .................................................................... Gross profit ............................................................................... Selling expense ........................................................................ Administrative expenses ........................................................... Depreciation expense ............................................................... Amortization expense ............................................................... Income from operations ............................................................ Other income and expenses ..................................................... Income before taxes ................................................................. Provision for income taxes........................................................ Net income................................................................................

$620,000 223,000 $397,000 $140,000 172,500 20,550 10,600

343,650 $ 53,350 9,000 $ 62,350 18,705 $ 43,645

Ch. 1—Problems

1–22

Problem 1-9, Continued

Name of Acquiring Company: Faber Enterprises Name of Acquired Company: Ann’s Tool Company Income Statement For the Year Ending December 31, 2015 (Tax rate expressed as 0.3 for 30%)

Income Statement Accounts Sales Revenue ........................................ Cost of Goods Sold ................................. Gross Profit.............................................. Selling Expenses ..................................... Administrative Expenses ......................... Depreciation Expense—Faber ................. Depreciation Expense—Ann’s Tool ......... Amortization Expense—Faber ................. Amortization Expense—Ann’s Tool ......... Total Operating Expenses ....................... Operating Income .................................... Nonoperating Revenues and Expenses: Interest Expense ...................................... Interest Income ........................................ Dividend Income ...................................... Total Nonoperating Revenues and Expenses ............................... Income Before Taxes .............................. Provision for Income Taxes (30%) ........... Net Income.......................................... (1)

Reduce (sold) inventory to fair value.

(2)

New depreciation: Building, 1/2($125,000/25 years) Equipment, ½($56,000/8 years) Trucks, ½($3,000/2 years) Total new depreciation Recorded depreciation Adjustment

2,500 3,500 750 6,750 3,750 3,000

Faber 6 Mo. Ann’s Enterprises Tool Co. (550,000) (70,000) 25,000 200,000 (45,000) (350,000) 125,000 15,000 150,000 22,500 13,800 .............. .............. 3,750 5,600 .............. 1,000 .............. 42,250 294,400 (55,600) (2,750)

(2) (3)

Adjustments Debit Credit .............. ............... .............. (1) 2,000 .............. ............... .............. ............... .............. ............... .............. ............... 3,000 ............... .............. ............... 4,000 ............... .............. ............... .............. ...............

Combined Income Statement .............. (620,000) .............. 223,000 .............. (397,000) 140,000 .............. 172,500 .............. 13,800 .............. 6,750 .............. 5,600 .............. 5,000 .............. .............. 343,650 .............. (53,350)

.............. (7,000) (4,000)

2,000 .............. ..............

.............. .............. ..............

............... ............... ...............

2,000 (7,000) (4,000)

.............. .............. ..............

.............. (66,600) 19,980 (46,620)

.............. (750) 225 (525)

.............. 7,000 .............. ..............

............... 2,000 ............... ...............

.............. .............. .............. ..............

(9,000) (62,350) 18,705 (43,645)

(3) New amortization: Patent, (1/2($18,000/6 years) Computer software, ½($10,000/2years) Copyright, ½($20,000/10 years) Total new amortization ......... Recorded amortization ......... Adjustment ...........................

1,500 2,500 1,000 5,000 1,000 4,000

part.

1–23

Ch. 1—Problems

Problem 1-9, Concluded

(2) Pro forma disclosure for 2015 as if acquisition occurred at the start of the year: Sales revenue ($550,000 + $140,000) .......................................................

$ 690,000

Net income..................................................................................................

$ 39,270

Calculation of net income: Reported net incomes before tax ($66,600 + $1,500) .......................... Inventory adjustment ............................................................................ Old Ann depreciation and amortization ($7,500 + $2,000) ................... New Ann amortization and depreciation .............................................. Adjusted income before tax .................................................................. Tax provision (30%) .............................................................................. Net income............................................................................................

$ 68,100 2,000 9,500 (23,500)* $ 56,100 (16,830) $ 39,270

*($2,500 + $3,500 + $750 + $1,500 + $2,500 + $1,000) = $11,750 × 2 = $23,500

PROBLEM 1-10

Part A1 Total consideration for Iris: Common stock (10,000 shares × $27) ....................................... Less fair value of net assets acquired: Accounts receivable ................................................................... Inventory .................................................................................... Prepaid expenses ...................................................................... Investments ................................................................................ Land ........................................................................................... Building ...................................................................................... Equipment .................................................................................. Patent ......................................................................................... Copyright .................................................................................... Accounts payable ....................................................................... Interest payable.......................................................................... Notes payable ............................................................................ Value of net identifiable assets acquired .............................. Excess of total cost over fair value of net assets (goodwill) .............

$270,000 $ 15,000 40,000 12,000 33,000 40,000 85,000 50,000 12,000 26,000 (22,000) (2,000) (40,000) 249,000 $ 21,000

Ch. 1—Problems

1–24

Problem 1-10, Continued

Journal Entry: Accounts Receivable.................................................................. Inventory .................................................................................... Prepaid Expenses ...................................................................... Investments ................................................................................ Land ........................................................................................... Building ...................................................................................... Equipment .................................................................................. Patent ......................................................................................... Copyright .................................................................................... Goodwill ..................................................................................... Accounts Payable ................................................................ Interest Payable ................................................................... Notes Payable ...................................................................... Common Stock (10,000 shares × $5 par) ............................ Paid-In Capital in Excess of Par ($270,000 – $50,000) .......

15,000 40,000 12,000 33,000 40,000 85,000 50,000 12,000 26,000 21,000 22,000 2,000 40,000 50,000 220,000

Dr. = Cr. Check Totals

334,000

Acquisition Expense ......................................................................... Cash ...........................................................................................

10,000

334,000

10,000

Part A2 Summary disclosure: Sales revenue ..................................................................................

$475,000

Net income .......................................................................................

$28,920

1–25

Ch. 1—Problems

Problem 1-10, Concluded

Worksheet for Pro Forma Income Statement For the Year Ending December 31, 2016 (Tax rate expressed as 0.4 for 40%)

Garman International

Iris Company

Sales Revenue ................................................ Cost of Goods Sold ......................................... Gross Profit.............................................. Selling Expenses ............................................. Administrative Expenses ................................. Acquisition Expense ........................................ Depreciation Expense—Garman ..................... Depreciation Expense—Iris ............................. Amortization Expense—Garman ..................... Amortization Expense—Iris ............................. Total Operating Expenses ....................... Operating Income ............................................ Nonoperating Revenues and Expenses: Interest Expense ............................................. Investment Income .......................................... Total Nonoperating Revenues and Expenses ..................................... Income Before Taxes ...................................... Provision for Income Taxes (40%) .................. Net Income ..............................................

(350,000) 147,000 (203,000) 100,000 50,000 .............. 12,500 .............. 1,000 .............. 163,500 (39,500)

(125,000) 55,000 (70,000) 20,000 30,000 .............. .............. 8,600 .............. 3,900 62,500 (7,500)

.............. (12,000)

3,000 (4,500)

.............. (51,500) 20,600 (30,900)

.............. (9,000) 3,600 (5,400)

(1)

(2) Adjust amortization as follows: New amounts: Patent ............................ $1,200 Copyright ....................... 2,600 Total new ............................. $3,800 Recorded ............................. 3,900 Adjustment .................... $ (100)

Income Statement Accounts

Adjust depreciation as follows: New amounts: Building .................................. Equipment ............................. Total new...................................... Recorded...................................... Adjustment .............................

$4,000 5,000 $9,000 8,600 $ 400

Adjustments

(3)

(4) (1)

Debit

Credit

Pro Forma Combined Income Statement

.............. 2,000 .............. .............. .............. 10,000 .............. 400 .............. .............. .............. ..............

............... ............... ............... ............... ............... ............... ............... ............... ............... 100 ............... ...............

.............. .............. .............. 120,000 80,000 10,000 12,500 9,000 1,000 3,800 .............. ..............

(475,000) 204,000 (271,000) .............. .............. .............. .............. .............. .............. .............. 236,300 (34,700)

.............. ..............

............... ...............

3,000 (16,500)

.............. ..............

.............. 12,400 .............. ..............

............... 100 ............... ...............

.............. .............. .............. ..............

(13,500) (48,200) 19,280 (28,920)

(2)

(3) Increase cost of goods sold to reflect fair value of beginning inventory. (4) Expense acquisition costs.

part.

Ch. 1—Problems

1–26

PROBLEM 1-11

Current Assets ................................................................................. Assets Under Operating Leases (fair) .............................................. Net Investment in Direct Financing Leases* .................................... Leased Equipment Under Capital Lease (fair) ................................. Buildings (fair) .................................................................................. Land (fair)......................................................................................... Research & Development (fair) ........................................................ Goodwill‡ .......................................................................................... Current Liabilities ....................................................................... Obligation Under Capital Lease of Equipment** ........................ Estimated Liabilities Under Lawsuit (estimate) .......................... Cash ........................................................................................... *Recorded net investment in direct financing leases ................. Less adjustment for $50,000 per year lease: Present value of payments of $50,000 per year for 5 years at 8%: $50,000 × 3.9927 ................................... Present value of payments of $50,000 per year for 5 years at 12%: $50,000 × 3.6048 .................................

100,000 580,000 710,605 60,000 400,000 100,000 200,000 382,678 150,000 33,283 50,000 2,300,000 $730,000 $ 199,635 (180,240)***

19,395 $710,605

**Present value of 5 payments of $9,233 at 12%: $9,233 × 3.6048 = $33,283 ***PV amounts are based on tables at the end of text. The use of a financial calculator or Excel will result in a minor (under $2) difference. ‡

Cash ........................................................................................ Value assigned to identifiable net assets ................................ Goodwill ..................................................................................

$2,300,000 1,917,322 $ 382,678

1–27

Ch. 1—Problems

PROBLEM 1-12

Current Assets ................................................................................. Equipment ($150,000 increase) ....................................................... Land and Buildings .......................................................................... Deferred Tax Asset .......................................................................... Goodwill* .......................................................................................... Bonds Payable ........................................................................... Deferred Tax Liability ................................................................ Common Stock ($10 par) ........................................................... Paid-In Capital in Excess of Par ($650,000 – $100,000 par) ..... Dr. = Cr. Check Totals

*Price paid (10,000 shares × $65 fair value) .............................. Fair value of net assets: Current assets ...................................................................... Equipment ............................................................................ Deferred tax liability [30% × ($350,000 – $200,000)] from deferred increase in equipment value .................... Land and buildings ............................................................... Bonds payable ..................................................................... Deferred tax asset (30% × $180,000) from carryover losses Excess attributable to goodwill (net of deferred tax liability) .....

150,000 350,000 250,000 54,000 91,000 200,000 45,000 100,000 550,000 895,000

895,000

$650,000 $ 150,000 350,000 (45,000) 250,000 (200,000) 54,000

Acquisition Expense ......................................................................... Cash ...........................................................................................

10,000

Paid-In Capital in Excess of Par ...................................................... Cash ...........................................................................................

3,000

559,000 $ 91,000 10,000 3,000

Ch. 1—Problems

1–28

PROBLEM 1-13

(1) Total consideration for Weber: Common stock (20,000 shares × $60 + $20,000 contingency) Less fair value of net assets acquired: Cash ..................................................................................... Accounts receivable ............................................................. Investment in marketable securities ..................................... Land ..................................................................................... Buildings ............................................................................... Equipment ............................................................................ Accounts payable ................................................................. Income tax payable .............................................................. Value of net identifiable assets acquired ........................ Excess of fair value of net assets over cost (gain) ................... Journal Entry: Cash ..................................................................................... Accounts Receivable ............................................................ Investment in Marketable Securities .................................... Land ..................................................................................... Buildings ............................................................................... Equipment ............................................................................ Accounts Payable........................................................... Income Tax Payable....................................................... Gain on Acquisition ........................................................ Common Stock ($2 × 20,000 shares) ............................ Paid in capital, contingent consideration ........................ Paid-In Capital in Excess of Par ($1,200,000 – $40,000) Dr. = Cr. Check Totals

$1,220,000 $ 30,000 60,000 150,000 450,000 450,000 600,000 (120,000) (190,000) 1,430,000 $ (210,000) 30,000 60,000 150,000 450,000 450,000 600,000 120,000 190,000 210,000 40,000 20,000 1,160,000 1,740,000

1,740,000

(2) Entry to record contingent consideration: Paid-in capital, contingent consideration ..................................

20,000

Common Stock (870 shares × $2) ....................................... Paid-In Capital in Excess of Par ($50,000 - $1,740) ............ Amount of consideration = deficiency in price /share price: $2.50 × 20,000 shares = ...................................................... Divide by share price ............................................................... Shares issued ...........................................................................

1,740 18,260 $50,000 $57.50 870

1–29

Ch. 1—Problems

APPENDIX PROBLEM PROBLEM 1A-1

(1) Bonds: Present value of interest payments for 5 years at 8%, $27,000 × 3.9927 .................................................................................. Present value of principal due in 5 years at 8%, $300,000 × 0.6806 ................................................................................ Present value of bonds ...............................................................................

$107,803 204,180* $311,983

Goodwill: Expected return ($120,000 + $140,000 + $150,000 + $160,000 + $180,000) ÷ 5 .......... Normal return on assets ($150,000 + $200,000 + $100,000 + $600,000) × 10% ........................ Profit in excess of normal return ................................................................. Present value of excess of normal return for 5 years at 16%, $45,000 × 3.2743 ..................................................................................

$150,000 105,000 $ 45,000 $147,344

*PV amounts are based on tables at the end of text. The use of a financial calculator or Excel will result in a minor (under $2) difference. (2) Cash and Receivables .............................................................. Inventory ................................................................................... Land .......................................................................................... Building ..................................................................................... Goodwill .................................................................................... Current Liabilities ................................................................. 9% Bonds Payable ............................................................... Premium on Bonds Payable ................................................. Cash .....................................................................................

150,000 200,000 100,000 600,000 147,344 120,000 300,000 11,983 765,361

Ch. 1—Cases

1–30

CASES CASE 1-1

Part A Confirmation: Building: Payment ........................................................................................... n ....................................................................................................... Rate ..................................................................................................

$80,000 20 0.14

Present value ................................................................................... Land (20 acres × $10,000) ............................................................... Balance, building ..............................................................................

$529,850 (200,000) $329,850

Patent: Payment ........................................................................................... n ....................................................................................................... Rate .................................................................................................. Present value ...................................................................................

$40,000 4 0.2 $103,549

Mortgage payable: Payment ........................................................................................... n ....................................................................................................... Rate .................................................................................................. Present value ...................................................................................

$50,000 5 0.07 $205,010

1–31

Ch. 1—Problems

Case 1-1, Continued

Part B (1) Discounted cash flows: Period 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20

Operating Capital 150,000 165,000 181,500 199,650 219,615 219,615 219,615 219,615 219,615 219,615 219,615 219,615 219,615 219,615 219,615 219,615 219,615 219,615 219,615 219,615

Salvage/ (Capital Expenditures)

(100,000)

(120,000)

(130,000)

300,000

Rate .......................................................................................... NPV ..........................................................................................

Total 150,000 165,000 181,500 199,650 119,615 219,615 219,615 219,615 219,615 99,615 219,615 219,615 219,615 219,615 89,615 219,615 219,615 219,615 219,615 519,615 0.12 1,406,855

(2) Fair value comparison: NPV of cash flows..................................................................... Total paid price for net assets................................................... Excess of fair value...................................................................

$1,406,855 1,300,000 $ 106,855

(3) Entry to record acquisition: Cash Equivalents ...................................................................... Inventory ................................................................................... Accounts Receivable ................................................................ Land .......................................................................................... Building ..................................................................................... Equipment................................................................................. Patent ....................................................................................... Goodwill .................................................................................... Current Liabilities ................................................................. Mortgage Payable ................................................................ Cash .....................................................................................

80,000 150,000 180,000 200,000 329,850 220,000 103,550 361,610

Dr. = Cr. Check Totals ...................................................................................................

1,625,010

120,000 205,010 1,300,000 1,625,010

Ch. 1—Cases

1–32

Case 1-1, Concluded

Part C Impairment test: Implied fair value of Frontier ................................................................... Book value, including goodwill ...............................................................

$1,200,000 1,300,000

Book value exceeds implied fair value; goodwill is impaired. Impairment adjustment: Implied fair value of Frontier ................................................................... Fair value of net identifiable assets (without goodwill) ........................... Implied remaining goodwill ..................................................................... Recorded goodwill .................................................................................. Required adjustment .............................................................................. Goodwill Impairment Loss .......................................................... Goodwill ...............................................................................

$1,200,000 1,020,000 $ 180,000 (361,610) $ (181,610)

181,610 181,610

1–33

Ch. 1—Problems

CASE 1-2

1. The acquisition would be qualified as horizontal. 2. The total price paid and its assignment are as follows: Cash (79.2 million shares × $30) .................................. $2,376,000,000 Stock issued (59 million shares × $32.25) .................... 1,902,750,000 Total consideration ....................................................... $4,278,750,000 Less fair value of net assets acquired: Cash and cash equivalents ..................................... $ 105,000,000 Receivables ............................................................ 141,000,000 Capitalized film costs .............................................. 269,000,000 Intangible assets ..................................................... 3,140,000,000 Accounts payable ................................................... (325,000,000) Other liabilities ........................................................ (83,000,000) Deferred income tax liability .................................... (1,121,000,000) Value of net identifiable assets acquired ............ 2,126,000,000 Excess of total cost over fair value of net assets (goodwill) $2,152,750,000 3. Journal Entry: Cash and Cash Equivalents .................................................. 105,000,000 Receivables ........................................................................... 141,000,000 Capitalized Film Costs ........................................................... 269,000,000 Intangible Assets ................................................................... 3,140,000,000 Goodwill ................................................................................. 2,152,750,000 Accounts Payable ............................................................ 325,000,000 Other Liabilities ................................................................ 83,000,000 Deferred Income Tax Liability .......................................... 1,121,000,000 Common Stock, par value (59,000,000 × $0.01) ............. 590,000 Paid-In Capital in Excess of Par ($1,902,750,000 – $590,000 par) ................................ 1,902,160,000 Cash ................................................................................ 2,376,000,000 Dr. = Cr. Check Totals

5,807,750,000

CHAPTER 2 UNDERSTANDING THE ISSUES (d) Jacobson has a controlling level of ownership and in future periods will add 100% of Biltrite’s net income to its own net income. All (100%) of Biltrite’s nominal account balances will be added to Jacobson’s nominal account balances. This will result in consolidated net income, followed by a distribution to the non-controlling interest equal to 20% of Biltrite’s income. Any dividends declared by Biltrite will not affect Jacobson’s income.

1. (a) Jacobson has a passive level of ownership and in future periods will record dividend income of only 15% of Biltrite’s declared dividends. Jacobson will also have to adjust the investment to market value at the end of each period. (b) Jacobson has an influential level of ownership and in future periods will record investment income of 40% of Biltrite’s net income. Any dividends declared by Biltrite will reduce the investment account but will not affect the investment income amount. (c) Jacobson has a controlling level of ownership and in future periods will add 100% of Biltrite’s net income to its own net income. Biltrite’s nominal account balances will be added to Jacobson’s nominal accounts. Any dividends declared by Biltrite will not affect Jacobson’s income.

2. The elimination process serves to make the consolidated financial statements appear as though the parent had purchased the net assets of the subsidiary. The investment account and the subsidiary equity accounts are eliminated and replaced by the subsidiary’s net assets.

3. (a) Value Analysis Schedule Company fair value...................................... Fair value of net assets excluding goodwill . Goodwill .......................................................

Company Implied Fair Value $1,200,000 800,000 $ 400,000

Parent Price (100%) $1,200,000 800,000 $ 400,000

NCI Value (0%) N/A

Net Assets—marked up 300,000 ($800,000 fair value – $500,000 book value) Goodwill—$400,000 ($1,200,000 – $800,000) (b) Value Analysis Schedule Company fair value...................................... Fair value of net assets excluding goodwill . Goodwill .......................................................

Company Implied Fair Value $1,200,000 800,000 $ 400,000

Parent Price (80%) $960,000 640,000 $320,000

NCI Value (20%) $240,000 160,000 $ 80,000

Net Assets—marked up $300,000 ($800,000 fair value – $500,000 book value) Goodwill—$400,000 ($1,200,000 – $800,000) The NCI would be valued at $240,000 (20% of the implied company value) to allow the full recognition of fair values.

2–2 4. (a) Value Analysis Schedule Company fair value...................................... Fair value of net assets excluding goodwill . Goodwill .......................................................

Company Implied Fair Value $1,000,000 850,000 $ 150,000

Parent Price (100%) $1,000,000 850,000 $ 150,000

NCI Value (0%) N/A

The determination and distribution of excess schedule would make the following adjustments: $1,000,000 price – $350,000 net book value = $650,000 excess to be allocated as follows: Current assets ............................................. $ 50,000 Fixed assets ................................................ 450,000 Goodwill ....................................................... 150,000 $650,000 (b) Value Analysis Schedule Company fair value...................................... Fair value of net assets excluding goodwill . Gain on acquisition ......................................

Company Implied Fair Value $ 500,000 850,000 $ (350,000)

Parent Price (100%) $ 500,000 850,000 $ (350,000)

NCI Value (0%) N/A

The determination and distribution of excess schedule would make the following adjustments: $500,000 price – $350,000 net book value = $150,000 excess to be allocated as follows: Current assets .................................................... $ 50,000 Fixed assets ....................................................... 450,000 Gain on acquisition ............................................ (350,000) $ 150,000 5. (a) Value Analysis Schedule Company fair value...................................... Fair value of net assets excluding goodwill . Goodwill ....................................................... *$800,000/80% = $1,000,000.

Company Implied Fair Value $1,000,000* 850,000 $ 150,000

Parent Price (80%) $800,000 680,000 $120,000

NCI Value (20%) $200,000 170,000 $ 30,000

The determination and distribution of excess schedule would make the following adjustments: $800,000 parent’s price – (80% × $350,000 net book value) ............. NCI adjustment, $200,000 – (20% × $350,000 net book value) ......... Total adjustment to be allocated ......................................................... Current assets .................................................................................... Fixed assets ....................................................................................... Goodwill ...............................................................................................

$520,000 130,000 $650,000 as follows: $ 50,000 450,000 150,000 $650,000

2–3 (b)

Company Parent NCI Implied Price Value Value Analysis Schedule Fair Value (80%) (20%) Company fair value...................................... $770,000** $600,000 $170,000* 680,000 170,000 Fair value of net assets excluding goodwill . 850,000 Gain on acquisition ...................................... $ (80,000) $ (80,000) N/A *Cannot be less than the NCI share of the fair value of net assets excluding goodwill. **$600,000 parent price + $170,000 minimum allowable for NCI = $770,000. $600,000 parent’s price – (80% × $350,000 book value) ............... NCI adjustment, $170,000 – (20% × $350,000 net book value) ..... Total adjustment to be allocated ..................................................... Current assets ................................................................................. Fixed assets .................................................................................... Gain on acquisition ..........................................................................

6. Value Analysis Schedule Company fair value...................................... Fair value of net assets excluding goodwill . Goodwill ....................................................... *$800,000/80% = $1,000,000

Company Implied Fair Value $1,000,000* 850,000 $ 150,000

$320,000 100,000 $420,000 as follows: $ 50,000 450,000 (80,000) $420,000 Parent Price (80%) $800,000 680,000 $120,000

NCI Value (20%) $200,000 170,000 $ 30,000

The NCI will be valued at $200,000, which is 20% of the implied company value. The NCI account will be displayed on the consolidated balance sheet as a subdivision of equity. It is shown as a total, not broken down into par, paid-in capital in excess of par, and retained earnings.

Ch. 2—Exercises

2–4

EXERCISES EXERCISE 2-1 Santos Corporation Pro Forma Income Statement Ownership Levels Sales ........................................................................ Cost of goods sold ................................................... Gross profit .............................................................. Selling and administrative expenses ........................ Operating income..................................................... Dividend income (10% × $15,000 dividends)........... Investment income (30% × $70,000 reported income) .............................................................. Net income ............................................................... Noncontrolling interest (20% × $70,000 reported income) .............................................................. Controlling interest ...................................................

10%

30%

80%

$700,000 300,000 $400,000 120,000 $280,000 1,500

$700,000 300,000 $400,000 120,000 $280,000

$1,150,000 600,000 $ 550,000 200,000 $ 350,000

21,000 $301,000

$ 350,000

$281,500

14,000 $ 336,000

EXERCISE 2-2 Company Implied Fair Value

Parent Price (100%)

NCI Value (0%)

$530,000

N/A

300,000 $230,000

(a) Cash .................................................................................. Accounts Receivable......................................................... Inventory ........................................................................... Property, Plant, and Equipment ($270,000 + $20,000) ..... Goodwill ............................................................................ Current Liabilities ......................................................... Bonds Payable ............................................................ Cash ............................................................................

20,000* 70,000 100,000 290,000 230,000

Value Analysis Schedule Company fair value .................................................. Fair value of net assets excluding goodwill ($280,000 book value + $20,000) ..................... Goodwill ................................................................... 1.

80,000 100,000 530,000*

*Cash may be shown as a net credit of $510,000.

2–5

Ch. 2—Exercises

Exercise 2-2, Concluded (b)

Glass Company Balance Sheet Assets Current assets: Cash ................................................................ Accounts receivable ........................................ Inventory.......................................................... Property, plant, and equipment (net) ..................... Goodwill ................................................................ Total assets ...........................................................

$ 30,000 120,000 150,000

$ 300,000 520,000 230,000 $1,050,000

Liabilities and Stockholders’ Equity Liabilities: Current liabilities .............................................. Bonds payable................................................. Stockholders’ equity: Common stock ($100 par) ............................... Retained earnings ........................................... Total liabilities and stockholders’ equity ................ 2.

(a) Investment in Plastic ............................................. Cash ................................................................

$220,000 350,000 $200,000 280,000

$ 570,000 480,000 $1,050,000

530,000 530,000

(b) Investment in Plastic appears as a long-term investment on Glass’s unconsolidated balance sheet. (c) The balance sheet would be identical to that which resulted from the asset acquisition of part (1).

EXERCISE 2-3

Value Analysis Schedule Company fair value .................................................. Fair value of net assets excluding goodwill .............. Goodwill Gain on acquisition

Company Implied Fair Value

Parent Price (100%)

NCI Value (0%)

To be determined $580,000

N/A

$580,000*

*$420,000 net asset book value + $40,000 inventory increase + $20,000 land increase + $100,000 building increase = $580,000 fair value. (1) Goodwill will be recorded if the price is above $580,000. (2) A gain will be recorded if the price is below $580,000.

Ch. 2—Exercises

2–6

EXERCISE 2-4 (1) Investment in Paint, Inc. .......................................................... Cash .....................................................................................

980,000

Acquisition Costs Expense ....................................................... Cash .....................................................................................

10,000

Company Implied Fair Value

Parent Price (100%)

NCI Value (0%)

$980,000 900,000* $80,000

$980,000 900,000 $80,000

N/A

(2) Value Analysis Schedule Company fair value ........................................... Fair value of net assets excluding goodwill ...... Goodwill ............................................................

980,000 10,000

*$700,000 net book value + $50,000 inventory increase + $150,000 depreciable fixed assets increase = $900,000 fair value. Determination and Distribution of Excess Schedule Company Implied Fair Value

Parent Price (100%)

NCI Value (0%)

Fair value of subsidiary .............. $980,000 Less book value of interest acquired: Common stock ($10 par) ........ $300,000 Paid-in capital in excess of par 380,000 Retained earnings .................. 20,000 Total stockholders’ equity ... $700,000 Interest acquired..................... Book value ................................. Excess of fair value over book value ....................................... $280,000

$980,000

N/A

$700,000 100% $700,000 $280,000

Adjustment of identifiable accounts:

Inventory ($250,000 fair – $200,000 book value) ............. Depreciable fixed assets ($750,000 fair – $600,000 book value) ............................. Goodwill ..................................... Total ...................................

Adjustment

Worksheet Key

$ 50,000

debit D1

150,000 80,000 $280,000

debit D2 debit D3

2–7

Ch. 2—Exercises

Exercise 2-4, Concluded (3) Elimination entries: Common Stock ($10 par)—Paint .............................................. Paid-In Capital in Excess of Par—Paint ................................... Retained Earnings—Paint ........................................................ Investment in Paint, Inc. .......................................................

300,000 380,000 20,000

Inventory ................................................................................... Depreciable Fixed Assets ......................................................... Goodwill .................................................................................... Investment in Paint, Inc. .......................................................

50,000 150,000 80,000

700,000

280,000

EXERCISE 2-5 (1) Value Analysis Schedule Company fair value ........................................... Fair value of net assets excluding goodwill ...... Goodwill Gain on acquisition ...........................................

Company Implied Fair Value

Parent Price (100%)

NCI Value (0%)

$ 700,000 885,000

N/A

$(185,000)

Determination and Distribution of Excess Schedule Company Implied Fair Value

Parent Price (100%)

NCI Value (0%)

Price paid for investment ........... $700,000 Less book value of interest acquired: Common stock ($5 par) .......... $200,000 Paid-in capital in excess of par 300,000 Retained earnings .................. 175,000 Total equity ......................... $675,000 Interest acquired..................... Book value ................................. Excess of fair value over book value ....................................... $ 25,000

$700,000

N/A

$675,000 100% $675,000 $ 25,000

Ch. 2—Exercises

2–8

Exercise 2-5, Concluded Adjustment of identifiable accounts:

Inventory ($215,000 fair – $200,000 book value) ............. Property, plant, and equipment ($700,000 fair – $500,000 book value) ............................. Computer software ($130,000 fair – $125,000 book value) .... Premium on bonds payable ($200,000 fair – $210,000 book value) ............................. Gain on acquisition .................... Total ...................................

Adjustment

Worksheet Key

$ 15,000

debit D1

200,000

debit D2

5,000

debit D3

(10,000) (185,000) $ 25,000

credit D4 credit D5

(2) Elimination entries: Common Stock ($5 par)—Genall.............................................. Paid-In Capital in Excess of Par—Genall ................................. Retained Earnings—Genall ...................................................... Investment in Genall Company ............................................

200,000 300,000 175,000

Inventory ................................................................................... Property, Plant, and Equipment ................................................ Computer Software ................................................................... Gain on Acquisition .............................................................. Premium on Bonds Payable ................................................. Investment in Genall Company ............................................

15,000 200,000 5,000

675,000

185,000 10,000 25,000

EXERCISE 2-6 (1) (a) Value of NCI implied by price paid by parent

Value Analysis Schedule Company fair value ........................................... Fair value of net assets excluding goodwill ...... Goodwill ............................................................ *$800,000/80% = $1,000,000. **$1,000,000 × 20% = $200,000.

Company Implied Fair Value

Parent Price (80%)

NCI Value (20%)

$1,000,000* 820,000 $ 180,000

$800,000 656,000 $144,000

$200,000** 164,000 $ 36,000

2–9

Ch. 2—Exercises

Exercise 2-6, Continued Determination and Distribution of Excess Schedule

Fair value of subsidiary .............. Less book value of interest acquired: Common stock ($5 par) .......... Paid-in capital in excess of par Retained earnings .................. Total equity ......................... Interest acquired..................... Book value ................................. Excess of fair value over book value .......................................

Company Implied Fair Value

Parent Price (80%)

NCI Value (20%)

$1,000,000

$800,000

$200,000

$500,000 80% $400,000

$500,000 20% $100,000

$400,000

$100,000

$ 100,000 150,000 250,000 $ 500,000

$ 500,000

Adjustment of identifiable accounts: Inventory ($250,000 fair – $200,000 book value) ............. Land ($200,000 fair – $100,000 book value) ............. Building ($650,000 fair – $450,000 book value) ............. Equipment ($200,000 fair – $230,000 book value) ............. Goodwill ..................................... Total ...................................

Adjustment

Worksheet Key

$ 50,000

debit D1

100,000

debit D2

200,000

debit D3

(30,000) 180,000 $500,000

credit D4 debit D5

(b) NCI = 4,000 shares at $45

Company Implied Fair Value

Parent Price (80%)

NCI Value (20%)

$980,000 820,000 $160,000

$800,000 656,000 $144,000

$180,000* 164,000 $ 16,000

*4,000 shares × $45.

Ch. 2—Exercises

2–10

Exercise 2-6, Continued Determination and Distribution of Excess Schedule Company Implied Fair Value

Parent Price (80%)

NCI Value (20%)

Fair value of subsidiary .............. $980,000 Less book value of interest acquired: Common stock ($5 par) .......... $100,000 Paid-in capital in excess of par 150,000 Retained earnings .................. 250,000 Total equity ......................... $500,000 Interest acquired..................... Book value ................................. Excess of fair value over book value ....................................... $480,000

$800,000

$180,000

$500,000 80% $400,000

$500,000 20% $100,000

$400,000

$ 80,000

Adjustment

Worksheet Key

$ 50,000

debit D1

100,000

debit D2

200,000

debit D3

(30,000) 160,000 $480,000

credit D4 debit D5

Value Analysis Schedule

Company Implied Fair Value

Parent Price (80%)

NCI Value (20%)

$964,000 820,000 $144,000

$800,000 656,000 $144,000

$164,000* 164,000 $ 0

Company fair value ........................................... Fair value of net assets excluding goodwill ...... Goodwill ............................................................ *Equal to 20% of fair value of net identifiable assets.

2–11

Ch. 2—Exercises

Exercise 2-6, Continued Determination and Distribution of Excess Schedule Company Implied Fair Value

Parent Price (80%)

NCI Value (20%)

Fair value of subsidiary .............. $964,000 Less book value of interest acquired: Common stock ($5 par) .......... $100,000 Paid-in capital in excess of par 150,000 Retained earnings .................. 250,000 Total equity ......................... $500,000 Interest acquired..................... Book value ................................. Excess of fair value over book value ....................................... $464,000

$800,000

$164,000

$500,000 80% $400,000

$500,000 20% $100,000

$400,000

$ 64,000

Adjustment

Worksheet Key

$ 50,000

debit D1

100,000

debit D2

200,000

debit D3

(30,000) 144,000 $464,000

credit D4 debit D5

(2) Elimination entries: (a) Value of NCI implied by price paid by parent Common Stock ($5 par)—Commo (80%) ................................. Paid-In Capital in Excess of Par—Commo (80%) .................... Retained Earnings—Commo (80%) ......................................... Investment in Commo Company ..........................................

80,000 120,000 200,000

Inventory ................................................................................... Land .......................................................................................... Building ..................................................................................... Goodwill .................................................................................... Equipment ............................................................................ Investment in Commo Company (excess remaining)........... Noncontrolling Interest (to adjust to fair value) .....................

50,000 100,000 200,000 180,000

400,000

30,000 400,000 100,000

Ch. 2—Exercises

2–12

Exercise 2-6, Concluded (b) NCI = 4,000 shares at $45 Common Stock ($5 par)—Commo (80%) ................................. Paid-In Capital in Excess of Par—Commo (80%) .................... Retained Earnings—Commo (80%) ......................................... Investment in Commo Company ..........................................

80,000 120,000 200,000

50,000 100,000 200,000 160,000

400,000

30,000 400,000 80,000

(c) NCI = 20% of fair value of net tangible assets Common Stock ($5 par)—Commo (80%) ................................. Paid-In Capital in Excess of Par—Commo (80%) .................... Retained Earnings—Commo (80%) ......................................... Investment in Commo Company ..........................................

80,000 120,000 200,000

50,000 100,000 200,000 144,000

400,000

30,000 400,000 64,000

EXERCISE 2-7 (1) Value Analysis Schedule Company fair value ........................................... Fair value of net assets excluding goodwill ...... Gain on acquisition ...........................................

Company Implied Fair Value

Parent Price (80%)

NCI Value (20%)

$646,000 670,000 $ (24,000)

$512,000** 536,000 $ (24,000)

$134,000* 134,000 N/A

*Must at least equal fair value of assets. **8,000 shares × $64.

2–13

Ch. 2—Exercises

Exercise 2-7, Concluded Determination and Distribution of Excess Schedule Company Implied Fair Value

Parent Price (80%)

NCI Value (20%)

Price paid for investment ........... $646,000 Less book value of interest acquired: Common stock ($5 par) .......... $ 50,000 Paid-in capital in excess of par 130,000 Retained earnings .................. 370,000 Total equity ......................... $550,000 Interest acquired..................... Book value ................................. Excess of fair value over book value ....................................... $ 96,000

$512,000

$134,000

$550,000 80% $440,000

$550,000 20% $110,000

$ 72,000

$ 24,000

Adjustment of identifiable accounts: Inventory ($400,000 fair – $280,000 book value) ............. Property, plant, and equipment ($500,000 fair – $400,000 book value) ............................. Goodwill ($0 fair – $100,000 book value) ............................. Gain on acquisition .................... Total ...................................

Adjustment

Worksheet Key

$ 120,000

debit D1

100,000

debit D2

(100,000) (24,000) $ 96,000

credit D3 credit D4

(2) Elimination entries: Common Stock ($5 par) (80%) ................................................. Paid-In Capital in Excess of Par (80%)..................................... Retained Earnings (80%).......................................................... Investment in Sundown Company .......................................

40,000 104,000 296,000

Inventory ................................................................................... Property, Plant, and Equipment ................................................ Goodwill ............................................................................... Gain on Acquisition (Venus retained earnings) .................... Investment in Sundown Company (excess remaining) ........ Noncontrolling Interest (to adjust to fair value) .....................

120,000 100,000

440,000

100,000 24,000 72,000 24,000

Ch. 2—Exercises

2–14

EXERCISE 2-8 (1) Value Analysis Schedule Company fair value ........................................... Fair value of net assets excluding goodwill ...... Goodwill ............................................................

Company Implied Fair Value

Parent Price (80%)

NCI Value (20%)

$500,000 390,000 $110,000

$400,000* 312,000 $ 88,000

$100,000 78,000 $22,000

*1,000 prior shares included at $50 ($350,000/7,000 shares) per share, the market value on January 1, 2020. $350,000 + $50,000 = $400,000. Determination and Distribution of Excess Schedule Company Implied Fair Value

Parent Price (80%)

NCI Value (20%)

Fair value of subsidiary .............. $500,000 Less book value of interest acquired: Common stock ($10 par) ........ $100,000 Retained earnings .................. 240,000 Total equity ......................... $340,000 Interest acquired..................... Book value ................................. Excess of fair value over book value ....................................... $160,000

$400,000

$100,000

$340,000 80% $272,000

$340,000 20% $ 68,000

$128,000

$ 32,000

Adjustment of identifiable accounts: Adjustment Equipment ($150,000 fair – $100,000 book value) ............. Goodwill ..................................... Total ...................................

$ 50,000 110,000 $160,000

Worksheet Key debit D1 debit D2

(2) Investment in Delta ................................................................... Cash ..................................................................................... Investment in Delta (1,000 × $50) ............................................ Available-for-Sale Investment .............................................. Unrealized Gain on Investment ............................................

350,000 350,000 50,000 42,000 8,000

Note: Applicable allowance for any market value adjustment would also be reversed.

2–15

Ch. 2—Exercises

EXERCISE 2-9 (1) Investment in Craig Company .................................................. Cash .....................................................................................

950,000

(2)

Company Implied Fair Value

Parent Price (100%)

NCI Value (0%)

$950,000 900,000 $ 50,000

$950,000

N/A

950,000

Determination and Distribution of Excess Schedule Company Implied Fair Value

Parent Price (100%)

NCI Value (0%)

Fair value of subsidiary .............. $950,000 Less book value of interest acquired: Common stock ($10 par) ........ $300,000 Retained earnings .................. 420,000 Total equity ......................... $720,000 Interest acquired..................... Book value ................................. Excess of fair value over book value ....................................... $230,000

$950,000

N/A

$720,000 100% $720,000 $230,000

Adjustment of identifiable accounts:

Land ($250,000 fair – $200,000 book value) ............................. Building ($700,000 fair – $600,000 book value) ............. Discount on bonds payable ($280,000 fair – $300,000 book value) ............................. Deferred tax liability ($40,000 fair – $50,000 book value) ...... Goodwill ..................................... Total .......................................

Adjustment

Worksheet Key

$ 50,000

debit D1

100,000

debit D2

20,000

debit D3

10,000 50,000 $230,000

debit D4 debit D5

Ch. 2—Exercises

2–16

Exercise 2-9, Concluded (3) Adjustments on Craig books: Land .......................................................................................... Building ..................................................................................... Discount on Bonds Payable...................................................... Goodwill .................................................................................... Deferred Tax Liability ................................................................ Paid-In Capital in Excess of Par ...........................................

50,000 100,000 20,000 50,000 10,000 230,000

(4) Elimination entries: Common Stock ......................................................................... Paid-In Capital in Excess of Par ............................................... Retained Earnings .................................................................... Investment in Craig Company ..............................................

300,000 230,000 420,000 950,000

2–17

Ch. 2—Exercises

APPENDIX EXERCISE EXERCISE 2A-1

Value Analysis Schedule Company fair value .................................................. Fair value of net assets excluding goodwill .............. Goodwill ...................................................................

Big Company Implied Fair Value

Parent Price (60%)b

$5,000a 3,000 $2,000

$5,000 3,000 $2,000

NCI Value (40%)c

Values are prior to acquisition (200 shares × $25 market value).

Determination and Distribution of Excess Schedule Big Company Implied Fair Value Fair value of subsidiary ..................... acquired: Common stock ($1 par)............... Paid-in capital in excess of par ... Retained earnings ....................... Total equity ............................ Interest acquired ......................... Book value ........................................ Excess of fair value over book value............................................

$5,000 $ 200 800 1,000 $2,000

Parent Price (100%)

NCI Value

$5,000 Less book value of interest

$2,000 100% $2,000

$3,000

Adjustment

Worksheet Key

Adjustment of identifiable accounts:

Fixed assets ($3,000 fair – $2,000 book value)...................... Goodwill ............................................ Total ......................................

$1,000 2,000 $3,000

debit D1 debit D2

Ch. 2—Problems

2–18

PROBLEMS PROBLEM 2-1 (1) Investment in Downes Company .............................................. Common Stock ($1 par) ....................................................... Paid-In Capital in Excess of Par ($810,000 – $18,000 par) . *18,000 shares × $45.

810,000*

Acquisition Expense (close to Retained Earnings) ................... Cash .....................................................................................

40,000

Company Implied Fair Value

Parent Price (100%)

NCI Value (0%)

$810,000 430,000 $380,000

N/A

18,000 792,000

40,000

Determination and Distribution of Excess Schedule Company Implied Fair Value

Parent Price (100%)

NCI Value (0%)

Fair value of subsidiary .............. $810,000 Less book value of interest acquired: Common stock ($1 par) .......... $ 20,000 Paid-in capital in excess of par 180,000 Retained earnings .................. 140,000 Total equity ......................... $340,000 Interest acquired..................... Book value ................................. Excess of fair value over book value ....................................... $470,000

$810,000

N/A

$340,000 100% $340,000 $470,000

Adjustment of identifiable accounts: Inventory ($80,000 fair – $60,000 book value) ............... Land ($90,000 fair – $40,000 book value) ............................. Building ($150,000 fair – $120,000 book value) ............. Equipment ($100,000 fair – $110,000 book value) ............. Goodwill ..................................... Total ...................................

Adjustment

Worksheet Key

$ 20,000

debit D1

50,000

debit D2

30,000

debit D3

(10,000) 380,000 $470,000

credit D4 debit D5

2–19

Ch. 2—Problems

Problem 2-1, Concluded (3)

Roland Company and Subsidiary Downes Company Consolidated Balance Sheet July 1, 2016 Assets Current assets: Other assets ......................................................................... Inventory (including $20,000 adjustment) ............................

$ 80,000* 200,000 $ 280,000

Long-lived assets: Land (including $50,000 increase) ....................................... Building (including $30,000 increase) .................................. Equipment (including $10,000 decrease) ............................. Goodwill ............................................................................... Total assets ..............................................................................

$190,000 450,000 530,000 380,000

1,550,000 $1,830,000

Liabilities and Stockholders’ Equity Current liabilities ....................................................................... Stockholders’ equity: Common stock, par .............................................................. Paid-in capital in excess of par ............................................ Retained earnings ................................................................ Total stockholders’ equity ......................................................... Total liabilities and stockholders’ equity....................................

$ 240,000 $ 58,000 1,152,000 380,000** 1,590,000 $1,830,000

*$50,000 + $70,000 less $40,000 acquisition costs. **$420,000 less $40,000 acquisition costs.

PROBLEM 2-2 (1) Investment in Downes Company .............................................. Common Stock ($1 par) ....................................................... Paid-In Capital in Excess of Par ($630,000 – $14,000 par) . *14,000 shares × $45.

630,000*

Acquisition Expense (close to Retained Earnings) ................... Cash .....................................................................................

40,000

14,000 616,000

40,000

Ch. 2—Problems

2–20

Problem 2-2, Continued (2) Value Analysis Schedule Company fair value ........................................... Fair value of net assets excluding goodwill ...... Goodwill ............................................................

Company Implied Fair Value

Parent Price (80%)

NCI Value (20%)

$787,500* 430,000 $357,500

$630,000 344,000 $286,000

$157,500 86,000 $ 71,500

*$630,000/80%. Determination and Distribution of Excess Schedule Company Implied Fair Value

Parent Price (80%)

NCI Value (20%)

Fair value of subsidiary .............. $787,500 Less book value of interest acquired: Common stock ($10 par) ........ $ 20,000 Paid-in capital in excess of par 180,000 Retained earnings .................. 140,000 Total equity ......................... $340,000 Interest acquired..................... Book value ................................. Excess of fair value over book value ....................................... $447,500

$630,000

$157,500

$340,000 80% $272,000

$340,000 20% $ 68,000

$358,000

$ 89,500

Adjustment of identifiable accounts:

Inventory ($80,000 fair – $60,000 book value) ............... Land ($90,000 fair – $40,000 book value) ............................. Building ($150,000 fair – $120,000 book value) ............. Equipment ($100,000 fair – $110,000 book value) ............. Goodwill ..................................... Total ...................................

Adjustment

Worksheet Key

$ 20,000

debit D1

50,000

debit D2

30,000

debit D3

(10,000) 357,500 $447,500

credit D4 debit D5

2–21

Ch. 2—Problems

Problem 2-2, Concluded (3)

$ 80,000* 200,000 $ 280,000

$190,000 450,000 530,000 357,500

1,527,500 $1,807,500

Liabilities and Stockholders’ Equity Current liabilities ....................................................................... Stockholders’ equity: Common stock (par) ............................................................. Paid-in capital in excess of par ............................................ Retained earnings ................................................................ Total controlling interest............................................................ Noncontrolling interest ............................................................. Total stockholders’ equity ......................................................... Total liabilities and stockholders’ equity....................................

$ 240,000 $ 54,000 976,000 380,000** $1,410,000 157,500 $1,567,500 $1,807,500

*$50,000 + $70,000 less $40,000 acquisition costs. **$420,000 less $40,000 acquisition costs.

PROBLEM 2-3 (1) Investment in Entro Corporation ............................................... Cash .....................................................................................

400,000

(2)

Company Implied Fair Value

Parent Price (100%)

NCI Value (0%)

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

N/A

Value Analysis Schedule Company fair value ........................................... Fair value of net assets excluding goodwill ...... Gain on acquisition (retained earnings) ............

400,000

Ch. 2—Problems

2–22

Problem 2-3, Concluded Determination and Distribution of Excess Schedule Company Implied Fair Value

Parent Price (100%)

NCI Value (0%)

Price paid for investment ........... $400,000 Less book value of interest acquired: Common stock ($5 par) .......... $ 50,000 Paid-in capital in excess of par 250,000 Retained earnings .................. 70,000 Total equity ......................... $370,000 Interest acquired..................... Book value ................................. Excess of fair value over book value ....................................... $ 30,000

$400,000

N/A

$370,000 100% $370,000 $ 30,000

Adjustment of identifiable accounts:

Inventory ($100,000 fair – $80,000 book value) ............... Land ($40,500 fair – $40,000 book value) ............................. Building ($202,500 fair – $180,000 net book value) ....... Equipment ($162,000 fair – $160,000 net book value) ....... Discount on bonds payable ($95,000 fair – $100,000 book value) ............................. Gain on acquisition .................... Total .......................................

Adjustment

Worksheet Key

$ 20,000

debit D1

500

debit D2

22,500

debit D3

2,000

debit D4

5,000 (20,000) $ 30,000

debit D5 credit D6

(3) Elimination entries: Common Stock—Entro ............................................................. Paid-In Capital in Excess of Par—Entro ................................... Retained Earnings—Entro ........................................................ Investment in Entro Corporation ..........................................

50,000 250,000 70,000

Inventory ................................................................................... Land .......................................................................................... Building ..................................................................................... Equipment................................................................................. Discount on Bonds Payable...................................................... Retained Earnings, Carlson (controlling gain) ...................... Investment in Entro Corporation ..........................................

20,000 500 22,500 2,000 5,000

370,000

20,000 30,000

2–23

Ch. 2—Problems

PROBLEM 2-4 (1) Investment in Express Corporation........................................... Cash .....................................................................................

320,000

(2)

Company Implied Fair Value

Parent Price (80%)

NCI Value (20%)

$405,400** 427,000 $ (21,600)

$320,000 341,600 $ (21,600)

$85,400* 85,400 $ 0

Value Analysis Schedule Company fair value ........................................... Fair value of net assets excluding goodwill ...... Gain on acquisition (retained earnings) ............

320,000

*NCI minimum allowed is equal to fair value of net assets. **Parent’s 80% + NCI’s minimum. Determination and Distribution of Excess Schedule Company Implied Fair Value

Parent Price (80%)

NCI Value (20%)

Price paid for investment ........... $405,400 Less book value of interest acquired: Common stock ($10 par) ........ $ 50,000 Paid-in capital in excess of par 250,000 Retained earnings .................. 70,000 Total equity ......................... $370,000 Interest acquired..................... Book value ................................. Excess of fair value over book value ....................................... $ 35,400

$320,000

$ 85,400

$370,000 80% $296,000

$370,000 20% $ 74,000

$ 24,000

$ 11,400

Adjustment of identifiable accounts:

Inventory ($100,000 fair – $80,000 book value) ............... Land ($50,000 fair – $40,000 book value) ............................. Buildings ($200,000 fair – $180,000 net book value) ....... Equipment ($162,000 fair – $160,000 net book value) ....... Discount on bonds payable ($95,000 fair – $100,000 book value) ............................. Gain on acquisition .................... Total ...................................

Adjustment

Worksheet Key

$ 20,000

debit D1

10,000

debit D2

20,000

debit D3

2,000

debit D4

5,000 (21,600) $ 35,400

debit D5 credit D6

Ch. 2—Problems

2–24

Problem 2-4, Concluded (3) Elimination entries: Common Stock—Express ($50,000 × 80%) ............................. Paid-In Capital in Excess of Par—Express ($250,000 × 80%) . Retained Earnings—Express ($70,000 × 80%) ........................ Investment in Express Corporation ......................................

40,000 200,000 56,000

Inventory ................................................................................... Land .......................................................................................... Buildings ................................................................................... Equipment................................................................................. Discount on Bonds Payable...................................................... Retained Earnings—Penson (controlling gain) .................... Investment in Express Corporation ...................................... Retained Earnings—Express (NCI equity share) .................

20,000 10,000 20,000 2,000 5,000

296,000

21,600 24,000 11,400

PROBLEM 2-5 (1) Investment in Robby Corporation ............................................. Cash .....................................................................................

480,000

(2)

Company Implied Fair Value

Parent Price (100%)

NCI Value (0%)

$480,000 417,000 $ 63,000

N/A

480,000

Determination and Distribution of Excess Schedule Company Implied Fair Value

Parent Price (100%)

NCI Value (0%)

Fair value of subsidiary .............. $480,000 Less book value of interest acquired: Common stock ($5 par) .......... $ 50,000 Paid-in capital in excess of par 250,000 Retained earnings .................. 70,000 Total equity ......................... $370,000 Interest acquired..................... Book value ................................. Excess of fair value over book value ....................................... $110,000

$480,000

N/A

$370,000 100% $370,000 $110,000

2–25

Ch. 2—Problems

Problem 2-5, Concluded Adjustment of identifiable accounts:

Inventory ($100,000 fair – $80,000 book value) ............... Land ($55,000 fair – $40,000 book value) ............................. Buildings ($200,000 fair – $180,000 net book value) ....... Equipment ($150,000 fair – $160,000 net book value) ....... Discount on bonds payable ($98,000 fair – $100,000 book value) ............................. Goodwill ..................................... Total ...................................

Adjustment

Worksheet Key

$ 20,000

debit D1

15,000

debit D2

20,000

debit D3

(10,000)

credit D4

2,000 63,000 $110,000

debit D5 debit D6

(3) Inventory ................................................................................... Land .......................................................................................... Buildings ................................................................................... Discount on Bonds Payable...................................................... Goodwill .................................................................................... Equipment ............................................................................ Paid-In Capital in Excess of Par ...........................................

20,000 15,000 20,000 2,000 63,000 10,000 110,000

Ch. 2—Problems

2–26

PROBLEM 2-6 (1) Value Analysis Schedule Company fair value ........................................... Fair value of net assets excluding goodwill ...... Goodwill ............................................................

Company Implied Fair Value

Parent Price (100%)

NCI Value (0%)

$450,000 335,000 $115,000

N/A

Determination and Distribution of Excess Schedule Company Implied Fair Value

Parent Price (100%)

NCI Value (0%)

Fair value of subsidiary .............. $450,000 Less book value of interest acquired: Common stock ($5 par) .......... $ 50,000 Paid-in capital in excess of par 70,000 Retained earnings .................. 130,000 Total equity ......................... $250,000 Interest acquired..................... Book value ................................. Excess of fair value over book value ....................................... $200,000

$450,000

N/A

$250,000 100% $250,000 $200,000

Adjustment of identifiable accounts:

Inventory ($140,000 fair – $120,000 book value) ............. Land ($45,000 fair – $35,000 book value) ............................. Building and equipment ($225,000 fair – $180,000 net book value) ....................... Copyright ($25,000 fair – $10,000 book value) ............... Premium on bonds payable ($105,000 fair – $100,000 book value) ............................. Goodwill ($450,000 – $335,000) ............................... Total ...................................

Adjustment

Worksheet Key

$ 20,000

debit D1

10,000

debit D2

45,000

debit D3

15,000

debit D4

(5,000)

credit D5

115,000 $200,000

debit D6

2–27

Ch. 2—Problems

Problem 2-6, Concluded (2)

Aron Company and Subsidiary Shield Company Worksheet for Consolidated Balance Sheet December 31, 2015 Eliminations Consolidated and Adjustments Balance Balance Sheet Aron Shield Dr. Cr. Sheet Cash ........................................... 185,000 40,000 ............. ............ 225,000 Accounts Receivable.................. 70,000 30,000 ............. ............ 100,000 Inventory..................................... 130,000 120,000 (D1) 20,000 ............ 270,000 Investment in Shield ................... 450,000 ............ ............. (EL) 250,000 ............ ............ ............ ............. (D) 200,000 ............ Land ........................................... 50,000 35,000 (D2) 10,000 ............ 95,000 Buildings and Equipment ........... 350,000 230,000 (D3) 45,000 ............ 625,000 Accumulated Depreciation ......... (100,000) (50,000) ............. ............ (150,000) Copyrights .................................. 40,000 10,000 (D4) 15,000 ............ 65,000 Goodwill...................................... ............ ............ (D6) 115,000 ............ 115,000 Current Liabilities ....................... (192,000) (65,000) ............. ............ (257,000) Bonds Payable ........................... ............ (100,000) ............. ............ (100,000) Discount (premium) .................... ............ ............ ............. (D5) 5,000 (5,000) Common Stock—Shield ............. ............ (50,000) (EL) 50,000 ............ ............ Paid-In Capital in Excess of Par—Shield ............................. ............ (70,000) (EL) 70,000 ............ ............ Retained Earnings—Shield ........ ............ (130,000) (EL) 130,000 ............ ............ Common Stock—Aron ............... (100,000) ............ ............. ............ (100,000) Paid-In Capital in Excess of Par—Aron ............................... (250,000) ............ ............. ............ (250,000) Retained Earnings—Aron .......... (633,000) ............ ............. ............ (633,000) Totals ...................................... 0 0 455,000 455,000 0 Eliminations and Adjustments: (EL) Eliminate investment in subsidiary against subsidiary equity accounts. (D) Distribute $200,000 excess of cost over book value to: (D1) Inventory, $20,000. (D2) Land, $10,000. (D3) Buildings and equipment, $45,000. (D4) Copyrights, $15,000. (D5) Premium on bonds payable, ($5,000). (D6) Goodwill, $115,000.

Ch. 2—Problems

2–28

PROBLEM 2-7 (1) Value Analysis Schedule Company fair value ........................................... Fair value of net assets excluding goodwill ...... Goodwill ............................................................

Company Implied Fair Value

Parent Price (80%)

NCI Value (20%)

$400,000 335,000 $65,000

$320,000 268,000 $52,000

$80,000 67,000 $13,000

Determination and Distribution of Excess Schedule Company Implied Fair Value

Parent Price (80%)

NCI Value (20%)

Fair value of subsidiary .............. $400,000 Less book value of interest acquired: Common stock ($5 par) .......... $ 50,000 Paid-in capital in excess of par 70,000 Retained earnings .................. 130,000 Total equity ......................... $250,000 Interest acquired..................... Book value ................................. Excess of fair value over book value ....................................... $2150000

$320,000

$ 80,000

$250,000 80% $200,000

$250,000 20% $ 50,000

$120,000

$ 30,000

Adjustment of identifiable accounts:

Inventory ($140,000 fair – $120,000 book value) ............. Land ($45,000 fair – $35,000 book value) ............................. Buildings and equipment ($225,000 fair – $180,000 net book value) ....................... Copyrights ($25,000 fair – $10,000 book value) ............... Premium on bonds payable ($105,000 fair – $100,000 book value) ............................. Goodwill ..................................... Total .......................................

Adjustment

Worksheet Key

$ 20,000

debit D1

10,000

debit D2

45,000

debit D3

15,000

debit D4

(5,000) 65,000 $150,000

credit D5 debit D6

2–29

Ch. 2—Problems

Problem 2-7, Concluded (2)

Aron Company and Subsidiary Shield Company Worksheet for Consolidated Balance Sheet December 31, 2015

Cash ....................................... Accounts Receivable .............. Inventory ................................. Investment in Shield ...............

Balance Sheet Aron Shield 315,000 40,000 70,000 30,000 130,000 120,000 320,000 ............ ............ ............ 50,000 35,000 350,000 230,000 (100,000) (50,000) 40,000 10,000 ............ ............ (192,000) (65,000) ............ (100,000) ............ ............ ............ (50,000)

Land........................................ Buildings and Equipment........ Accumulated Depreciation ..... Copyrights .............................. Goodwill .................................. Current Liabilities .................... Bonds Payable ....................... Discount (premium) ................ Common Stock—Shield ......... Paid-In Capital in Excess of Par—Shield ......................... ............ Retained Earnings—Shield .... ............ Common Stock—Aron............ (100,000) Paid-In Capital in Excess of Par—Aron ........................... (250,000) Retained Earnings—Aron....... (633,000) Noncontrolling Interest ........... ............ Totals................................... 0

(70,000) (130,000) ............ ............ ............ ............ 0

(D1) (D2) (D3) (D4) (D6)

(EL)

Eliminations and Adjustments Dr. Cr. ............. ............ ............. ............ 20,000 ............ ............. (EL) 200,000 ............. (D) 120,000 10,000 ............ 45,000 ............ ............. ............ 15,000 ............ 65,000 ............ ............. ............ ............. ............ (D5) 5,000 40,000 ............

(EL) 56,000 ............ (EL) 104,000 (NCI) 30,000 ............. ............ ............. ............. ............. 355,000

............ ............ ............ 355,000

NCI ............ ............ ............ ............ ............ ............ ............ ............ ............ ............ ............ ............ (5,000) (10,000)

Consolidated Balance Sheet 355,000 100,000 270,000 ............ ............ 95,000 625,000 (150,000) 65,000 65,000 (257,000) (100,000) ............

(14,000) ............ (56,000) ............ ............ (100,000) ............ (250,000) ............ (633,000) (85,000) (85,000) 0 0

Eliminations and Adjustments: (EL) Eliminate investment in subsidiary against 80% of the subsidiary equity accounts. (D)/(NCI) Distribute $120,000 excess of cost over book value and $30,000 NCI adjustment to: (D1) Inventory, $20,000. (D2) Land, $10,000. (D3) Buildings and equipment, $45,000. (D4) Copyrights, $15,000. (D5) Premium on bonds payable, ($5,000). (D6) Goodwill, $65,000.

Ch. 2—Problems

2–30

PROBLEM 2-8 (1) Value Analysis Schedule Company fair value ........................................... Fair value of net assets excluding goodwill ...... Goodwill ............................................................

Company Implied Fair Value

Parent Price (100%)

NCI Value (0%)

$500,000 450,000 $ 50,000

N/A

Determination and Distribution of Excess Schedule Company Implied Fair Value

Parent Price (100%)

NCI Value (0%)

Fair value of subsidiary .............. $500,000 Less book value of interest acquired: Common stock ($1 par) .......... $ 10,000 Paid-in capital in excess of par 90,000 Retained earnings .................. 60,000 Total equity ......................... $160,000 Interest acquired..................... Book value ................................. Excess of fair value over book value ....................................... $340,000

$500,000

N/A

$160,000 100% $160,000 $340,000

Adjustment of identifiable accounts:

Inventory ($60,000 fair – $50,000 book value) ............... Land ($80,000 fair – $40,000 book value) ............................. Buildings ($320,000 fair – $150,000 net book value) ....... Equipment ($60,000 fair – $40,000 net book value) ......... Copyright ($50,000 fair – $0 book value) ........................ Goodwill ..................................... Total ...................................

Adjustment

Worksheet Key

$ 10,000

debit D1

40,000

debit D2

170,000

debit D3

20,000

debit D4

50,000 50,000 $340,000

debit D5 debit D6

2–31

Ch. 2—Problems

Problem 2-8, Concluded (2)

Palto Company and Subsidiary Saleen Company Worksheet for Consolidated Balance Sheet January 1, 2015

Cash ....................................... Accounts Receivable .............. Inventory ................................. Investment in Saleen ..............

Balance Sheet Palto Saleen 61,000 ............ 65,000 20,000 80,000 50,000 500,000 ............ ............ ............ 100,000 40,000 250,000 200,000 (80,000) (50,000) 90,000 60,000 (40,000) (20,000) ............ ............ ............ ............ (80,000) (40,000) (200,000) (100,000)

(D1)

Eliminations and Adjustments Dr. Cr. ............. ............ ............. ............ 10,000 ............ ............. (EL) 160,000 ............. (D) 340,000 40,000 ............ 170,000 ............ ............. ............ 20,000 ............ ............. ............ 50,000 ............ 50,000 ............ ............. ............ ............. ............

Land........................................ (D2) Buildings ................................. (D3) Accumulated Depreciation ..... Equipment .............................. (D4) Accumulated Depreciation ..... Copyright ................................ (D5) Goodwill .................................. (D6) Current Liabilities .................... Bonds Payable ....................... Common Stock ($1 par)— Saleen ................................. ............ (10,000) (EL) 10,000 ............ Paid-In Capital in Excess of Par—Saleen ........................ ............ (90,000) (EL) 90,000 ............ Retained Earnings—Saleen ... ............ (60,000) (EL) 60,000 ............ Common Stock—Palto ........... (20,000) ............ ............. ............ Paid-In Capital in Excess of Par—Palto ........................... (180,000) ............ ............. ............ Retained Earnings—Palto ...... (546,000) ............ ............. ............ Totals................................... 0 0 500,000 500,000 Noncontrolling Interest ....................................................................................................... Controlling Retained Earnings............................................................................................ Totals...............................................................................................................................

Consolidated Balance Sheet 61,000 85,000 140,000 ............ ............ 180,000 620,000 (130,000) 170,000 (60,000) 50,000 50,000 (120,000) (300,000) ............ ............ ............ (20,000) (180,000) (546,000) ............ ............ ............ 0

Eliminations and Adjustments: (EL) Eliminate the investment in the subsidiary against the subsidiary equity accounts. (D) Distribute $340,000 excess of cost over book value as follows: (D1) Inventory, $10,000. (D2) Land, $40,000. (D3) Buildings, $170,000. (D4) Equipment, $20,000. (D5) Copyright, $50,000. (D6) Goodwill, $50,000.

Ch. 2—Problems

2–32

PROBLEM 2-9 (1) Value Analysis Schedule Company fair value ........................................... Fair value of net assets excluding goodwill ...... Gain on acquisition ...........................................

Company Implied Fair Value

Parent Price (100%)

NCI Value (0%)

$400,000 450,000 $ (50,000)

N/A

Determination and Distribution of Excess Schedule Company Implied Fair Value

Parent Price (100%)

NCI Value (0%)

Price paid for investment ........... $400,000 Less book value of interest acquired: Common stock ($1 par) .......... $ 10,000 Paid-in capital in excess of par 90,000 Retained earnings .................. 60,000 Total equity ......................... $160,000 Interest acquired..................... Book value ................................. Excess of fair value over book value ....................................... $240,000

$400,000

N/A

$160,000 100% $160,000 $240,000

Adjustment of identifiable accounts:

Inventory ($60,000 fair – $50,000 book value) ............... Land ($80,000 fair – $40,000 book value) ............................. Buildings ($320,000 fair – $150,000 net book value) ....... Equipment ($60,000 fair – $40,000 net book value) ......... Copyright ($50,000 fair – $0 book value) ........................ Gain ........................................... Total ...................................

Adjustment

Worksheet Key

$ 10,000

debit D1

40,000

debit D2

170,000

debit D3

20,000

debit D4

50,000 (50,000) $240,000

debit D5 debit D6

2–33

Ch. 2—Problems

Problem 2-9, Concluded (2)

Palto Company and Subsidiary Saleen Company Worksheet for Consolidated Balance Sheet January 1, 2015

Cash ....................................... Accounts Receivable .............. Inventory ................................. Investment in Saleen ..............

Balance Sheet Palto Saleen 161,000 ............ 65,000 20,000 80,000 50,000 400,000 ............ ............ ............ 100,000 40,000 250,000 200,000 (80,000) (50,000) 90,000 60,000 (40,000) (20,000) ............ ............ ............ ............ (80,000) (40,000) (200,000) (100,000)

(D1)

Eliminations and Adjustments Dr. Cr. ............. ............ ............. ............ 10,000 ............ ............. (EL) 160,000 ............. (D) 240,000 40,000 ............ 170,000 ............ ............. ............ 20,000 ............ ............. ............ 50,000 ............ ............. ............ ............. ............ ............. ............

Land........................................ (D2) Buildings ................................. (D3) Accumulated Depreciation ..... Equipment .............................. (D4) Accumulated Depreciation ..... Copyright ................................ (D5) Goodwill .................................. Current Liabilities .................... Bonds Payable ....................... Common Stock ($1 par)— Saleen ................................. ............ (10,000) (EL) 10,000 ............ Paid-In Capital in Excess of Par—Saleen ........................ ............ (90,000) (EL) 90,000 ............ Retained Earnings—Saleen ... ............ (60,000) (EL) 60,000 ............ Common Stock—Palto ........... (20,000) ............ ............. ............ Paid-In Capital in Excess of Par—Palto ........................... (180,000) ............ ............. ............ Retained Earnings—Palto ...... (546,000) ............ ............. (D6) 50,000 Totals................................... 0 0 450,000 450,000 Noncontrolling Interest ....................................................................................................... Controlling Retained Earnings............................................................................................ Totals...............................................................................................................................

Consolidated Balance Sheet 161,000 85,000 140,000 ............ ............ 180,000 620,000 (130,000) 170,000 (60,000) 50,000 ............ (120,000) (300,000) ............ ............ ............ (20,000) (180,000) (596,000) ............ ............ ............ .......... 0

Eliminations and Adjustments: (EL) Eliminate the investment in the subsidiary against the subsidiary equity accounts. (D) Distribute $240,000 excess of cost over book value as follows: (D1) Inventory, 10,000. (D2) Land, $40,000. (D3) Buildings, $170,000. (D4) Equipment, $20,000. (D5) Copyright, $50,000. (D6) Gain on acquisition (close to Palto’s Retained Earnings), $50,000.

Ch. 2—Problems

2–34

PROBLEM 2-10 (1) Value Analysis Schedule Company fair value ........................................... Fair value of net assets excluding goodwill ...... Goodwill ............................................................

Company Implied Fair Value

Parent Price (80%)

NCI Value (20%)

$492,000 450,000 $ 42,000

$400,000 360,000 $ 40,000

$92,000* 90,000 $ 2,000

*2,000 shares × $46. Determination and Distribution of Excess Schedule Company Implied Fair Value

Parent Price (80%)

NCI Value (20%)

Fair value of subsidiary .............. $492,000 Less book value of interest acquired: Common stock ($1 par) .......... $ 10,000 Paid-in capital in excess of par 90,000 Retained earnings .................. 60,000 Total equity ......................... $160,000 Interest acquired..................... Book value ................................. Excess of fair value over book value ....................................... $332,000

$400,000

$ 92,000

$160,000 80% $128,000

$160,000 20% $ 32,000

$272,000

$ 60,000

Adjustment of identifiable accounts:

Adjustment

Worksheet Key

$ 10,000

debit D1

40,000

debit D2

170,000

debit D3

20,000

debit D4

50,000 42,000 $332,000

debit D5 debit D6

2–35

Ch. 2—Problems

Problem 2-10, Concluded (2)

Palto Company and Subsidiary Saleen Company Worksheet for Consolidated Balance Sheet January 1, 2015

Cash ....................................... Accounts Receivable .............. Inventory ................................. Investment in Saleen ..............

(D1)

Eliminations and Adjustments Dr. Cr. ............. ............ ............. ............ 10,000 ............ ............. (EL) 128,000 ............. (D) 272,000 40,000 ............ 170,000 ............ ............. ............ 20,000 ............ ............. ............ 50,000 ............ 42,000 ............ ............. ............ ............. ............

Consolidated Balance NCI Sheet ............ 161,000 ............ 85,000 ............ 140,000 ............ ............ ............ ............ ............ 180,000 ............ 620,000 ............ (130,000) ............ 170,000 ............ (60,000) ............ 50,000 ............ 42,000 ............ (120,000) ............ (300,000)

Land........................................ (D2) Buildings ................................. (D3) Accumulated Depreciation ..... Equipment .............................. (D4) Accumulated Depreciation ..... Copyright ................................ (D5) Goodwill .................................. (D6) Current Liabilities .................... Bonds Payable ....................... Common Stock ($1 par)— Saleen ................................. ............ (10,000) (EL) 8,000 ............ (2,000) ............ Paid-In Capital in Excess of Par—Saleen ........................ ............ (90,000) (EL) 72,000 ............ (18,000) ............ Retained Earnings—Saleen ... ............ (60,000) (EL) 48,000 (NCI) 60,000 (72,000) ............ Common Stock—Palto ........... (20,000) ............ ............. ............ ............ (20,000) Paid-In Capital in Excess of Par—Palto ........................... (180,000) ............ ............. ............ ............ (180,000) Retained Earnings—Palto ...... (546,000) ............ ............. ............ ............ (546,000) Totals................................... 0 0 460,000 460,000 ............ ............ Noncontrolling Interest ....................................................................................................... (92,000) (92,000) Controlling Retained Earnings............................................................................................................... ............ Totals.................................................................................................................................................. 0 Eliminations and Adjustments: (EL) Eliminate the investment in the subsidiary against the subsidiary equity accounts. (D)/(NCI) Distribute $272,000 excess and adjust NCI $60,000 (total $332,000 excess) as follows: (D1) Inventory, $10,000. (D2) Land, $40,000. (D3) Buildings, $170,000. (D4) Equipment, $20,000. (D5) Copyright, $50,000. (D6) Goodwill, $42,000.

Ch. 2—Problems

2–36

PROBLEM 2-11 (1) Value Analysis Schedule Company fair value ........................................... Fair value of net assets excluding goodwill ...... Gain on acquisition ...........................................

Company Implied Fair Value

Parent Price (80%)

NCI Value (20%)

$390,000 450,000 $ (60,000)

$300,000 360,000 $ (60,000)

$90,000* 90,000 $ 0

*NCI minimum allowed. Determination and Distribution of Excess Schedule Company Implied Fair Value

Parent Price (80%)

NCI Value (20%)

Price paid for investment ........... $390,000 Less book value of interest acquired: Common stock ($1 par) .......... $ 10,000 Paid-in capital in excess of par 90,000 Retained earnings .................. 60,000 Total equity ......................... $160,000 Interest acquired..................... Book value ................................. Excess of fair value over book value ....................................... $230,000

$300,000

$ 90,000

$160,000 80% $128,000

$160,000 20% $ 32,000

$172,000

$ 58,000

Adjustment of identifiable accounts:

Inventory ($60,000 fair – $50,000 book value) ............... Land ($80,000 fair – $40,000 book value) ............................. Buildings ($320,000 fair – $150,000 net book value) ....... Equipment ($60,000 fair – $40,000 net book value) ......... Copyright ($50,000 fair – $0 book value) ............................. Gain on acquisition .................... Total ...................................

Adjustment

Worksheet Key

$ 10,000

debit D1

40,000

debit D2

170,000

debit D3

20,000

debit D4

50,000 (60,000) $230,000

debit D5 credit D6

2–37

Ch. 2—Problems

Problem 2-11, Concluded (2)

Palto Company and Subsidiary Saleen Company Worksheet for Consolidated Balance Sheet January 1, 2015

Cash ....................................... Accounts Receivable .............. Inventory ................................. Investment in Saleen ..............

Balance Sheet Palto Saleen 261,000 ............ 65,000 20,000 80,000 50,000 300,000 ............ ............ ............ 100,000 40,000 250,000 200,000 (80,000) (50,000) 90,000 60,000 (40,000) (20,000) ............ ............ ............ ............ (80,000) (40,000) (200,000) (100,000)

(D1)

Eliminations and Adjustments Dr. Cr. ............. ............ ............. ............ 10,000 ............ ............. (EL) 128,000 ............. (D) 172,000 40,000 ............ 170,000 ............ ............. ............ 20,000 ............ ............. ............ 50,000 ............ ............. ............ ............. ............ ............. ............

NCI ............ ............ ............ ............ ............ ............ ............ ............ ............ ............ ............ ............ ............ ............

Land........................................ (D2) Buildings ................................. (D3) Accumulated Depreciation ..... Equipment .............................. (D4) Accumulated Depreciation ..... Copyright ................................ (D5) Goodwill .................................. Current Liabilities .................... Bonds Payable ....................... Common Stock ($1 par)— Saleen ................................. ............ (10,000) (EL) 8,000 ............ (2,000) Paid-In Capital in Excess of Par—Saleen ........................ ............ (90,000) (EL) 72,000 ............ (18,000) Retained Earnings—Saleen ... (60,000) (EL) 48,000 (NCI) 58,000 (70,000) Common Stock—Palto ........... (20,000) ............ ............. ............ ............ Paid-In Capital in Excess of Par—Palto ........................... (180,000) ............ ............. ............ ............ Retained Earnings—Palto ...... (546,000) ............ ............. (D6) 60,000 ............ Totals................................... 0 0 418,000 418,000 ............ Noncontrolling Interest ....................................................................................................... (90,000) Controlling Retained Earnings............................................................................................................... Totals..................................................................................................................................................

Consolidated Balance Sheet 261,000 85,000 140,000 ............ ............ 180,000 620,000 (130,000) 170,000 (60,000) 50,000 ............ (120,000) (300,000) ............ ............ ............ (20,000) (180,000) (606,000) ............ (90,000) ............ 0

Eliminations and Adjustments: (EL) Eliminate the investment in the subsidiary against the subsidiary equity accounts. (D)/(NCI) Distribute $172,000 excess and adjust NCI $58,000 (total $230,000 excess) as follows: (D1) Inventory, $10,000. (D2) Land, $40,000. (D3) Buildings, $170,000. (D4) Equipment, $20,000. (D5) Copyright, $50,000. (D6) Gain on acquisition (close to Palto’s Retained Earnings), $60,000.

Ch. 2—Problems

2–38

PROBLEM 2-12 (1) Value Analysis Schedule Company fair value ........................................... Fair value of net assets excluding goodwill ...... Goodwill ............................................................

Company Implied Fair Value

Parent Price (100%)

NCI Value (0%)

$1,100,000 850,000 $ 250,000

N/A

Determination and Distribution of Excess Schedule Company Implied Fair Value

Parent Price (100%)

NCI Value (0%)

Fair value of subsidiary .............. $1,100,000 Less book value interest acquired: Common stock ($1 par) .......... $ 10,000 Paid-in capital in excess of par 190,000 Retained earnings .................. 140,000 Total equity ......................... $ 340,000 Interest acquired..................... Book value ................................. Excess of fair value over book value ....................................... $ 760,000

$1,100,000

N/A

$ 340,000 100% $ 340,000 $ 760,000

Adjustment of identifiable accounts:

Inventory ($100,000 fair – $120,000 book value) ............. Land ($200,000 fair – $100,000 book value) ............................. Buildings ($400,000 fair – $200,000 net book value) ....... Equipment ($200,000 fair – $90,000 net book value) ......... Patent ($150,000 fair – $10,000 book value) ............... Computer software ($50,000 fair – $0 book value) ............... Premium on bonds payable ($210,000 fair – $200,000 book value) ............................. Goodwill ($250,000 fair – $60,000 book value) ............... Total .......................................

Adjustment

Worksheet Key

$(20,000)

credit D1

100,000

debit D2

200,000

debit D3

110,000

debit D4

140,000

debit D5

50,000

debit D6

(10,000)

credit D7

190,000 $760,000

debit D8

2–39

Ch. 2—Problems

Problem 2-12, Concluded (2)

Purnell Corporation and Subsidiary Sentinel Corporation Worksheet for Consolidated Balance Sheet December 31, 2015

Cash .................................... Accounts Receivable ........... Inventory .............................. Investment in Sentinel ......... Land..................................... Buildings .............................. Accumulated Depreciation .. Equipment ........................... Accumulated Depreciation .. Patent .................................. Computer Software ............. Goodwill ............................... Current Liabilities ................. Bonds Payable .................... Premium on Bonds Payable

Balance Sheet Purnell Sentinel 20,000 ............ 300,000 50,000 410,000 120,000 1,100,000 ............ ............ ............ 800,000 100,000 2,800,000 300,000 (500,000) (100,000) 600,000 140,000 (230,000) (50,000) ............ 10,000 ............ ............ ............ 60,000 (150,000) (90,000) (300,000) (200,000) ............ ............

(D2) (D3) (D4) (D5) (D6) (D8)

Eliminations and Adjustments Dr. Cr. ............. ............ ............. ............ ............. (D1) 20,000 ............. (EL) 340,000 ............. (D) 760,000 100,000 ............ 200,000 ............ ............. ............ 110,000 ............ ............. ............ 140,000 ............ 50,000 ............ 190,000 ............ ............. ............ ............. ............ ............. (D7) 10,000

Common Stock—Sentinel ... ............ (10,000) (EL) 10,000 ............ Paid-In Capital in Excess of Par—Sentinel ................... ............ (190,000) (EL) 190,000 ............ Retained Earnings—Sentinel ............ (140,000) (EL) 140,000 ............ Common Stock—Purnell ..... (95,000) ............ ............. ............ Paid-In Capital in Excess of Par—Purnell ..................... (3,655,000) ............ ............. ............ Retained Earnings—Purnell (1,100,000) ............ ............. ............ Totals................................ 0 0 1,130,000 1,130,000 NCI ..................................................................................................................................... Totals...............................................................................................................................

Consolidated Balance Sheet 20,000 350,000 510,000 ............ ............ 1,000,000 3,300,000 (600,000) 850,000 (280,000) 150,000 50,000 250,000 (240,000) (500,000) (10,000) ............ ............ ............ (95,000) (3,655,000) (1,100,000) ............ ............ 0

Eliminations and Adjustments: (EL) Eliminate parent ownership interest. (D) Distribute excess. Distribute adjustments: (D1) Inventory. (D2) Land. (D3) Buildings. (D4) Equipment. (D5) Patent. (D6) Computer software. (D7) Premium on bonds payable. (D8) Goodwill.

Ch. 2—Problems

2–40

PROBLEM 2-13 (1) Value Analysis Schedule Company fair value ........................................... Fair value of net assets excluding goodwill ...... Gain on acquisition ...........................................

Company Implied Fair Value

Parent Price (100%)

NCI Value (0%)

$800,000 850,000 $ (50,000)

N/A

Determination and Distribution of Excess Schedule

Price paid for investment ........... Less book value interest acquired: Common stock ($1 par) .......... Paid-in capital in excess of par Retained earnings .................. Total equity ......................... Interest acquired ........................ Book value ................................. Excess of fair value over book value .......................................

Company Implied Fair Value

Parent Price (100%)

NCI Value (0%)

$800,000

N/A

$ 10,000 190,000 140,000 $340,000

$460,000

$340,000 100% $340,000 $460,000

Adjustment of identifiable accounts:

Inventory ($100,000 fair – $120,000 book value) ............. Land ($200,000 fair – $100,000 book value) ............. Buildings ($400,000 fair – $200,000 net book value) ....... Equipment ($200,000 fair – $90,000 net book value) ......... Patent ($150,000 fair – $10,000 book value) ............................. Computer software ($50,000 fair – $0 book value) ............... Premium on bonds payable ($210,000 fair – $200,000 book value) ............................. Goodwill ($0 fair – $60,000 book value) ............................. Gain on acquisition .................... Total ...................................

Adjustment

Worksheet Key

$ (20,000)

credit D1

100,000

debit D2

200,000

debit D3

110,000

debit D4

140,000

debit D5

50,000

debit D6

(10,000)

credit D7

(60,000) (50,000) $460,000

credit D8 credit D9

2–41

Ch. 2—Problems

Problem 2-13, Concluded (2)

Purnell Corporation and Subsidiary Sentinel Corporation Worksheet for Consolidated Balance Sheet December 31, 2015

Balance Sheet Purnell Sentinel 20,000 ............ 300,000 50,000 410,000 120,000 800,000 ............ ............ ............ 800,000 100,000 2,800,000 300,000 (500,000) (100,000) 600,000 140,000 (230,000) (50,000) ............ 10,000 ............ ............ ............ 60,000 (150,000) (90,000) (300,000) (200,000) ............ ............ ............ (10,000) ............ ............

(190,000) (140,000)

(D2) (D3) (D4) (D5) (D6)

(EL)

Eliminations and Adjustments Dr. Cr. ............. ............ ............. ............ ............. (D1) 20,000 ............. (EL) 340,000 ............. (D) 460,000 100,000 ............ 200,000 ............ ............. ............ 110,000 ............ ............. ............ 140,000 ............ 50,000 ............ ............. (D8) 60,000 ............. ............ ............. ............ ............. (D7) 10,000 10,000 ............

(EL) 190,000 (EL) 140,000

Consolidated Balance Sheet 20,000 350,000 510,000 ............ ............ 1,000,000 3,300,000 (600,000) 850,000 (280,000) 150,000 50,000 ............ (240,000) (500,000) (10,000) ............

............ ............

Common Stock—Purnell ..... (89,000) ............ ............. ............ Paid-In Capital in Excess of Par—Purnell ..................... (3,361,000) ............ ............. ............ Retained Earnings—Purnell (1,100,000) ............ ............. (D9) 50,000 Totals................................ 0 0 940,000 940,000 NCI ..................................................................................................................................... Totals...............................................................................................................................

(89,000) (3,361,000) (1,150,000) ............ ............ 0

Ch. 2—Problems

2–42

PROBLEM 2-14 (1) Value Analysis Schedule Company fair value ........................................... Fair value of net assets excluding goodwill ...... Goodwill ............................................................

Company Implied Fair Value

Parent Price (80%)

NCI Value (20%)

$1,187,500 850,000 $ 337,500

$950,000 680,000 $270,000

$237,500 170,000 $ 67,500

Determination and Distribution of Excess Schedule Company Implied Fair Value

Parent Price (80%)

NCI Value (20%)

Fair value of subsidiary .............. $1,187,500 Less book value interest acquired: Common stock ($1 par) .......... $ 10,000 Paid-in capital in excess of par 190,000 Retained earnings .................. 140,000 Total equity ......................... $ 340,000 Interest acquired..................... Book value ................................. Excess of fair value over book value ....................................... $ 847,500

$950,000

$237,500

$340,000 80% $272,000

$340,000 20% $ 68,000

$678,000

$169,500

Adjustment of identifiable accounts:

Inventory ($100,000 fair – $120,000 book value) ............. Land ($200,000 fair – $100,000 book value) ............. Buildings ($400,000 fair – $200,000 net book value) ....... Equipment ($200,000 fair – $90,000 net book value) ......... Patent ($150,000 fair – $10,000 book value) ............... Computer software ($50,000 fair – $0 book value) ............... Premium on bonds payable ($210,000 fair – $200,000 book value) ............................. Goodwill ($337,500 fair – $60,000 book value) ............... Total ...................................

Adjustment

Worksheet Key

$(20,000)

credit D1

100,000

debit D2

200,000

debit D3

110,000

debit D4

140,000

debit D5

50,000

debit D6

(10,000)

credit D7

277,500 $847,500

debit D8

2–43

Ch. 2—Problems

Problem 2-14, Concluded (2)

Purnell Corporation and Subsidiary Sentinel Corporation Worksheet for Consolidated Balance Sheet December 31, 2015

Balance Sheet Purnell Sentinel 20,000 ............ 300,000 50,000 410,000 120,000 950,000 ............ ............ ............ 800,000 100,000 2,800,000 300,000 (500,000) (100,000) 600,000 140,000 (230,000) (50,000) ............ 10,000 ............ ............ ............ 60,000 (150,000) (90,000) (300,000) (200,000) ............ ............ ............ (10,000) ............ ............

(190,000) (140,000)

(D2) (D3) (D4) (D5) (D6) (D8)

(EL)

Eliminations and Adjustments Dr. Cr. ............. ............ ............. ............ ............. (D1) 20,000 ............. (EL) 272,000 ............. (D) 678,000 100,000 ............ 200,000 ............ ............. ............ 110,000 ............ ............. ............ 140,000 ............ 50,000 ............ 277,500 ............ ............. ............ ............. ............ ............. (D7) 10,000 8,000 ............

(EL) 152,000 ............ (EL) 112,000 (NCI) 169,500

Consolidated Balance NCI Sheet ............ 20,000 ............ 350,000 ............ 510,000 ............ ............ ............ ............ ............ 1,000,000 ............ 3,300,000 ............ (600,000) ............ 850,000 ............ (280,000) ............ 150,000 ............ 50,000 ............ 337,500 ............ (240,000) ............ (500,000) ............ (10,000) (2,000) ............ (38,000) (197,500)

............ ............

Common Stock—Purnell ..... (92,000) ............ ............. ............ ............ (92,000) Paid-In Capital in Excess of Par—Purnell ..................... (3,508,000) ............ ............. ............ ............ (3,508,000) Retained Earnings—Purnell (1,100,000) ............ ............. ............ ............ (1,100,000) Totals................................ 0 0 1,149,500 1,149,500 ............ ............ NCI ..................................................................................................................................... (237,500) (237,500) Totals.................................................................................................................................................. 0 Eliminations: (EL) Eliminate parent ownership interest. (D) Distribute excess. (NCI) Adjust NCI to fair value (credit subsidiary Retained Earnings). Distribute adjustments: (D1) Inventory. (D2) Land. (D3) Buildings. (D4) Equipment. (D5) Patent. (D6) Computer software. (D7) Premium on bonds payable. (D8) Goodwill.

Ch. 2—Problems

2–44

PROBLEM 2-15 (1) Value Analysis Schedule Company fair value ........................................... Fair value of net assets excluding goodwill ...... Gain on acquisition ........................................... *Must at least be equal to fair value of net assets.

Company Implied Fair Value $ 670,000 850,000 $(180,000)

Parent Price (80%) $ 500,000 680,000 $(180,000)

NCI Value (20%) $170,000* 170,000 $ 0

Determination and Distribution of Excess Schedule

Price paid for investment ........... Less book value interest acquired: Common stock ($1 par) .......... Paid-in capital in excess of par Retained earnings .................. Total equity ......................... Interest acquired..................... Book value ................................. Excess of fair value over book value .......................................

Company Implied Fair Value $670,000 $ 10,000 190,000 140,000 $340,000

$330,000

Parent Price (80%) $500,000

NCI Value (20%) $170,000

$340,000 80% $272,000

$340,000 20% $ 68,000

$228,000

$102,000

Adjustment of identifiable accounts:

Adjustment

Worksheet Key

$ (20,000)

credit D1

100,000

debit D2

200,000

debit D3

110,000

debit D4

140,000

debit D5

50,000

debit D6

(10,000)

credit D7

(60,000) (180,000) $ 330,000

credit D8 credit D9

2–45

Ch. 2—Problems

Problem 2-15, Concluded (2)

Purnell Corporation and Subsidiary Sentinel Corporation Worksheet for Consolidated Balance Sheet December 31, 2015

Balance Sheet Purnell Sentinel 20,000 ............ 300,000 50,000 410,000 120,000 500,000 ............ ............ ............ 800,000 100,000 2,800,000 300,000 (500,000) (100,000) 600,000 140,000 (230,000) (50,000) ............ 10,000 ............ ............ ............ 60,000 (150,000) (90,000) (300,000) (200,000) ............ ............ ............ (10,000) ............ ............

(190,000) (140,000)

(D2) (D3) (D4) (D5) (D6)

(EL)

Eliminations and Adjustments Dr. Cr. ............. ............ ............. ............ ............. (D1) 20,000 ............. (EL) 272,000 ............. (D) 228,000 100,000 ............ 200,000 ............ ............. ............ 110,000 ............ ............. ............ 140,000 ............ 50,000 ............ ............. (D8) 60,000 ............. ............ ............. ............ ............. (D7) 10,000 8,000 ............

(EL) 152,000 ............ (EL) 112,000 (NCI) 102,000

Consolidated Balance NCI Sheet ............ 20,000 ............ 350,000 ............ 510,000 ............ ............ ............ ............ ............ 1,000,000 ............ 3,300,000 ............ (600,000) ............ 850,000 ............ (280,000) ............ 150,000 ............ 50,000 ............ ............ ............ (240,000) ............ (500,000) ............ (10,000) (2,000) ............ (38,000) (130,000)

............ ............

Common Stock—Purnell ..... (83,000) ............ ............. ............ ............ (83,000) Paid-In Capital in Excess of Par—Purnell ..................... (3,067,000) ............ ............. ............ ............ (3,067,000) Retained Earnings—Purnell (1,100,000) ............ ............. (D9) 180,000 ............ (1,280,000) Totals................................ 0 0 872,000 872,000 ............ ............ NCI ..................................................................................................................................... (170,000) (170,000) Totals.................................................................................................................................................. 0 Eliminations: (EL) Eliminate parent ownership interest. (D) Distribute excess. (NCI) Adjust NCI to fair value (credit subsidiary retained earnings). Distribute adjustments: (D1) Inventory. (D2) Land. (D3) Buildings. (D4) Equipment. (D5) Patent. (D6) Computer software. (D7) Premium on bonds payable. (D8) Goodwill. (D9) Gain on acquisition (close to parent Retained Earnings).

Ch. 2—Problems

2–46

APPENDIX PROBLEM PROBLEM 2A-1 (1) Value Analysis Schedule Company fair value ........................................... Fair value of net assets excluding goodwill ...... Goodwill ............................................................ Gain on acquisition

Famous Company Implied Fair Value $240,000a 235,000 $ 5,000

Parent Price (100%)b $240,000 235,000 $ 5,000

NCI Value

Values are prior to acquisition (4,000 shares × $60 market value).

Determination and Distribution of Excess Schedule Famous Company Implied Fair Value Fair value of subsidiary .............. $240,000 Less book value of interest acquired: Common stock ($1 par) .......... $ 4,000 Paid-in capital in excess of par 96,000 Retained earnings .................. 15,000 Total equity ......................... $115,000 Interest acquired..................... Book value ................................. Excess of fair value over book value ....................................... $125,000

Parent Price (100%)

NCI Value

$240,000

$115,000 100% $115,000 $125,000

Adjustment of identifiable accounts:

Building ($200,000 fair – $100,000 book value) ............. Equipment ($40,000 fair – $20,000 book value) ............... Goodwill ..................................... Total ...................................

Adjustment

Worksheet Key

$100,000

debit D1

20,000 5,000 $125,000

debit D2 debit D3

2–47

Ch. 2—Problems

PROBLEM 2A-1 (2)

Reverse Acquisition Famous Company and Subsidiary Unknown Company Worksheet for Consolidated Balance Sheet December 31, 2015 Eliminations and Adjustments Dr. Cr. ............. ............

Consolidated Balance NCI Sheet ............ 15,000

............. (EL) 360,000

............

………

Buildings .............................. 150,000 100,000 (D1) 100,000 ............ ............ Equipment ........................... 100,000 20,000 (D2) 20,000 ............ ............ Goodwill ............................... ............ ............ (D3) 5,000 ............ ............ Long-Term Liabilities ........... (5,000) (10,000) ............. ............ ............ Common Stock—Unknown . (5,000) ............ (TR) 5,000 ............ ............ Paid-In Capital in Excess of Par—Unknown ............. (115,000) ............ (TR) 115,000 ............ ............ Retained Earnings— Unknown .......................... (135,000) ............ ............. ............ ............ Common Stock—Famous ... ............ (10,000) (EL) 6,000 (TR) 6,000 (4,000 + 6,000) Paid-In Capital in Excess of Par—Famous ................... ............ (450,000) (EL) 354,000 (TR) 254,000 ……… (96,000 + 354,000) Retained Earnings—Famous ............ (15,000) (TR) 140,000 (D) 125,000 ……… Totals................................ 0 0 745,000 745,000 ............ NCI ..................................................................................................................................... Totals..................................................................................................................................................

350,000 140,000 5,000 (15,000) ……..

(Credits are in parentheses) Current Assets ..................... Investment in Unknown Company ..........................

Balance Sheet Unknown Famous 10,000 5,000 ………

360,000

…….. (135,000) (10,000) 0 (350,000) ............ ............ 0 0

Eliminations and Adjustments: (EL) Eliminate investment account and the equity recorded at the time of acquisition. (D) Distribute the excess applicable to the investment and the adjustment to fair value for the NCI as follows: (D1) Increase building, $100,000. (D2) Increased equipment, $20,000. (D3) Record goodwill, $5,000. (TR) Transfer paid-in equity of Unknown Company and retained earnings of Famous Company to paid-in capital of Famous Company. $260,000 total, $6,000 assigned to par value, and balance to paid-in excess.

Ch. 2—Case

2–48

CASE CASE 2-1 (1) Evaluation of price—Fair value of Al’s Hardware: Cash ......................................................................... Accounts receivable ................................................. Inventory .................................................................. Land ......................................................................... Building .................................................................... Equipment ................................................................ Current liabilities ....................................................... Mortgage .................................................................. Lawsuit ..................................................................... Value given ...................................................................

$ 180,000 350,000 600,000 100,000 300,000 100,000 (425,000) (600,000) (300,000) $ 305,000 × 60% = $183,000 7,500 × $40 = $300,000

This purchase would not be a bargain, because comparing the fair values (including the lawsuit) to the price would result in goodwill of $117,000 ($300,000 – $183,000). Note: This analysis would have the same result if done for only 60% interest in the form of the D&D schedule with the same result. (2) Accounting methods: (a) GAAP would require that many of the adjustments to recognize fair values must be made directly on Al’s books before consolidation: Adjust accounts receivable to net realizable value. Decrease inventory to fair value. Record estimated liability from lawsuit. (b) There are no major differences between fair and book values of the long-lived assets. Normally, they would not be adjusted to fair value, but this could be done under quasireorganization or push-down accounting. The recommendation would be that they be adjusted to fair value to improve future reporting. Noncontrolling interest would have to agree to it as well. (c) The goodwill on Al’s books should be written off because there is no reason to think it exists. (d) Al’s Hardware is a likely candidate for quasi-reorganization, because this procedure adjusts all assets to fair values and decreases paid-in capital in excess of par to provide the amount needed to cover the negative balance in retained earnings. Summary: Accounts receivable, inventory, estimated liability, and goodwill should be adjusted on the subsidiary’s books. The adjustments of long-lived assets could be done on the subsidiary’s books under push-down accounting. If the long-lived assets are not adjusted on the subsidiary books, the adjustment relative to the controlling interest would be made in the consolidation process.

CHAPTER 3 UNDERSTANDING THE ISSUES 1. (a) Subsidiary Income = $40,000. Investment in Subsidiary ($500,000 + $40,000 – $5,000) = $535,000. (b) Subsidiary Income ($40,000 – $7,000 amortization) = $33,000. Investment in Subsidiary ($500,000 + $33,000 – $5,000) = $528,000. (c) Subsidiary Income = $0. Dividend Income = $5,000. Investment in Subsidiary = $500,000.

by fair value adjustments on the acquisition date. The NCI share of consolidated net income has, in the past, been shown as an expense. That is no longer allowed. It is to be shown as a distribution of consolidated net income. 4. The $80,000 excess attributed to the controlling interest means that the patent is adjusted by $100,000 ($80,000/80%). (a) Parent net income for 2015 . $140,000 Subsidiary net income in 2015 ($60,000 × ½ year) .. 30,000 Amortization of excess for 2015 ($100,000 ÷ 10 × ½ year) .............................. (5,000) Consolidated net income ..... $165,000 (b) NCI share of net income = 1/2 × ($60,000 – $10,000) × 20% = $5,000.

2. Date alignment means adjusting the investment account to reflect the same date as the subsidiary equity accounts so that their balances reflect the same point in time. (a) Simple equity method—The subsidiary’s equity accounts reflect beginningof-year balances, yet the investment account reflects an end-of-year balance. During the consolidation process, the subsidiary income and the parent’s share of the subsidiary’s declared dividends are closed to the investment account to return it to its beginning-ofyear balance. (b) Sophisticated equity method—The subsidiary’s equity accounts reflect beginning-of-year balances, yet the investment account reflects an end-ofyear balance. During the consolidation process, the subsidiary income and the parent’s share of the subsidiary’s declared dividends are closed to the investment account to return it to its beginning-of-year balance. (c) Cost method—The subsidiary’s equity accounts reflect beginning-of-year balances, yet the investment account reflects the balance on the date of acquisition. Therefore, the investment account is converted to its simple equity balance at the beginning of the period to create date alignment.

5. In 2015, consolidated net income would be reduced by $17,000 as a result of the inventory and equipment. The inventory would increase cost of goods sold by $5,000 ($55,000 – $50,000). The equipment would increase depreciation expense by $12,000 [($160,000 – $100,000) ÷ 5 years]. In 2016, consolidated net income would be reduced by $12,000 as a result of the equipment. The equipment would increase depreciation expense by $12,000 [($160,000 – $100,000) ÷ 5 years]. 6. The total noncontrolling interest will consist of 20% of the subsidiary’s common stock, paid-in capital in excess of par, retained earnings, dividends declared, and internally generated income. The NCI is shown, in total, as a subdivision of equity on the consolidated balance sheet. 7. Consolidated net income could exceed the sum of the separately calculated net incomes of the parent and subsidiary. This would occur if the fair value of the subsidiary’s net assets were less than their book value, resulting in a markdown of assets. The amortization of this markdown would decrease expense; therefore, consolidated net income is increased.

3. The noncontrolling share of consolidated net income is the outside ownership share of the subsidiary’s internally generated income as adjusted for amortizations created 3–1

Ch. 3—Exercises

3–2

EXERCISES EXERCISE 3-1 Determination and Distribution of Excess Schedule

Fair value of subsidiary ..................... Less book value of interest acquired: Common stock ($5 par)............... Paid-in capital in excess of par ... Retained earnings ....................... Total equity ............................ Interest acquired ......................... Book value ........................................ Excess of fair value over book value............................................

Company Implied Fair Value

Parent Price (80%)

NCI Value (20%)

$525,000*

$420,000

$105,000

$300,000 80% $240,000

$300,000 20% $ 60,000

$225,000

$180,000

$ 45,000

Adjustment

Worksheet Key

$ 50,000 100,000 150,000 $300,000

*$420,000/80% = $525,000 Adjustment of identifiable accounts:

Equipment ......................................... Goodwill ............................................ Total ............................................

(a)

$ 40,000 185,000 $225,000

Life

Amortization per Year

$8,000

debit D1 debit D2

Event 2015 Subsidiary income of $50,000 reported to parent

Investment in Huron Company .......... Subsidiary Income .......................

40,000

Dividends of $10,000 paid by Huron

Cash .................................................. Investment in Huron Company ....

8,000

2016 Subsidiary income of $45,000 reported to parent

Investment in Huron Company .......... Subsidiary Income .......................

36,000

Dividends of $10,000 paid by Huron

Cash .................................................. Investment in Huron Company ....

8,000

Simple Equity Method 40,000 8,000

36,000 8,000

3-3

Ch. 3—Exercises

Exercise 3-1, Concluded (b)

Event 2015 Subsidiary income of ($50,000 – $8,000 amortization) × 80% reported to parent

Investment in Huron Company .......... Subsidiary Income .......................

33,600

Dividends of $10,000 paid by Huron

Cash .................................................. Investment in Huron Company ....

8,000

Investment in Huron Company .......... Subsidiary Income .......................

29,600

Cash .................................................. Investment in Huron Company ....

8,000

2016 Subsidiary income of ($45,000 – $8,000 amortization) × 80% reported to parent Dividends of $10,000 paid by Huron

Sophisticated Equity Method 33,600

8,000

29,600

8,000

Cost Method No entry

Dividends of $10,000 paid by Huron

Cash .................................................. Dividend Income .........................

2016 Subsidiary income of $45,000 reported to parent

No entry

Dividends of $10,000 paid by Huron

Cash .................................................. Dividend Income .........................

8,000 8,000

Ch. 3—Exercises

3–4

EXERCISE 3-2 Determination and Distribution of Excess Schedule

Company Implied Fair Value

Parent Price (75%)

NCI Value (25%)

$616,667*

$462,500

$154,167

$400,000 75% $300,000

$400,000 25% $100,000

$216,667

$162,500

$ 54,167

Adjustment

Worksheet Key

Life

Amortization per Year

$ 10,000

debit D1

100,000

debit D2

$5,000

20,000 86,667 $216,667

debit D3 debit D4

2,000

$ 50,000 150,000 200,000 $400,000

*$462,500/75% = $616,667 Adjustment of identifiable accounts:

Inventory ($50,000 fair – $40,000 book value).................................. Buildings and equipment ($300,000 fair – $200,000 book value).................................. Patent ($50,000 fair – $30,000 fair value) ...................... Goodwill ............................................ Total ............................................

(a) Simple equity ........................................................................................ + (75% × Increase in Retained Earnings of $78,000*) ......................... Balance .................................................................................................

$462,500 58,500** $521,000

(b) Sophisticated equity.............................................................................. + (75% × Increase in Retained Earnings of $78,000*) ......................... – 2014 Amortization of Excess 75% × ($10,000 Inventory + $5,000 Buildings and Equipment + $2,000 Patent) ................................................................................ – 2015 Amortization of Excess 75% × ($5,000 Buildings and Equipment + $2,000 Patent) ............ Balance .................................................................................................

$462,500 58,500**

(c) Cost ...................................................................................................... *Shaw’s ending retained earnings, December 31, 2015 ..................... – Shaw’s beginning retained earnings, January 1, 2014 .................. Increase in retained earnings ............................................................ **Or 75% × ($70,000 – $20,000 + $48,000 – $20,000)

$462,500 $278,000 200,000 $ 78,000

(12,750) (5,250) $503,000

3-5

Ch. 3—Exercises

EXERCISE 3-3 (1) Determination and Distribution of Excess Schedule Company Implied Fair Value

Parent Price (80%)

NCI Value (20%)

Fair value of subsidiary .............. $375,000* Less book value of interest acquired: Common stock ($10 par) ........ $100,000 Retained earnings .................. 150,000 Total equity ......................... $250,000 Interest acquired..................... Book value ................................. Excess of fair value over book value ....................................... $125,000

$300,000

$ 75,000

$250,000 80% $200,000

$250,000 20% $ 50,000

$100,000

$ 25,000

Worksheet Key

Life

Amortization per Year

$5,000

*$300,000/80% = $375,000 Adjustment of identifiable accounts: Adjustment Fixed assets............................... Goodwill ..................................... Total ...................................... (2) (CY1)

(CY2)

(EL)

(D)

(A)

$ 50,000 75,000 $125,000

debit D1 debit D2

Subsidiary Income ................................................................... Investment in Sargent Company ....................................... To eliminate parent’s share of subsidiary earnings for the current year.

20,000

Investment in Sargent Company ($5,000 × 80%) ................... Dividends Declared ........................................................... To eliminate parent’s share of dividends for the current year.

4,000

Common Stock—Sargent ($100,000 × 80%) .......................... Retained Earnings—Sargent ($150,000 × 80%) ..................... Investment in Sargent Company ....................................... To eliminate pro rata share of the beginning-ofyear Sargent equity balances.

80,000 120,000

Depreciable Fixed Assets ........................................................ Goodwill................................................................................... Investment in Sargent Company ....................................... Retained Earnings—Sargent (NCI adjustment)................. To distribute excess per determination and distribution of excess schedule.

50,000 75,000

Depreciation Expense ............................................................. Accumulated Depreciation................................................. To amortize excess for the current year.

5,000

20,000

4,000

200,000

100,000 25,000

5,000

Ch. 3—Exercises

3–6

Exercise 3–3, Continued (3)

Parker Company and Sargent Company Consolidated Income Statement For Year Ended December 31, 2015 Sales ................................................................................................................ Less expenses (add $5,000 adjustment) ......................................................... Consolidated net income .................................................................................

$250,000 190,000 $ 60,000

Distributed to noncontrolling interest ............................................................... Distributed to controlling interest .....................................................................

4,000 $ 56,000

Subsidiary Sargent Company Income Distribution Depreciation adjustment .......

$5,000

Internally generated net income .................................

$25,000

Adjusted income ........................ NCI share ................................... NCI .............................................

$20,000 × 20% $ 4,000

Parent Parker Company Income Distribution Internally generated net income ................................. 80% × Sargent adjusted income of $20,000 ............... Controlling interest .....................

(4)

$40,000 16,000 $56,000

Parker Company and Subsidiary Sargent Company Consolidated Statement of Retained Earnings For the Year Ended December 31, 2015

Retained earnings, January 1, 2015 ................. Consolidated net income .................................. Dividends declared ........................................... Retained earnings, December 31, 2015 ...........

Noncontrolling Interest $30,000 4,000 (1,000) $33,000

Controlling Retained Earnings $200,000 56,000 $256,000

3-7

Ch. 3—Exercises

Exercise 3–3, Concluded (5)

Parker Company and Sargent Company Consolidated Balance Sheet December 31, 2015 Assets Current assets .......................................................................... Depreciable fixed assets........................................................... Less accumulated depreciation ................................................ Goodwill .................................................................................... Total assets .............................................................................. Liabilities and Stockholders’ Equity Current liabilities ....................................................................... Stockholders’ equity: Controlling interest: Common stock ($10 par) ................................................ Retained earnings .......................................................... Noncontrolling interest ........................................................

$650,000 131,000b

$140,000 519,000 75,000 $734,000 $100,000

$300,000 256,000

Total liabilities and stockholders’ equity....................................

556,000 78,000c $734,000

$400,000 + $200,000 + $50,000 = $650,000 $106,000 + $20,000 + $5,000 = $131,000 c $75,000 fair value at acquisition + $4,000 share of income – $1,000 dividends = $78,000 b

EXERCISE 3-4 (1) (CY1)

(CY2)

(EL)

(D)

12,000

Investment in Sargent Company ............................................. Dividends Declared ........................................................... To eliminate parent’s share of dividends for the current year.

8,000

Common Stock—Sargent ........................................................ Retained Earnings—Sargent ($170,000 × 80%) ..................... Investment in Sargent Company ....................................... To eliminate pro rata share of the beginning-ofyear Sargent equity balances.

80,000 136,000

50,000 75,000

12,000

8,000

216,000

100,000 25,000

Ch. 3—Exercises

3–8

Exercise 3–4, Concluded (A)

(2)

Depreciation Expense ............................................................. Retained Earnings—Parker (80% × $5,000) ........................... Retained Earnings—Sargent (20% × $5,000) ......................... Accumulated Depreciation (2 years × $5,000) .................. To amortize excess for the prior and current years.

5,000 4,000 1,000 10,000

Parker Company and Sargent Company Consolidated Income Statement For Year Ended December 31, 2016 Sales ................................................................................................................ Less expenses (add $5,000 adjustment) ......................................................... Consolidated net income .................................................................................

$300,000 250,000 $ 50,000

2,000 $ 48,000

Subsidiary Sargent Company Income Distribution Depreciation adjustment ...... (A)

5,000

Internally generated net income .....................................

$15,000

Adjusted income ............................ NCI share ...................................... NCI ................................................

$10,000 × 20% $ 2,000

Parent Parker Company Income Distribution Internally generated net income ..................................... 80% × Sargent adjusted income of $10,000 ................... Controlling interest ........................

$40,000 8,000 $48,000

3-9

Ch. 3—Exercises

EXERCISE 3-5 (1) Same as Exercise 3, part (1). (2) (CY1) (CY2) (EL)

(D)

(A)

Subsidiary Income $20,000 – $4,000 amortization) ................ Investment in Sargent Company .......................................

16,000

Investment in Sargent Company ............................................. Dividends Declared ...........................................................

4,000

Common Stock—Sargent ........................................................ Retained Earnings—Sargent ................................................... Investment in Sargent Company .......................................

80,000 120,000

50,000 75,000

Depreciation Expense ............................................................. Accumulated Depreciation................................................. To amortize excess for the current year.

5,000

16,000 4,000

200,000

100,000 25,000

5,000

(3) Same as Exercise 3, part (3). (4) Same as Exercise 3, part (4). (5) Same as Exercise 3, part (5). EXERCISE 3-6 (1) (CY1) (CY2) (EL)

(D)

(A)

Subsidiary Income ................................................................... Investment in Sargent Company .......................................

8,000

Investment in Sargent Company ............................................. Dividends Declared ...........................................................

8,000

80,000 136,000

Depreciable Fixed Assets ($50,000 – $5,000 depr. for 2015) . Goodwill................................................................................... Investment in Sargent Company ($100,000 – $4,000 amort. for 2015) ................................................................. Retained Earnings—Sargent (NCI adjustment) ($25,000 – $1,000 amort. for 2015) .................................................. To distribute remaining excess per determination and distribution of excess schedule.

45,000 75,000

Depreciation Expense ............................................................. Accumulated Depreciation................................................. To amortize excess for the current year.

5,000

8,000 8,000

216,000

96,000 24,000

5,000

(2) Same as Exercise 4, part (2).

Ch. 3—Exercises

3–10

EXERCISE 3-7 (1) Same as Exercise 3, part (1). (2) (CY2)

(EL)

(D)

(A)

Dividend Income ...................................................................... Dividends Declared ........................................................... To eliminate parent’s share of subsidiary dividends for the current year.

4,000

80,000 120,000

50,000 75,000

Depreciation Expense ............................................................. Accumulated Depreciation................................................. To amortize excess for the current year.

5,000

4,000

200,000

100,000 25,000

5,000

(3) Same as Exercise 3, part (3). (4) Same as Exercise 3, part (4). (5) Same as Exercise 3, part (5).

3-11

Ch. 3—Exercises

EXERCISE 3-8 (1) (CV)

(CY2)

(EL)

(D)

(A)

Investment in Sargent Company ............................................. Retained Earnings—Parker ............................................... Convert from cost to equity method by adding to investment account parent’s share of subsidiary equity increase. [80% × ($170,000 – $150,000)]

16,000

8,000

80,000 136,000

50,000 75,000

5,000 4,000 1,000

16,000

8,000

216,000

100,000 25,000

10,000

(2) Same as Exercise 4, part (2). EXERCISE 3-9 Amortization Schedule Account Adjustments Inventory ........................................ Amortization: Investments .............................. Buildings (net) .......................... Equipment (net)........................ Patent ....................................... Trademark ................................ Discount on Bonds Payable ..... Total .........................................

Life

Annual Amount

2015

$ 6,250

3 20 5 10 10 5

5,000 12,500 34,500 2,250 2,000 2,500

5,000 12,500 34,500 2,250 2,000 2,500 $65,000

2016

2017

2018

$ 5,000 12,500 34,500 2,250 2,000 2,500 $58,750

$ 0 12,500 34,500 2,250 2,000 2,500 $53,750

Ch. 3—Exercises

3–12

EXERCISE 3-10 (1) Determination and Distribution of Excess Schedule Company Implied Fair Value

Parent Price (80%)

NCI Value (20%)

Fair value of subsidiary .............. $387,500 Less book value of interest acquired: Common stock ...................... $100,000 Retained earnings ................. 300,000 Total equity ...................... $400,000 Interest acquired ................... Book value ................................. Excess of fair value over book value ...................................... $ (12,500)

$310,000

$ 77,500

$400,000 80% $320,000

$400,000 20% $ 80,000

$ (10,000)

$ (2,500)

Worksheet Key

Life

Amortization per Year

credit D

$(2,500)

Adjustment of identifiable accounts: Adjustment Fixed assets ................................ Total ...................................... (2) (EL)

(D)

(A)

(3)

$(12,500) $(12,500)

Common Stock—Kraus ........................................................... Retained Earnings—Kraus ...................................................... Investment in Kraus Company .......................................... To eliminate pro rata share of the beginning-ofyear Kraus equity balances and purchased income.

80,000 240,000

Investment in Kraus Company ................................................ Retained Earnings—Kraus (NCI adjustment) .......................... Equipment ......................................................................... To distribute excess book value to plant assets.

10,000 2,500

Accumulated Depreciation [($12,500 ÷ 5) × 1/2] ..................... General Expenses ............................................................. To reduce depreciation expense for one-half year.

1,250

320,000

12,500

1,250

Neiman Company and Subsidiary Kraus Company Consolidated Income Statement For Year Ended December 31, 2016 Sales ..................................................................................................... Less cost of goods sold ........................................................................ Gross profit ........................................................................................... Less general expenses (less $1,250 adjustment) ................................ Consolidated net income ...................................................................... Distributed to noncontrolling interest .................................................... Distributed to controlling interest ..........................................................

$400,000 225,000 $175,000 83,750 $ 91,250 6,250 $ 85,000

3-13

Ch. 3—Exercises

Exercise 3-10, Concluded Subsidiary Kraus Company Income Distribution Internally generated net income .................................... Adjustment of depreciation ...........

$30,000 1,250

Adjusted income ........................... NCI share ...................................... NCI ................................................

$31,250 × 20% $ 6,250

Parent Neiman Company Income Distribution Internally generated net income .................................... 80% × Kraus adjusted income of $31,250 (past 6 months) ....................... Controlling interest ........................

$60,000 25,000 $85,000

EXERCISE 3-11 Calculation of book value of Subsidiary: Fair value at purchase ....................................................................................... Add $200,000 increase in Barker retained earnings ......................................... Deduct amortization of excess (5 years × $10,000 per year) ............................ Book value balance............................................................................................

$1,062,500 200,000 (50,000) $1,212,500

Fair value of Barker Company, December 31, 2019 (given) ..............................

$1,000,000

Since the adjusted (for acquisition) book value ($1,212,500) exceeds the fair value balance ($1,000,000), goodwill is impaired. Impairment loss: Fair value of Barker Company ........................................................................... Fair value of Barker Company identifiable assets .............................................. Estimated goodwill ............................................................................................. Existing goodwill ................................................................................................ Impairment loss..................................................................................................

$1,000,000 900,000 $ 100,000 262,500 $ 162,500

Ch. 3—Exercises

3–14

APPENDIX EXERCISES EXERCISE 3B-1 (1) Investment in Largo Company ........................................................ Common Stock ........................................................................... Paid-In Capital in Excess of Par ................................................. (2) Value Analysis Schedule Company fair value ........................................... Fair value of net assets excluding goodwill ...... Goodwill ............................................................

500,000 100,000 400,000

Company Implied Fair Value

Parent Price (100%)

NCI Value (0%)

$500,000 386,000 $114,000

$500,000 386,000* $114,000

N/A

*$330,000 equity + $80,000 asset adjustment – $24,000 (30% tax × $80,000) DTL Based on the above information, the following D&D schedule is prepared: Determination and Distribution of Excess Schedule Company Implied Fair Value

Parent Price (100%)

NCI Value (0%)

Fair value of subsidiary .............. $500,000 Less book value of interest acquired: Common stock ($10 par) ........ $100,000 Retained earnings .................. 230,000 Total equity ......................... $330,000 Interest acquired..................... Book value ................................. Excess of fair value over book value ....................................... $170,000

$500,000

N/A

$330,000 100% $330,000 $170,000

Adjustment of identifiable accounts:

Inventory ($120,000 fair – $100,000 book value) ............ Deferred tax liability (30% tax rate × $20,000) ...................... Depreciable fixed assets ($270,000 fair – $210,000 book value) ............................ Deferred tax liability (30% tax rate × $60,000) ...................... Goodwill ..................................... Total ......................................

Adjustment

Worksheet Key

Amortization per Year

Life

$ 20,000

debit D1

(6,000)

credit D1t

60,000

debit D2

$6,000

(18,000) 114,000 $170,000

credit D2t debit D3

(1,800)

3-15

Ch. 3—Exercises

Exercise 3B-1, Concluded (3) Elimination Entries: Common Stock ............................................................................... Retained Earnings .......................................................................... Investment in Largo Company ...................................................

100,000 230,000

Inventory ......................................................................................... Equipment....................................................................................... Goodwill .......................................................................................... Deferred Tax Liability (on inventory and equipment) ................. Investment in Largo Company ...................................................

20,000 60,000 114,000

330,000

24,000 170,000

EXERCISE 3B-2 (1) Value Analysis Schedule Company fair value ........................................... Fair value of net assets excluding goodwill ...... Goodwill ............................................................

Company Implied Fair Value

Parent Price (90%)

NCI Value (10%)

$520,000 329,000* $191,000

$468,000 296,100 $171,900

$52,000 32,900 $19,100

*$280,000 equity + $70,000 asset adjustment – $21,000 (30% tax × $70,000) DTL Based on the above information, the following D&D schedule is prepared: Determination and Distribution of Excess Schedule Company Implied Fair Value

Parent Price (90%)

NCI Value (10%)

Fair value of subsidiary .............. $520,000 Less book value of interest acquired: Common stock ($5 par) .......... $100,000 Paid-in capital in excess of par 130,000 Retained earnings .................. 50,000 Total equity ......................... $280,000 Interest acquired..................... Book value ................................. Excess of fair value over book value ....................................... $240,000

$468,000

$ 52,000

$280,000 90% $252,000

$280,000 10% $ 28,000

$216,000

$ 24,000

Ch. 3—Exercises

3–16

Exercise 3B-2, Continued Adjustment of identifiable accounts:

Inventory .................................... Deferred tax liability (30% tax rate × $20,000) ...................... Depreciable fixed assets............ Deferred tax liability (30% tax rate × $50,000) ...................... Goodwill ..................................... Total ...................................... (2)

Adjustment

Worksheet Key

Life

Amortization per Year

$ 20,000

debit D1

(6,000) 50,000

credit D1t debit D2

1 10

$5,000

(15,000) 191,000 $240,000

credit D2t debit D3

(1,500)

Lucy Company and Subsidiary Diamond Company Consolidated Income Statement For Year Ended December 31, 2015 Sales ......................................................................................... Less cost of goods sold (add $20,000 adjustment) .................. Gross profit ............................................................................... Less expenses: General expenses............................................................... Depreciation expense (add $5,000 adjustment) ................. Consolidated income before tax ......................................... Provision for tax (30%) ............................................................. Consolidated net income .......................................................... Distributed to NCI ..................................................................... Distributed to controlling interest ..............................................

$550,000 310,000 $240,000 $75,000 80,000

155,000 $ 85,000 25,500 $ 59,500 (350) $ 59,850

3-17

Ch. 3—Exercises

Exercise 3B-2, Concluded Subsidiary Diamond Company Income Distribution Inventory consumption............. Building depreciation ...............

$20,000 5,000

Internally generated income before tax ...............

$20,000

Adjusted income before tax ...... Provision for tax, 30% ............... Adjusted net income ................. NCI share .................................. NCI ............................................

$ (5,000) 1,500 $ (3,500) × 10% $ (350)

Parent Lucy Company Income Distribution Internally generated income before tax .................... Adjusted income ............................ Tax, 30% ....................................... Adjusted net income ...................... 90% × Diamond adjusted net income of ($3,500) ............ Controlling interest ........................

$ 90,000 $ 90,000 (27,000) $ 63,000 (3,150) $ 59,850

Ch. 3—Exercises

3–18

EXERCISE 3B-3

Company Implied Fair Value

Parent Price (100%)

NCI Value (0%)

$700,000 445,000* $255,000

$700,000 455,000 $255,000

N/A

*$350,000 equity + $50,000 asset adjustment – $15,000 (30% tax × $50,000) DTL + $60,000 deferred tax expense ($200,000 × 30%) Based on the above information, the following D&D schedule is prepared: Determination and Distribution of Excess Schedule

Fair value of subsidiary ..................... Less book value of interest acquired: Common stock ($5 par)............... Retained earnings ....................... Total equity ............................ Interest acquired ......................... Book value ........................................ Excess of fair value over book value............................................

Company Implied Fair Value

Parent Price (100%)

NCI Value (0%)

$700,000

N/A

$250,000 100,000 $350,000

$350,000 100% $350,000

$350,000

Adjustment

Worksheet Key

Life

Amortization per Year

$ 50,000

debit D1

$5,000

(15,000)

credit D1t

(1,500)

12,000

debit D2

48,000 255,000 $350,000

debit D3 debit D4

Adjustment of identifiable accounts:

Buildings and equipment ................... Deferred tax liability (30% tax rate × $50,000)............................ Current deferred tax expense ($40,000 × 30%) ......................... Noncurrent deferred tax expense ($160,000 × 30%) ....................... Goodwill ............................................ Total ............................................

3-19

Ch. 3—Problems

PROBLEMS PROBLEM 3-1 (1) Value Analysis Schedule Company fair value ........................................... Fair value of net assets excluding goodwill ...... Goodwill ............................................................

Company Implied Fair Value

Parent Price (80%)

NCI Value (20%)

$950,000 710,000** $240,000

$800,000 568,000 $232,000

$150,000* 142,000 $ 8,000

*2,000 shares × $80 **$550,000 equity + $160,000 asset adjustments Based on the above information, the following D&D schedule is prepared: Determination and Distribution of Excess Schedule Company Implied Fair Value

Parent Price (80%)

NCI Value (20%)

Fair value of subsidiary .............. $9500,000 Less book value of interest acquired: Common stock ($10 par) ........ $100,000 Paid-in capital in excess of par 200,000 Retained earnings .................. 250,000 Total equity ......................... $550,000 Interest acquired ........................ Book value ................................. Excess of fair value over book value ....................................... $400,000

$800,000

$150,000

$550,000 80% $440,000

$550,000 20% $110,000

$360,000

$ 40,000

Adjustment

Worksheet Key

Life

Amortization per Year

$ 60,000

debit D1

100,000 240,000 $400,000

debit D2 debit D3

$5,000

Adjustment of identifiable accounts:

Land ($180,000 book – $120,000 fair value) .............. Building ($450,000 book – $350,000 fair value) .............. Goodwill ..................................... Total ......................................

Ch. 3—Problems

3-20

Problem 3-1, Continued (2) Investment Entries: Simple Equity Method Investment Entries 2015 Subsidiary reports Investment in income of $60,000. Solvo Company ......... 48,000 Subsidiary Income (80% × reported) .... 48,000 Subsidiary pays $10,000 dividend.

2016 Subsidiary reports income of $50,000.

Subsidiary pays $10,000 dividend.

Cash .......................... Investment in Solvo Company (80% × declared) ....

8,000 8,000

Sophisticated Equity Method Investment in Solvo Company ............. 44,000 Subsidiary Income [80% × (reported – $5,000 depreciation)] . 44,000

No entry

Cash .............................. Investment in Solvo Company (80% × declared) .......

Cash .............................. Dividend (or Investment) Income .......................

8,000 8,000

Investment in Solvo Company ......... 40,000 Subsidiary Income (80% × reported) .... 40,000

Investment in Solvo Company ............. 36,000 Subsidiary Income [80% × (reported – 36,000 $5,000 depreciation)] .

Cash .......................... Investment in Solvo Company (80% × declared) ....

Cash .............................. Investment in Solvo Company (80% × declared) .......

8,000 8,000

Cost Method

8,000 8,000

No entry

Cash .............................. Dividend (or Investment) Income .......................

part.

8,000 8,000

3-21

Ch. 3—Problems

Problem 3-1, Continued Eliminations 2015 (CY1) Eliminated currentyear entries. (CY2)

Simple Equity Method

Sophisticated Equity Method

Subsidiary Income ..... 48,000 Investment in Solvo Company ...... 48,000

Subsidiary Income ........ 44,000 Investment in Solvo Company ......... 44,000

No conversion needed first year

Investment in Solvo Company ......... Dividends Declared

Investment in Solvo Company…… Dividends Declared....

Dividend Income ........... Dividends Declared....

8,000 8,000

8,000

Cost Method

8,000 8,000

8,000

(EL) Eliminate investment as of January 1.

Common Stock .......... 80,000 Paid-In Capital in Excess of Par ............ 160,000 Retained Earnings ..... 200,000 Investment in Solvo Company ...... 440,000

Common Stock.............. 80,000 Paid-In Capital in Excess of Par ................ 160,000 Retained Earnings ........ 200,000 Investment in Solvo Company ......... 440,000

(D) Distribute excess.

Land ........................... 60,000 Building ...................... 100,000 Goodwill ..................... 240,000 Investment in Solvo Company ...... 360,000 RE—Solvo (NCI) ... 40,000

Land .............................. 60,000 Building ......................... 100,000 Goodwill ........................ 240,000 Investment in Solvo Company ......... 360,000 RE—Solvo (NCI) ........ 40,000

(A) Amortize excess for current year.

Depr. Expense ........... Acc. Depreciation ...

Depr. Expense .............. Acc. Depreciation .......

5,000 5,000

part.

5,000 5,000

Ch. 3—Problems

3–22

Problem 3-1, Concluded Simple Equity Method

Sophisticated Equity Method

Eliminations 2016 (CV)

Cost Method Investment in Solvo Company (80% × $50,000) ........... 40,000 RE—Port .................... 40,000

Equity conversion. (CY1) Eliminated currentyear entries.

Subsidiary Income ..... 40,000 Investment in Solvo Company ...... 40,000

Subsidiary Income ........ 36,000 Investment in Solvo Company ......... 36,000

(CY2)

Investment in Solvo Company ......... Dividends Declared

Investment in Solvo Company ............. Dividends Declared....

8,000 8,000

Dividend Income ........... Dividends Declared....

8,000 8,000

(EL) Eliminate investment as of January 1.

Common Stock .......... 80,000 Paid-In Capital in Excess of Par ............ 160,000 Retained Earnings ..... 240,000 Investment in Solvo Company ...... 480,000

Common Stock.............. 80,000 Paid-In Capital in Excess of Par ................ 160,000 Retained Earnings ........ 240,000 Investment in Solvo Company ......... 480,000

(D) Distribute excess.

Land ........................... 60,000 Building ...................... 100,000 Goodwill ..................... 240,000 Investment in Solvo Company ...... 360,000 RE—Solvo (NCI) ... 40,000

Land .............................. 60,000 Building (19 years) ........ 95,000 Goodwill ........................ 240,000 Investment in Solvo Company ......... 356,000 RE—Solvo (NCI) ........ 39,000

(A) Amortize excess for current and prior years.

RE—Solvo ................. RE—Port ................... Depr. Expense ........... Acc. Depreciation ...

Depr. Expense .............. Acc. Depreciation .......

RE—Solvo..................... RE—Port ....................... Depr. Expense .............. Acc. Depreciation .......

4,000 1,000 5,000 10,000

5,000 5,000

part.

4,000 1,000 5,000 10,000

3-23

Ch. 3—Problems

PROBLEM 3-2 (1) Value Analysis Schedule Company fair value ........................................... Fair value of net assets excluding goodwill ...... Goodwill ............................................................

Company Implied Fair Value

Parent Price (80%)

NCI Value (20%)

$400,000 340,000 $ 60,000

$320,000 272,000 $ 48,000

$80,000 68,000 $12,000

Determination and Distribution of Excess Schedule Company Implied Fair Value

Parent Price (80%)

NCI Value (20%)

Fair value of subsidiary .............. $400,000 Less book value of interest acquired: Common stock ...................... $ 50,000 Paid-in capital in excess of par 100,000 Retained earnings ................. 150,000 Total equity ...................... $300,000 Interest acquired ................... Book value ................................. Excess of fair value over book value ...................................... $100,000

$320,000

$ 80,000

$300,000 80% $240,000

$300,000 20% $ 60,000

$ 80,000

$ 20,000

Worksheet Key

Life

Amortization per Year

$3,000

Adjustment of identifiable accounts: Adjustment Inventory .................................... Buildings .................................... Goodwill ..................................... Total ......................................

$ 10,000 30,000 60,000 $100,000

debit D1 debit D2 debit D3

Ch. 3—Problems

3–24

Problem 3-2, Continued (2)

Paro Company and Solar Company Worksheet for Consolidated Financial Statements For Year Ended December 31, 2016

NCI

Controlling Retained Earnings

Consolidated Balance Sheet

........... ........... ........... ........... ........... ........... ........... ........... ........... ........... ........... ........... ........... ........... (10,000)

........... ........... ........... ........... ........... ........... ........... ........... ........... ........... ........... ........... ........... ........... ...........

150,000 316,000 ........... ........... ........... ........... 100,000 700,000 (166,000) 60,000 20,000 (160,000) (100,000) (200,000) ...........

........... ........... ........... ........... ...........

(20,000) (55,400) ........... ........... ...........

........... ........... ........... ........... ...........

...........

(200,000)

........... ........... ........... ........... ........... (100,000) ............ (214,000) ............ ........... ........... ........... ........... ........... ........... ............ (D1) 8,000 ........... ........... ........... ........... ........... ............ (A2) 2,400 ........... ........... ........... ........... ........... ........... ........... ........... ........... (203,600) ............ Sales ............................................................... (520,000) (450,000) ........... ........... (970,000) ........... ........... Cost of Goods Sold ......................................... 300,000 260,000 ........... ........... 560,000 ........... ........... Operating Expenses ....................................... 120,000 100,000 (A2) 3,000 ........... 223,000 ........... ........... Subsidiary Income .......................................... (72,000) ............ (CY1) 72,000 ........... ........... ........... ........... Dividends Declared—Solar ............................. ........... 30,000 ........... (CY2) 24,000 ........... 6,000 ........... ............ ............ ............ ........... ........... 50,000 Dividends Declared—Paro .............................. 50,000 Totals .......................................................... 0 0 474,000 474,000 ........... ........... ........... Consolidated Net Income ..................................................................................................................................................... (187,000) ........... ........... NCI Share ............................................................................................................................................................................ 17,400 (17,400) ........... Controlling Share ................................................................................................................................................................. (169,600) .......... (169,600) NCI ................................................................................................................................................................................................................ (96,800) ............ Controlling Retained Earnings .............................................................................................................................................................................................. (323,200) Totals ........................................................................................................................................................................................................................................................

(100,000) ........... ........... ........... ........... ........... ........... ........... ........... ........... ........... ........... ........... ........... ........... (96,800) (323,200) 0

Inventory ......................................................... Other Current Assets ...................................... Investment in Solar .........................................

Land ................................................................ Buildings and Equipment ................................ Accumulated Depreciation .............................. Goodwill .......................................................... Other Intangible Assets ................................... Current Liabilities ............................................ Bonds Payable ................................................ Other Long-Term Liabilities............................. Common Stock—Solar ................................... Other Paid-In Capital in Excess of Par—Solar .................................. Retained Earnings—Solar ..............................

Common Stock—Paro .................................... Other Paid-In Capital in Excess of Par—Paro................................... Retained Earnings—Paro ...............................

Cr.

Consolidated Net Income

........... ........... 72,000 ........... 272,000 80,000 ........... ........... 6,000 ........... ........... ........... ........... ........... ...........

........... ........... ........... ........... ........... ........... ........... ........... ........... ........... ........... ........... ........... ........... ...........

........... .......... 20,000 ........... ........... ...........

Eliminations

Trial Balance Paro Solar

Dr.

100,000 136,000 400,000 ........... ........... ........... 50,000 350,000 (100,000) ........... 20,000 (120,000) ........... (200,000) ...........

50,000 180,000 ............ ............ ............ ............ 50,000 320,000 (60,000) ............ ............ (40,000) (100,000) ............ (50,000)

........... ........... ........... 24,000 ........... ........... ........... 30,000 ........... 60,000 ........... ........... ........... ........... 40,000

........... ........... ........... ........... ...........

(100,000) (190,000) ............ ............ ............

(200,000)

............

(CY2)

(D2) (D3)

(EL) (EL) (EL) (D1) (A2)

80,000 152,000 ........... 2,000 600 ...........

(CY1) (EL) (D) (A2)

(NCI)

part.

3–25

Ch. 3—Problems

Problem 3-2, Concluded Eliminations and Adjustments: (CY1) Current-year subsidiary income. (CY2) Current-year dividend. (EL) Eliminate controlling interest in the subsidiary equity. (D)/(NCI) Distribute excess and adjust NCI. (D1) Inventory (retained earnings). (D2) Buildings and equipment. (D3) Goodwill. (A2) Amortize excess. Income Distribution Schedules Solar Company Amortizations .................................

$3,000

Internally generated net income ....................................

$90,000

Adjusted income ........................... NCI share ...................................... NCI ................................................

$87,000 20% $17,400

Paro Company Internally generated net income .............................. $100,000 Controlling share of subsidiary ..... 69,600 Controlling interest ........................ $169,600

PROBLEM 3-3 (1) Use part (1), from Problem 3-2. (2) Entries under the sophisticated equity method:

2015 Debit

Credit

37,600a

Investment in Solar ...................................... Subsidiary Income ................................. Cash ............................................................ Investment in Solar ................................

Debit

2016 Credit

69,600b 37,600

16,000

16,000c

69,600 24,000

24,000d

80% of ($60,000 net income less $13,000) ($10,000 write-off of inventory and $3,000 extra depreciation) b 80% of ($90,000 net income less $3,000) (extra depreciation) c 80% of $20,000 dividends d 80% of $30,000 dividends (3) Balance in Investment in Solar Company: $320,000 + $37,600 – $16,000

$69,600

–

$24,000

$387,200

Ch. 3—Problems

3–26

Problem 3-3, Continued (4)

Paro Company and Solar Company Worksheet for Consolidated Financial Statements For Year Ended December 31, 2016 Eliminations and Adjustments Dr. Cr.

Trial Balance Paro Solar Inventory, December 31 ......................... Other Current Assets ............................. Investment in Solar ................................

100,000 136,000 387,200 .......... .......... 50,000 350,000 (100,000)

50,000 180,000 .......... .......... .......... 50,000 320,000 (60,000)

(CY2)

.......... .......... 24,000 .......... .......... .......... 30,000 .......... .......... 60,000 .......... .......... .......... .......... ..........

(CY1) (EL) (D)

.......... .......... 69,600 272,000 69,600 .......... .......... 3,000 3,000 .......... .......... .......... .......... .......... ..........

Consolidated Income Statement ......... ......... ......... ......... ......... ......... ......... .........

NCI

Controlling Retained Earnings

Consolidated Balance Sheet

.......... .......... .......... .......... .......... .......... .......... ..........

150,000 316,000 .......... .......... .......... 100,000 700,000 (166,000)

.......... .......... .......... .......... .......... ..........

60,000 20,000 (160,000) (100,000) (200,000) (200,000)

.......... (203,600) ..........

(100,000) .......... ..........

.......... .......... .......... .......... .......... .......... 50,000 .......... .......... .......... .......... (169,600) .......... (323,200)

.......... .......... .......... .......... .......... .......... .......... .......... .......... .......... .......... .......... (96,800) (323,200) 0

Land ....................................................... Buildings and Equipment ....................... (D2) Accumulated Depreciation ..................... (D2) ............................................................... (A2) Goodwill ................................................. .......... .......... (D3) ......... .......... Other Intangibles .................................... 20,000 .......... ......... .......... Current Liabilities ................................... (120,000) (40,000) ......... .......... Bonds Payable ....................................... .......... (100,000) ......... .......... Other Long-Term Liabilities .................... (200,000) .......... ......... .......... Common Stock—Paro ........................... (200,000) .......... ......... .......... Other Paid-In Capital in Excess of Par—Paro ........................................... (100,000) .......... .......... .......... ......... .......... Retained Earnings—Paro ...................... (203,600) .......... .......... .......... ......... .......... Common Stock—Solar ........................... .......... (50,000) (EL) 40,000 .......... ......... (10,000) Other Paid-In Capital in Excess of Par—Solar .......................................... .......... (100,000) (EL) 80,000 .......... ......... (20,000) Retained Earnings—Solar ...................... .......... (190,000) (EL) 152,000 (NCI) 17,400 ......... (55,400) Net Sales ............................................... (520,000) (450,000) .......... .......... (970,000) .......... Cost of Goods Sold ................................ 300,000 260,000 .......... .......... 560,000 .......... Operating Expenses ............................... 120,000 100,000 (A2) 3,000 .......... 223,000 .......... Subsidiary Income.................................. (69,600) .......... (CY1) 69,600 .......... ......... .......... Dividends Declared—Paro ..................... 50,000 .......... .......... .......... ......... .......... Dividends Declared—Solar .................... .......... 30,000 .......... (CY2) 24,000 ......... 6,000 0 458,600 458,600 ......... .......... Total ................................................... 0 Consolidated Net Income ............................................................................................................................... (187,000) .......... (17,400) To Noncontrolling Interest (see distribution schedule) ................................................................................ 17,400 To Controlling Interest (see distribution schedule)...................................................................................... 169,600 .......... Total NCI ............................................................................................................................................................................. (96,800) Retained Earnings—Controlling Interest, December 31, 2016 ..................................................................................................................

part.

3-27

Ch. 3—Problems

Problem 3-3, Concluded Eliminations and Adjustments: (CY) Eliminate the current-year entries made in the investment account and in the subsidiary income account. (EL) Eliminate the pro rata share of Solar Company equity balances at the beginning of the year against the investment account. (D)/(NCI) Distribute the $69,600 remaining excess of cost over book value ($80,000 less 2015 charges of $8,000 to Cost of Goods Sold for inventory and $2,400 to Operating Expenses for extra depreciation). Adjust NCI, $17,400 ($20,000 on acquisition date – 20% × $13,000 amortizations for 2015). (D2) Buildings for $30,000 for 2015 and accumulated depreciation for $3,000 for 2015. (D3) Goodwill for $56,000. (A2) For 2016 only, depreciate the write-up to Buildings and Equipment for $3,000 and increase depreciation expense. Use income distribution schedules from Problem 3-2. PROBLEM 3-4 (1) Determination and Distribution of Excess Schedule Company Implied Fair Value

Parent Price (100%)

NCI Value (0%)

Fair value of subsidiary .............. $400,000 Less book value of interest acquired: Common stock ($5 par) ......... $ 50,000 Paid-in capital in excess of par 15,000 Retained earnings ................. 135,000 Total equity ...................... $200,000 Interest acquired ................... Book value ............................ Excess of fair value over book value ...................................... $200,000

$400,000

N/A

$200,000 100% $200,000 $200,000

Adjustment of identifiable accounts: Adjustment Fixed assets............................... Goodwill ..................................... Total ......................................

$ 50,000 150,000 $200,000

Worksheet Key debit D1 debit D2

Life

Amortization per Year

$5,000

Ch. 3—Problems

3–28

Problem 3-4, Concluded (2)

Charles Company and Subsidiary Lehto, Inc. Consolidated Income Statement For Year Ended December 31, 2017 Revenue ............................................................................................... Expenses ($450,000 + $170,000 + $5,000 depreciation) ..................... Consolidated net income ......................................................................

$670,000 625,000 $ 45,000

Charles Company and Subsidiary Lehto, Inc. Retained Earnings Statement For Year Ended December 31, 2017 Retained earnings, Charles Company, January 1, 2017 ($230,000 Charles + $35,000 equity conversion) ...........................

$265,000

Add consolidated net income................................................................ Less dividends declared ....................................................................... Balance, December 31, 2017 ...............................................................

45,000 (10,000) $300,000

Charles Company and Subsidiary Lehto Inc. Consolidated Balance Sheet December 31, 2017 Assets Current assets .......................................................................... Depreciable fixed assets ($1,805,000 + $440,000 + $50,000) . $2,295,000 Accumulated depreciation (($405,000 + $70,000 + $5,000) (480,000) Goodwill .................................................................................... Total assets ..............................................................................

$ 720,000 1,815,000 150,000 $2,685,000

Liabilities and Stockholders’ Equity Liabilities ................................................................................... Stockholders’ equity: Common stock ($1 par) ...................................................... $ 220,000 Paid-in capital in excess of par ........................................... 1,040,000 Retained earnings............................................................... 300,000 Total liabilities and stockholders’ equity....................................

$1,125,000

1,560,000 $2,685,000

3-29

Ch. 3—Problems

PROBLEM 3-5 (1) Determination and Distribution of Excess Schedule Company Implied Fair Value

Parent Price (100%)

NCI Value (0%)

Fair value of subsidiary .............. $220,000 Less book value of interest acquired: Common stock ($10 par) ....... $100,000 Paid-in capital in excess of par 50,000 Retained earnings ................. 100,000 Total equity ...................... $250,000 Interest acquired ................... Book value ................................. Excess of fair value over book value ...................................... $ (30,000)

$220,000

N/A

$250,000 100% $250,000 $ (30,000)

Adjustment of identifiable accounts:

Building ......................................

Adjustment

Worksheet Key

Life

Amortization per Year

$(30,000)

debit D

$(3,000)

Ch. 3—Problems

3-30

Problem 3-5, Continued (2)

Bell Corporation and Subsidiary Stockdon Corporation Worksheet for Consolidated Financial Statements For Year Ended December 31, 2017 Trial Balance Bell Stockdon 180,000 143,000 60,000 30,000 120,000 120,000 600,000 162,000 220,000 .......... (405,000) (210,000) (300,000) .......... (180,000) .......... (255,000) .......... .......... (100,000)

Eliminations and Adjustments Dr. Cr. .......... .......... .......... .......... .......... .......... 3,000 (D) 30,000 30,000 (EL) 250,000 .......... .......... .......... .......... .......... .......... .......... .......... 100,000 ..........

Consolidated Income Statement ......... ......... ......... ......... ......... ......... ......... ......... ......... .........

NCI .......... .......... .......... .......... .......... .......... .......... .......... .......... ..........

Cash....................................................... Inventory ................................................ Land ....................................................... Building (net) .......................................... (A) Investment in Stockdon Corporation ...... (D) Accounts Payable .................................. Common Stock ($3 par)—Bell................ Paid-In Capital in Excess of Par—Bell ... Retained Earnings—Bell ........................ Common Stock ($10 par)—Stockdon..... (EL) Paid-In Capital in Excess of Par— Stockdon ............................................ .......... (50,000) (EL) 50,000 .......... ......... .......... Retained Earnings—Stockdon ............... .......... (100,000) (EL) 100,000 .......... ......... .......... Sales ...................................................... (210,000) (40,000) .......... .......... (250,000) .......... Cost of Goods Sold ................................ 120,000 35,000 .......... .......... 155,000 .......... Other Expenses ..................................... 45,000 10,000 .......... (A) 3,000 52,000 .......... Dividends Declared ................................ 5,000 .......... .......... .......... ......... .......... Total ................................................... 0 0 283,000 283,000 ......... .......... .......... Consolidated Income ..................................................................................................................................... (43,000) Retained Earnings—Controlling Interest, December 31, 2017 ..................................................................................................................

Controlling Retained Earnings .......... .......... .......... .......... .......... .......... .......... .......... (255,000) ..........

Consolidated Balance Sheet 323,000 90,000 240,000 735,000 .......... (615,000) (300,000) (180,000) .......... ..........

.......... .......... .......... .......... .......... 5,000 .......... (43,000) (293,000)

.......... .......... .......... .......... .......... .......... .......... .......... (293,000) 0

Eliminations and Adjustments: (EL) Eliminate 100% of the subsidiary’s January 2017 equity balances against the balance of the investment account. Distribute excess of Stockdon book value over cost of investment according to the determination and distribution of excess schedule. (D) Reduce the building account by $3,000 as a result of the amortization resulting from the excess adjustment resulting from entry 2. (A)

part.

3-31

Ch. 3—Problems

Problem 3-5, Concluded (3)

Bell Corporation and Subsidiary Stockdon Corporation Consolidated Income Statement For Year Ended December 31, 2017 Revenues ................................................................................................... Cost of goods sold ...................................................................................... Gross profit ................................................................................................. Other expenses .......................................................................................... Consolidated net income ............................................................................

$ 250,000 (155,000) $ 95,000 (52,000) $ 43,000

Bell Corporation and Subsidiary Stockdon Corporation Retained Earnings Statement For Year Ended December 31, 2017 Retained earnings, January 1, 2017 ........................................................... Add consolidated net income...................................................................... Less dividends declared ............................................................................. Balance, December 31, 2017 .....................................................................

$255,000 43,000 (5,000) $293,000

Bell Corporation and Subsidiary Stockdon Corporation Consolidated Balance Sheet December 31, 2017 Assets Current assets: Cash ............................................................................. Inventory ....................................................................... Property, plant, and equipment: Land .............................................................................. Building (net)................................................................. Total assets ........................................................................

$323,000 90,000 $240,000 735,000

$ 413,000 975,000 $1,388,000

Liabilities and Stockholders’ Equity Current liabilities ................................................................. Stockholders’ equity: Common stock ($3 par) ................................................ Paid-in capital in excess of par ..................................... Retained earnings......................................................... Total liabilities and stockholders’ equity..............................

$ 615,000 $300,000 180,000 293,000

773,000 $1,388,000

Ch. 3—Problems

3–32

PROBLEM 3-6 (1) Value Analysis Schedule Company fair value ........................................... Fair value of net assets excluding goodwill ...... Goodwill ............................................................

Company Implied Fair Value

Parent Price (80%)

NCI Value (20%)

$337,500* 235,000** $102,500

$270,000 188,000 $ 82,000

$67,500 47,000 $20,500

*$270,000/80% **$195,000 equity + $40,000 asset adjustments Based on the above information, the following D&D schedule is prepared: Determination and Distribution of Excess Schedule Company Implied Fair Value

Parent Price (80%)

NCI Value (20%)

Fair value of subsidiary .............. $337,500 Less book value of interest acquired: Common stock ($10 par) ....... $100,000 Paid-in capital in excess of par 120,000 Retained earnings ................. (25,000) Total equity ...................... $195,000 Interest acquired ................... Book value ................................. Excess of fair value over book value ...................................... $142,500

$270,000

$ 67,500

$195,000 80% $156,000

$195,000 20% $ 39,000

$114,000

$ 28,500

Worksheet Key

Life

Amortization per Year

$4,000

Adjustment of identifiable accounts: Adjustment Buildings .................................... Goodwill ..................................... Total ......................................

$ 40,000 102,500 $142,500

debit D1 debit D2

3-33

Ch. 3—Problems

Problem 3-6, Continued (2)

Prescott Company and Subsidiary Sandin Company Worksheet for Consolidated Financial Statements For Year Ended December 31, 2016

Current Assets ....................................... Land ....................................................... Buildings ................................................ Accumulated Depreciation—Buildings ... Investment in Sandin Company ............. Goodwill ................................................. Liabilities ................................................ Common Stock ($10 par)—Prescott ...... Retained Earnings, January 1, 2016— Prescott ...........................................

Trial Balance Prescott Sandin 180,000 115,000 150,000 75,000 590,000 350,000 (265,000) (182,000) 294,000 .......... .......... .......... .......... .......... .......... .......... (175,000) (133,000) (200,000) ..........

..........

(120,000)

(A)

NCI .......... .......... .......... .......... .......... .......... .......... .......... .......... ..........

Controlling Retained Earnings .......... .......... .......... .......... .......... .......... .......... .......... .......... ..........

Consolidated Balance Sheet 295,000 225,000 980,000 (455,000) .......... .......... .......... 102,500 (308,000) (200,000)

(EL)

.......... .......... ..........

......... ......... .........

.......... .......... (20,000)

.......... (499,800) ..........

.......... .......... ..........

(EL)

96,000

..........

.........

(24,000)

..........

.......... 15,000 (A) 800 (EL) 12,000 ......... (24,700) .......... .......... .......... (NCI) 28,500 ......... .......... Sales ...................................................... (360,000) (120,000) .......... .......... (480,000) .......... Cost of Goods Sold ................................ 179,000 50,000 .......... .......... 229,000 .......... Expenses ............................................... 120,000 45,000 .......... .......... ......... .......... .......... .......... (A) 4,000 .......... 169,000 .......... Subsidiary Income.................................. (20,000) .......... (CY1) 20,000 .......... ......... .......... Dividends Declared ................................ 10,000 5,000 .......... (CY2) 4,000 ......... 1,000 0 350,500 350,500 ......... .......... Total ................................................ 0 Consolidated Net Income ............................................................................................................................... (82,000) .......... To Noncontrolling Interest (see distribution schedule) ............................................................................ 4,200 (4,200) To Controlling Interest (see distribution schedule) .................................................................................. 77,800 .......... Total NCI ............................................................................................................................................................................. (71,900) Retained Earnings—Controlling Interest, December 31, 2016 ..................................................................................................................

.......... .......... .......... .......... .......... .......... .......... 10,000 .......... .......... .......... (77,800) .......... (567,600)

.......... .......... .......... .......... .......... .......... .......... .......... .......... .......... .......... .......... (71,900) (567,600) 0

.......... .......... (100,000)

Consolidated Income Statement ......... ......... ......... ......... ......... ......... ......... ......... ......... .........

3,200 .......... 80,000

Common Stock ($10 par)—Sandin ........ Paid-In Capital in Excess of Par— Sandin ............................................. Retained Earnings, January 1, 2016— Sandin .............................................

(503,000) .......... ..........

Eliminations and Adjustments Dr. Cr. .......... .......... .......... .......... (D1) 40,000 .......... .......... (A) 8,000 (CY2) 4,000 (CY1) 20,000 .............. (EL) 164,000 .............. (D) 114,000 (D2) 102,500 .......... .......... .......... .......... ..........

part.

Ch. 3—Problems

3–34

Problem 3-6, Continued Eliminations and Adjustments: (CY1) Eliminate the subsidiary income against the investment account. (CY2) Eliminate the 80% ownership portion of the subsidiary dividends, including $15,000 negative retained earnings. (EL) Eliminate the 80% ownership portion of the subsidiary equity accounts against the investment. (D)/(NCI) Distribute the excess cost and NCI adjustment as follows, in accordance with the determination and distribution of excess schedule: (D1) Increase buildings by $40,000. (D2) Increase goodwill $102,500. (A) Record $4,000 annual increase in building depreciation for current and prior years. Subsidiary Sandin Company Income Distribution Building depreciation .............. (A)

$4,000

Internally generated net income ....................................

$25,000

Adjusted income ........................... NCI share ...................................... NCI ................................................

$21,000 × 20% $ 4,200

Parent Prescott Company Income Distribution Internally generated net income .................................... 80% × Sandin adjusted income of $21,000 .................. Controlling interest ........................

(3)

$61,000 16,800 $77,800

Prescott Company and Subsidiary Sandin Company Consolidated Income Statement For Year Ended December 31, 2016 Sales ................................................................................................................ Cost of goods sold ........................................................................................... Gross profit ...................................................................................................... Expenses ......................................................................................................... Consolidated net income ................................................................................. Distributed to noncontrolling interest ............................................................... Distributed to controlling interest .....................................................................

$480,000 229,000 $251,000 169,000 $ 82,000 4,200 $ 77,800

3-35

Ch. 3—Problems

Problem 3-6, Concluded Prescott Company and Subsidiary Sandin Company Retained Earnings Statement For Year Ended December 31, 2016

Retained earnings, January 1, 2016 ......................................... Add distribution of net income .................................................. Less dividends declared ........................................................... Balance, December 31, 2016 ...................................................

NCI $(3,000)* 4,200 (1,000) $ 200

Controlling Interest $499,800 77,800 (10,000) $567,600

*$15,000 debit balance × 20% Prescott Company and Subsidiary Sandin Company Consolidated Balance Sheet December 31, 2016 Assets Current assets .................................................. Property, plant, and equipment: Land ............................................................. Buildings ....................................................... Accumulated depreciation ............................ Goodwill ............................................................ Total assets ......................................................

$ 295,000 $225,000 $ 980,000 (455,000)

525,000

750,000 102,500 $1,147,500

Liabilities and Stockholders’ Equity Liabilities ........................................................... Stockholders’ equity: Controlling interest: Common stock ($10 par) ........................ Retained earnings .................................. NCI ............................................................... Total liabilities and stockholders’ equity ...........

$ 308,000 $200,000 567,600 71,900

839,500 $1,147,500

Ch. 3—Problems

3–36

PROBLEM 3-7 (1) Value Analysis Schedule Company fair value ........................................... Fair value of net assets excluding goodwill ...... Goodwill ............................................................

Company Implied Fair Value

Parent Price (80%)

NCI Value (20%)

$343,750* 260,000** $ 83,750

$275,000 208,000 $ 67,000

$68,750 52,000 $16,750

*$275,000/80% **$200,000 equity + $60,000 asset adjustments Based on the above information, the following D&D schedule is prepared: Determination and Distribution of Excess Schedule Company Implied Fair Value

Parent Price (80%)

NCI Value (20%)

Fair value of subsidiary .............. $343,750 Less book value of interest acquired: Common stock ($5 par) .......... $150,000 Retained earnings .................. 50,000 Total equity ......................... $200,000 Interest acquired..................... Book value ................................. Excess of fair value over book value ....................................... $143,750

$275,000

$ 68,750

$200,000 80% $160,000

$200,000 20% $ 40,000

$115,000

$ 28,750

Worksheet Key

Life

Amortization per Year

5 20

$2,000 2,500

Adjustment of identifiable accounts: Adjustment Equipment.................................. Building ...................................... Goodwill ..................................... Total ......................................

$ 10,000 50,000 83,750 $143,750

debit D1 debit D2 debit D3

3-37

Ch. 3—Problems

Problem 3-7, Continued (2)

Jeter Corporation and Subsidiary Super Company Worksheet for Consolidated Financial Statements For Year Ended December 31, 2015

Eliminations Consolidated and Adjustments Income Trial Balance Jeter Super Dr. Cr. Statement NCI Cash....................................................... 296,600 91,000 .......... .......... ......... .......... Land ....................................................... 160,000 90,000 .......... .......... ......... .......... Building .................................................. 225,000 135,000 (D2) 50,000 .......... ......... .......... Accumulated Depreciation—Building ..... (100,000) (50,000) .......... (A2) 1,250 ......... .......... Equipment .............................................. 450,000 150,000 (D1) 10,000 .......... ......... .......... Accumulated Depreciation—Equipment . (115,000) (60,000) .......... (A1) 1,000 ......... .......... Investment in Super Company ............... 284,600 .......... .......... (CY1) 9,600 ......... .......... .......... .......... .......... (EL) 160,000 ......... .......... .......... .......... .......... (D) 115,000 ......... .......... Goodwill ................................................. .......... .......... (D3) 83,750 .......... ......... .......... Liabilities ................................................ (480,000) (150,000) .......... .......... ......... .......... Common Stock ($100 par)—Jeter.......... (400,000) .......... .......... .......... ......... .......... Paid-In Capital in Excess of Par—Jeter . (40,000) .......... .......... .......... ......... .......... Retained Earnings—Jeter ...................... (251,600) .......... .......... .......... ......... .......... Common Stock ($5 par)—Super ............ .......... (150,000) (EL) 120,000 .......... ......... (30,000) Retained Earnings, July 1, 2015—Super .......... (50,000) (EL) 40,000 (NCI) 28,750 ......... (38,750) Sales ...................................................... (460,000) (60,000) .......... .......... (520,000) .......... Cost of Goods Sold ................................ 220,000 30,000 .......... .......... 250,000 .......... Other Expenses ..................................... 210,000 24,000 (A2) 1,250 .......... 236,250 .......... .......... .......... (A1) 1,000 .......... ......... .......... Subsidiary Income.................................. (9,600) .......... (CY1) 9,600 .......... ......... .......... .......... ......... .......... ......... .......... Dividends Declared ................................ 10,000 Total ................................................... 0 0 315,600 315,600 ......... .......... Consolidated Net Income ............................................................................................................................... (33,750) .......... To Noncontrolling Interest (see distribution schedule) ................................................................................ 750 (750) .......... To Controlling Interest (see distribution schedule)...................................................................................... 33,000 Total NCI ............................................................................................................................................................................. (69,500) Retained Earnings—Controlling Interest, December 31, 2015 ..................................................................................................................

part.

Consolidated Balance Sheet 387,600 250,000 410,000 (151,250) 610,000 (176,000) .......... .......... .......... 83,750 (630,000) (400,000) (40,000) .......... .......... .......... .......... .......... .......... .......... .......... .......... .......... .......... .......... .......... (69,500) (274,600) 0

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Ch. 3—Problems

3–38

Problem 3-7, Continued Subsidiary Super Company Income Distribution Equipment depreciation ....... (A1) Building depreciation ........... (A2)

$1,000 1,250

Internally generated net income ..................................

$6,000

Adjusted income ......................... NCI share ................................... NCI .............................................

$3,750 × 20% $ 750

Parent Jeter Corporation Income Distribution Internally generated net income ................................. 80% × Super adjusted income of $3,750 (last 6 months) ..... Controlling interest .....................

$30,000 3,000 $33,000

Eliminations and Adjustments: (CY1) Eliminate parent’s current-year entry for subsidiary income. (EL) Eliminate the pro rata share of Super Company equity balances and purchased income. (D)/(NCI) Distribute the excess and adjust NCI as determined by the determination and distribution of excess schedule: (D1) Increase equipment by $10,000. (D2) Increase building by $50,000. (D3) Record goodwill of $83,750. Record amortizations resulting from the asset and liability revaluations of entry 3: (A1) Amortize equipment for $2,000 ($10,000 ÷ 5 years) for the half-year ($1,000) (A2) Amortize building for $2,500 ($50,000 ÷ 20 years) for the half-year ($1,250). (3)

Jeter Corporation and Subsidiary Super Company Consolidated Income Statement For Year Ended December 31, 2015 Revenues ........................................................................................................ Cost of goods sold ........................................................................................... Gross profit ...................................................................................................... Other expenses ............................................................................................... Consolidated net income ................................................................................. To noncontrolling interest .......................................................................... To controlling interest ................................................................................

$520,000 250,000 $270,000 236,250 $ 33,750 750 $ 33,000

3-39

Ch. 3—Problems

Problem 3-7, Concluded Jeter Corporation and Subsidiary Super Company Consolidated Retained Earnings Statement For Year Ended December 31, 2015 NCI $10,000 750

Retained earnings, January 1, 2015* ....................................... Add distribution of net income .................................................. Less dividends declared ........................................................... Balance, December 31, 2015 ...................................................

$10,750

Controlling Interest $251,600 33,000 (10,000) $274,600

*July 1 balance for NCI. Jeter Corporation and Subsidiary Super Company Consolidated Balance Sheet For Year Ended December 31, 2015 Assets Current assets: Cash ................................................................................... Property, plant, and equipment: Land .................................................................................... Building ............................................................................... Equipment........................................................................... Less accumulated depreciation* ............................................... Goodwill .................................................................................... Total assets ..............................................................................

$ 387,600 $ 250,000 410,000 610,000 (327,250)

942,750 83,750 $1,414,100

Liabilities and Stockholders’ Equity Current liabilities ....................................................................... Stockholders’ equity: Controlling interest: Common stock ($100 par) .............................................. Paid-in capital in excess of par....................................... Retained earnings .......................................................... NCI...................................................................................... Total liabilities and stockholders’ equity....................................

$ 630,000 $400,000 40,000 274,600 69,500

784,100 $1,414,100

*Includes both building and equipment depreciation.

Ch. 3—Problems

3–40

PROBLEM 3-8 (1) Value Analysis Schedule Company fair value ........................................... Fair value of net assets excluding goodwill ...... Goodwill ............................................................

Company Implied Fair Value

Parent Price (80%)

NCI Value (20%)

$2,000,000* $1,600,000 1,860,000** 1,488,000 $ 140,000 $ 112,000

$400,000 372,000 $ 28,000

*$1,600,000/80% **$1,700,000 equity + $160,000 asset adjustments Based on the above information, the following D&D schedule is prepared: Determination and Distribution of Excess Schedule Company Implied Fair Value

Parent Price (80%)

NCI Value (20%)

Fair value of subsidiary .............. $2,000,000 Less book value of interest acquired: Common stock ($10 stated value) ................................. $1,000,000 Paid-in capital in excess of par 300,000 Retained earnings .................. 400,000 Total equity ......................... $1,700,000 Interest acquired ........................ Book value ................................. Excess of fair value over book value ....................................... $ 300,000

$1,600,000

$ 400,000

$1,700,000 $1,700,000 80% 20% $1,360,000 $ 340,000 $ 240,000

60,000

Adjustment of identifiable accounts: Adjustment Inventory .................................... Equipment.................................. Patents ...................................... Goodwill ..................................... Total ......................................

$ 10,000 50,000 100,000 140,000 $300,000

Worksheet Key debit D1 debit D2 debit D3 debit D4

Life

Amortization per Year

8 10

$ 6,250 10,000

3-41

Ch. 3—Problems

Problem 3-8, Continued (2)

Detner International and Subsidiary Hardy Company Worksheet for Consolidated Financial Statements For Year Ended December 31, 2017 Eliminations Consolidated Trial Balance and Adjustments Income Detner Hardy Dr. Cr. Statement

Controlling Retained Earnings

Consolidated Balance Sheet

632,000 505,000 .............. ............. ............. .............. ............. Current Assets ....................................... Equipment (net)...................................... 1,320,000 940,000 (D2) 50,000 (A2) 18,750 ............. .............. ............. Patents ................................................... 100,000 35,000 (D3) 100,000 (A3) 30,000 ............. .............. ............. Other Assets .......................................... 1,620,000 730,000 .............. ............. ............. .............. ............. Investment in Hardy Company ............... 1,600,000 .............. (CV) 144,000 (EL) 1,504,000 ............. .............. ............. ............. .............. .............. (D) 240,000 ............. .............. ............. Goodwill ................................................. ............. .............. (D4) 140,000 ............. ............. .............. ............. Accounts Payable .................................. (658,000) (205,000) .............. ............. ............. .............. ............. Common Stock ($5 par)—Detner ........... (2,000,000) .............. .............. ............. ............. .............. ............. Paid-In Capital in Excess of Par— Detner ................................................. (1,200,000) .............. .............. ............. ............. .............. ............. Retained Earnings—Detner, January 1, 2017 .................................. (1,255,000) .............. (D1) 8,000 (CV) 144,000 ............. .............. ............. ............. .............. (A2) 10,000 ............. ............. .............. ............. ............. .............. (A3) 16,000 ............. ............. .............. ............. ............. .............. .............. ............. ............. .............. (1,365,000) Common Stock ($10 par)—Hardy .......... ............. (1,000,000) (EL) 800,000 ............. ............. (200,000) ............. Paid-In Capital in Excess of Par— Hardy .................................................. ............. (300,000) (EL) 240,000 ............. ............. (60,000) ............. Retained Earnings—Hardy, January 1, 2017 .................................. ............. (580,000) (EL) 464,000 (NCI) 60,000 ............. (167,500) ............. ............. .............. (D1) 2,000 ............. ............. .............. ............. ............. .............. (A2) 2,500 ............. ............. .............. ............. ............. .............. (A3) 4,000 ............. ............. .............. ............. Sales ...................................................... (905,000) (425,000) .............. ............. (1,330,000) .............. ............. Cost of Goods Sold ................................ 470,000 170,000 .............. ............. 640,000 .............. ............. Other Expenses ..................................... 250,000 100,000 (A2) 6,250 ............. ............. .............. ............. ............. .............. (A3) 10,000 ............. ............. .............. ............. ............. .............. .............. ............. 366,250 .............. ............. Dividend Income .................................... (24,000) .............. (CY2) 24,000 ............. ............. .............. ............. Dividends Declared ................................ 50,000 30,000 .............. (CY2) 24,000 ............. 6,000 50,000 0 2,020,750 2,020,750 ............. .............. ............. Total ................................................... 0 Consolidated Net Income ............................................................................................................................... (323,750) .............. ............. (27,750) ............. To Noncontrolling Interest (see distribution schedule) ................................................................................ 27,750 To Controlling Interest (see distribution schedule)...................................................................................... 296,000 .............. (296,000) ............. Total NCI ............................................................................................................................................................................. (449,250) Retained Earnings—Controlling Interest, December 31, 2017 .................................................................................................................. (1,611,000)

1,137,000 2,291,250 205,000 2,350,000 ............. ............. 140,000 (863,000) (2,000,000)

NCI

part.

(1,200,000) ............. ............. ............. ............. ............. ............. ............. ............. ............. ............. ............. ............. ............. ............. ............. ............. ............. ............. ............. ............. ............. (449,250) (1,611,000) 0

Ch. 3—Problems

3–42

Problem 3-8, Concluded Eliminations and Adjustments: (CV) Convert from cost to the equity method as of January 1, 2017. ($580,000 January 1, 2017 – $400,000 January 1, 2015 = $180,000 × 80% = $144,000.) (CY2) Eliminate intercompany dividends. (EL) Eliminate subsidiary equities. (D)/(NCI) Distribute the excess cost and adjust NCI as given by the determination and distribution of excess schedule: (D1) Distribute inventory adjustment for units sold in prior years to retained earnings, 80% controlling. (D2) Increase equipment by $50,000. (D3) Increase patents by $100,000. (D4) Increase goodwill by $140,000. Record amortizations resulting from the revaluations: (A1) No amortizations necessary. (A2) Record $6,250 annual increase in equipment depreciation for the current and past two years. (A3) Record $10,000 annual increase in patents depreciation for the current and past two years. Subsidiary Hardy Company Income Distribution Equipment depreciation ....... (A2) Patent depreciation .............. (A3)

$ 6,250 10,000

Internally generated net income ..............................

$155,000

Adjusted income ..................... NCI share ................................ NCI ..........................................

$138,750 × 20% $ 27,750

Parent Detner International Income Distribution Internally generated net income .............................. 80% × Hardy adjusted income of $138,750 .......... Controlling interest ..................

$185,000 111,000 $296,000

3-43

Ch. 3—Problems

PROBLEM 3-9 (1) Value Analysis Schedule Company fair value ........................................... Fair value of net assets excluding goodwill ...... Gain on acquisition ...........................................

Company Implied Fair Value

Parent Price (100%)

NCI Value (0%)

$420,000 464,000 $ (44,000)

N/A

Determination and Distribution of Excess Schedule

Price paid for investment............. Less book value of interest acquired: Common stock ...................... Paid-in capital in excess of par Retained earnings ................. Total equity ...................... Interest acquired ................... Book value .................................. Excess of fair value over book value ......................................

Company Implied Fair Value

Parent Price (100%)

NCI Value (0%)

$420,000

N/A

$ 10,000 90,000 112,000 $212,000

$208,000

$212,000 100% $212,000 $208,000

Adjustment of identifiable accounts:

Inventory ($38,000 fair – $40,000 book value) ............................ Land ($150,000 fair – $60,000 book value) ............................ Bonds payable ($96,000 fair – $100,000 book value) ............ Buildings ($280,000 fair – $150,000 net book value) ...... Equipment ($100,000 fair – $70,000 net book value) ........ Gain on acquisition .................... Total ......................................

Adjustment

Worksheet Key

Life

Amortization per Year

$ (2,000)

credit D1

90,000

debit D2

4,000

debit D3

130,000

debit D4

6,500

30,000 (44,000) $208,000

debit D5 credit D6

6,000

800

Ch. 3—Problems

3–44

Problem 3-9, Continued (2) Annual Amount

Current Year

Account Adjustments

Life

Inventory ........................ Subject to amortization: Bonds payable ............... Buildings ........................ Equipment...................... Total amortizations ....

$ (2,000) $

5 20 5

800 6,500 6,000 $13,300

—

800 6,500 6,000 $13,300

Prior Years

Total

Key

$ (2,000) $ (2,000)

(D1)

$ 1,600 13,000 12,000 $26,600

(A3) (A4) (A5)

$ 2,400 19,500 18,000 $39,900

Subsidiary Switzer Corporation Income Distribution Current-year amortizations ............

$13,300 Internally generated net income ................................. Adjusted income ........................ NCI share ................................... NCI .............................................

$35,000 $21,700 0% $21,700

Parent Paulcraft Corporation Income Distribution Internally generated net income ................................. Controlling share of subsidiary ..

$165,000 21,700

Controlling interest .....................

$186,700

3-45

Ch. 3—Problems

Problem 3-9, Continued Paulcraft Corporation and Subsidiary Switzer Corporation Worksheet for Consolidated Financial Statements For Year Ended December 31, 2017 Eliminations Consolidated Trial Balance and Adjustments Income Paulcraft Switzer Dr. Cr. Statement 160,000 90,000 120,000 100,000 515,000 ........... ........... ........... 800,000 (220,000) 150,000 (90,000)

110,000 55,000 86,000 60,000 ............ ............ ............ ............ 250,000 (80,000) 100,000 (72,000)

(60,000) ........... ........... ........... ........... ........... ........... (100,000) (900,000) (385,000) ........... ...........

(102,000) (100,000) ............ ............ (10,000) (90,000) (182,000) ............ ............ ............ ............ ............

(800,000) 450,000 30,000 15,000 140,000 ...........

(350,000) 210,000 15,000 14,000 68,000 8,000

NCI

Controlling Retained Earnings

........... ........... ........... ........... 35,000 ........... 282,000 208,000 ........... 19,500 ........... 18,000

........... ........... ........... ........... ........... ........... ........... ........... ........... ........... ........... ...........

270,000 145,000 206,000 250,000 ........... ........... ........... ........... 1,180,000 (319,500) 280,000 (180,000)

........... ........... ........... 2,400 ........... ........... ........... ........... ........... 44,000 2,000 ...........

........... ........... ........... ........... ........... ........... ........... ........... ........... ........... ........... ...........

........... ........... ........... ........... ........... ........... ........... ........... ........... ........... ........... (404,400)

(162,000) (100,000) ........... 1,600 ........... ........... ........... (100,000) (900,000) ............... ............... ...............

........... ........... ........... ........... ........... ...........

(1,150,000) 660,000 51,500 35,000 208,000 8,800

........... ........... ........... ........... ........... ...........

............... ............... ............... ............... ............... ...............

Subsidiary (Dividend) Income ......................... (35,000) ............ (CY1) 35,000 ........... ........... ........... Dividends Declared—Switzer ......................... ........... 10,000 ........... (CY2) 10,000 ........... ........... Dividends Declared—Paulcraft ....................... 20,000 ............ ........... ........... ........... ........... Total ................................................................ 0 0 620,900 620,900 ........... ........... Consolidated Net Income ..................................................................................................................................................... (186,700) ........... To Noncontrolling interest (see distribution schedule) ..................................................................................................... ........... ........... To Controlling Interest (see distribution schedule)........................................................................................................... 186,700 ........... Total NCI ............................................................................................................................................................................................................................... Retained Earnings—Controlling Interest, December 31, 2017 .............................................................................................................................................

........... ........... 20,000 ........... ........... ........... (186,700) ........... (571,100)

............... ............... ............... ............... ............... ............... ............... ........... (571,100) 0

Cash ................................................................ Accounts Receivable ...................................... Inventory ......................................................... Land ................................................................ Investment in Switzer ......................................

Buildings ......................................................... Accumulated Depreciation .............................. Equipment ....................................................... Accumulated Depreciation .............................. Current Liabilities ............................................ Bond Payable .................................................. Discount (Premium) ........................................ Common Stock ($1 par)—Switzer .................. Paid-In Capital in Excess of Par—Switzer ...... Retained Earnings—Switzer ........................... Common Stock ($1 par)—Paulcraft ................ Paid-In Capital in Excess of Par—Paulcraft.... Retained Earnings—Paulcraft .........................

Sales ............................................................... Cost of Goods Sold ......................................... Depreciation Expense—Building .................... Depreciation Expense—Equipment ................ Other Expenses .............................................. Interest Expense

(D2) (CY2) (D4) (D5)

(D3) (EL) (EL) (EL)

(A3–A5)

(A4) (A5) (A3)

........... ........... ........... 90,000 ........... 10,000 ........... ........... 130,000 ........... 30,000 ........... ........... ........... 4,000 ........... 10,000 90,000 182,000 ........... ........... ........... ........... 26,600 ........... ........... 6,500 6,000 ........... 800

(CY1) (EL) (D) (A4) (A5)

(A3)

(D6) (D1)

part.

Consolidated Balance Sheet

Ch. 3—Problems

3–46

Problem 3-9, Concluded Eliminations and Adjustments: (CY1) Current-year subsidiary income. (CY2) Current-year dividend. (EL) Eliminate controlling interest in subsidiary equity. (D) Distribute excess according to D&D schedule (gain and inventory go to Paulcraft’s retained earnings). (A) Amortize excess using amortization schedule (prior years go to Paulcraft’s retained earnings). PROBLEM 3-10 (1) Value Analysis Schedule Company fair value ........................................... Fair value of net assets excluding goodwill ...... Goodwill ............................................................

Company Implied Fair Value

Parent Price (100%)

NCI Value (0%)

$480,000 464,000 $ 16,000

N/A

Determination and Distribution of Excess Schedule Company Implied Fair Value Fair value of subsidiary ...................... $480,000 Less book value of interest acquired: Common stock ($1 par) .......... $ 10,000 Paid-in capital in excess of par 90,000 Retained earnings .................. 112,000 Total equity ......................... $212,000 Interest acquired..................... Book value ................................. Excess of fair value over book value ....................................... $268,000

Parent Price (100%)(0%)

NCI Value

$480,000

N/A

$212,000 100% $212,000 $268,000

3-47

Ch. 3—Problems

Problem 3-10, Continued Adjustment of identifiable accounts: Adjustment

Worksheet Key

Life

Amortization per Year

$ (2,000)

credit D1

90,000

debit D2

4,000

debit D3

$ 800

Inventory ($38,000 fair – $40,000 book value) ............................ Land ($150,000 fair – $60,000 book value) ............................ Bonds payable ($96,000 fair – $100,000 book value) ............ Buildings ($280,000 fair – $150,000 book value) ............ Equipment ($100,000 fair – $70,000 book value) .............. Goodwill ..................................... Total ......................................

130,000

debit D4

6,500

30,000 16,000 $268,000

debit D5 debit D6

6,000

Account Adjustments

Life

Annual Amount

Inventory ........................ Subject to amortization: Bonds payable ............... Buildings ........................ Equipment...................... Total amortizations ....

$ (2,000) $

5 20 5

(2)

800 6,500 6,000 $13,300

Current Year

—

800 6,500 6,000 $13,300

Prior Years

Total

Key

$ (2,000) $ (2,000)

(D1)

$ 1,600 13,000 12,000 $26,600

(A3) (A4) (A5)

Cost-to-Equity Conversion: Subsidiary retained earnings, worksheet .................................. Subsidiary retained earnings, purchase date ........................... Increase (decrease) .................................................................. Ownership interest .................................................................... Adjust investment .....................................................................

$ 2,400 19,500 18,000 $39,900

$182,000 112,000 $ 70,000 100% $ 70,000

Subsidiary Switzer Corporation Income Distribution Current-year amortizations ............

$35,000 $21,700 0% $21,700

Parent Paulcraft Corporation Income Distribution Internally generated net income ................................. Controlling share of subsidiary ..

$165,000 21,700

Controlling interest .....................

$186,700

Ch. 3—Problems

3–48

Problem 3-10, Continued Paulcraft Corporation and Subsidiary Switzer Corporation Worksheet for Consolidated Financial Statements For Year Ended December 31, 2017 NCI

Controlling Retained Earnings

Consolidated Balance Sheet

210,000 145,000 206,000 250,000 ............... ............... ............... ............... 1,180,000 (319,500) 280,000 (180,000) 16,000 (162,000) (100,000) ........... 1,600 ........... ........... ...........

........... ........... ........... ........... ........... ........... (1,150,000) 660,000 51,500 35,000 208,000 8,800

........... ........... ........... ........... ........... ........... ........... ........... ........... ........... ........... ...........

........... ........... ........... ........... ........... (360,400) ........... ........... ........... ........... ........... ...........

(100,000) (900,000) ........... ........... ........... ........... ........... ........... ........... ........... ........... ...........

Subsidiary (Dividend) Income ......................... (10,000) ............ (CY1) 10,000 ........... ........... ........... Dividends Declared—Switzer ......................... ........... 10,000 ........... (CY2) 10,000 ........... ........... Dividends Declared—Paulcraft ....................... 20,000 ............ ........... ........... ........... ........... Total ................................................................ 0 0 681,900 681,900 ........... ........... Consolidated Net Income ..................................................................................................................................................... (186,700) ........... To Noncontrolling Interest (see distribution schedule) ..................................................................................................... ........... ........... To Controlling Interest (see distribution schedule)........................................................................................................... 186,700 ........... Total NCI ............................................................................................................................................................................................................................... Retained Earnings—Controlling Interest, December 31, 2017 .............................................................................................................................................

........... ........... 20,000 ........... ........... ........... (186,700) ........... (527,100)

........... ........... ........... ........... ...........

Buildings ......................................................... Accumulated Depreciation .............................. Equipment ....................................................... Accumulated Depreciation .............................. Goodwill .......................................................... Current Liabilities ............................................ Bonds Payable ................................................ Discount (Premium) ........................................ Common Stock ($1 par)—Switzer .................. Paid-In Capital in Excess of Par—Switzer ...... Retained Earnings—Switzer ........................... Common Stock ($1 par)—Paulcraft ................ Paid-In Capital in Excess of Par—Paulcraft ... Retained Earnings—Paulcraft .........................

Sales .............................................................. Cost of Goods Sold ......................................... Depreciation Expense—Buildings................... Depreciation Expense—Equipment ................ Other Expenses .............................................. Interest Expense .............................................

Eliminations and Adjustments

Trial Balance Switzer Paulcraft

Dr.

100,000 90,000 120,000 100,000 480,000 ........... ........... ........... 800,000 (220,000) 150,000 (90,000) ........... (60,000) ........... ........... ........... ........... ........... ...........

110,000 55,000 86,000 60,000 ............ ............ ............ ............ 250,000 (80,000) 100,000 (72,000) ............ (102,000) (100,000) ............ ............ (10,000) (90,000) (182,000)

........... ........... ........... 90,000 70,000 10,000 ........... ........... 130,000 ........... 30,000 ........... 16,000 ........... ........... 4,000 ........... 10,000 90,000 182,000

(100,000) (900,000) (315,000) ........... ........... ........... (800,000) 450,000 30,000 15,000 140,000 ...........

............ ............ ............ ............ ............ ............ (350,000) 210,000 15,000 14,000 68,000 8,000

(D2) (CV) (CY2) (D4) (D5) (D6) (D3) (EL) (EL) (EL)

(A3–A5)

(A4) (A5) (A3)

........... ........... ........... ........... 26,600 ........... ........... ........... 6,500 6,000 ........... 800

(CY1) (EL) (D) (A4) (A5)

(CV) (D1)

Cr.

Consolidated Income Statement

........... ........... ........... ........... 10,000 ........... 282,000 268,000 ........... 19,500 ........... 18,000 ........... ........... ........... ........... 2,400 ........... ........... ........... ........... ........... 70,000 2,000 ........... ........... ........... ........... ........... ........... ........... ...........

part.

........... ........... (527,100) 0

3-49

Ch. 3—Problems

Problem 3-10, Concluded Eliminations and Adjustments: (CV) Conversion to equity. (CY1) Current-year subsidiary income. (CY2) Current-year dividend. (EL) Eliminate controlling interest in subsidiary equity. (D) Distribute excess according to D&D schedule (goodwill and inventory to Paulcraft’s retained earnings). (A) Amortize excess using amortization schedule (prior years to Paulcraft’s retained earnings). PROBLEM 3-11 (1) Value Analysis Schedule Company fair value ........................................... Fair value of net assets excluding goodwill ...... Goodwill ............................................................

Company Implied Fair Value

Parent Price (80%)

NCI Value (20%)

$550,000 464,000 $ 86,000

$440,000 371,200 $ 68,800

$110,000 92,800 $ 17,200

Determination and Distribution of Excess Schedule Company Implied Fair Value

Parent Price (80%)

NCI Value (20%)

Fair value of subsidiary .............. $550,000 Less book value of interest acquired: Common stock ($1 par) .......... $ 10,000 Paid-in capital in excess of par 90,000 Retained earnings .................. 112,000 Total equity ......................... $212,000 Interest acquired..................... Book value ................................. Excess of fair value over book value ....................................... $338,000

$440,000

$110,000

$212,000 80% $169,600

$212,000 20% $ 42,400

$270,400

$ 67,600

Ch. 3—Problems

3–50

Problem 3-11, Continued Adjustment of identifiable accounts: Adjustment

Worksheet Key

Life

Amortization per Year

$ (2,000)

credit D1

90,000

debit D2

4,000

debit D3

$ 800

Inventory ($38,000 fair – $40,000 book value) .............. Land ($150,000 fair – $ 60,000 book value) ............................ Bonds payable ($96,000 fair – $100,000 book value) ............ Buildings ($280,000 fair – $150,000 book value) ............ Equipment ($100,000 – $70,000 book value) .............. Goodwill ..................................... Total ......................................

130,000

debit D4

6,500

30,000 86,000 $338,000

debit D5 debit D6

6,000

Account Adjustments

Life

Annual Amount

Inventory ........................ Subject to amortization: Bonds payable ............... Buildings ........................ Equipment...................... Total amortizations ....

$ (2,000) $

5 20 5

(2)

To IDS ....................... To controlling interest

800 6,500 6,000 $13,300

Current Year

—

800 6,500 6,000 $13,300

Prior Years

Total

Key

$ (2,000) $ (2,000)

(D1)

$ 1,600 13,000 12,000 $26,600

(A3) (A4) (A5)

$ 2,400 19,500 18,000 $39,900

5,320 21,280

Subsidiary Switzer Corporation Income Distribution Current-year amortizations ............

$35,000 $21,700 20% $ 4,340

Parent Paulcraft Corporation Income Distribution Internally generated net income ................................. Controlling share of subsidiary ..

$165,000 17,360

Controlling interest .....................

$182,360

3-51

Ch. 3—Problems

Problem 3-11, Continued Paulcraft Corporation and Subsidiary Switzer Corporation Worksheet for Consolidated Financial Statements For Year Ended December 31, 2017 Eliminations Consolidated and Adjustments Income Trial Balance Switzer Dr. Cr. Statement NCI Paulcraft Cash ................................................................ 138,000 110,000 ........... ........... ........... ........... Accounts Receivable ...................................... 90,000 55,000 ........... ........... ........... ........... Inventory ......................................................... 120,000 86,000 ........... ........... ........... ........... Land ................................................................ 100,000 60,000 (D2) 90,000 ........... ........... ........... ............ Investment in Switzer ...................................... 516,000 ........... (CY1) 28,000 ........... ........... ........... ............ (CY2) 8,000 ........... ........... ........... ........... ........... (EL) 225,600 ........... ........... ............ ........... ........... 270,400 ........... ........... ............ (D) Buildings ......................................................... 800,000 250,000 (D4) 130,000 ........... ........... ........... Accumulated Depreciation .............................. (220,000) (80,000) ........... (A4) 19,500 ........... ........... ........... Equipment ....................................................... 150,000 100,000 (D5) 30,000 ........... ........... Accumulated Depreciation .............................. (90,000) (72,000) ........... (A5) 18,000 ........... ........... Goodwill .......................................................... ........... ............ (D6) 86,000 ........... ........... ........... Current Liabilities ............................................ (60,000) (102,000) ........... ........... ........... ........... Bonds Payable ................................................ ........... (100,000) ........... ........... ........... ........... Discount (Premium) ........................................ ........... ............ (D3) 4,000 ........... ........... ........... ........... (A3) 2,400 ........... ........... ............ ........... Common Stock ($1 par)—Switzer .................. ........... (10,000) (EL) 8,000 ........... ........... (2,000) Paid-In Capital in Excess of Par—Switzer ...... ........... (90,000) (EL) 72,000 ........... ........... (18,000) Retained Earnings—Switzer ........................... ........... (182,000) (EL) 145,600 ........... ........... (99,080) ........... ............ (A3–A5) 5,320 (NCI) 67,600 ........... ........... ............ ........... ........... (D1) 400 ........... ........... Common Stock ($1 par)—Paulcraft ................ (100,000) ........... ........... ........... ........... ............ Paid-In Capital in Excess of Par—Paulcraft.... (900,000) ........... ........... ........... ........... ............ Retained Earnings—Paulcraft ......................... (371,000) ............ ........... ........... ........... ........... ............ ........... ........... (D1) 1,600 ........... ........... ........... ............ (A3–A5) 21,280 ........... ........... ........... ........... ........... ........... ........... ........... ............ Sales ............................................................... (800,000) (350,000) ........... ........... (1,150,000) ........... ........... ........... 660,000 ........... Cost of Goods Sold ......................................... 450,000 210,000 Depreciation Expense—Buildings................... 30,000 15,000 (A4) 6,500 ........... 51,500 ........... Depreciation Expense—Equipment ................ 15,000 14,000 (A5) 6,000 ........... 35,000 ........... Other Expenses .............................................. 140,000 68,000 ........... ........... 208,000 ........... Interest Expense ............................................. ........... 8,000 (A3) 800 ........... 8,800 ........... ........... ........... ........... ........... ........... ............ ............ ........... ........... ........... ........... ........... Subsidiary (Dividend) Income ......................... (28,000) ............ (CY1) 28,000 ........... ........... ........... Dividends Declared—Switzer ......................... ........... 10,000 ........... (CY2) 8,000 ........... 2,000 ............ ........... ........... ........... ........... Dividends Declared—Paulcraft ....................... 20,000 Total ................................................................ 0 0 641,500 641,500 ........... ........... Consolidated Net Income ..................................................................................................................................................... (186,700) ........... To Noncontrolling Interest (see distribution schedule) ..................................................................................................... 4,340 (4,340) To Controlling Interest (see distribution schedule)........................................................................................................... 182,360 ........... Total NCI ....................................................................................................................................................................................................... (121,420) Retained Earnings—Controlling Interest, December 31, 2017 .............................................................................................................................................

Controlling Retained Earnings ........... ........... ........... ........... ........... ........... ........... ........... ........... ........... ........... ........... ........... ........... ........... ........... ........... ........... ........... ........... ........... ........... ........... ........... ........... ........... ........... (351,320) ........... ........... ........... ........... ........... ........... ........... ........... ........... ........... 20,000 ........... ........... ........... (182,360) ........... (513,680)

Consolidated Balance Sheet 248,000 145,000 206,000 250,000 ........... ........... ........... ........... 1,180,000 (319,500) 280,000 (180,000) 86,000 (162,000) (100,000) ........... 1,600 ........... ........... ........... ........... ........... (100,000) (900,000) ........... ........... ........... ........... ........... ........... ........... ........... ........... ........... ........... ........... ........... ........... ........... ........... ........... ........... ........... (121,420) (513,680)

part.

Ch. 3—Problems

3–52

Problem 3-11, Concluded Eliminations and Adjustments: (CY1) Current-year subsidiary income. (CY2) Current-year dividend. (EL) Eliminate controlling interest in subsidiary equity. (D)/(NCI) Distribute excess according to D&D schedule (goodwill and inventory go to Paulcraft and to Switzer’s retained earnings). (A) Amortize excess using amortization schedule (prior years to Paulcraft and to Switzer’s retained earnings). PROBLEM 3-12 (1) Value Analysis Schedule Company fair value ........................................... Fair value of net assets excluding goodwill ...... Goodwill ............................................................

Company Implied Fair Value

Parent Price (80%)

NCI Value (20%)

$500,000 464,000 $ 36,000

$400,000 371,200 $ 28,800

$100,000 92,800 $ 7,200

Determination and Distribution of Excess Schedule Company Implied Fair Value

Parent Price (80%)

NCI Value (20%)

Fair value of subsidiary .............. $500,000 Less book value of interest acquired: Common stock ($1 par) .......... $ 10,000 Paid-in capital in excess of par 90,000 Retained earnings .................. 112,000 Total equity ......................... $212,000 Interest acquired..................... Book value ................................. Excess of fair value over book value ....................................... $288,000

$400,000

$100,000

$212,000 80% $169,600

$212,000 20% $ 42,400

$230,400

$ 57,600

3-53

Ch. 3—Problems

Problem 3-12, Continued Adjustment of identifiable accounts:

Inventory ($38,000 fair – $40,000 book value) .............. Land ($150,000 fair – $60,000 book value) ............................ Bonds payable ($96,000 fair – $100,000 book value) ............ Buildings ($280,000 fair – $150,000 book value) ............ Equipment ($100,000 fair – $70,000 book value) .............. Goodwill ..................................... Total ......................................

Adjustment

Worksheet Key

Life

Amortization per Year

$ (2,000)

credit D1

90,000

debit D2

4,000

debit D3

130,000

debit D4

6,500

30,000 36,000 $288,000

debit D5 debit D6

6,000

800

(2) Account Adjustments

Life

Inventory ........................ Subject to amortization: Bonds payable ............... Buildings ........................ Equipment...................... Total amortizations ....

1 5 20 5

Annual Amount

Prior Years

Total

$ (2,000) $ (2,000) $

—

$(2,000)

(D1)

— — — —

(A3) (A4) (A5)

800 6,500 6,000 $13,300

Current Year

800 6,500 6,000 $13,300

$ $

800 6,500 6,000 $13,300

Key

Subsidiary Switzer Corporation Income Distribution Current-year amortizations ............

$13,300

Internally generated net income ................................. Inventory adjustment .................

$34,000 2,000

Adjusted income ........................ NCI share ................................... NCI .............................................

$22,700 20% $ 4,540

Parent Paulcraft Corporation Income Distribution Internally generated net income ................................. Controlling share of subsidiary ..

$185,000 18,160

Controlling interest .....................

$203,160

Ch. 3—Problems

3–54

Problem 3-12, Continued Paulcraft Corporation and Subsidiary Switzer Corporation Worksheet for Consolidated Financial Statements For Year Ended December 31, 2015 Trial Balance Switzer Paulcraft Cash ................................................................ Accounts Receivable ...................................... Inventory ......................................................... Land ................................................................ Investment in Switzer ......................................

Eliminations and Adjustments Dr.

Cr.

Consolidated Income Statement

NCI

178,000 81,000 ........... ........... ........... ........... 80,000 35,000 ........... ........... ........... ........... 90,000 52,000 ........... ........... ........... ........... 100,000 60,000 (D2) 90,000 ........... ........... ........... ............ 400,000 (CY1) 8,000 ........... ........... ........... ............ (CY2) 8,000 ........... ........... ........... ........... ........... (EL) 169,600 ........... ........... ............ ........... ........... 230,400 ........... ........... ............ (D) Buildings ......................................................... 800,000 200,000 (D4) 130,000 ........... ........... ........... Accumulated Depreciation .............................. (200,000) (60,000) ........... (A4) 6,500 ........... ........... Equipment ....................................................... 150,000 100,000 (D5) 30,000 ........... ........... ........... Accumulated Depreciation .............................. (75,000) (44,000) ........... (A5) 6,000 ........... ........... Goodwill .......................................................... ........... ............ (D6) 36,000 ........... ........... ........... Current Liabilities ............................................ (50,000) (88,000) ........... ........... ........... ........... Bonds Payable ................................................ ........... (100,000) ........... ........... ........... ........... Discount (Premium) ........................................ ........... ............ (D3) 4,000 ........... ........... ........... ........... (A3) 800 ........... ........... ............ ........... Common Stock ($1 par)—Switzer .................. ........... (10,000) (EL) 8,000 ........... ........... (2,000) Paid-In Capital in Excess of Par—Switzer ...... ........... (90,000) (EL) 72,000 ........... ........... (18,000) Retained Earnings—Switzer ........................... ........... (112,000) (EL) 89,600 ........... ........... (80,000) ........... (NCI) 57,600 ........... ........... ............ ........... ........... ............ ........... ........... ........... ........... ........... ........... ........... ........... ........... ............ Common Stock ($1 par)—Paulcraft ................ (100,000) ........... ........... ........... ........... ............ Paid-In Capital in Excess of Par—Paulcraft.... (900,000) ............ ........... ........... ........... ........... ............ Retained Earnings—Paulcraft ......................... (300,000) ........... ........... ........... ............ ........... ........... ........... ........... ........... ........... ........... ........... ........... ........... ............ ........... ............ ........... ........... ........... ........... ........... ........... (1,050,000) ........... Sales ............................................................... (750,000) (300,000) Cost of Goods Sold ......................................... 400,000 180,000 ........... (D1) 2,000 578,000 ........... Depreciation Expense—Buildings................... 30,000 10,000 (A4) 6,500 ........... 46,500 ........... Depreciation Expense—Equipment ................ 15,000 14,000 (A5) 6,000 ........... 35,000 ........... Other Expenses .............................................. 120,000 54,000 ........... ........... 174,000 ........... Interest Expense ............................................. ........... 8,000 (A3) ........... 8,800 ........... 800 ............ ........... ........... ........... ........... ........... Subsidiary (Dividend) Income ......................... (8,000) ............ (CY1) 8,000 ........... ........... ........... Dividends Declared—Switzer ......................... ........... 10,000 ........... (CY2) 8,000 ........... 2,000 ............ ........... ......... ........... ........... Dividends Declared—Paulcraft ....................... 20,000 Total ................................................................ 0 0 488,900 488,900 ........... ........... Consolidated Net Income ..................................................................................................................................................... (207,700) ........... To Noncontrolling Interest (see distribution schedule) ..................................................................................................... 4,540 (4,540) To Controlling Interest (see distribution schedule)........................................................................................................... 203,160 ........... Total NCI ....................................................................................................................................................................................................... (102,540) Retained Earnings—Controlling Interest, December 31, 2015 .............................................................................................................................................

Controlling Retained Earnings

Consolidated Balance Sheet

........... ........... ........... ........... ........... ........... ........... ........... ........... ........... ........... ........... ........... ........... ........... ........... ........... ........... ........... ........... ........... ........... ........... ........... ........... ........... ........... ........... (300,000) ........... ........... ........... ........... ........... ........... ........... ........... ........... 20,000 ........... ........... ........... (203,160) ........... (483,160)

259,000 115,000 142,000 250,000 ........... ........... ........... ........... 1,130,000 (266,500) 280,000 (125,000) 36,000 (138,000) (100,000) ........... 3,200 ........... ........... ........... ........... ........... ........... (100,000) (900,000) ........... ........... ........... ........... ........... ........... ........... ........... ........... ........... ........... ........... ........... ........... ........... ........... ........... ........... (102,540) (483,160)

0 .

part.

3-55

Ch. 3—Problems

Problem 3-12, Concluded Eliminations and Adjustments: (CV) Conversion to equity (CY1) Current-year subsidiary income. (CY2) Current-year dividend. (EL) Eliminate controlling interest in subsidiary equity. (D)/(NCI) Distribute excess according to D&D schedule. (A) Amortize excess using amortization schedule. PROBLEM 3-13 (1) Value Analysis Schedule Company fair value ........................................... Fair value of net assets excluding goodwill ...... Goodwill ............................................................

Company Implied Fair Value

Parent Price (70%)

NCI Value (30%)

$600,000 464,000 $136,000

$420,000 324,800 $ 95,200

$180,000 139,200 $ 40,800

Determination and Distribution of Excess Schedule Company Implied Fair Value

Parent Price (70%)

NCI Value (30%)

Fair value of subsidiary .............. $600,000 Less book value of interest acquired: Common stock ($1 par) .......... $ 10,000 Paid-in capital in excess of par 90,000 Retained earnings .................. 112,000 Total equity ......................... $212,000 Interest acquired..................... Book value ................................. Excess of fair value over book value ....................................... $388,000

$420,000

$180,000

$212,000 70% $148,400

$212,000 30% $ 63,600

$271,600

$116,400

Adjustment of identifiable accounts:

Inventory ($38,000 fair – $40,000 book value) .............. Land ($150,000 fair – $60,000 book value) ............................ Bonds payable ($96,000 fair – $100,000 book value) ............ Buildings ($280,000 fair – $150,000 book value) ............ Equipment ($100,000 fair – $70,000 book value) .............. Goodwill ..................................... Total ......................................

Adjustment

Worksheet Key

Amortization per Year

Life

$ (2,000)

credit D1

90,000

debit D2

4,000

debit D3

$ 800

130,000

debit D4

6,500

30,000 136,000 $388,000

debit D5 debit D6

6,000

Ch. 3—Problems

3–56

Problem 3-13, Continued (2) Annual Amount

Current Year

Account Adjustments

Life

Inventory ........................ Subject to amortization: Bonds payable ............... Buildings ........................ Equipment...................... Total amortizations .... To NCI ....................... To controlling interest

$ (2,000) $

5 20 5

800 6,500 6,000 $13,300

—

800 6,500 6,000 $13,300

Prior Years

Total

Key

$ (2,000) $ (2,000)

(D1)

$ 1,600 13,000 12,000 $26,600 7,980 18,620

(A3) (A4) (A5)

$ 2,400 19,500 18,000 $39,900

$182,000 112,000 $ 70,000 70% $ 49,000

Subsidiary Switzer Corporation Income Distribution Current-year amortizations ............

$13,300

Internally generated net income .................................

$35,000

Adjusted income ........................ NCI share ................................... NCI .............................................

$21,700 30% $ 6,510

Parent Paulcraft Corporation Income Distribution Internally generated net income ................................. Controlling share of subsidiary ..

$165,000 15,190

Controlling interest .....................

$180,190

3-57

Ch. 3—Problems

Problem 3-13, Continued Paulcraft Corporation and Subsidiary Switzer Corporation Worksheet for Consolidated Financial Statements For Year Ended December 31, 2017 Trial Balance Switzer Paulcraft Cash ................................................................ Accounts Receivable ...................................... Inventory ......................................................... Land ................................................................ Investment in Switzer ......................................

Eliminations and Adjustments Dr.

Cr.

Consolidated Income Statement

NCI

157,000 110,000 ........... ........... ........... ........... 90,000 55,000 ........... ........... ........... ........... 120,000 86,000 ........... ........... ........... ........... 100,000 60,000 (D2) 90,000 ........... ........... ........... (CV) 420,000 ............ 49,000 (CY1) 7,000 ........... ........... ........... ............ (CY2) 7,000 ........... ........... ........... ........... ........... (EL) 197,400 ........... ........... ............ ........... ........... 271,600 ........... ........... ............ (D) Buildings ......................................................... 800,000 250,000 (D4) 130,000 ........... ........... ........... Accumulated Depreciation .............................. (220,000) (80,000) ........... (A4) 19,500 ........... ........... ........... Equipment ....................................................... 150,000 100,000 (D5) 30,000 ........... ........... Accumulated Depreciation .............................. (90,000) (72,000) ........... (A5) 18,000 ........... ........... Goodwill .......................................................... ........... ............ (D6) 136,000 ........... ........... ........... Current Liabilities ............................................ (60,000) (102,000) ........... ........... ........... ........... Bonds Payable ................................................ ........... (100,000) ........... ........... ........... ........... Discount (Premium) ........................................ ........... ............ (D3) 4,000 ........... ........... ........... ........... (A3) 2,400 ........... ........... ............ ........... Common Stock ($1 par)—Switzer ................. ........... (10,000) (EL) 7,000 ........... ........... (3,000) Paid-In Capital in Excess of Par—Switzer ...... ........... (90,000) (EL) 63,000 ........... ........... (27,000) Retained Earnings—Switzer ........................... ........... (182,000) (EL) 127,400 ........... ........... (163,620) ........... (NCI) 116,400 ........... ........... ............ ........... ........... ............ ........... (D1) 600 ........... ........... ........... ............ (A3–A5) 7,980 ........... ........... ........... Common Stock ($1 par)—Paulcraft ................ (100,000) ........... ........... ........... ........... ............ Paid-In Capital in Excess of Par—Paulcraft.... (900,000) ............ ........... ........... ........... ........... ............ (CV) Retained Earnings—Paulcraft ......................... (315,000) ........... 49,000 ........... ........... ............ ........... ........... (D1) 1,400 ........... ........... ........... ............ (A3–A5) 18,620 ........... ........... ........... ........... ............ ........... ........... ........... ........... ........... ........... (1,150,000) ........... Sales ............................................................... (800,000) (350,000) Cost of Goods Sold ......................................... 450,000 210,000 ........... ........... 660,000 ........... Depreciation Expense—Buildings................... 30,000 15,000 (A4) 6,500 ........... 51,500 ........... Depreciation Expense—Equipment ................ 15,000 14,000 (A5) 6,000 ........... 35,000 ........... Other Expenses .............................................. 140,000 68,000 ........... ........... 208,000 ........... Interest Expense ............................................. ........... 8,000 (A3) ........... 8,800 ........... 800 ............ ........... ........... ........... ........... ........... Subsidiary (Dividend) Income ......................... (7,000) ............ (CY1) 7,000 ........... ........... ........... Dividends Declared—Switzer ......................... ........... 10,000 ........... (CY2) 7,000 ........... 3,000 ............ ........... ........... ........... ........... Dividends Declared—Paulcraft ....................... 20,000 Total ................................................................ 0 0 690,300 690,300 ........... ........... Consolidated Net Income ..................................................................................................................................................... (186,700) ........... To Noncontrolling Interest (see distribution schedule) ..................................................................................................... 6,510 (6,510) To Controlling Interest (see distribution schedule)........................................................................................................... 180,190 Total NCI ....................................................................................................................................................................................................... (197,130) Retained Earnings—Controlling Interest, December 31, 2017 .............................................................................................................................................

Controlling Retained Earnings

Consolidated Balance Sheet

............... ............... ............... ............... ............... ............... ............... ............... ............... ............... ............... ............... ............... ............... ............... ............... ............... ............... ............... ............... ............... ............... ............... ............... ............... ............... ............... ............... (346,780) ............... ............... ............... ............... ............... ............... ............... ............... ............... 20,000 ........... ........... ........... (180,190) ........... (506,970)

267,000 145,000 206,000 250,000 ........... ........... ........... ........... 1,180,000 (319,500) 280,000 (180,000) 136,000 (162,000) (100,000) ........... 1,600 ........... ........... ........... ........... ........... ........... (100,000) (900,000) ........... ........... ........... ........... ........... ........... ........... ........... ........... ........... ........... ........... ........... ........... ........... ........... ........... ........... (197,130) (506,970) 0

part.

Ch. 3—Problems

3–58

Problem 3-13, Concluded Eliminations and Adjustments: (CV) Conversion to equity. (CY1) Current-year subsidiary income. (CY2) Current-year dividend. (EL) Eliminate controlling interest in subsidiary equity. (D)/(NCI) Distribute excess according to D&D schedule (goodwill and inventory go to Paulcraft and to Switzer’s retained earnings). (A) Amortize excess using amortization schedule (prior years to Paulcraft and to Switzer’s retained earnings).

PROBLEM 3-14 (1) Value Analysis Schedule Company fair value ........................................... Fair value of net assets excluding goodwill ...... Goodwill ............................................................

Company Implied Fair Value

Parent Price (100%)

NCI Value (0%)

$800,000 630,000 $170,000

N/A

Determination and Distribution of Excess Schedule Company Implied Fair Value

Parent Price (100%)

NCI Value (0%)

Fair value of subsidiary .............. $800,000 Less book value of interest acquired: Common stock ($1 par) .......... $100,000 Paid-in capital in excess of par 200,000 Retained earnings .................. 180,000 Total equity ......................... $480,000 Interest acquired..................... Book value ................................. Excess of fair value over book value ....................................... $320,000

$800,000

N/A

$480,000 100% $480,000 $320,000

3-59

Ch. 3—Problems

Problem 3-14, Continued Adjustment of identifiable accounts: Adjustment

Worksheet Key

Life

Amortization per Year

Inventory ($65,000 fair – $60,000 book value) .............. Land ($100,000 fair – $50,000 book value) ............................ Mortgage payable ($205,000 fair – $200,000 book value) ... Buildings ($500,000 fair – $350,000 book value) ............ Equipment ($100,000 fair – $120,000 book value) ............ Patent ($50,000 fair – $40,000 book value) ............................ Purchase contract ($10,000 fair – $0 book value) .............. Goodwill ($170,000 – $50,000 book value) ............................ Total ................................ Account Adjustments

Life

Annual Amount

Current Year

Prior Years

Total

Inventory ........................ Subject to amortization: Mortgage payable .......... Buildings ........................ Equipment...................... Patent ............................ Purchase contract .......... Total amortizations ....

$ 5,000

$ —

$ 5,000

(D1)

5 20 5 5 2

$ (1,000) $ (1,000) 7,500 7,500 (4,000) (4,000) 2,000 2,000 5,000 5,000 $ 9,500 $ 9,500

$ — — — — — $ —

$ (1,000) 7,500 (4,000) 2,000 5,000 $ 9,500

(A3) (A4) (A5) (A6) (A7)

(2)

5,000

debit D1

50,000

debit D2

(5,000)

credit D3

$(1,000)

150,000

debit D4

7,500

(20,000)

credit D5

(4,000)

10,000

debit D6

2,000

10,000

debit D7

5,000

120,000 $320,000

debit D8

Key

Subsidiary Fast Air Company Income Distribution Inventory adjustment ..................... Current-year amortizations ............

$5,000 9,500

Internally generated net income .................................

$47,500

Adjusted income ........................ NCI share ................................... NCI .............................................

$33,000 0% $ 0

Parent Fast Cool Company Income Distribution Internally generated net income ................................. Controlling share of subsidiary ..

$253,000 33,000

Controlling interest .....................

$286,000

Ch. 3—Problems

3–60

Problem 3-14, Continued Fast Cool Company and Subsidiary Fast Air Company Worksheet for Consolidated Financial Statements For Year Ended December 31, 2015 Trial Balance Fast Cool Fast Air

Eliminations and Adjustments Dr.

Cr.

Consolidated Income Statement

NCI

Controlling Retained Earnings

Consolidated Balance Sheet

............ ............ ............ ............ ............ ............ ............ ............ ............ ............ ............ ............ ............ ............ ............ ............ ............ ............ ............ ............ ............ ............ ............ ............ ............ ............ ............ ............ ............ ............ (400,000) ............ ............ ............ ............ ............ ............ ............ ............ ............ ............ ............ 20,000 ............ ............ ............ (286,000) ............ (666,000)

184,000 170,000 210,000 160,000 ............ ............ ............ ............ 1,750,000 (251,000) 270,000 (118,000) 40,000 5,000 170,000 (120,000) (200,000) ............ (4,000) ............ ............ ............ ............ ............ ............ (100,000) (1,500,000) ............ ............ ............ ............ ............ ............ ............ ............ ............ ............ ............ ............ ............ ............ ............ ............ ............ ............ ............ ............ ............ (666,000) 0

Cash .................................................................... Accounts Receivable ........................................... Inventory.............................................................. Land .................................................................... Investment in Fast Air ..........................................

147,000 37,000 ............ ............ ............ ............ 70,000 100,000 ............ ............ ............ ............ 150,000 60,000 ............ ............ ............ ............ 60,000 50,000 (D2) 50,000 ............ ............ ............ 837,500 ............ ............ (CY1) 47,500 ............ ............ ............ ............ (CY2) 10,000 ............ ............ ............ ............ ............ ............ (EL) 480,000 ............ ............ ............ ............ ............ (D) 320,000 ............ ............ Buildings .............................................................. 1,200,000 400,000 (D4) 150,000 ............ ............ ............ Accumulated Depreciation................................... (176,000) (67,500) ............ (A4) 7,500 ............ ............ Equipment ........................................................... 140,000 150,000 ............ (D5) 20,000 ............ ............ Accumulated Depreciation................................... (68,000) (54,000) (A5) 4,000 ............ ............ ............ Patent .................................................................. ............ 32,000 (D6) 10,000 (A6) 2,000 ............ ............ Purchase Contract ............................................... ............ ............ (D7) 10,000 (A7) 5,000 ............ ............ Goodwill............................................................... ............ 50,000 (D8) 120,000 ............ ............ ............ Current Liabilities................................................. (80,000) (40,000) ............ ............ ............ ............ Mortgage Payable ............................................... ............ (200,000) ............ ............ ............ ............ Discount (Premium) ............................................. ............ ............ ............ (D3) 5,000 ............ ............ ............ ............ (A3) 1,000 ............ ............ ............ Common Stock ($1 par)—Fast Air ...................... ............ (100,000) (EL) 100,000 ............ ............ ............ Paid-In Capital in Excess of Par—Fast Air .......... ............ (200,000) (EL) 200,000 ............ ............ ............ Retained Earnings—Fast Air ............................... ............ (180,000) (EL) 180,000 ............ ............ ............ ............ ............ ............ ............ ............ ............ ............ ............ ............ ............ ............ ............ ............ ............ ............ ............ ............ ............ Common Stock ($1 par)—Fast Cool ................... (100,000) ............ ............ ............ ............ ............ Paid-In Capital in Excess of Par—Fast Cool ....... (1,500,000) ............ ............ ............ ............ ............ Retained Earnings—Fast Cool ............................ (400,000) ............ ............ ............ ............ ............ ............ ............ ............ ............ ............ ............ ............ ............ ............ ............ ............ ............ ............ ............ ............ ............ ............ ............ Sales ................................................................... (700,000) (400,000) ............ ............ (1,100,000) ............ Cost of Goods Sold ............................................. 380,000 210,000 (D1) 5,000 ............ 595,000 ............ Depreciation Expense—Buildings ....................... 10,000 17,500 (A4) 7,500 ............ 35,000 ............ Depreciation Expense—Equipment ..................... 7,000 24,000 ............ (A5) 4,000 27,000 ............ Other Expenses................................................... 50,000 85,000 (A6) 2,000 ............ 142,000 ............ ............ ............ (A7) 5,000 ............ ............ ............ Interest Expense ................................................. ............ 16,000 ............ (A3) 1,000 15,000 ............ ............ ............ ............ ............ ............ ............ ............ ............ ............ ............ ............ ............ Subsidiary (Dividend) Income.............................. (47,500) ............ (CY1) 47,500 ............ ............ ............ Dividends Declared—Fast Air ............................. ............ 10,000 ............ (CY2) 10,000 ............ ............ ............ ............ ............ ............ ............ Dividends Declared—Fast Cool .......................... 20,000 0 902,000 902,000 ............ ............ Total .................................................................... 0 Consolidated Net Income ................................................................................................................................................................ (286,000) ............ To Noncontrolling Interest (see distribution schedule) ................................................................................................................ ............ ............ To Controlling Interest (see distribution schedule) ...................................................................................................................... 286,000 ............ Total NCI ............................................................................................................................................................................................................................................. Retained Earnings—Controlling Interest, December 31, 2015 ............................................................................................................................................................ .

part.

3-61

Ch. 3—Problems

Problem 3-14, Concluded Eliminations and Adjustments: (CY1) Current-year subsidiary income. (CY2) Current-year dividend. (EL) Eliminate controlling interest in subsidiary equity. (D) Distribute excess according to D&D schedule. (A) Amortize excess using amortization schedule. PROBLEM 3-15 (1) Value Analysis Schedule Company fair value ........................................... Fair value of net assets excluding goodwill ...... Goodwill ............................................................

Company Implied Fair Value

Parent Price (100%)

NCI Value (0%)

$800,000 630,000 $170,000

N/A

Determination and Distribution of Excess Schedule Company Implied Fair Value

Parent Price (100%)

NCI Value (0%)

Fair value of subsidiary .............. $800,000 Less book value of interest acquired: Common stock ($1 par) ......... $100,000 Paid-in capital in excess of par 200,000 Retained earnings ................. 180,000 Total equity ...................... $480,000 Interest acquired ................... Book value ................................. Excess of fair value over book value ...................................... $320,000

$800,000

N/A

$480,000 100% $480,000 $320,000

Ch. 3—Problems

3–62

Problem 3-15, Continued Adjustment of identifiable accounts: Adjustment

Worksheet Key

Life

Amortization per Year

Inventory ($65,000 fair – $60,000 book value) .............. Land ($100,000 fair – $50,000 book value) .............. Mortgage payable ($205,000 fair – $200,000 book value) ... Buildings ($500,000 fair – $350,000 book value) ............ Equipment ($100,000 fair – $120,000 book value) ............ Patent ($50,000 fair – $40,000 book value) ............................ Purchase contract ($10,000 fair – $0 book value) .............. Goodwill ($170,000 – $50,000 book value) ............................ Total ................................ Account Adjustments

Life

Annual Amount

Current Year

Prior Years

Total

Inventory ......................... Subject to amortization: Mortgage payable ........... Buildings.......................... Equipment ....................... Patent .............................. Purchase contract ........... Total amortizations ....

$ 5,000

(D1)

5 20 5 5 2

$ (1,000) $ (1,000) 7,500 7,500 (4,000) (4,000) 2,000 2,000 5,000 5,000 $ 9,500 $ 9,500

$(1,000) $ (2,000) 7,500 15,000 (4,000) (8,000) 2,000 4,000 5,000 10,000 $ 9,500 $19,000

(A3) (A4) (A5) (A6) (A7)

(2)

5,000

debit D1

50,000

debit D2

(5,000)

credit D3

$(1,000)

150,000

debit D4

7,500

(20,000)

credit D5

(4,000)

10,000

debit D6

2,000

10,000

debit D7

5,000

120,000 $320,000

debit D8

—

Key

Subsidiary Fast Air Company Income Distribution Current-year amortizations ............

$9,500

Internally generated net income .................................

$67,500

Adjusted income ........................ NCI share ................................... NCI .............................................

$58,000 0% $ 0

Parent Fast Cool Company Income Distribution Internally generated net income ................................. Controlling share of subsidiary ..

$253,000 58,000

Controlling interest .....................

$311,000

3-63

Ch. 3—Problems

Problem 3-15, Continued Fast Cool Company and Subsidiary Fast Air Company Worksheet for Consolidated Financial Statements For Year Ended December 31, 2016 Eliminations Trial Balance and Adjustments Fast Cool Fast Air Dr. Cr.

Consolidated Income Statement

NCI

Controlling Retained Earnings

Consolidated Balance Sheet

............ ............ ............ ............ ............ ............ ............ ............ ............ ............ ............ ............ ............ ............ ............ ............ ............ ............ ............ ............ ............ ............ ............ ............ ............ ............ ............ ............ ............ ............ (666,000) ............ ............ ............ ............ ............ ............ ............ ............ ............ ............ ............ 20,000 ............ ............ ............ (311,000) ............ (957,000)

495,000 320,000 215,000 160,000 ............ ............ ............ ............ 1,750,000 (300,000) 270,000 (150,000) 30,000 ............ 170,000 (200,000) (200,000) ............ (3,000) ............ ............ ............ ............ ............ ............ (100,000) (1,500,000) ............ ............ ............ ............ ............ ............ ............ ............ ............ ............ ............ ............ ............ ............ ............ ............ ............ ............ ............ ............ ............ (957,000) 0

396,000 99,000 ............ ............ ............ ............ 200,000 120,000 ............ ............ ............ ............ 120,000 95,000 ............ ............ ............ ............ 60,000 50,000 (D2) 50,000 ............ ............ ............ 895,000 ............ ............ (CY1) 67,500 ............ ............ ............ ............ (CY2) 10,000 ............ ............ ............ ............ ............ ............ (EL) 517,500 ............ ............ ............ ............ ............ (D) 320,000 ............ ............ Buildings .............................................................. 1,200,000 400,000 (D4) 150,000 ............ ............ ............ Accumulated Depreciation................................... (200,000) (85,000) ............ (A4 15,000 ............ ............ Equipment ........................................................... 140,000 150,000 ............ (D5) 20,000 ............ ............ Accumulated Depreciation................................... (80,000) (78,000) (A5) 8,000 ............ ............ ............ Patent .................................................................. ............ 24,000 (D6) 10,000 (A6) 4,000 ............ ............ Purchase Contract ............................................... ............ ............ (D7) 10,000 (A7) 10,000 ............ ............ Goodwill............................................................... ............ 50,000 (D8) 120,000 ............ ............ ............ Current Liabilities................................................. (150,000) (50,000) ............ ............ ............ ............ Mortgage Payable ............................................... ............ (200,000) ............ ............ ............ ............ Discount (Premium) ............................................. ............ ............ ............ (D3) 5,000 ............ ............ ............ ............ (A3) 2,000 ............ ............ ............ Common Stock ($1 par)—Fast Air ...................... ............ (100,000) (EL) 100,000 ............ ............ ............ Paid-In Capital in Excess of Par—Fast Air .......... ............ (200,000) (EL) 200,000 ............ ............ ............ Retained Earnings—Fast Air ............................... ............ (217,500) (EL) 217,500 ............ ............ ............ ............ ............ ............ ............ ............ ............ ............ ............ ............ ............ ............ ............ ............ ............ ............ ............ ............ ............ Common Stock ($1 par)—Fast Cool ................... (100,000) ............ ............ ............ ............ ............ Paid-In Capital in Excess of Par—Fast Cool ....... (1,500,000) ............ ............ ............ ............ ............ Retained Earnings—Fast Cool ............................ (680,500) ............ ............ ............ ............ ............ ............ ............ (D1) 5,000 ............ ............ ............ ............ ............ (A3–A7) 9,500 ............ ............ ............ ............ ............ ............ ............ ............ ............ Sales ................................................................... (700,000) (500,000) ............ ............ (1,200,000) ............ Cost of Goods Sold ............................................. 380,000 260,000 ............ ............ 640,000 ............ Depreciation Expense—Buildings ....................... 10,000 17,500 (A4) 7,500 ............ 35,000 ............ Depreciation Expense—Equipment ..................... 7,000 24,000 ............ (A5) 4,000 27,000 ............ Other Expenses................................................... 50,000 115,000 (A6) 2,000 ............ 172,000 ............ ............ ............ (A7) 5,000 ............ ............ ............ Interest Expense ................................................. ............ 16,000 ............ (A3) 1,000 15,000 ............ ............ ............ ............ ............ ............ ............ ............ ............ ............ ............ ............ ............ Subsidiary (Dividend) Income.............................. (67,500) ............ (CY1) 67,500 ............ ............ ............ Dividends Declared—Fast Air ............................. ............ 10,000 ............ (CY2) 10,000 ............ ............ ............ ............ ............ ............ ............ Dividends Declared—Fast Cool .......................... 20,000 0 974,000 974,000 ............ ............ Total .................................................................... 0 Consolidated Net Income ................................................................................................................................................................ (311,000) ............ To Noncontrolling Interest (see distribution schedule) ................................................................................................................ ............ ............ To Controlling Interest (see distribution schedule) ...................................................................................................................... ... 311,000 ............ Total NCI ............................................................................................................................................................................................................................................. Retained Earnings—Controlling Interest, December 31, 2016 ............................................................................................................................................................

part.

Ch. 3—Problems

3–64

Problem 3-15, Concluded Eliminations and Adjustments: (CY1) Current-year subsidiary income. (CY2) Current-year dividend. (EL) Eliminate controlling interest in subsidiary equity. (D) Distribute excess according to D&D schedule (inventory goes to Fast Cool’s retained earnings). (A) Amortize excess using amortization schedule (prior years go to Fast Cool’s retained earnings). PROBLEM 3-16 (1) Value Analysis Schedule Company fair value ........................................... Fair value of net assets excluding goodwill ...... Gain on acquisition ...........................................

Company Implied Fair Value

Parent Price (100%)

NCI Value (0%)

$500,000 630,000 $130,000

N/A

Determination and Distribution of Excess Schedule Company Implied Fair Value

Parent Price (100%)

NCI Value (0%)

Price paid for investment ........... $500,000 Less book value of interest acquired: Common stock ($1 par) .......... $100,000 Paid-in capital in excess of par 200,000 Retained earnings .................. 180,000 Total equity ......................... $480,000 Interest acquired..................... Book value ................................. Excess of fair value over book value ....................................... $ 20,000

$500,000

N/A

$480,000 100% $480,000 $ 20,000

3-65

Ch. 3—Problems

Problem 3-16, Continued Adjustment of identifiable accounts: Adjustment Inventory ($65,000 fair – $60,000 book value) .............. Land ($100,000 fair – $50,000 book value) ............................ Mortgage payable ($205,000 fair – $200,000 book value) ... Buildings ($500,000 fair – $350,000 book value) ............ Equipment ($100,000 fair – $120,000 book value) ............ Patent ($50,000 fair – $40,000 book value) ............................ Purchase contract ($10,000 fair – $0 book value) .............. Goodwill (remove $50,000 book value) ............................ Gain on acquisition ($500,000 fair – $630,000 book value) ... Total ................................

Worksheet Key

Life

Amortization per Year

5,000

debit D1

50,000

debit D2

(5,000)

credit D3

$(1,000)

150,000

debit D4

7,500

(20,000)

credit D5

(4,000)

10,000

debit D6

2,000

10,000

debit D7

5,000

(50,000)

credit D8

(130,000) $ 20,000

credit D9

(2) Account Adjustments

Life

Annual Amount

Current Year

Prior Years

Total

$ 5,000

(D1)

5 20 5 5 2

$ (1,000) $ (1,000) 7,500 7,500 (4,000) (4,000) 2,000 2,000 5,000 5,000 $ 9,500 $ 9,500

$(1,000) $ (2,000) 7,500 15,000 (4,000) (8,000) 2,000 4,000 5,000 10,000 $ 9,500 $19,000

(A3) (A4) (A5) (A6) (A7)

—

Key

Ch. 3—Problems

3–66

Problem 3-16, Continued Subsidiary Fast Air Company Income Distribution Current-year amortizations ............

$9,500

Internally generated net income .................................

$67,500

Adjusted income ........................ NCI share ................................... NCI .............................................

$58,000 0% $ 0

Parent Fast Cool Company Income Distribution Internally generated net income ................................. Controlling share of subsidiary ..

$253,000 58,000

Controlling interest .....................

$311,000

3-67

Ch. 3—Problems

Problem 3-16, Continued Fast Cool Company and Subsidiary Fast Air Company Worksheet for Consolidated Financial Statements For Year Ended December 31, 2016 Trial Balance Fast Cool Fast Air Cash .................................................................... Accounts Receivable ........................................... Inventory.............................................................. Land .................................................................... Investment in Fast Air ..........................................

Eliminations and Adjustments Dr.

Cr.

Consolidated Income Statement

NCI

396,000 99,000 ............ ............ ............ ............ 200,000 120,000 ............ ............ ............ ............ 120,000 95,000 ............ ............ ............ ............ 60,000 50,000 (D2) 50,000 ............ ............ ............ 595,000 ............ ............ (CY1) 67,500 ............ ............ ............ ............ (CY2) 10,000 ............ ............ ............ ............ ............ ............ (EL) 517,500 ............ ............ ............ ............ ............ (D) 20,000 ............ ............ Buildings .............................................................. 1,200,000 400,000 (D4) 150,000 ............ ............ ............ Accumulated Depreciation................................... (200,000) (85,000) ............ (A4) 15,000 ............ ............ Equipment ........................................................... 140,000 150,000 ............ (D5) 20,000 ............ ............ Accumulated Depreciation................................... (80,000) (78,000) (A5) 8,000 ............ ............ ............ Patent .................................................................. ............ 24,000 (D6) 10,000 (A6) 4,000 ............ ............ Purchase Contract ............................................... ............ ............ (D7) 10,000 (A7) 10,000 ............ ............ Goodwill............................................................... ............ 50,000 ............ (D8) 50,000 ............ ............ Current Liabilities................................................. (150,000) (50,000) ............ ............ ............ ............ Mortgage Payable ............................................... ............. (200,000) ............ ............ ............ ............ Discount (Premium) ............................................. ............. ............ ............ (D3) 5,000 ............ ............ ............................................................................ ............. ............ (A3) 2,000 ............ ............ ............ Common Stock ($1 par)—Fast Air ...................... ............. (100,000) (EL) 100,000 ............ ............ ............ Paid-In Capital in Excess of Par—Fast Air .......... ............. (200,000) (EL) 200,000 ............ ............ ............ Retained Earnings—Fast Air ............................... ............. (217,500) (EL) 217,500 ............ ............ ............ ............. ............ ............ ............ ............ ............ ............. ............ ............ ............ ............ ............ ............. ............ ............ ............ ............ ............ Common Stock ($1 par)—Fast Cool ................... (85,000) ............ ............ ............ ............ ............ Paid-In Capital in Excess of Par—Fast Cool ....... (1,215,000) ............ ............ ............ ............ ............ Retained Earnings—Fast Cool ............................ (680,500) ............ ............ (D9) 130,000 ............ ............ ............ ............ (D1) 5,000 ............ ............ ............ ............ ............ (A3–A7) 9,500 ............ ............ ............ ............ ............ ............ ............ ............ ............ Sales ................................................................... (700,000) (500,000) ............ ............ (1,200,000) ............ Cost of Goods Sold ............................................. 380,000 260,000 ............ ............ 640,000 ............ Depreciation Expense—Buildings ....................... 10,000 17,500 (A4) 7,500 ............ 35,000 ............ Depreciation Expense—Equipment ..................... 7,000 24,000 ............ (A5) 4,000 27,000 ............ Other Expenses................................................... 50,000 115,000 (A6) 2,000 ............ 172,000 ............ ............. ............ (A7) 5,000 ............ ............ ............ Interest Expense ................................................. ............. 16,000 ............ (A3) 1,000 15,000 ............ ............. ............ ............ ............ ............ ............ Subsidiary (dividend) Income .............................. (67,500) ............ (CY1) 67,500 ............ ............ ............ Dividends Declared—Fast Air ............................. ............ 10,000 ............ (CY2) 10,000 ............ ............ ............ ............ ............ ............ ............ Dividends Declared—Fast Cool .......................... 20,000 0 854,000 854,000 ............ ............ Total .................................................................... 0 Consolidated Net Income ................................................................................................................................................................ (311,000) ............ ............ To Noncontrolling Interest (see distribution schedule) ................................................................................................................ ............ To Controlling Interest (see distribution schedule) ...................................................................................................................... . 311,000 ............ Total NCI ............................................................................................................................................................................................................................................. Retained Earnings—Controlling Interest, December 31, 2016 ............................................................................................................................................................

Controlling Retained Earnings

Consolidated Balance Sheet

............ ............ ............ ............ ............ ............ ............ ............ ............ ............ ............ ............ ............ ............ ............ ............ ............ ............ ............ ............ ............ ............ ............ ............ ............ ............ ............ ............ ............ ............ (796,000) ............ ............ ............ ............ ............ ............ ............ ............ ............ ............ 20,000 ............ ............ ............ (311,000) ............ (1,087,000)

495,000 320,000 215,000 160,000 ............ ............ ............ ............ 1,750,000 (300,000) 270,000 (150,000) 30,000 ............ ............ (200,000) (200,000) ............ (3,000) ............ ............ ............ ............ ............ ............ (85,000) (1,215,000) ............ ............ ............ ............ ............ ............ ............ ............ ............ ............ ............ ............ ............ ............ ............ ............ ............ ............ ............ ............ (1,087,000) 0

part.

Ch. 3—Problems

3–68

Problem 3-16, Concluded Eliminations and Adjustments: (CY1) Current-year subsidiary income. (CY2) Current-year dividend. (EL) Eliminate controlling interest in subsidiary equity. (D) Distribute excess according to D&D schedule (gain and inventory go to Fast Cool’s retained earnings). (A) Amortize excess using amortization schedule (prior years go to Fast Cool’s retained earnings). PROBLEM 3-17 (1) Value Analysis Schedule Company fair value ........................................... Fair value of net assets excluding goodwill ...... Goodwill ............................................................

Company Implied Fair Value

Parent Price (80%)

NCI Value (20%)

$875,000 630,000 $245,000

$700,000 504,000 $196,000

$175,000 126,000 $ 49,000

Determination and Distribution of Excess Schedule Company Implied Fair Value

Parent Price (80%)

NCI Value (20%)

Fair value of subsidiary .............. $875,000 Less book value of interest acquired: Common stock ($1 par) ......... $100,000 Paid-in capital in excess of par 200,000 Retained earnings .................. 180,000 Total equity ......................... $480,000 Interest acquired..................... Book value ................................. Excess of fair value over book value ....................................... $395,000

$700,000

$175,000

$480,000 80% $384,000

$480,000 20% $ 96,000

$316,000

$ 79,000

3-69

Ch. 3—Problems

Problem 3-17, Continued Adjustment of identifiable accounts: Worksheet Key

Life

5,000

debit D1

50,000

debit D2

(5,000)

credit D3

$(1,000)

150,000

debit D4

7,500

(20,000)

credit D5

(4,000)

10,000

debit D6

2,000

5,000

Adjustment

Amortization per Year

Inventory ($65,000 fair – $60,000 book value) .............. Land ($100,000 fair – $50,000 book value) ............................ Mortgage payable ($205,000 fair – $200,000 book value) ... Buildings ($500,000 fair – $350,000 book value) ............ Equipment ($100,000 fair – $120,000 book value) ............ Patent ($50,000 fair – $40,000 book value) ............................ Purchase contract ($10,000 fair – $0 book value) .............. Goodwill ($245,000 – $50,000 book value) ............................ Total ................................

10,000

debit D7

195,000 $395,000

debit D8

Account Adjustments

Life

Annual Amount

Current Year

Prior Years

Total

$ 5,000

$ —

$ 5,000

(D1)

5 20 5 5 2

$ (1,000) $ (1,000) 7,500 7,500 (4,000) (4,000) 2,000 2,000 5,000 5,000 $ 9,500 $ 9,500

$ — — — — — $ —

$ (1,000) 7,500 (4,000) 2,000 5,000 $ 9,500

(A3) (A4) (A5) (A6) (A7)

(2) Key

Ch. 3—Problems

3–70

Problem 3-17, Continued Subsidiary Fast Air Company Income Distribution Inventory adjustment ..................... Current-year amortizations ............

$5,000 9,500

Internally generated net income .................................

$47,500

Adjusted income ........................ NCI share ................................... NCI .............................................

$33,000 20% $ 6,600

Parent Fast Cool Company Income Distribution Internally generated net income ................................. Controlling share of subsidiary ..

$253,000 26,400

Controlling interest .....................

$279,400

3-71

Ch. 3—Problems

Problem 3-17, Continued Fast Cool Company and Subsidiary Fast Air Company Worksheet for Consolidated Financial Statements For Year Ended December 31, 2015 Trial Balance Fast Cool Fast Air

Eliminations and Adjustments Dr.

Cr.

Consolidated Income Statement

NCI

Controlling Retained Earnings

Consolidated Balance Sheet

............ ............ ............ ............ ............ ............ ............ ............ ............ ............ ............ ............ ............ ............ ............ ............ ............ ............ ............ ............ ............ ............ ............ ............ ............ ............ ............ ............ ............ ............ (400,000) ............ ............ ............ ............ ............ ............ ............ ............ ............ ............ 20,000 ............ ............ ............ (279,400) ............ (659,400)

182,000 170,000 210,000 160,000 ............ ............ ............ ............ 1,750,000 (251,000) 270,000 (118,000) 40,000 5,000 245,000 (120,000) (200,000) ............ (4,000) ............ ............ ............ ............ ............ ............ (95,000) (1,405,000) ............ ............ ............ ............ ............ ............ ............ ............ ............ ............ ............ ............ ............ ............ ............ ............ ............ ............ ............ (179,600) (659,400) 0

145,000 37,000 ............ ............ ............ ............ 70,000 100,000 ............ ............ ............ ............ 150,000 60,000 ............ ............ ............ ............ 60,000 50,000 (D2) 50,000 ............ ............ ............ 730,000 ............ ............ (CY1) 38,000 ............ ............ ............ ............ (CY2) 8,000 ............ ............ ............ ............ ............ ............ (EL) 384,000 ............ ............ ............ ............ ............ (D) 316,000 ............ ............ Buildings .............................................................. 1,200,000 400,000 (D4) 150,000 ............ ............ ............ Accumulated Depreciation................................... (176,000) (67,500) ............ (A4) 7,500 ............ ............ Equipment ........................................................... 140,000 150,000 ............ (D5) 20,000 ............ ............ Accumulated Depreciation................................... (68,000) (54,000) (A5) 4,000 ............ ............ ............ Patent .................................................................. ............ 32,000 (D6) 10,000 (A6) 2,000 ............ ............ Purchase Contract ............................................... ............ ............ (D7) 10,000 (A7) 5,000 ............ ............ Goodwill............................................................... ............ 50,000 (D8) 195,000 ............ ............ ............ Current Liabilities................................................. (80,000) (40,000) ............ ............ ............ ............ Mortgage Payable ............................................... ............ (200,000) ............ ............ ............ ............ Discount (Premium) ............................................. ............ ............ ............ (D3) 5,000 ............ ............ ............................................................................ ............ ............ (A3) 1,000 ............ ............ ............ Common Stock ($1 par)—Fast Air ...................... ............ (100,000) (EL) 80,000 ............ ............ (20,000) Paid-In Capital in Excess of Par—Fast Air .......... ............ (200,000) (EL) 160,000 ............ ............ (40,000) Retained Earnings—Fast Air ............................... ............ (180,000) (EL) 144,000 ............ ............ (115,000) ............ ............ ............ (NCI) 79,000 ............ ............ ............ ............ ............ ............ ............ ............ ............ ............ ............ ............ ............ ............ Common Stock ($1 par)—Fast Cool ................... (95,000) ............ ............ ............ ............ ............ Paid-In Capital in Excess of Par—Fast Cool ....... (1,405,000) ............ ............ ............ ............ ............ Retained Earnings—Fast Cool ............................ (400,000) ............ ............ ............ ............ ............ ............ ............ ............ ............ ............ ............ ............ ............ ............ ............ ............ ............ ............ ............ ............ ............ ............ ............ Sales ................................................................... (700,000) (400,000) ............ ............ (1,100,000) ............ Cost of Goods Sold ............................................. 380,000 210,000 (D1) 5,000 ............ 595,000 ............ Depreciation Expense—Buildings ....................... 10,000 17,500 (A4) 7,500 ............ 35,000 ............ Depreciation Expense—Equipment ..................... 7,000 24,000 ............ (A5) 4,000 27,000 ............ Other Expenses................................................... 50,000 85,000 (A6) 2,000 ............ 142,000 ............ ............ ............ (A7) 5,000 ............ ............ ............ Interest Expense ................................................. ............ 16,000 ............ (A3) 1,000 15,000 ............ ............ ............ ............ ............ ............ ............ Subsidiary (Dividend) Income ............................. (38,000) ............ (CY1) 38,000 ............ ............ ............ Dividends Declared—Fast Air ............................. ............ 10,000 ............ (CY2) 8,000 ............ 2,000 ............ ............ ............ ............ ............ Dividends Declared—Fast Cool .......................... 20,000 0 869,500 869,500 ............ ............ Total ...................................... ............................. 0 Consolidated Net Income ................................................................................................................................................................ (286,000) ............ (6,600) To Noncontrolling Interest (see distribution schedule) ................................................................................................................ 6,600 To Controlling Interest (see distribution schedule) ...................................................................................................................... 279,400 Total NCI ................................................................................................................................................................................................................... (179,600) Retained Earnings—Controlling Interest, December 31, 2015 ............................................................................................................................................................

part.

Ch. 3—Problems

3–72

Problem 3-17, Concluded Eliminations and Adjustments: (CY1) Current-year subsidiary income. (CY2) Current-year dividend. (EL) Eliminate controlling interest in subsidiary equity. (D)/(NCI) Distribute excess according to D&D schedule. (A) Amortize excess using amortization schedule. PROBLEM 3-18 (1) Value Analysis Schedule Company fair value ........................................... Fair value of net assets excluding goodwill ...... Goodwill ............................................................

Company Implied Fair Value

Parent Price (80%)

NCI Value (20%)

$875,000 630,000 $245,000

$700,000 504,000 $196,000

$175,000 126,000 $ 49,000

Determination and Distribution of Excess Schedule Company Implied Fair Value

Parent Price (80%)

NCI Value (20%)

Fair value of subsidiary .............. $875,000 Less book value of interest acquired: Common stock ($1 par) .......... $100,000 Paid-in capital in excess of par 200,000 Retained earnings .................. 180,000 Total equity ......................... $480,000 Interest acquired..................... Book value ................................. Excess of fair value over book value ....................................... $395,000

$700,000

$175,000

$480,000 80% $384,000

$480,000 20% $ 96,000

$316,000

$ 79,000

3-73

Ch. 3—Problems

Problem 3-18, Continued Adjustment of identifiable accounts: Worksheet Key

Life

5,000

debit D1

(5,000)

credit D3

$(1,000)

50,000

debit D2

150,000

debit D4

7,500

(20,000)

credit D5

(4,000)

10,000

debit D6

2,000

5,000

Adjustment

Amortization per Year

Inventory ($65,000 fair – $60,000 book value) .............. Mortgage payable ($205,000 fair – $200,000 book value) ... Land ($100,000 fair – $50,000 book value) .............. Buildings ($500,000 fair – $350,000 book value) ............ Equipment ($100,000 fair – $120,000 book value) ............ Patent ($50,000 fair – $40,000 book value) ............................ Purchase contract ($10,000 fair – $0 book value) .............. Goodwill ($245,000 – $50,000 book value) ............................ Total ................................

10,000

debit D7

195,000 $395,000

debit D8

Account Adjustments

Life

Annual Amount

Current Year

Prior Years

Total

$ 5,000

(D1)

5 20 5 5 2

$ (1,000) $ (1,000) 7,500 7,500 (4,000) (4,000) 2,000 2,000 5,000 5,000 $ 9,500 $ 9,500

$(1,000) $ (2,000) 7,500 15,000 (4,000) (8,000) 2,000 4,000 5,000 10,000 $ 9,500 $19,000

(A3) (A4) (A5) (A6) (A7)

(2)

To NCI ....................... To controlling interest

—

Key

1,900 7,600

Ch. 3—Problems

3–74

Problem 3-18, Continued Subsidiary Fast Air Company Income Distribution Current-year amortizations ............

$9,500

Internally generated net income .................................

$67,500

Adjusted income ........................ NCI share ................................... NCI .............................................

$58,000 20% $11,600

Parent Fast Cool Company Income Distribution Internally generated net income ................................. Controlling share of subsidiary ..

$253,000 46,400

Controlling interest .....................

$299,400

3-75

Ch. 3—Problems

Problem 3-18, Continued Fast Cool Company and Subsidiary Fast Air Company Worksheet for Consolidated Financial Statements For Year Ended December 31, 2016 Trial Balance Fast Cool Fast Air Cash .................................................................... Accounts Receivable ........................................... Inventory.............................................................. Land .................................................................... Investment in Fast Air ..........................................

Eliminations and Adjustments Dr.

Cr.

Consolidated Income Statement

NCI

Controlling Retained Earnings

Consolidated Balance Sheet

............ ............ ............ ............ ............ ............ ............ ............ ............ ............ ............ ............ ............ ............ ............ ............ ............ ............ ............ ............ ............ ............ ............ ............ ............ ............ ............ ............ ............ ............ (659,400) ............ ............ ............ ............ ............ ............ ............ ............ ............ ............ ............ 20,000 ............ ............ ............ (299,400) ............ (938,800)

491,000 320,000 215,000 160,000 ............ ............ ............ ............ 1,750,000 (300,000) 270,000 (150,000) 30,000 ............ 245,000 (200,000) (200,000) ............ (3,000) ............ ............ ............ ............ ............ ............ (95,000) (1,405,000) ............ ............ ............ ............ ............ ............ ............ ............ ............ ............ ............ ............ ............ ............ ............ ............ ............ ............ ............ ............ (189,200) (938,800) 0

99,000 ............ ............ ............ ............ 120,000 ............ ............ ............ ............ 95,000 ............ ............ ............ ............ 50,000 (D2) 50,000 ............ ............ ............ ............ ............ (CY1) 54,000 ............ ............ ............ (CY2) 8,000 ............ ............ ............ ............ ............ (EL) 414,000 ............ ............ ............ ............ (D) 316,000 ............ ............ Buildings .............................................................. 400,000 (D4) 150,000 ............ ............ ............ Accumulated Depreciation................................... (85,000) ............ (A4) 15,000 ............ ............ Equipment ........................................................... 150,000 ............ (D5) 20,000 ............ ............ Accumulated Depreciation................................... (78,000) (A5) 8,000 ............ ............ ............ Patent .................................................................. 24,000 (D6) 10,000 (A6) 4,000 ............ ............ Purchase Contract ............................................... ............ (D7) 10,000 (A7) 10,000 ............ ............ Goodwill............................................................... 50,000 (D8) 195,000 ............ ............ ............ Current Liabilities................................................. (50,000) ............ ............ ............ ............ Mortgage Payable ............................................... (200,000) ............ ............ ............ ............ Discount (Premium) ............................................. ............ ............ (D3) 5,000 ............ ............ ............ (A3) 2,000 ............ ............ ............ Common Stock ($1 par)—Fast Air ...................... (100,000) (EL) 80,000 ............ ............ (20,000) Paid-In Capital in Excess of Par—Fast Air .......... (200,000) (EL) 160,000 ............ ............ (40,000) Retained Earnings—Fast Air ............................... (217,500) (EL) 174,000 ............ ............ (119,600) ............ ............ (NCI) 79,000 ............ ............ ............ (D1) 1,000 ............ ............ ............ ............ (A3–A7) 1,900 ............ ............ ............ Common Stock ($1 par)—Fast Cool ................... ............ ............ ............ ............ ............ Paid-In Capital in Excess of Par—Fast Cool ....... ............ ............ ............ ............ ............ Retained Earnings—Fast Cool ............................ ............ ............ ............ ............ ............ ............ (D1) 4,000 ............ ............ ............ ............ (A3–A7) 7,600 ............ ............ ............ ............ ............ ............ ............ ............ Sales ................................................................... (500,000) ............ ............ (1,200,000) ............ Cost of Goods Sold ............................................. 260,000 ............ ............ 640,000 ............ Depreciation Expense—Buildings ....................... 17,500 (A4) 7,500 ............ 35,000 ............ Depreciation Expense—Equipment ..................... 24,000 ............ (A5) 4,000 27,000 ............ Other Expenses................................................... 115,000 (A6) 2,000 ............ 172,000 ............ ............ (A7) 5,000 ............ ............ ............ Interest Expense ................................................. 16,000 ............ (A3) 1,000 15,000 ............ ............ ............ ............ ............ ............ ............ ............ ............ ............ ............ ............ ............ Subsidiary (Dividend) Income.............................. (54,000) ............ (CY1) 54,000 ............ ............ ............ Dividends Declared—Fast Air ............................. ............ 10,000 ............ (CY2) 8,000 ............ 2,000 ............ ............ ............ ............ ............ Dividends Declared—Fast Cool .......................... 20,000 0 930,000 930,000 ............ ............ Total .................................................................... 0 Consolidated Net Income ................................................................................................................................................................ (311,000) ............ To Noncontrolling Interest (see distribution schedule) ................................................................................................................ 11,600 (11,600) To Controlling Interest (see distribution schedule) ...................................................................................................................... 299,400 Total NCI ................................................................................................................................................................................................................... (189,200) Retained Earnings—Controlling Interest, December 31, 2016 ............................................................................................................................................................ .

392,000 200,000 120,000 60,000 776,000 ............ ............ ............ 1,200,000 (200,000) 140,000 (80,000) ............. ............. ............. (150,000) ............ ............ ............ ............ ............ ............ ............ ............ ............ (95,000) (1,405,000) (671,000) ............ ............ ............ (700,000) 380,000 10,000 7,000 50,000 ............

part.

Ch. 3—Problems

3–76

Problem 3-18, Concluded Eliminations and Adjustments: (CY1) Current-year subsidiary income. (CY2) Current-year dividend. (EL) Eliminate controlling interest in subsidiary equity. (D)/(NCI) Distribute excess according to D&D schedule. (A) Amortize excess using amortization schedule.

3-77

Ch. 3—Problems

APPENDIX PROBLEMS PROBLEM 3A-1 (1) See part (1) of solution to Problem 3-2. (2)

Paro Company and Solar Company Worksheet for Consolidated Financial Statements For Year Ended December 31, 2016 Financial Statements Paro Solar Income Statement: Net Sales .............................................. Cost of Goods Sold .............................. Operating Expenses ............................. Subsidiary Income ................................ Net Income ..................................... Consolidated Net Income ..................... NCI (see income distribution schedule) Controlling Interest (see income distribution schedule) ..................... Retained Earnings Statement: Balance, January 1, 2016—Paro ......... ....................................................... Balance, January 1, 2016—Solar ........ ....................................................... ....................................................... ....................................................... Net Income (from above) ..................... Dividends Declared—Paro ................... Dividends Declared—Solar .................. Balance, December 31, 2016 ...................

(520,000) 300,000 120,000 (72,000) (172,000) ........... ...........

Eliminations and Adjustments Dr. Cr.

(450,000) 260,000 100,000 (A) ........... (CY1) (90,000) ........... ...........

...........

(214,000) ........... ........... ........... ........... ........... (172,000) 50,000 ........... (336,000)

........... ........... (190,000) ........... ........... ........... (90,000) ........... 30,000 (250,000)

(D1) (A) (EL) (D1) (A)

Noncontrolling Interest

Consolidated

........... ........... 3,000 72,000 ........... ........... ...........

........... ........... ........... ........... ........... ........... ...........

........... ........... ........... ........... ........... ........... (17,400)

(970,000) 560,000 223,000 ........... ........... (187,000) ...........

...........

(169,600)

8,000 2,400 152,000 ........... 2,000 600 ........... ........... ........... ...........

........... ........... ........... 20,000 ........... ........... ........... ........... 24,000 ...........

........... ........... (55,400) ........... ........... ........... (17,400) ........... 6,000 (66,800)

........... (203,600) ........... ........... ........... ........... (169,600) 50,000 ........... (323,200)

(NCI)

(CY2)

part.

Ch. 3—Problems

3–78

Problem 3A-1, Continued Paro Company and Solar Company Worksheet for Consolidated Financial Statements For Year Ended December 31, 2016 (Concluded) Financial Eliminations Statements and Adjustments Paro Solar Dr. Cr. Consolidated Balance Sheet: Inventory, December 31, 2016 ............. Other Current Assets ........................... Investment in Solar Company ..............

100,000 136,000 400,000 ........... ........... 50,000 350,000 (100,000) ........... 20,000 (120,000) ........... (200,000) (200,000)

Land ..................................................... Building and Equipment ....................... Accumulated Depreciation ................... Goodwill ............................................... Other Intangibles .................................. Current Liabilities ................................. Bonds Payable ..................................... Other Long-Term Liabilities .................. Common Stock—Paro ......................... Other Paid-In Capital in Excess of Par—Paro................................... (100,000) Common Stock—Solar ......................... ........... Other Paid-In Capital in Excess of Par—Solar .................................. ........... Retained Earnings, December 31, 2016 (carrydown) .................................... (336,000) Retained Earnings—Controlling Interest, December 31, 2016 .......... ........... Retained Earnings—NCI, December 31, 2016 ........................................ ........... Total NCI .............................................. ........... Totals ........................................................ 0

Noncontrolling Interest

Consolidated

50,000 180,000 ........... (CY2) ........... ........... 50,000 320,000 (D2) (60,000) ........... (D3) ........... (40,000) (100,000) ........... ...........

........... ........... 24,000 ........... ........... ........... 30,000 ........... 60,000 ........... ........... ........... ........... ...........

........... ........... (CY1) 72,000 (EL) 272,000 (D) 80,000 ........... ........... (A) 6,000 ........... ........... ........... ........... ........... ...........

........... ........... ........... ........... ........... ........... ........... ........... ........... ........... ........... ........... ........... ...........

150,000 316,000 ........... ........... ........... 100,000 700,000 (166,000) 60,000 20,000 (160,000) (100,000) (200,000) (200,000)

........... (50,000)

(EL)

........... 40,000

........... ...........

........... (10,000)

(100,000) ...........

(100,000)

(EL)

80,000

...........

(20,000)

...........

(250,000)

...........

(323,200)

........... ........... 0

........... ........... 474,000

(66,800) 96,800 0

........... (96,800) 0

part.

3-79

Ch. 3—Problems

Problem 3A-1, Concluded See solution to Problem 3-2 for value analysis, D&D schedule, and amortization schedules. Eliminations and Adjustments: (CY) Eliminate the current-year entries made in the investment account and in the subsidiary income account. (EL) Eliminate the pro rata share of Solar Company equity balances at the beginning of the year against the investment account. (D)/(NCI) Distribute the $80,000 excess cost and $20,000 NCI adjustment as required by the determination and distribution of excess schedule. (D1) Because FIFO is used for inventory, allocate the $10,000 write-up to the January 1, 2016, retained earnings of Paro Company. (D2) Building and Equipment, $30,000. (D3) Goodwill, $60,000. (A) Cumulatively depreciate the write-up to Building and Equipment over 10 years. Charge the 2015 Depreciation against January 1, 2016, retained earnings of Paro Company. Charge the 2016 Depreciation to Operating Expenses.

Income Distribution Schedules Solar Company Building depreciation .....................

$3,000

Internally generated net income .....................................

$90,000

Adjusted income ............................ NCI share ....................................... NCI .................................................

$87,000 × 20% $17,400

Paro Company Internally generated net income ................................... $100,000 80% × Solar adjusted net income ............................. 69,600 Controlling interest ....................... $169,600

Ch. 3—Problems

3–80

PROBLEM 3A-2

Company Implied Fair Value

Parent Price (80%)

NCI Value (20%)

$1,040,000 910,000 $ 130,000

$850,000 728,000 $122,000

$190,000 182,000 $ 8,000

Based on the above information, the following D&D schedule is prepared: Determination and Distribution of Excess Schedule

Fair value of subsidiary ..................... Less book value of interest acquired: Common stock ($10 par)............. Paid-in capital in excess of par ... Retained earnings ....................... Total equity ............................ Interest acquired ......................... Book value ........................................ Excess of fair value over book value............................................

Company Implied Fair Value

Parent Price (80%)

NCI Value (20%)

$1,040,000

$850,000

$190,000

$750,000 80% $600,000

$750,000 20% $150,000

$ 290,000

$250,000

$ 40,000

Adjustment

Worksheet Key

Life

Amortization per Year

10 20

$8,000 3,000

$ 150,000 200,000 400,000 $ 750,000

Adjustment of identifiable accounts:

Land .................................................. Equipment ......................................... Building ............................................. Goodwill ............................................ Total ............................................

$ 20,000 80,000 60,000 130,000 $290,000

debit D1 debit D2 debit D3 debit D4

3-81

Ch. 3—Problems

Problem 3A-2, Continued Account Adjustments

Life

Subject to amortization: Equipment ............................. Building ................................. Total amortizations ..........

10 20

Annual Amount

Current Year

Prior Years

Total

$ 8,000 3,000 $11,000

$16,000 6,000 $22,000

$24,000 9,000 $33,000

Controlling retained earnings adjustment NCI retained earnings adjustment

Key (A2) (A3)

$17,600 4,400

Eliminations and Adjustments: (CY) Eliminate the current-year entries made in the investment account to arrive at the January 1, 2017, balance: (CY1) 80% of subsidiary loss. (CY2) 80% of subsidiary dividends. (EL) Eliminate the 80% ownership portion of the beginning-of-year subsidiary equity accounts against the investment. (D)/(NCI) Distribute the excess cost and the NCI adjustment as follows, in accordance with the determination and distribution of excess schedule: (D1) Increase Land by $20,000. (D2) Increase Equipment by $80,000. (D3) Increase Building by $60,000. (D4) Create Goodwill, $90,000. Record amortizations resulting from the revaluations: (A2) Record $8,000 annual increase in equipment depreciation for current and prior years. See account adjustment schedule. (A3) Record $3,000 annual increase in building depreciation for current and prior years. See account adjustment schedule.

Ch. 3—Problems

3–82

Problem 3A-2, Continued Baker Enterprises and Kohlenberg International Worksheet for Consolidated Financial Statements For Year Ended December 31, 2017 Financial Statements Baker Kohlenberg Income Statement: Sales ....................................................... Cost of Goods Sold ................................. Operating Expense ................................. Depreciation Expenses ........................... Subsidiary (Income)/Loss........................ Net (Income)/Loss ......................................... Consolidated Net Income .............................. Noncontrolling Interest (see distribution schedule)................................................. Controlling Interest (see distribution schedule)................................................. Retained Earnings: Retained Earnings, January 1, 2017— Baker ................................................. Retained Earnings, January 1, 2017— Kohlenberg ........................................ Net (Income)/Loss (carrydown) ............... Dividends Declared ................................. Retained Earnings, December 31, 2017 . NCI in Retained Earnings, December 31, 2017 ........................................... Controlling Interest in Retained Earnings, December 31, 2017 ..........

(650,000) 260,000 170,000 65,000 16,000 (139,000) ...........

Eliminations and Adjustments Dr. Cr.

(320,000) ........... 240,000 ........... 70,000 ........... 30,000 (A2–A3) 11,000 ........... ........... 20,000 ........... ........... ...........

(CY1)

Noncontrolling Interest

Consolidated

........... ........... ........... ........... 16,000 ........... ...........

........... ........... ........... ........... ........... ........... ...........

(970,000) 500,000 240,000 106,000 ........... ........... (124,000)

...........

6,200

...........

(130,200)

(625,000)

........... (A2–A3) 17,600

...........

(607,400)

........... ........... (139,000)

(460,000) (EL) 368,000 ........... (A2–A3) 4,400 20,000 ........... 10,000 ........... (430,000) ...........

40,000 ........... ........... 8,000 ...........

(127,600) ........... 6,200 2,000 ...........

........... ........... (130,200) ........... ...........

(764,000)

(NCI) (CY2)

...........

(119,400)

...........

(737,600)

part.

3-83

Ch. 3—Problems

Problem 3A-2, Continued Baker Enterprises and Kohlenberg International Worksheet for Consolidated Financial Statements For Year Ended December 31, 2017 (Concluded) Financial Statements Baker Kohlenberg Balance Sheet: Cash ........................................................ Inventory ................................................. Land ........................................................ Building ................................................... Acc. Dep.—Building ................................ Equipment ............................................... Acc. Dep.—Equipment ............................ Investment in Kohlenberg ....................... Goodwill .................................................. Liabilities ................................................. Bonds Payable ........................................ Common Stock—Baker........................... Common Stock—Kohlenberg.................. Paid-In Capital in Excess of Par— Kohlenberg ........................................ Retained Earnings, December 31, 2017 (carrydown) .............................. Retained Earnings—Controlling Interest, December 31, 2017 ............. Retained Earnings—NCI, December 31, 2017 ............................................ Total NCI ................................................. Total ..............................................................

288,000 135,000 145,000 900,000 (345,000) 350,000 (135,000) 874,000 ........... ........... (248,000) ........... (1,200,000) ...........

Eliminations and Adjustments Dr. Cr.

170,000 ........... 400,000 ........... 20,000 150,000 (D1) 60,000 500,000 (D3) (360,000) ........... 250,000 (D2) 80,000 (90,000) ........... ........... (CY1) 16,000 ........... (CY2) 8,000 ........... (D4) 130,000 (40,000) ........... (200,000) ........... ........... ........... (150,000) (EL) 120,000 (EL)

Noncontrolling Interest

Consolidated

........... ........... ........... ........... 9,000 ........... 24,000 648,000 250,000 ........... ........... ........... ........... ...........

........... 458,000 ........... 535,000 ........... 315,000 ........... 1,460,000 ........... (714,000) ........... 680,000 ........... (249,000) ........... ........... ........... ........... ........... 130,000 ........... (288,000) ........... (200,000) ........... (1,200,000) (30,000) ...........

160,000

...........

(40,000)

...........

(A3) (A2) (EL) (D)

...........

(200,000)

(764,000)

(430,000)

...........

(737,600)

........... ........... 0

........... ........... 995,000

(119,400) (189,400)

........... (189,400) 0

part.

Ch. 3—Problems

3–84

Problem 3A-2, Concluded Subsidiary Kohlenberg International Income Distribution Internally generated net loss ....... Building depreciation ................... Equipment depreciation ..............

$20,000 3,000 8,000

Adjusted loss ............................... NCI share .................................... NCI ..............................................

$ 31,000 × 20% $ 6,200

Parent Baker Enterprises Income Distribution 80% × Kohlenberg adjusted loss of $31,000 ......................

$24,800

Internally generated net income ...............................

$155,000

Controlling interest ..................

$130,200

3-85

Ch. 3—Problems

PROBLEM 3A-3

Company Implied Fair Value

Parent Price (90%)

NCI Value (10%)

$800,000 730,000* $ 70,000

$720,000 657,000 $ 63,000

$80,000 73,000 $ 7,000

*Equity of $550,000 + $180,000 adjustments Based on the above information, the following D&D schedule is prepared: Determination and Distribution of Excess Schedule Company Implied Fair Value

Parent Price (90%)

NCI Value (10%)

$800,000

$720,000

$ 80,000

$550,000 90% $495,000

$550,000 10% $ 55,000

$250,000

$225,000

$ 25,000

Adjustment

Worksheet Key

Fair value of subsidiary ..................... Less book value of interest acquired: Common stock ($10 par)............. Retained earnings ....................... Total equity ............................ Interest acquired ......................... Book value ........................................ Excess of fair value over book value............................................

$350,000 200,000 $550,000

Adjustment of identifiable accounts:

Building ............................................. Goodwill ............................................ Total ........................................

$180,000 70,000 $250,000

Account Adjustments

Life

Subject to amortization: Building ................................. Total amortizations ..........

Life

Amortization per Year

$9,000

debit D1 debit D2

Annual Amount

Current Year

Prior Years

Total

$9,000 $9,000

$18,000 $18,000

Controlling retained earnings adjustment NCI retained earnings adjustment

Key (A)

$8,100 900

Ch. 3—Problems

3–86

Problem 3A-3, Continued Harvard Company and Subsidiary Bart Company Worksheet for Consolidated Financial Statements For Year Ended December 31, 2016 Financial Statements Harvard Bart Income Statement: Sales ....................................................... Cost of Goods Sold ................................. Operating Expenses................................ Depreciation Expense ............................. Dividend Income ..................................... Net Income .............................................. Consolidated Net Income ........................ Noncontrolling Interest (see distribution schedule) ........................ Controlling Interest (see distribution schedule) ........................ Retained Earnings Statement: Retained Earnings, January 1, 2016—Harvard .................................. Retained Earnings, January 1, 2016 —Bart ................................................ Net Income (carrydown) .......................... Dividends Declared ................................. Retained Earnings, December 31, 2016 .................................................. Noncontrolling Interest in Retained Earnings, December 31, 2016 .......... Controlling Interest in Retained Earnings, December 31, 2016 ..........

(580,000) 285,000 140,000 72,000 (9,000) (92,000) ...........

(280,000) 155,000 55,000 30,000

Eliminations and Adjustments Dr. Cr.

Noncontrolling Interest

Consolidated

(40,000) ...........

........... ........... ........... 9,000 9,000 ........... ...........

........... ........... ........... ........... ........... ........... ...........

(860,000) 440,000 195,000 111,000 ........... ............ (114,000

...........

(3,100)

...........

(110,900)

(484,000) ...........

........... ...........

........... 8,100

(CV)

108,000 ...........

........... ...........

........... (583,900)

........... ........... (92,000) 20,000

(320,000) ........... (40,000) 10,000

288,000 900 ........... ...........

(NCI)

25,000 ........... ........... 9,000

(56,100) ........... (3,100) 1,000

........... ........... (110,900) 20,000

(556,000)

(350,000)

...........

(58,200)

...........

(674,800)

(A) (CY2)

(A) (EL) (A)

(CY2)

part.

3-87

Ch. 3—Problems

Problem 3A-3, Continued Harvard Company and Subsidiary Bart Company Worksheet for Consolidated Financial Statements For Year Ended December 31, 2016 (Concluded) Financial Statements Harvard Bart Balance Sheet: Cash ........................................................ Inventory ................................................. Land ........................................................ Building .................................................. Accumulated Depr.—Building ................. Equipment ............................................... Accumulated Depr.—Equipment ............. Investment in Bart Company ................... Goodwill .................................................. Current Liabilities .................................... Bonds Payable ........................................ Common Stock—Harvard ....................... Paid-In Capital in Excess of Par—Harvard .................................... Common Stock—Bart ............................. Retained Earnings (carrydown) .............. Retained Earnings—Controlling Interest, December 31, 2016 ............. Retained Earnings—Bart (NCI) December 31, 2016 ........................... Total NCI ................................................. Total ..............................................................

Eliminations and Adjustments Dr. Cr.

Noncontrolling Interest

Consolidated

........... ........... ........... ........... 18,000 ........... ........... ........... 603,000 225,000 ........... ........... ........... ...........

........... ........... ........... ........... ........... ........... ........... ........... ........... ........... ........... ........... ........... ...........

500,000 600,000 249,000 1,480,000 (758,000) 590,000 (280,000) ........... ........... ........... 70,000 (183,000) (200,000) (800,000)

........... 315,000 ...........

........... ........... ...........

........... (35,000) ...........

(500,000) ........... ...........

330,000 260,000 99,000 800,000 (380,000) 340,000 (190,000) 720,000 ........... ........... ........... (123,000) ........... (800,000)

170,000 340,000 150,000 500,000 (360,000) 250,000 (90,000) ........... ........... ........... ........... (60,000) (200,000) ...........

(500,000) ........... (556,000)

........... (350,000) (350,000)

...........

(674,800)

...........

........... 0

........... ........... 988,000

(58,200) (93,200)

........... ........... 988,000

........... (93,200) 0

(D1)

(CV) (D2)

(EL)

........... ........... ........... 180,000 ........... ........... ........... 108,000 ........... ........... 70,000 ........... ........... ...........

(A)

(EL) (D)

part.

Ch. 3—Problems

3–88

Problem 3A-3, Concluded Eliminations and Adjustments: (CV) Convert from the cost to the equity method as of January 1, 2016 [90% × ($320,000 – $200,000)]. (CY2) Eliminate the 90% ownership portion of the subsidiary dividends. (EL) Eliminate the 90% ownership portion of the subsidiary equity accounts against the investment. (D)/(NCI) Distribute the excess cost and NCI adjustment as follows, in accordance with the determination and distribution of excess schedule: (D1) Increase Building by $180,000. (D2) Increase Goodwill by $70,000. (A) Record amortizations resulting from the revaluations of entry 3. Record $9,000 annual increase in building depreciation for current and prior years. See amortization schedule. Subsidiary Bart Company Income Distribution Building depreciation.....................

$9,000

Internally generated net income .................................

$40,000

Adjusted income ........................ NCI share .................................. NCI ............................................

$31,000 × 10% $ 3,100

Parent Harvard Company Income Distribution Internally generated net income ................................. $ 83,000 90% × Bart adjusted income of $31,000 ........................... 27,900 Controlling interest ....................

$110,900

PROBLEM 3B-1 Entry to record investment: Investment in Jones ......................................................................... Common Stock........................................................................... Paid-In Capital in Excess of Par.................................................

720,000 100,000 620,000

3-89

Ch. 3—Problems

Problem 3B-1, Concluded

Company Implied Fair Value

Parent Price (90%)

NCI Value (10%)

$800,000 679,000* $121,000

$720,000 611,100 $108,900

$80,000 67,900 $12,100

*Equity of $500,000 + $170,000 asset adjustments – $51,000 DTL ($170,000 × 30%) + $60,000 ($200,000 × 30%) tax loss carryover Based on the above information, the following D&D schedule is prepared: Determination and Distribution of Excess Schedule

Company Implied Fair Value

Parent Price (90%)

NCI Value (10%)

$800,000

$720,000

$ 80,000

$500,000 90% $450,000

$500,000 10% $ 50,000

$300,000

$270,000

$ 30,000

Adjustment

Worksheet Key

Life

Amortization per Year

$ 50,000

debit D1

100,000

debit D2

$5,000

20,000

debit D3

(51,000)

credit D1-3

12,000

debit D4

48,000 121,000 $300,000

debit D5 debit D6

$100,000 150,000 250,000 $500,000

Adjustment of identifiable accounts:

Inventory ($200,000 fair – $150,000 book value).................................. Depreciable fixed assets ($500,000 fair – $400,000 book value)......... Investment in marketable securities ($170,000 – $150,000 book value) DTL on above adjustments ($170,000 × 30%) ....................... Current deferred tax expense ($40,000 × 30%) ......................... Noncurrent deferred tax expense ($160,000 × 30%) ....................... Goodwill ............................................ Total ............................................

Ch. 3—Problems

3–90

PROBLEM 3B-2

Company Implied Fair Value

Parent Price (80%)

NCI Value (20%)

$2,740,000 2,337,000* $ 403,000

$2,240,000 1,869,600 $ 370,400

$500,000 467,400 $ 32,600

*Equity of $1,847,000 + $700,000 asset adjustments – $210,000 ($700,000 × 30%) DTL Based on the above information, the following D&D schedule is prepared: Determination and Distribution of Excess Schedule

Fair value of subsidiary ..................... Less book value of interest acquired: Common stock ($100 par)........... Retained earnings ....................... Total equity ............................ Interest acquired ......................... Book value ........................................ Excess of fair value over book value............................................

Company Implied Fair Value

Parent Price (80%)

NCI Value (20%)

$2,740,000

$2,240,000

$ 500,000

$1,000,000 847,000 $1,847,000

$1,847,000 $1,847,000 80% 20% $1,477,600 $ 369,400

$ 893,000

$ 762,400

Adjustment

Worksheet Key

Life

Amortization per Year

$ 700,000

debit D1

$ 35,000

(210,000) 403,000 $ 893,000

credit D1t debit D2

(10,500)

$ 130,600

Adjustment of identifiable accounts:

Depreciable fixed assets ($2,800,000 fair – $2,100,000 book value).................................. DTL on above adjustment ($700,000 × 30%) ....................... Goodwill ............................................ Total ............................................

3-91

Ch. 3—Problems

Problem 3B-2, Continued Todd Company and Subsidiary Keller Company Worksheet for Consolidated Balance Sheet December 31, 2016

Cash.................................................. Accounts Receivable ........................ Inventory ........................................... Prepayments ..................................... Depreciable Fixed Assets (net) ......... Investment in Keller ..........................

Financial Statements Todd Keller 1,200,000 50,000 2,400,000 300,000 11,200,000 1,500,000 47,000 422,000 18,978,000 2,100,000 2,240,000 .............. ............. .............. ............. .............. (7,200,000) (1,750,000) (1,615,000) (400,000) ............. .............. (1,000,000) ..............

(D1)

Eliminations and Adjustments Dr. Cr. ............. .............. ............. .............. ............. .............. ............. .............. 700,000 .............. ............. (EL) 1,477,600 (D) ............. 762,400 403,000 .............. ............. .............. ............. .............. ............. (D1t) 210,000 ............. ..............

Goodwill ............................................ (D2) Payables ........................................... Accruals ............................................ Deferred Tax Liability ........................ Common Stock ($100 par)—Todd .... Paid-In Capital in Excess of Par—Todd ................................... (8,900,000) .............. ............. .............. Retained Earnings—Todd ................. (17,725,000) .............. ............. .............. Common Stock ($100 par)—Keller ... ............. (1,000,000) (EL) 800,000 .............. (847,000) (EL) 677,600 (NCI) 130,600 Retained Earnings—Keller ................ ............. 0 2,580,600 2,580,600 Total ............................................ 0 Total NCI ...........................................................................................................................................................

Noncontrolling ConsoliInterest dated .............. 1,250,000 .............. 2,700,000 .............. 12,700,000 .............. 469,000 .............. 21,778,000 .............. .............. .............. .............. .............. 403,000 .............. (8,950,000) .............. (2,015,000) .............. (210,000) .............. (1,000,000) .............. (8,900,000) .............. (17,725,000) (200,000) .............. (300,000) .............. .............. .............. (500,000) (500,000) 0

Eliminations and Adjustments: N/A because worksheet is prepared on the same day as consolidation. (CY) (EL) Elimination of 80% of the subsidiary equity against the investment. (D)/(NCI) Distribute the balance of the investment account, $762,400 and the $130,600 NCI adjustment, to the specific subsidiary accounts to the determination and distribution of excess schedule: (D1) Increase depreciable fixed assets by $700,000. (D1t) Record a deferred tax liability of $210,000 relating to the increase in depreciable fixed assets. (D2) Record goodwill of $403,000.

part.

Ch. 3—Problems

3–92

Problem 3B-2, Concluded Todd Company and Subsidiary Keller Company Consolidated Balance Sheet December 31, 2016 Assets Current assets: Cash ..................................................................................... Accounts receivable ............................................................. Inventory .............................................................................. Prepayments ........................................................................ Depreciable fixed assets ............................................................ Goodwill ..................................................................................... Total assets................................................................................

$ 1,250,000 2,700,000 12,700,000 469,000 $21,778,000 403,000

$17,119,000 22,181,000 $39,300,000

Liabilities and Stockholders’ Equity Payables .................................................................................... Accruals ..................................................................................... Deferred tax liability ................................................................... Total liabilities ............................................................................ Stockholders’ equity: Noncontrolling interest ......................................................... Controlling interest: Common stock ($100 par) .............................................. Paid-in capital in excess of par ...................................... Retained earnings .......................................................... Total liabilities and stockholders’ equity .....................................

$ 8,950,000 2,015,000 210,000 $11,175,000 500,000 $ 1,000,000 8,900,000 17,725,000

27,625,000 $39,300,000

3-93

Ch. 3—Problems

PROBLEM 3B-3 (1) Value Analysis Schedule Company fair value ........................................... Fair value of net assets excluding goodwill ...... Goodwill ............................................................

Company Implied Fair Value

Parent Price (90%)

NCI Value (10%)

$700,000 430,000* $270,000

$630,000 387,000 $243,000

$70,000 43,000 $27,000

*Equity of $300,000 + $100,000 asset adjustments – $30,000 ($100,000 × 30%) DTL + $60,000 ($200,000 × 30%) tax loss carryover Based on the above information, the following D&D schedule is prepared: Determination and Distribution of Excess Schedule Company Implied Fair Value

Parent Price (90%)

NCI Value (10%)

Fair value of subsidiary .............. $700,000 Less book value of interest acquired: Common stock ($50 par) ....... $200,000 Retained earnings ................. 100,000 Total equity ...................... $300,000 Interest acquired ................... Book value ................................. Excess of fair value over book value ...................................... $400,000

$630,000

$ 70,000

$300,000 90% $270,000

$300,000 10% $ 30,000

$360,000

$ 40,000

Adjustment

Worksheet Key

Life

Amortization per Year

$100,000 (30,000)

debit D1 credit D1t

10 10

$10,000 (3,000)

6,000

debit D2

54,000 270,000 $400,000

debit D3 debit D4

Adjustment of identifiable accounts:

Building and equipment ............. DTL on above adjustment.......... Current deferred tax expense ($20,000 × 30%).................... Noncurrent deferred tax expense ($180,000 × 30%).................. Goodwill ..................................... Total ......................................

Ch. 3—Problems

3–94

Problem 3B-3, Continued (2)

Campton Corporation and Subsidiary Dorn Corporation Worksheet for Consolidated Financial Statements For Year Ended December 31, 2015

Current Assets ................................. Land ................................................. Building and Equipment (net) ........... Investment in Dorn Corporation .......

Trial Balance Campton Dorn 150,000 100,000 400,000 100,000 900,000 240,000 642,600 ............ ............ ............ ............ ............ ............ ............ ............ ............ (9,000) (12,000) (6,000) ............ (130,000) (100,000) ............ ............

Eliminations Consolidated and Adjustments Income Dr. Cr. Statement ............. ............ ............ ............. ............ ............ (D1) 100,000 (A1) 10,000 ............ ............. (CY1) 12,600 ............ ............. (EL) 270,000 ............ ............. (D) 360,000 ............ (D3) 54,000 ............ ............ (D4) 270,000 ............ ............ ............. ............ ............ (D2) 6,000 ............ ............ ............. ............ ............ (A1t) 3,000 (D1t) 30,000 ............

NCI ............ ............ ............ ............ ............ ............ ............ ............ ............ ............ ............ ............

Noncurrent Deferred Tax Expense .. Goodwill............................................ Current Tax Liability ......................... Deferred Tax Liability ....................... Other Current Liabilities ................... Deferred Tax Liability ....................... Common Stock ($5 par)— Campton ....................................... (500,000) ............ ............. ............ ............ ............ Paid-In Capital in Excess of Par— Campton ....................................... (750,000) ............ ............. ............ ............ ............ Retained Earnings, January 1, 2015—Campton ............................ (650,000) ............ ............. ............ ............ ............ Common Stock ($50 par)—Dorn ..... ............ (200,000) (EL) 180,000 ............ ............ (20,000) Retained Earnings, January 1, 2015—Dorn................................... ............ (100,000) (EL) 90,000 (NCI) 40,000 ............ (50,000) Sales ................................................ (309,000) (170,000) ............. ............ (479,000) ............ Subsidiary Income............................ (12,600) ............ (CY1) 12,600 ............ ............ ............ Cost of Goods Sold .......................... 170,000 80,000 ............. ............ 250,000 ............ Expenses.......................................... 89,000 50,000 (A1) 10,000 ............ 149,000 ............ Provision for Tax .............................. 15,000 12,000 ............. (A1t) 3,000 24,000 ............ 0 725,600 725,600 ............ ............ Total .............................................. 0 Consolidated Net Income ................................................................................................................ (56,000) ............ (900) To NCI (see distribution schedule) .............................................................................................. 900 ............ To Controlling Interest (see distribution schedule) ...................................................................... 55,100 Total NCI ............................................................................................................................................................ (70,900) Retained Earnings—Controlling Interest, December 31, 2015 ..............................................................................................

Controlling Consolidated Retained Balance Earnings Sheet ............. 250,000 ............. 500,000 ............. 1,230,000 ............ ............. ............. ............ ............. ............ ............. 54,000 ............. 270,000 ............. (21,000) ............. ............ ............. (230,000) ............. (27,000) .............

(500,000)

.............

(750,000)

(650,000) .............

............ ............

............. ............. ............. ............. ............. ............. ............. ............. ............. (55,100) ............. (705,100)

............ ............ ............ ............ ............ ............ ............ ............ ............ ............ (70,900) (705,100) 0

part.

3-95

Ch. 3—Problems

Problem 3B-3, Continued Subsidiary Dorn Corporation Income Distribution Equipment depreciation .... (A1)

$10,000

Internally generated income before tax ................

$40,000

Adjusted net income before tax . Provision for tax (30%) ..............

$30,000 (9,000)

Adjusted net income .................. NCI share ................................... NCI .............................................

$ 9,000 × 10% $ 900

Parent Campton Corporation Income Distribution Internally generated net income ................................. 90% × Dorn adjusted income of $9,000 ................. Controlling interest ....................

$47,000 8,100 $55,100

Eliminations and Adjustments: (CY1) Eliminate current-year investment entries. (EL) Eliminate the 90% ownership portion of the subsidiary equity accounts against the investment. (D)/(NCI) Distribute the excess cost and NCI adjustment in accordance with the determination and distribution of excess schedule: (D1) Increase building and equipment by $100,000. (D1t) Record a $30,000 deferred tax liability relating to the increase in building and equipment. (D2) Record current portion of DTA. (D3) Record a noncurrent DTA of $54,000 for the portion of the tax loss carryover to be used in future years. (D4) Record goodwill of $270,000. (A1) Record $10,000 annual increase in building and equipment depreciation for current year. (A1t) Reduce provision for tax by 30% of the increase in depreciation expense, $3,000.

Ch. 3—Problems

3–96

Problem 3B-3, Concluded (3)

Campton Corporation and Subsidiary Dorn Corporation Consolidated Income Statement For Year Ended December 31, 2015 Sales ..................................................................................................... Cost of goods sold ................................................................................ Gross profit ........................................................................................... Expenses .............................................................................................. Consolidated net income before tax ..................................................... Provision for tax (30%) ......................................................................... Consolidated net income ...................................................................... To noncontrolling interest .................................................................... To controlling interest ...........................................................................

$479,000 250,000 $229,000 149,000 $ 80,000 (24,000) $ 56,000 900 $ 55,100

Campton Corporation and Subsidiary Dorn Corporation Retained Earnings Statement For Year Ended December 31, 2015 Retained earnings, January 1, 2015 ............................. Add net income ............................................................. Balance, December 31, 2015 .......................................

NCI $10,000 900 $10,900

Controlling $650,000 55,100 $705,100

Campton Corporation and Subsidiary Dorn Corporation Consolidated Balance Sheet December 31, 2015 Assets Current assets .......................................................................... Property, plant, and equipment: Land ..................................................................................... Building and equipment (net) ............................................... Goodwill .................................................................................... Noncurrent deferred tax expense ............................................. Total assets ..............................................................................

$ 250,000 $ 500,000 1,230,000

1,730,000 270,000 54,000 $2,304,000

Liabilities and Stockholders’ Equity Liabilities: Current liabilities ................................................................... Current tax liability ................................................................ Deferred tax liability .............................................................. Total liabilities ................................................................. Stockholders’ equity: NCI ....................................................................................... Controlling interest: Common stock ($5 par) .................................................. Paid-in capital in excess of par....................................... Retained earnings .......................................................... Total liabilities and stockholders’ equity....................................

$ 230,000 21,000 27,000 $ 278,000 70,900 $ 500,000 750,000 705,100

1,955,100 $2,304,000

CHAPTER 4 UNDERSTANDING THE ISSUES 1.

6. a. Company S is better off borrowing the funds from Company P since it will receive a lower interest rate (9.5% instead of 10%). Therefore, Company S will have lower annual interest charges. b. During 2016, Company P will record interest revenue and Company S will record interest expense of $47,500 ($500,000 × 9.5%). However, the interest expense and interest revenue are eliminated during the consolidation process. Only the $40,000 ($500,000 × 8%) of external interest expense remains on the consolidated statements. c. Intercompany interest expense and interest revenue should not appear on the 2015 consolidated income statement. Only the external interest expense of $40,000 will appear on the consolidated income statement.

The intercompany sale will cause both sales and costs of goods sold to be overstated by $50,000 on the consolidated income statement. The amount remaining in ending inventory will cause cost of goods sold to be understated by $3,000 (1/4 × $12,000) on the consolidated income statement and inventory to be overstated by $3,000 (1/4 × $12,000) on the consolidated balance sheet.

2. Debit Sales and credit Cost of Goods Sold for $50,000. Debit Cost of Goods Sold and credit Inventory for $3,000 (1/4 × $12,000). 3.

2015 2016 NCI $ 0 $ 200 ($1,000 × 20%) Controlling interest 0 3,800 [$3,000 + ($1,000 × 80%)] Total profit $ 0 $4,000

4. Company S has realized a $50,000 profit; however, it is not immediate. The profit will be realized over the 5-year life of the asset. Company S will realize the profit by reducing consolidated depreciation expense by $10,000 ($50,000 ÷ 5 years) each year for 5 years. The NCI will realize $2,000 (20% × $10,000) each year. 5.

2015 2016 2017 Realized gain by reducing depreciation expense [($60,000 – $50,000) ÷ 5 years] $2,000 $2,000 $2,000 Balance of gain at time of sale 4,000

Ch. 4—Exercises

4–2

EXERCISES EXERCISE 4-1 Pattern Company and Subsidiary Sorel Company Consolidated Income Statement For the Year Ended December 31, 2015 Sales ($250,000 + $500,000 – $120,000).......................................................... Cost of goods sold [$150,000 + $310,000 – $120,000 + (40% × $30,000)] ...... Gross profit ........................................................................................................ Expenses ($45,000 + $120,000) ........................................................................ Consolidated net income ................................................................................... Distributed to NCI ............................................................................................... Distributed to controlling interest........................................................................

$630,000 352,000 $278,000 165,000 $113,000 $ 8,600 $104,400

Sorel Income Distribution Schedule Unrealized profit in ending inventory (40% × $30,000) ......

Internally generated income ..........

$55,000

Adjusted income ............................ NCI share....................................... NCI.................................................

$43,000 × 20% $ 8,600

$12,000

Pattern Income Distribution Schedule Internally generated income .......... 80% × Sorel adjusted income of $43,000 ...................

$ 70,000

Controlling interest .........................

$104,400

34,400

Pattern Company and Subsidiary Sorel Company Consolidated Income Statement For the Year Ended December 31, 2016 Sales ($350,000 + $540,000 – $150,000).......................................................... Cost of goods sold [$210,000 + $360,000 – $150,000 – (40% × $30,000) + (40% × $25,000)] ...................................................................................... Gross profit ........................................................................................................ Expenses ($66,000 + $125,000) ........................................................................ Consolidated net income ................................................................................... Distributed to NCI ............................................................................................... Distributed to controlling interest........................................................................

$740,000 418,000 $322,000 191,000 $131,000 $ 15,200 $115,800

4–3

Ch. 4—Exercises

Exercise 4-1, Concluded Sorel Income Distribution Schedule Unrealized profit in ending inventory (40% × $25,000) ......

$10,000

Internally generated net income ..................................... Realized profit in beginning inventory (40% × $30,000)....... Adjusted income ............................ NCI share....................................... NCI.................................................

$74,000 12,000 $76,000 × 20% $15,200

Pattern Income Distribution Schedule Internally generated net income ..................................... 80% × Sorel adjusted income of $76,000 ................... Controlling interest .........................

$ 55,000 60,800 $115,800

Ch. 4—Exercises

4–4

EXERCISE 4-2 (1) Gross profit recorded on the separate books: Gross profit—Hide: Sales .................................................................................... Gross profit (25% × $400,000) ............................................. Gross profit—Seek: Sales .................................................................................... Cost of goods sold (80% × $400,000) ................................. Add write-down of ending inventory .................................... Gross profit .......................................................................... (2) Consolidated gross profit: Sales .................................................................................... Cost of goods sold to consolidated group* ........................... Gross profit .......................................................................... *Cost of goods sold is computed as follows: Purchases at cost (80% × $400,000) .................................. Less ending inventory at cost ($80,000 × 80%) ................... (note that cost is less than market) Cost of goods sold ...............................................................

$400,000 100,000 $416,000 $320,000 10,000

330,000 $ 86,000 $416,000 256,000 $160,000

$320,000 64,000 $256,000

4–5

Ch. 4—Exercises

EXERCISE 4-3 Source of income components: Victory Sales ....................................................... Cost of goods sold .................................. Other income .......................................... Other expenses....................................... Consolidated net income ........................ Distributed to NCI .................................... Distributed to controlling interest.............

Norco

Eliminations

(220,000) (150,000) 150,000 112,500

(IS) 90,000 (IS) (90,000) (BI) (5,000) (EI) 7,500 (S) 5,000 (S) (5,000)

(5,000) 40,000

15,000

Consolidated Income Statement (280,000) 175,000 50,000 (55,000) 4,000 (51,000)

Eliminations and Adjustments: (IS) Elimination of $90,000 intercompany sales. (BI) Elimination of 25% profit from beginning inventory; debit would be to Retained Earnings; allocated 80% to the controlling interest and 20% to the NCI. (EI) Elimination of 25% profit from ending inventory; credit would be to inventory account. (S) Elimination of consulting services transaction. Note: The above format and presentation is not to be expected of the student. All that is required is the final consolidated income statement and its distribution to controlling and noncontrolling interests. This format is presented to aid explanation of the exercise as it shows the sources of the numbers that determine the income statement. This form will be used for future exercises and problems to aid the instructor. Subsidiary Norco Company Income Distribution Unrealized ending inventory profit ................................... (EI)

$7,500

Internally generated net income ................................. Realized beginning inventory profit .....................................

$22,500 (BI)

Adjusted income ........................ NCI share................................... NCI.............................................

5,000 $20,000 × 20% $ 4,000

+ Parent Victory Corporation Income Distribution Internally generated net income ..................................... 80% × Norco adjusted income of $20,000 ................................ Controlling interest .........................

$35,000 16,000 $51,000

Ch. 4—Exercises

4–6

EXERCISE 4-4 (1) In the year of sale, eliminate the $15,000 gain on the sale of the machine, and adjust the machine to its net book value on the date of the sale. Reduce depreciation expense and accumulated depreciation by $3,000 to reflect depreciation based on the consolidated book value. For 2016 to 2020, eliminate unamortized gain as reflected in Jungle’s beginning retained earnings. Adjust machinery to reflect book value on the date of the sale. Reduce currentyear depreciation expense and accumulated depreciation by $3,000. (2) Gain on Sale of Machinery ....................................................... Machinery ...........................................................................

15,000

Accumulated Depreciation ........................................................ Depreciation Expense.........................................................

3,000

(3) Retained Earnings—Jungle Company ..................................... Accumulated Depreciation ........................................................ Machinery ...........................................................................

12,000 3,000

Accumulated Depreciation ........................................................ Depreciation Expense.........................................................

3,000

15,000 3,000

4–7

Ch. 4—Exercises

EXERCISE 4-5 (1) Gain on Sale of Land ................................................................ Gain on Building ....................................................................... Land .................................................................................... Building ............................................................................... To defer unrealized gain on sale of land and on building and reduce the assets to the cost to the consolidated entity.

50,000 150,000

(2) Retained Earnings—Sayner* .................................................... Retained Earnings—Wavemasters** ........................................ Accumulated Depreciation ($150,000 ÷ 20 years).................... Building ............................................................................... Land ....................................................................................

38,500 154,000 7,500

50,000 150,000

150,000 50,000

*[$50,000 land + (19 ÷ 20 × $150,000 on building)] × 20% **($200,000 original gain – $7,500 realized = $192,500) × 80% Accumulated Depreciation ........................................................ Depreciation Expense.........................................................

7,500 7,500

Ch. 4—Exercises

4–8

EXERCISE 4-6 In 2016, only a $4,000 loss can be recognized for the sale of the machinery on the consolidated income statement. This is the amount of the impairment (FV – BV). The remaining $5,000 loss must be deferred. This loss is deferred in the year of the intercompany sale. During each following year of use, the asset and accumulated depreciation accounts are adjusted to reflect the $10,000 fair value, with an additional entry for the $1,000 of incremental depreciation. On December 31, 2016, $5,000 of the $9,000 recorded loss should be eliminated. Machine...................................................................................... 5,000 Loss on Sale of Machine ......................................................

5,000

Depreciation for the year is also restated: Depreciation Expense ................................................................ Accumulated Depreciation ...................................................

1,000

2017 Entry: Loss on Sale of Machine (remaining unrecognized loss at end of second year)* ................................................. Depreciation Expense (adjustment for current year).................. Retained Earnings—Hilton ($5,000 original unrecognized loss less one year’s amortization)............... To record increase in depreciation expense and increase in loss to the consolidated company on sale of machine.

1,000

3,000 1,000 4,000

*Added to the subsidiary’s recorded loss of $1,000 results in a total loss of $4,000 to the consolidated entity to be recognized in 2017.

4–9

Ch. 4—Exercises

EXERCISE 4-7

Danner

Link

Sales ....................................................... Cost of goods sold .................................. Other expenses.......................................

(650,000) (280,000) 400,000 190,000 180,000 70,000

Other income .......................................... Consolidated net income ........................ Distributed to NCI .................................... Distributed to controlling interest.............

(20,000)

Consolidated Income Eliminations Statement (F1) 60,000 (F1) (40,000) (F2a) (4,000) (F2b) (2,500)

(870,000) 550,000 243,500 (20,000) (96,500) (400) (96,100)

Eliminations and Adjustments: (F1) Eliminate the gain on the intercompany machine sale. The machine account is credited for the $20,000 gain. (F2a) Reduce machine depreciation expense to reflect depreciation based on the consolidated book value of the asset ($20,000 profit ÷ 5 years = $4,000 per year). The debit is to Accumulated Depreciation. (F2b) Reduce building depreciation expense to reflect depreciation based on the consolidated book value of the asset ($50,000 profit ÷ 20 years = $2,500 per year). The debit is to Accumulated Depreciation. Subsidiary Link Company Income Distribution Unrealized gain on sale of machine....................... (F1)

$20,000

Internally generated net income .............................. $20,000 Realized gain through use of machine ........................ (F2a) 4,000 Adjusted income ..................... NCI share................................ NCI..........................................

$ 4,000 × 10% $ 400

Parent Danner Company Income Distribution Internally generated net income ................................ Gain realized on use of building sold to subsidiary ................ 90% × Link adjusted income of $4,000 ................ Controlling interest ....................

$90,000 (F2b) 2,500 3,600 $96,100

Ch. 4—Exercises

4–10

EXERCISE 4-8 2015 Subsidiary Sandbar Company Income Distribution Unrealized profit in ending inventory (40% × $15,000) ......

$6,000

Internally generated net income .....................................

$250,000

Adjusted income ............................ NCI share....................................... NCI.................................................

$244,000 × 20% $ 48,800

Parent Peninsula Company Income Distribution Gain on sale of real estate ......................................

$200,000

Internally generated net income ..................................... Realized gain on use of sold real estate [(75% × $200,000)/20] ............. 80% × Sandbar adjusted income of $244,000 ................. Controlling interest .........................

$520,000 8,000 195,200 $523,200

2016 Subsidiary Sandbar Company Income Distribution Unrealized profit in ending inventory (40% × $20,000) ......

$8,000

Internally generated net income ..................................... Realized profit in beginning inventory .................................. Adjusted income ............................ NCI share....................................... NCI.................................................

$235,000 6,000 $233,000 × 20% $ 46,600

Parent Peninsula Company Income Distribution Internally generated net income ..................................... Realized gain on use of sold real estate ........................ 80% × Sandbar adjusted income of $233,000 ................. Controlling interest .........................

$340,000 8,000 186,400 $534,400

4–11

Ch. 4—Exercises

EXERCISE 4-9 (1)

Windsor

Saratoga Notes Receivable........... 50,000 Cash ........................... To record receipt of note on May 1, 2017. Accrued Interest Receivable.................. 2,000* Interest Revenue ........ Year-end interest accrual.

50,000

2,000

Cash ................................... Notes Payable ................ To record receipt of cash on May 1, 2017.

50,000

Interest Expense ................ Accrued Interest Payable ......................... Year-end interest accrual.

2,000

50,000

2,000

*$50,000 × 6% × 8/12 (2) Eliminations: (LN1) Notes Payable ................................................................ Accrued Interest Payable ............................................... Notes Receivable ....................................................... Accrued Interest Receivable ...................................... To eliminate intercompany note and accrued interest applicable to the note.

50,000 2,000

(LN2) Interest Revenue ............................................................ Interest Expense ........................................................ To eliminate intercompany interest revenue and expense.

2,000

50,000 2,000

2,000

Ch. 4—Exercises

4–12

EXERCISE 4-10 (1)

Saratoga May

July

May

Dec. 31

Notes Receivable ................................................................. Cash ................................................................................. To record receipt of note.

50,000

Accrued Interest Receivable ................................................ Interest Revenue .............................................................. To accrue interest for 2 months (6% × $50,000 × 2/12).

500

Interest Expense (loss on discounting)................................. Cash ..................................................................................... Notes Receivable ............................................................. Accrued Interest Receivable ............................................ To record proceeds of discounting note at 8%. (See schedule of computation of proceeds.)

1,033 49,467

Windsor Cash ..................................................................................... Notes Payable .................................................................. To record receipt of cash. Interest Expense .................................................................. Interest Payable ............................................................... To record year-end accrual (6% × $50,000 × 8/12).

Computation of Proceeds Principal of note ........................................................................ Interest due at maturity (6% × $50,000) ................................... Total maturity value .................................................................. Less maturity value multiplied by 8% discount rate for 10/12 of period............................................................... Net proceeds of note ................................................................

50,000

500

50,000 500

50,000 50,000 2,000 2,000

$50,000 3,000 $53,000 3,533 $49,467

(2) Eliminations: (LN1) Notes Receivable Discounted ........................................ Notes Receivable ....................................................... To eliminate intercompany note and reclassify the discounted note receivable as a note payable at its face value.

50,000

500

50,000

500

4–13

Ch. 4—Problems

PROBLEMS PROBLEM 4-1 Plato Corporation and Subsidiary Solo Company Worksheet for Consolidated Financial Statements For Year Ended December 31, 2015 Consolidated Income Statement ................. ................. ................. ................. ................. ................. ................. ................. ................. ................. .................

Consolidated Balance Sheet 1,105,000 735,000 862,500 6,570,000 ................. ................. ................. (105,000) (1,000,000) (1,500,000) .................

................. (400,000) (EL) 400,000 ................. ................. ................. (200,000) (EL) 200,000 ................. ................. ................. (2,400,000) (EL) 2,400,000 ................. ................. (12,000,000) (1,000,000) (IS) 300,000 ................. (12,700,000) 7,000,000 750,000 (EI) 12,500 (IS) 300,000 7,462,500 4,000,000 40,000 (A) 30,000 ................. 4,070,000 (210,000) ................. (CY1) 210,000 ................. ................. 0 3,882,500 3,882,500 ................. 0 Consolidated Net Income ................................................................................................................................................. (1,167,500) Retained Earnings—Controlling Interest, December 31, 2015 ..................................................................................................................

................. ................. ................. ................. ................. ................. ................. ................. (1,167,500) (6,667,500)

................. ................. ................. ................. ................. ................. ................. ................. ................. (6,667,500) 0

Cash....................................................... Accounts Receivable.............................. Inventory ................................................ Property, Plant, and Equipment (net) ..... Investment in Solo Company ................. Accounts Payable .................................. Common Stock ($10 par)—Plato ........... Paid-In Capital in Excess of Par—Plato . Retained Earnings—Plato ...................... Common Stock ($10 par)—Solo ............ Paid-In Capital in Excess of Par—Solo .. Retained Earnings—Solo ....................... Solo ........................................................ Cost of Goods Sold ................................ Other Expenses ..................................... Subsidiary Income..................................

Trial Balance Plato Solo 735,000 370,000 400,000 365,000 600,000 275,000 4,000,000 2,300,000 3,510,000 ................. ................. ................. ................. ................. (35,000) (100,000) (1,000,000) ................. (1,500,000) ................. (5,500,000) .................

Eliminations and Adjustments

(D)

(IA)

Dr. ................. ................. ................. 300,000 ................. ................. ................. 30,000 ................. ................. .................

Cr. ................. (IA) 30,000 (EI) 12,500 (A) 30,000 (CY1) 210,000 (EL) 3,000,000 (D) 300,000 ................. ................. ................. .................

part.

Ch. 4—Problems

4–14

Problem 4-1, Concluded Determination and Distribution of Excess Schedule

Fair value of subsidiary ..................... Less book value of interest acquired: Total equity.................................. Interest acquired ......................... Book value ........................................ Excess of cost over book value ........

Company Implied Fair Value

Parent Price (100%)

NCI Value (0%)

$3,300,000

N/A

3,000,000 $ 300,000

$3,000,000 100% $3,000,000 $ 300,000

Adjustment $ 300,000

Worksheet Key debit D

Adjustment of identifiable accounts:

Equipment .........................................

Periods 10

Amortization $30,000

Eliminations and Adjustments: (CY1) Eliminate the entry recording the parent’s share (100%) of the subsidiary’s net income. (EL) Eliminate the subsidiary’s equity balances. (D) Distribute excess to equipment. (A) Increase depreciation expense. (IS) Eliminate the intercompany sales of $300,000. (IA) Eliminate the intercompany trade balances of $30,000. (EI) Eliminate the intercompany profit (25%) applicable to $50,000 ($300,000 – $250,000) of intercompany goods in Plato’s ending inventory. Note: An income distribution schedule is not needed because all income goes to the 100% controlling interest.

4–15

Ch. 4—Problems

PROBLEM 4-2 (1)

Benton Corporation and Subsidiary Crandel Company Worksheet for Consolidated Financial Statements For Year Ended March 31, 2017 Eliminations Consolidated Trial Balance and Adjustments Income Benton Crandel Dr. Cr. Statement

NCI

Controlling Retained Earnings

Consolidated Balance Sheet

............... ............... ............... ............... ............... ............... ............... ............... ............... ............... ............... ............... ............... ............... ............... ............... ............... ............... ............... (40,000) (20,000) ............... (60,300) ............... ............... ............... ............... ............... ............... ............... ............... 6,000 ............... ...............

.............. .............. .............. .............. .............. .............. .............. .............. .............. .............. .............. .............. .............. .............. .............. .............. .............. .............. (1,134,400) .............. .............. .............. .............. .............. .............. .............. .............. .............. .............. .............. .............. 25,000 .............. ..............

235,500 ............... 372,000 ............... 388,050 ............... ............... 1,231,000 2,250,000 (1,150,000) 222,500 ............... (333,500) (400,000) (250,000) (1,250,000) ............... ............... ............... ............... ............... ............... ............... ............... ............... ............... ............... ............... ............... ............... ............... ............... ............... ...............

9,050 (9,050) To NCI (see distribution schedule)....................................................................................................................................... To Controlling Interest (see distribution schedule)............................................................................................................... 82,800 ............... Total NCI ....................................................................................................................................................................................................... (123,350) Retained Earnings—Controlling Interest, March 31, 2017....................................................................................................................................................

............... (82,800) ............... (1,192,200)

............... ............... (123,350) (1,192,200) 0

Cash ............................................................ Accounts Receivable (net) ..........................

191,200 44,300 ............... ............... 290,000 97,000 ............... (IAP) 10,000 ............... ................ ............... (IAS) 5,000 Inventory ..................................................... 310,000 80,000 ............... (EIP) 1,200 ............... ................ ............... (EIS) 750 Investment in Crandel Company................. 450,000 ................ 32,000 (EL) 352,000 (CV) ............... ................ ............... 130,000 (D) Land ............................................................ 1,081,000 150,000 ............... ............... Building and Equipment .............................. 1,850,000 400,000 ............... ............... Accumulated Depreciation .......................... (940,000) (210,000) ............... ............... Goodwill ...................................................... 60,000 ................ (D) 162,500 ............... Accounts Payable ....................................... (242,200) (106,300) (IAP) 10,000 ............... ............... ................ (IAS) 5,000 ............... Bonds Payable ............................................ (400,000) ................ ............... ............... Common Stock—Benton ............................ (250,000) ................ ............... ............... Paid-In Capital in Excess of Par—Benton .. (1,250,000) ................ ............... ............... (CV) Retained Earnings, April 1, 2016—Benton . (1,105,000) ................ ............... 32,000 ............... ................ (BIP) 1,800 ............... ............... ................ (BIS) 800 ............... Common Stock—Crandel ........................... ............... (200,000) (EL) 160,000 ............... Paid-In Capital in Excess of Par—Crandel . ............... (100,000) (EL) 80,000 ............... Retained Earnings, April 1, 2016—Crandel ............... (140,000) (EL) 112,000 (NCI) 32,500 ............... ................ (BIS) 200 ............... Sales ........................................................... (880,000) (630,000) (ISP) 32,000 ............... ............... ................ (ISS) 30,000 ............... Dividend Income (from Crandel Company) . (24,000) ................ (CY2) 24,000 ............... Cost of Goods Sold ..................................... 704,000 504,000 (EIP) 1,200 (BIP) 1,800 ............... ................ (EIS) 750 (ISP) 32,000 ............... ................ ............... (BIS) 1,000 ............... ................ ............... (ISS) 30,000 Other Expenses .......................................... 130,000 81,000 ............... ............... Dividends Declared ..................................... 25,000 30,000 ............... (CY2) 24,000 0 0 652,250 652,250 Consolidated Net Income .....................................................................................................................................................

............... ............... ............... ............... ............... ............... ............... ............... ............... ............... ............... ............... ............... ............... ............... ............... ............... ............... ............... ............... ............... ............... ............... ............... (1,448,000) ............... ............... ............... ............... 1,145,150 211,000 ............... ............... 91,850

part.

Ch. 4—Problems

4–16

Problem 4-2, Continued Eliminations and Adjustments: (CV) Convert to equity method: Change in equity × 80% = $40,000 × 80% = $32,000. (CY2) Eliminate intercompany dividends. (EL) Eliminate parent’s share of subsidiary equity. (D)/(NCI) Distribute excess and NCI adjustment to goodwill, according to determination and distribution of excess schedule. (BIP) Eliminate intercompany profit from beginning inventory on sales from Benton to Crandel, $9,000 × 20% = $1,800. (ISP) Eliminate sales from Benton to Crandel from April 2016–March 2017 ($32,000). (EIP) Eliminate intercompany profit from ending inventory on sales from Benton to Crandel, $6,000 × 20% = $1,200. (IAP) Eliminate intercompany trade balances on sales from Benton to Crandel. (BIS) Eliminate intercompany profit from beginning inventory on sales from Crandel to Benton, $4,000 × 25% = $1,000. (ISS) Eliminate sales from Crandel to Benton. (EIS) Eliminate intercompany profit from ending inventory on sales from Crandel to Benton, $3,000 × 25% = $750. (IAS) Eliminate intercompany trade balances on sales from Crandel to Benton.

Company Implied Fair Value

Parent Price (80%)

NCI Value (20%)

$562,500 400,000 $162,500

$450,000 320,000 $130,000

$112,500 80,000 $ 32,500

Based on the above information, the following D&D schedule is prepared: Determination and Distribution of Excess Schedule Company Implied Fair Value

Parent Price (80%)

NCI Value (20%)

Fair value of subsidiary .............. $562,500 Less book value of interest acquired: Total equity ............................. 400,000 Interest acquired..................... Book value of interest ................ Excess of cost over book value . $162,500

$450,000

$112,500

$400,000 80% $320,000 $130,000

$400,000 20% $ 80,000 $ 32,500

Adjustment of identifiable accounts: Goodwill .....................................

Adjustment $162,500

Worksheet Key debit D

4–17

Ch. 4—Problems

Problem 4-2, Concluded Subsidiary Crandel Company Income Distribution Unrealized profit in ending inventory ........................... (EIS) $750

Internally generated net income ................................. $45,000 Realized profit in beginning inventory .............................. (BIS) 1,000 Adjusted income ........................ NCI share ................................... NCI .............................................

$45,250 × 20% $ 9,050

Parent Benton Corporation Income Distribution Unrealized profit in ending Internally generated net inventory ........................... (EIP) $1,200 income ................................. $46,000 Realized profit in beginning inventory .............................. (BIP) 1,800 80% × Crandel adjusted income of $45,250 ............... 36,200 Controlling interest ....................

(2)

$82,800

Benton Corporation and Subsidiary Crandel Company Consolidated Income Statement For Year Ended March 31, 2017 Sales ......................................................................................... Cost of goods sold .................................................................... Gross profit ............................................................................... Expenses .................................................................................. Consolidated net income .......................................................... Distributed to NCI ..................................................................... Distributed to controlling interest ..............................................

$1,448,000 1,145,150 $ 302,850 211,000 $ 91,850 9,050 $ 82,800

Ch. 4—Problems

4–18

PROBLEM 4-3 (1)

Company Implied Fair Value

Parent Price (70%)

NCI Value (30%)

$550,000 422,000** $128,000

$400,000 295,400 $104,600

$150,000* 126,600 $ 23,400

*3,000 NCI shares × $50 **$212,000 + $150,000 + $60,000 Determination and Distribution of Excess Schedule Company Implied Fair Value

Parent Price (70%)

NCI Value (30%)

Price paid for investment ........... $550,000 Less book value of interest acquired: Common stock ....................... $ 10,000 Paid-in capital in excess of par 90,000 Retained earnings .................. 112,000 Total equity ......................... $212,000 Interest acquired..................... Book value ................................. Excess of cost over book value . $338,000

$400,000

$150,000

$212,000 70% $148,400 $251,600

$212,000 30% $ 63,600 $ 86,400

Adjustment of identifiable accounts:

Buildings .................................... Equipment.................................. Goodwill ..................................... Total adjustments ...................

Adjustment $150,000 60,000 128,000 $338,000

Worksheet Key debit D1 debit D2 debit D3

Periods 20 5

Amortization $ 7,500 12,000

4–19

Ch. 4—Problems

Problem 4-3, Continued Amortization Schedule Account adjustments to be amortized Buildings Equipment Total amortizations

Life 20 5

Annual Amount $ 7,500 12,000 $19,500

Current Year $ 7,500 12,000 $19,500

Prior Years $ 7,500 12,000 $19,500

Total $15,000 24,000 $39,000

Key A1 A2

Parent Profit — —

Sub Amount $10,000 6,000

Sub % 25% 30%

Sub Profit $2,500 1,800

Intercompany Inventory Profit Deferral

Beginning Ending

Parent Amount — —

Parent % 0% 0%

Subsidiary Stude Corporation Income Distribution Unrealized profit in ending inventory .............................. Amortizations .............................

$ 1,800 19,500

Internally generated net income ................................. Realized profit in beginning inventory .............................. Adjusted income........................ NCI share .................................. Controlling share .......................

$20,000 2,500 $ 1,200 30% $ 360

Parent Packard Corporation Income Distribution Internally generated net income .................................. 70% of Stude adjusted income of $1,200 ............................... Controlling interest ......................

$165,000 840 $165,840

Ch. 4—Problems

4–20

Problem 4-3, Continued (2)

Packard Corporation and Subsidiary Stude Corporation Consolidated Income Statement For Year Ended December 31, 2016 Eliminations Consolidated Trial Balance and Adjustments Income Packard Stude Dr. Cr. Statement

NCI

Controlling Retained Earnings

Consolidated Balance Sheet

198,000 124,000 174,200 160,000 ........... ........... ........... ........... 1,150,000 (300,000) 282,000 (160,000) 128,000 (151,000) (100,000) ........... ........... ........... ........... ........... (100,000) (800,000) ........... ........... ........... ........... ........... ........... ........... ........... ........... ........... ........... ........... ........... ........... ...........

To NCI (see distribution schedule)....................................................................................................................................... 360 (360) To Controlling Interest (see distribution schedule)............................................................................................................... (165,840) ........... Total NCI ....................................................................................................................................................................................................... (149,760) Retained Earnings—Controlling Interest, December 31, 2016 .............................................................................................................................................

........... (165,840) ............ (455,440)

........... ........... (149,760) (455,440) 0

66,000 132,000 ........... ........... 90,000 45,000 ........... (IA) 11,000 120,000 56,000 ........... (EI) 1,800 100,000 60,000 ........... ........... 428,000 ........... (CY1) 14,000 ............ ........... ............ (CY2) 7,000 ........... ........... ........... (EL) 169,400 ............ ........... ............ (D) ........... 251,600 Buildings ......................................................... 800,000 200,000 (D1) 150,000 ........... Accumulated Depreciation .............................. (220,000) (65,000) ........... (A1) 15,000 Equipment ....................................................... 150,000 72,000 (D2) 60,000 ........... Accumulated Depreciation .............................. (90,000) (46,000) ........... (A2) 24,000 Goodwill .......................................................... ........... ............ (D3) 128,000 ........... Accounts Payable ........................................... (60,000) (102,000) (IA) 11,000 ........... Bonds Payable ................................................ ........... (100,000) ........... ........... ........... Common Stock—Stude .................................. ........... (10,000) (EL) 7,000 Paid-In Capital in Excess of Par—Stude ........ ........... (90,000) (EL) 63,000 ........... Retained Earnings, January 1—Stude............ ........... (142,000) (EL) 99,400 (NCI) 86,400 ........... ............ (A1–A2) 5,850 ........... 750 ........... ............ (BI) ........... ............ Common Stock—Packard ............................... (100,000) ........... ........... Paid-In Capital in Excess of Par—Packard..... (800,000) ........... ........... ............ Retained Earnings, January 1—Packard ........ (325,000) ............ (A1–A2) 13,650 ........... ........... ............ (BI) 1,750 ........... ........... ........... ........... ............ Sales ............................................................... (800,000) (350,000) (IS) 40,000 ........... Cost of Goods Sold ......................................... 450,000 208,500 ........... (IS) 40,000 ........... ............ (EI) 1,800 (BI) 2,500 Depreciation Expense—Buildings................... 30,000 7,500 (A1) 7,500 ........... Depreciation Expense—Equipment ................ 15,000 8,000 (A2) 12,000 ........... Other Expenses .............................................. 140,000 98,000 ........... ........... ........... ........... Interest Expense ............................................. ........... 8,000 Subsidiary Income .......................................... (14,000) ............ (CY1) 14,000 ........... Dividends Declared—Stude ............................ ........... 10,000 ........... (CY2) 7,000 ............ ........... ........... Dividends Declared—Packard ........................ 20,000 0 0 622,700 622,700 Consolidated Net Income .....................................................................................................................................................

part.

4–21

Ch. 4—Problems

Problem 4-3, Concluded Eliminations and Adjustments: (CY1) Current-year subsidiary income. (CY2) Current-year dividend. (EL) Eliminate controlling interest in subsidiary equity. (D/NCI) Distribute excess and NCI adjustment. (A) Amortize excess. (IS) Eliminate intercompany sales during current period. (IA) Eliminate intercompany unpaid trade accounts. (BI) Defer beginning inventory profit. (EI) Defer ending inventory profit.

Ch. 4—Problems

4–22

PROBLEM 4-4 (1)

Company Implied Fair Value

Parent Price (70%)

NCI Value (30%)

$550,000 422,000** $128,000

$400,000 295,400 $104,600

$150,000* 126,600 $ 23,400

*$3,000 NCI shares × $50 **$212,000 + $150,000 + $60,000 Determination and Distribution of Excess Schedule Company Implied Fair Value

Parent Price (70%)

NCI Value (30%)

Price paid for investment ........... $550,000 Less book value of interest acquired: Common stock ....................... $ 10,000 Paid-in capital in excess of par 90,000 Retained earnings .................. 112,000 Total equity ......................... $212,000 Interest acquired..................... Book value of interest ................ Excess of cost over book value $338,000

$400,000

$150,000

$212,000 70% $148,400 $251,600

$212,000 30% $ 63,600 $ 86,400

Adjustment of identifiable accounts: Buildings .................................... Equipment.................................. Goodwill ..................................... Total adjustments ...................

Adjustment $150,000 60,000 128,000 $338,000

Worksheet Key debit D1 debit D2 debit D3

Periods 20 5

Amortization $ 7,500 12,000

4–23

Ch. 4—Problems

Problem 4-4, Continued Amortization Schedule Account adjustments to be amortized Buildings Equipment Total amortizations

Life 20 5

Annual Amount $ 7,500 12,000 $19,500

Current Year $ 7,500 12,000 $19,500

Prior Years $ 7,500 12,000 $19,500

Total $15,000 24,000 $39,000

Key A1 A2

Parent Profit $ 8,000 10,500

Sub Amount $10,000 6,000

Sub % 25% 30%

Sub Profit $2,500 1,800

Intercompany Inventory Profit Deferral

Beginning Ending

Parent Amount $20,000 30,000

Parent % 40% 35%

Subsidiary Stude Corporation Income Distribution Unrealized profit in ending inventory .............................. Amortizations .............................

$ 1,800 19,500

$20,000 2,500 $ 1,200 30% $ 360

Parent Packard Corporation Income Distribution Unrealized profit in ending inventory ..............................

$10,500

Internally generated net income ................................. 70% of Stude adjusted income of $1,200 ............................. Realized profit in beginning inventory .............................. Controlling interest ....................

$165,000 840 8,000 $163,340

Ch. 4—Problems

4–24

Problem 4-4, Continued (2)

NCI

Controlling Retained Earnings

Consolidated Balance Sheet

198,000 101,000 163,700 160,000 ........... ........... ........... ........... 1,150,000 (300,000) 282,000 (160,000) 128,000 (128,000) (100,000) ........... ........... ........... ........... ........... ........... (100,000) (800,000) ........... ........... ........... ........... ........... ........... ........... ........... ........... ........... ........... ........... ........... ........... ...........

To NCI (see distribution schedule)....................................................................................................................................... 360 (360) To Controlling Interest (see distribution schedule)............................................................................................................... 163,340 ........... Total NCI ....................................................................................................................................................................................................... (149,760) Retained Earnings—Controlling Interest, December 31, 2016 .............................................................................................................................................

........... (163,340) ............ (444,940)

........... ........... (149,760) (444,940) 0

66,000 132,000 ........... ........... 90,000 45,000 ........... (IA) 34,000 120,000 56,000 ........... (EI) 12,300 100,000 60,000 ........... ........... 428,000 ........... (CY1) 14,000 ............ ........... ............ (CY2) 7,000 ........... ........... ........... (EL) 169,400 ............ ........... ............ (D) ........... 251,600 Buildings ......................................................... 800,000 200,000 (D1) 150,000 ........... Accumulated Depreciation .............................. (220,000) (65,000) ........... (A1) 15,000 Equipment ....................................................... 150,000 72,000 (D2) 60,000 ........... Accumulated Depreciation .............................. (90,000) (46,000) ........... (A2) 24,000 Goodwill .......................................................... ........... ............ (D3) 128,000 ........... Accounts Payable ........................................... (60,000) (102,000) (IA) 34,000 ........... Bonds Payable ................................................ ........... (100,000) ........... ........... ............ ........... ........... Discount (Premium) ........................................ ........... Common Stock—Stude .................................. ........... (10,000) (EL) 7,000 ........... Paid-In Capital in Excess of Par—Stude ........ ........... (90,000) (EL) 63,000 ........... Retained Earnings—Stude ............................. ........... (142,000) (EL) 99,400 (NCI) 86,400 ........... ............ (A1–A2) 5,850 ........... 750 ........... ............ (BI) ........... Common Stock—Packard ............................... (100,000) ........... ........... ............ Paid-In Capital in Excess of Par—Packard..... (800,000) ........... ........... ............ Retained Earnings—Packard .......................... (325,000) ............ (A1–A2) 13,650 ........... ........... ............ (BI) 9,750 ........... ........... ............ ........... ........... Sales ............................................................... (800,000) (350,000) (IS) 100,000 ........... Cost of Goods Sold ......................................... 450,000 208,500 ........... (IS) 100,000 ........... ............ (EI) 12,300 (BI) 10,500 Depreciation Expense—Buildings................... 30,000 7,500 (A1) 7,500 ........... Depreciation Expense—Equipment ................ 15,000 8,000 (A2) 12,000 ........... ........... ........... Other Expenses .............................................. 140,000 98,000 Interest Expense ............................................. ........... 8,000 ........... ........... Subsidiary Income .......................................... (14,000) ............ (CY1) 14,000 ........... Dividends Declared—Stude ............................ ........... 10,000 ........... (CY2) 7,000 ............ ........... ........... Dividends Declared—Packard ........................ 20,000 0 0 724,200 724,200 Consolidated Net Income .....................................................................................................................................................

part.

4–25

Ch. 4—Problems

Problem 4-4, Concluded Eliminations and Adjustments: (CY1) Current-year subsidiary income. (CY2) Current-year dividend. (EL) Eliminate controlling interest in subsidiary equity. (D/NCI) Distribute excess and NCI adjustment. (A) Amortize excess. (IS) Eliminate intercompany sales during current period ($60,000 + $40,000). (IA) Eliminate intercompany unpaid trade accounts. (BI) Defer beginning inventory profit. (EI) Defer ending inventory profit.

Ch. 4—Problems

4–26

PROBLEM 4-5 Price paid for investment in Jenko Company stock: Jenko Company stock outstanding ($450,000 ÷ $5 par) ........... 90,000 shares Ownership interest ..................................................................... × 80% Shares acquired ......................................................................... 72,000 Silvio Corporation shares issued (72,000 ÷ 3) ........................... 24,000 Market value of shares............................................................... × $40 Price paid for 80% interest ......................................................... $960,000

Company Implied Fair Value

Parent Price (80%)

NCI Value (20%)

$1,200,000* 1,075,000** $ 125,000

$960,000 860,000 $100,000

$240,000 215,000 $ 25,000

*$960,000/80% **$1,000,000 equity + $75,000 adjustment Based on the above information, the following D&D schedule is prepared: Determination and Distribution of Excess Schedule

Fair value of subsidiary ..................... Less book value of interest acquired: Total equity.................................. Interest acquired ......................... Book value of interest ....................... Excess of cost over book value ........

Company Implied Fair Value

Parent Price (80%)

NCI Value (20%)

$1,200,000

$ 960,000

$ 240,000

1,000,000

$1,000,000 80% $ 800,000 $ 160,000

$1,000,000 20% $ 200,000 $ 40,000

$ 200,000

Adjustment of identifiable accounts:

Land .................................................. Goodwill ............................................ Total adjustments ........................

Adjustment $ 75,000 125,000 $200,000

Worksheet Key debit D1 debit D2

4–27

Ch. 4—Problems

Problem 4-5, Continued Silvio Corporation and Subsidiary Jenko Company Worksheet for Consolidated Financial Statements For Year Ended December 31, 2017 Trial Balance Silvio Jenko

Eliminations and Adjustments Dr. Cr.

Consolidated Income Statement

NCI

Controlling Consolidated Retained Balance Earnings Sheet

Cash............................................................... 140,000 205,200 ............. .............. ............. ............. .............. 345,200 Accounts Receivable...................................... 285,000 110,000 ............. .............. ............. ............. .............. 395,000 Interest Receivable ........................................ 1,500 .............. ............. (LN2) 200 ............. ............. .............. 1,300 Notes Receivable ........................................... 50,000 .............. ............. (LN1) 10,000 ............. ............. .............. 40,000 Inventory ........................................................ 470,000 160,000 ............. (EI) 3,500 ............. ............. .............. 626,500 Land ............................................................... 350,000 300,000 (D1) 75,000 .............. ............. ............. .............. 725,000 Depreciable Fixed Assets .............................. 1,110,000 810,000 ............. .............. ............. ............. .............. 1,920,000 Accumulated Depreciation ............................. (500,000) (200,000) ............. .............. ............. ............. .............. (700,000) Intangibles ...................................................... 60,000 .............. ............. .............. ............. ............. .............. 60,000 Investment in Jenko Company ....................... 1,128,000 .............. ............. (CY1) 88,000 ............. ............. .............. ............. ............. .............. ............. (EL) 880,000 ............. ............. .............. ............. ............. .............. ............. (D) 160,000 ............. ............. .............. ............. Goodwill ......................................................... ............. .............. (D2) 125,000 .............. ............. ............. .............. 125,000 Accounts Payable ......................................... (611,500) (165,000) (LN1) 10,000 .............. ............. ............. .............. (776,500) Note Payable ................................................. ............. 10,000 ............. .............. ............. ............. .............. ............. Interest Payable ............................................. ............. (200) (LN2) 200 .............. ............. ............. .............. ............. Common Stock—Silvio .................................. (400,000) .............. ............. .............. ............. ............. .............. (400,000) Paid-In Capital in Excess of Par—Silvio......... (1,235,000) .............. ............. .............. ............. ............. .............. (1,235,000) Retained Earnings, January 1, 2017—Silvio (958,500) .............. ............. .............. ............. ............. .............. ............. ............. .............. (BI) 7,500 .............. ............. ............. (951,000) ............. Common Stock—Jenko ................................. ............. (450,000) (EL) 360,000 .............. ............. (90,000) .............. ............. Paid-In Capital in Excess of Par—Jenko........ ............. (180,000) (EL) 144,000 .............. ............. (36,000) .............. ............. Retained Earnings, January 1, 2017—Jenko ............. (470,000) (EL) 376,000 (NCI) 40,000 ............. (134,000) .............. ............. Treasury Stock (at cost) ................................. 315,000 .............. ............. .............. ............. ............. .............. 315,000 Sales .............................................................. (1,020,000) (500,000) (IS) 140,000 .............. (1,380,000) ............. .............. ............. Interest Income .............................................. (1,500) .............. (LN2) 200 .............. (1,300) ............. .............. ............. Subsidiary Income ......................................... (88,000) .............. (CY1) 88,000 .............. ............. ............. .............. ............. Cost of Goods Sold ........................................ 705,000 300,000 (EI) 3,500 (BI) 7,500 ............. ............. .............. ............. ....................................................................... ............. .............. (IS) ............. 140,000 861,000 ............ .............. ............. 90,000 ............. (LN2) 200 289,800 ............. .............. ............. Other Expenses ............................................. 200,000 0 0 1,329,400 1,329,400 ............. ............. .............. ............. ............. .............. ............. Consolidated Net Income ................................................................................................................................... (230,500) To NCI (see distribution schedule) ..................................................................................................................... 22,000 (22,000) .............. ............. To Controlling Interest (see distribution schedule) ............................................................................................. 208,500 ............. (208,500) ............. Total NCI ................................................................................................................................................................................. (282,000) .............. (282,000) Retained Earnings—Controlling Interest, December 31, 2017 ..................................................................................................................... (1,159,500) (1,159,500) 0 .

part.

Ch. 4—Problems

4–28

Problem 4-5, Concluded Eliminations and Adjustments: (CY1) Eliminate the entry recording the parent’s share of the subsidiary’s net income. (EL) Eliminate the parent’s (80%) share of Jenko Company equity against the investment. (D)/(NCI) Distribute excess and NCI adjustment according to the determination and distribution of excess schedule. (BI) Eliminate the intercompany profit of $7,500 (30% × $25,000) from beginning inventory. (IS) Eliminate intercompany sales of $140,000. (EI) Eliminate intercompany profit remaining after write-down of ending inventory, $28,000 balance after write-down – ($35,000 × 70% = $24,500 seller’s cost) = $3,500 remaining profit. (LN1) Eliminate intercompany note. (LN2) Eliminate the intercompany interest on note, accrued receivable, and accrued payable (12% × 4/12 × 1/2 × $10,000). Subsidiary Jenko Company Income Distribution Internally generated net income .....................................

$110,000

Adjusted income ............................ NCI share....................................... NCI.................................................

$110,000 × 20% $ 22,000

Parent Silvio Corporation Income Distribution Unrealized profit in ending inventory..................................

$3,500

Internally generated net income ..................................... 80% × Jenko adjusted income of $110,000 ................. Realized profit on beginning inventory .................................. Controlling interest .........................

$116,500 88,000 7,500 $208,500

4–29

Ch. 4—Problems

PROBLEM 4-6

Cash............................................................... Accounts Receivable (net) ............................. Notes Receivable ........................................... Inventory, August 31, 2017 ............................ Investment in Sack Corporation ..................... Plant and Equipment ...................................... Accumulated Depreciation .............................

Parcel Corporation and Subsidiary Sack Corporation Worksheet for Consolidated Financial Statements For Year Ended August 31, 2017 Eliminations and Adjustments Trial Balance Parcel Sack Dr. Cr. 120,000 50,000 ............. ............. 115,000 18,000 ............. ............. ............. 10,000 ............. ............. 175,000 34,000 ............. ............. 217,440 .............. (CY2) 5,600 (CY1) 23,040 ............. .............. ............. (EL) 200,000 990,700 295,000 ............. (F1S) 9,000 ............. .............. ............. (F1P) 63,000 (170,000) (85,000) (F1S) 3,000 ............. ............. .............. (F2S) 3,000 ............. ............. .............. (F2P) 6,300 ............. 28,000 .............. ............. ............. (80,000) (50,200) ............. ............. (25,000) .............. ............. ............. (300,000) .............. ............. ............. (290,000) .............. ............. ............. (110,000) .............. ............. .............

NCI ............. ............. ............. ............. ............. ............. ............. ............. ............. ............. ............. ............. ............. ............. ............. ............. .............

Other Assets .................................................. Accounts Payable ......................................... Notes Payable ................................................ Bonds Payable ............................................... Common Stock ($10 par)—Parcel ................. Paid-In Capital in Excess of Par—Parcel ....... Retained Earnings, September 1, 2016— Parcel ......................................................... (498,850) .............. (F1S) 4,800 ............. .............. ............. Common Stock ($10 par)—Sack.................... ............. (70,000) (EL) 56,000 ............. .............. (14,000) Paid-In Capital in Excess of Par—Sack ......... ............. (62,000) (EL) 49,600 ............. .............. (12,400) Retained Earnings, September 1, 2016—Sack ............. (118,000) (EL) 94,400 ............. .............. (22,400) ............. .............. (F1S) 1,200 ............. .............. ............. Sales .............................................................. (920,000) (240,000) ............. ............. (1,160,000) ............. Cost of Goods Sold ........................................ 598,000 132,000 ............. ............. 730,000 ............. Selling and General Expenses ....................... 108,000 80,000 ............. (F2S) 3,000 178,700 ............. ............. .............. ............. (F2P) 6,300 .............. ............. Subsidiary Income.......................................... (23,040) .............. (CY1) 23,040 ............. .............. ............. Interest Income .............................................. ............. (800) ............. ............. (800) ............. Interest Expense ............................................ 37,750 .............. ............. ............. 37,750 ............. Gain on Sale of Equipment ............................ (63,000) .............. (F1P) 63,000 ............. .............. ............. 7,000 ............. (CY2) 5,600 .............. 1,400 Dividends Declared ........................................ 90,000 0 0 309,940 309,940 .............. ............. ............. Consolidated Net Income ...................................................................................................................................... (214,350) To NCI (see distribution schedule) ........................................................................................................................ 6,360 (6,360) ............. To Controlling Interest (see distribution schedule) ................................................................................................ 207,990 Total NCI ..................................................................................................................................................................................... (53,760) Retained Earnings—Controlling Interest, August 31, 2017 ..............................................................................................................................

part.

Controlling Consolidated Retained Balance Earnings Sheet ............. 170,000 ............. 133,000 ............. 10,000 ............. 209,000 ............. ............. ............. ............. ............. 1,213,700 ............. ............. ............. ............. ............. (242,700) ............. ............. ............. 28,000 ............. (130,200) ............. (25,000) ............. (300,000) ............. (290,000) ............. (110,000) (494,050) ............. ............. ............. ............. ............. ............. ............. ............. ............. ............. ............. ............. 90,000 ............. ............. ............. (207,990) ............. (612,040)

Ch. 4—Problems

4–30

Problem 4-6, Concluded Subsidiary Sack Corporation Income Distribution Internally generated net income ................................. 2017 amortization of deferred gain on 2015 sale of truck ......................... Adjusted income ........................ NCI share................................... NCI.............................................

$28,800 (F2S) 3,000 $31,800 × 20% $ 6,360

Parent Parcel Corporation Income Distribution 2017 deferred gain on sale of equipment ............ (F1P) $63,000

Internally generated net income ................................. 2017 amortization of the deferred gain ........................ 80% × Sack adjusted income of $31,800 ............... Controlling interest .....................

$239,250 (F2P) 6,300 25,440 $207,990

Eliminations and Adjustments: (CY1) Eliminate the entry recording the parent’s share of the subsidiary net income. (CY2) Eliminate the parent’s share of Sack’s dividends declared. (EL) Eliminate the investment in Sack and the parent’s share (80%) of the subsidiary equity balances. (F1S) Eliminate the prior-year intercompany gain ($14,000 – $5,000 = $9,000) less the $3,000 realized gain. Adjust the asset and the accumulated depreciation. (F2S) Adjust current-year depreciation expense and accumulated depreciation for the intercompany truck sale effect ($9,000 ÷ 3 = $3,000). (F1P) Eliminate the current-period intercompany gain on the sale of the equipment and reestablish its net book value by reducing the account by $63,000. (F2P) Adjust current-year depreciation expense and accumulated depreciation for the intercompany sale of equipment effect ($63,000 ÷ 10 = $6,300).

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4–31

Ch. 4—Problems

PROBLEM 4-7

Company Implied Fair Value

Parent Price (80%)

NCI Value (20%)

$590,000 372,000* $218,000

$480,000 297,600 $182,400

$110,000 74,400 $ 35,600

*$212,000 + $120,000 + $40,000 Determination and Distribution of Excess Schedule

Price paid for investment............. Less book value of interest acquired: Common stock ...................... Paid-in capital in excess of par Retained earnings ................. Total equity ...................... Interest acquired ................... Book value of interest.................. Excess of cost over book value...

Company Implied Fair Value

Parent Price (80%)

NCI Value (20%)

$590,000

$480,000

$110,000

$212,000 80% $169,600 $310,400

$212,000 20% $ 42,400 $ 67,600

$ 10,000 90,000 112,000 $212,000 $378,000

Adjustment $120,000 40,000 218,000 $378,000

Worksheet Key debit D1 debit D2 debit D3

Periods 20 5

Amortization $6,000 8,000

Ch. 4—Problems

4–32

Problem 4-7, Continued Amortization Schedule Account adjustments to be amortized Buildings Equipment Total amortizations

Life 20 5

Annual Amount $ 6,000 8,000 $14,000

Current Year $ 6,000 8,000 $14,000

Prior Years $ 6,000 8,000 $14,000

Total $12,000 16,000 $28,000

Key A10 A2

Parent Profit — —

Sub Amount $12,000 18,000

Sub % 25% 30%

Sub Profit $3,000 5,400

Parent $15,000 2 — 15,000 3,000

Sub — — — — —

Intercompany Inventory Profit Deferral

Beginning Ending

Parent Amount — —

Parent % 0% 0%

Intercompany Fixed Asset Profit Deferral Original profit ............................................... Year of sale.................................................. Realized in prior years ................................. Balance, start of year ................................... Realized in current year ...............................

Subsidiary Sandin Company Income Distribution Ending inventory profit ............... Amortizations .............................

$ 5,400 14,000

Internally generated net income ................................ Beginning inventory profit .........

$20,000 3,000

Total .......................................... NCI share.................................. Controlling share.......................

$ 3,600 720 $ 2,880

Parent Panther Company Income Distribution Equipment gain ..........................

$15,000 Internally generated net income................................. Controlling share of subsidiary .. Realized gain on equipment .....

$165,000 2,880 3,000

Total ..........................................

$155,800

4–33

Ch. 4—Problems

Problem 4-7, Continued (2)

Panther Company and Subsidiary Sandin Company Consolidated Income Statement For Year Ended December 31, 2016

Eliminations Consolidated Trial Balance and Adjustments Income Sandin Dr. Cr. Statement NCI Panther Cash ................................................................ 24,000 132,000 ............... ............... ............... ............... Accounts Receivable ...................................... 90,000 45,000 ............... (IA) 20,000 ............... ............... Inventory ......................................................... 120,000 56,000 ............... (EI) 5,400 ............... ............... ............... ............... Land ................................................................ 100,000 60,000 ............... ............... Investment in Sandin ...................................... 512,000 ................ ............... (CY1) 16,000 ............... ............... ............... ................ (CY2) 8,000 ............... ............... ............... ............... ................ ............... (EL) 193,600 ............... ............... (D) ............... ................ ............... 310,400 ............... ............... Buildings ......................................................... 800,000 200,000 (D1) 120,000 ............... ............... ............... Accumulated Depreciation .............................. (220,000) (65,000) ............... (A1) 12,000 ............... ............... Equipment ....................................................... 150,000 72,000 (D2) 40,000 (F1) 15,000 ............... ............... Accumulated Depreciation .............................. (90,000) (46,000) ............... (A2) 16,000 ............... ............... ............... ............... ............... ................ (F2) 3,000 ............... Goodwill .......................................................... ............... ................ (D3) 218,000 ............... ............... ............... Accounts Payable ........................................... (60,000) (102,000) (IA) 20,000 ............... ............... ............... ............... ............... Bonds Payable ................................................ ............... (100,000) ............... ............... Discount (Premium) ........................................ ............... ................ ............... ............... ............... ............... Common Stock—Sandin ................................. ............... (10,000) (EL) 8,000 ............... ............... (2,000) Paid-In Capital in Excess of Par—Sandin....... ............... (90,000) (EL) 72,000 ............... ............... (18,000) Retained Earnings—Sandin ............................ ............... (142,000) (EL) 113,600 (NCI) 67,600 ............... ............... ............... ................ (BI) 600 ............... ............... ............... ............... (92,600) ............... ................ ............... ............... ............... ................ (A1-2) 2,800 ............... ............... ............... Common Stock—Panther ............................... (100,000) ................ ............... ............... ............... ............... Paid-In Capital in Excess of Par—Panther ..... (800,000) ................ ............... ............... ............... ............... Retained Earnings—Panther .......................... (365,000) ................ (A1-2) 11,200 ............... ............... ............... ............... ................ (BI) 2,400 ............... ............... ............... ............... ............... ............... ................ ............... ............... Sales ............................................................... (800,000) (350,000) (IS) 75,000 ............... (1,075,000) ............... Cost of Goods Sold ........................................ 450,000 208,500 ............... (IS) 75,000 ............... ............... ............... ................ (EI) 5,400 (BI) 3,000 585,900 ............... Depreciation Expense—Buildings................... 30,000 7,500 (A1) 6,000 ............... 43,500 ............... Depreciation Expense—Equipment ................ 15,000 8,000 (A2) 8,000 ............... ............... ............... ............... ................ ............... (F2) 3,000 28,000 ............... Other Expenses ............................................. 160,000 98,000 ............... ............... 258,000 ............... Interest Expense ............................................ ............... 8,000 ............... ............... 8,000 ............... Gain on Sale of Fixed Asset ........................... (20,000) ................ (F1) 15,000 ............... (5,000) ............... Subsidiary Income ......................................... (16,000) ................ (CY1) 16,000 ............... ............... ............... 2,000 Dividends Declared—Sandin ......................... ............... 10,000 ............... (CY2) 8,000 ............... ................ ............... ............... ............... ............... Dividends Declared—Panther ......................... 20,000 Total ................................................................ 0 0 745,000 745,000 ............... ............... Consolidated Net Income ..................................................................................................................................................... (156,600) ............... (720) NCI Share (see distribution schedule) ................................................................................................................................. 720 ............... To Controlling Interest (see distribution schedule)............................................................................................................... 155,880 Total NCI ....................................................................................................................................................................................................... (111,320) Retained Earnings—Controlling Interest, December 31, 2016 .............................................................................................................................................

Controlling Retained Earnings ............... ............... ............... ............... ............... ............... ............... ............... ............... ............... ............... ............... ............... ............... ............... ............... ............... ............... ............... ............... ............... ............... ............... ............... ............... ............... ............... (351,400) ............... ............... ............... ............... ............... ............... ............... ............... ............... ............... ............... 20,000 ............... ............... ............... (155,880) ............... (487,280)

part.

Consolidated Balance Sheet 156,000 115,000 170,600 160,000 ............... ............... ............... ............... 1,120,000 (297,000) 247,000 ............... (149,000) 218,000 (142,000) (100,000) ............... ............... ............... ............... ............... ............... ............... (100,000) (800,000) ............... ............... ............... ............... ............... ............... ............... ............... ............... ............... ............... ............... ............... ............... ............... ............... ............... ............... ............... (111,320) (487,280) 0

Ch. 4—Problems

4–34

Problem 4-7, Concluded Eliminations and Adjustments: (CY1) Current-year subsidiary income. (CY2) Current-year dividend. (EL) Eliminate controlling interest in subsidiary. (D)/(NCI) Distribute excess and NCI adjustment. (A) Amortize excess. (IS) Eliminate intercompany sales during current period. (IA) Eliminate intercompany unpaid trade accounts. (BI) Defer beginning inventory profit. (EI) Defer ending inventory profit. (F1) Fixed asset profit at beginning of year. (F2) Fixed asset profit realized.

4–35

Ch. 4—Problems

PROBLEM 4-8

Company Implied Fair Value

Parent Price (80%)

NCI Value (20%)

$590,000 372,000* $218,000

$480,000 297,600 $182,400

$110,000 74,400 $ 35,600

*$212,000 + $120,000 + $40,000 Determination and Distribution of Excess Schedule

Price paid for investment............. Less book value of interest acquired: Common stock ...................... Paid-in capital in excess of par Retained earnings ................. Total equity ...................... Interest acquired ................... Book value of interest.................. Excess of cost over book value...

Company Implied Fair Value

Parent Price (80%)

NCI Value (20%)

$590,000

$480,000

$110,000

$212,000 80% $169,600 $310,400

$212,000 20% $ 42,400 $ 67,600

$ 10,000 90,000 112,000 $212,000 $378,000

Adjustment $120,000 40,000 218,000 $378,000

Worksheet Key debit D1 debit D2 debit D3

Periods 20 5

Amortization $6,000 8,000

Ch. 4—Problems

4–36

Problem 4-8, Continued Amortization Schedule Account adjustments to be amortized Buildings Equipment Total amortizations

Life 20 5

Annual Amount $ 6,000 8,000 $14,000

Current Year $ 6,000 8,000 $14,000

Prior Years $ 6,000 8,000 $14,000

Total $12,000 16,000 $28,000

Key A10 A2

Parent Profit $6,000 7,500

Sub Amount — —

Sub % 0% 0%

Sub Profit — —

Parent — — — — —

Sub $24,000 1 4,000 $20,000 $ 4,000

Intercompany Inventory Profit Deferral

Beginning Ending

Parent Amount $20,000 25,000

Parent % 30% 30%

Subsidiary Sandin Company Income Distribution Amortizations ............................. $14,000

Internally generated net income ................................... Realized gain on equipment........

$20,000 4,000

Total ............................................ NCI share .................................... Controlling share .........................

$10,000 2,000 $ 8,000

Parent Panther Company Income Distribution Ending inventory profit ................. $7,500

Internally generated net income ................................. Controlling share of subsidiary .. Beginning inventory profit..........

$165,000 8,000 6,000

Total ..........................................

$171,500

4–37

Ch. 4—Problems

Problem 4-8, Continued (2)

Panther Company and Subsidiary Sandin Company Consolidated Income Statement For Year Ended December 31, 2016

Eliminations Consolidated Trial Balance and Adjustments Income Sandin Dr. Cr. Statement NCI Panther Cash ................................................................ 24,000 132,000 ............... ............... ............... ............... Accounts Receivable ...................................... 90,000 45,000 ............... (IA) 15,000 ............... ............... Inventory ......................................................... 120,000 56,000 ............... (EI) 7,500 ............... ............... Land ................................................................ 100,000 60,000 ............... ............... ............... ............... Investment in Sandin ...................................... 512,000 ................ ............... (CY1) 16,000 ............... ............... ............... ............... ............... ................ (CY2) 8,000 ............... ............... ................ ............... (EL) 193,600 ............... ............... (D) ............... ................ ............... 310,400 ............... ............... Buildings ......................................................... 800,000 200,000 (D1) 120,000 ............... ............... ............... Accumulated Depreciation .............................. (220,000) (65,000) ............... (A1) 12,000 ............... ............... Equipment ....................................................... 150,000 72,000 (D2) 40,000 (F1) 24,000 ............... ............... Accumulated Depreciation .............................. (90,000) (46,000) ............... (A2) 16,000 ............... ............... ............... ............... ............... ................ (F1) 4,000 ............... ............... ................ (F2) 4,000 ............... ............... ............... ............... ............... Goodwill .......................................................... ............... ................ (D3) 218,000 ............... Accounts Payable ........................................... (60,000) (102,000) (IA) 15,000 ............... ............... ............... Bonds Payable ................................................ ............... (100,000) ............... ............... ............... ............... Discount (Premium) ........................................ ............... ................ ............... ............... ............... ............... Common Stock—Sandin ................................. ............... (10,000) (EL) 8,000 ............... ............... (2,000) Paid-In Capital in Excess of Par—Sandin....... ............... (90,000) (EL) 72,000 ............... ............... (18,000) Retained Earnings—Sandin ............................ ............... (142,000) (EL) 113,600 (NCI) 67,600 ............... ............... ............... ............... ............... ................ (FI) 4,000 ............... ............... (89,200) ............... ................ ............... ............... ............... ................ (A1-2) 2,800 ............... ............... ............... ............... ............... Common Stock—Panther ............................... (100,000) ................ ............... ............... Paid-In Capital in Excess of Par—Panther ..... (800,000) ................ ............... ............... ............... ............... Retained Earnings—Panther .......................... (365,000) ................ (A1-2) 11,200 ............... ............... ............... ............... ................ (BI) 6,000 ............... ............... ............... ............... ................ (F1) 16,000 ............... ............... ............... Sales ............................................................... (800,000) (350,000) (IS) 100,000 ............... (1,050,000) ............... Cost of Goods Sold ........................................ 450,000 208,500 ............... (IS) 100,000 ............... ............... ............... ................ (EI) 7,500 (BI) 6,000 560,000 ............... Depreciation Expense—Buildings................... 30,000 7,500 (A1) 6,000 ............... 43,500 ............... ............... ............... Depreciation Expense—Equipment ................ 15,000 8,000 (A2) 8,000 ............... ............... ................ ............... (F2) 4,000 27,000 ............... Other Expenses .............................................. 160,000 98,000 ............... ............... 258,000 ............... Interest Expense ............................................ ............... 8,000 ............... ............... 8,000 ............... Gain on Sale of Fixed Asset ........................... (20,000) ................ ............... ............... (20,000) ............... Subsidiary Income ......................................... (16,000) ................ (CY1) 16,000 ............... ............... ............... 2,000 Dividends Declared—Sandin ......................... ............... 10,000 ............... (CY2) 8,000 ............... Dividends Declared—Panther ......................... 20,000 ................ ............... ............... ............... ............... 0 780,100 780,100 ............... ............... 0 Consolidated Net Income ..................................................................................................................................................... (173,500) ............... (2,000) NCI Share (see distribution schedule) ................................................................................................................................. 2,000 ............... To Controlling Interest (see distribution schedule)............................................................................................................... 171,500 Total NCI ....................................................................................................................................................................................................... (109,200) Retained Earnings—Controlling Interest, December 31, 2016 ............................................................................................................................................. .

Controlling Retained Earnings ............... ............... ............... ............... ............... ............... ............... ............... ............... ............... ............... ............... ............... ............... ............... ............... ............... ............... ............... ............... ............... ............... ............... ............... ............... ............... ............... ............... (331,800) ............... ............... ............... ............... ............... ............... ............... ............... ............... ............... ............... 20,000 ............... ............... ............... (171,500) ............... (483,300) part.

Consolidated Balance Sheet 156,000 120,000 168,500 160,000 ............... ............... ............... ............... 1,120,000 (297,000) 238,000 ............... ............... (144,000) 218,000 (147,000) (100,000) ............... ............... ............... ............... ............... ............... ............... (100,000) (800,000) ............... ............... ............... ............... ............... ............... ............... ............... ............... ............... ............... ............... ............... ............... ............... ............... ............... ............... ............... (109,200) (483,300) 0

Ch. 4—Problems

4–38

Problem 4-8, Concluded Eliminations and Adjustments: (CY1) Current-year subsidiary income. (CY2) Current-year dividend. (EL) Eliminate controlling interest in subsidiary. (D)/(NCI) Distribute excess and NCI adjustment. (A) Amortize excess. (IS) Eliminate intercompany sales during current period. (IA) Eliminate intercompany unpaid trade accounts. (BI) Defer beginning inventory profit. (EI) Defer ending inventory profit. (F1) Fixed asset profit at beginning of year. (F2) Fixed asset profit realized.

4–39

Ch. 4—Problems

PROBLEM 4-9

Company Implied Fair Value

Parent Price (90%)

NCI Value (10%)

$1,400,000* 800,000 $ 600,000

$1,260,000 720,000 $ 540,000

$140,000 80,000 $ 60,000

*$1,260,000/90% Based on the above information, the following D&D schedule is prepared: Determination and Distribution of Excess Schedule

Fair value of subsidiary ..................... Less book value of interest acquired: Common stock ............................ Retained earnings ....................... Total equity ............................ Interest acquired ......................... Book value of interest ....................... Excess of cost over book value ........

Company Implied Fair Value

Parent Price (90%)

NCI Value (10%)

$1,400,000

$1,260,000

$140,000

$ 800,000 90% $ 720,000 $ 540,000

$800,000 10% $ 80,000 $ 60,000

$ 200,000 600,000 $ 800,000 $ 600,000

Adjustment of identifiable accounts: Goodwill ............................................

Adjustment $ 600,000

Worksheet Key debit D1

Ch. 4—Problems

4–40

Problem 4-9, Continued

Cash........................................................... Accounts and Other Current Receivables ..

Inventory .................................................... Property, Plant, and Equipment (net) ......... Investment in Sunco Corporation ............... Goodwill ..................................................... Accounts Payable and Other Current Liabilities ....................................

Common Stock—Pettie .............................. Retained Earnings, January 1, 2016—Pettie ....................................... Common Stock—Sunco ............................. Retained Earnings, January 1, 2016—Sunco ...................................... Dividends Declared .................................... Sales .......................................................... Dividend Income ........................................ Interest Expense ........................................ Interest Income .......................................... Cost of Goods Sold .................................... Other Expenses .........................................

Pettie Corporation and Subsidiary Sunco Corporation Worksheet for Consolidated Financial Statements For Year Ended December 31, 2016 Eliminations and Adjustments Trial Balance Pettie Sunco Dr. Cr. 15,000 45,500 ............. ............. 410,900 170,000 ............. (CY3) 900 ............. .............. ............. (LN1) 5,000 ............. .............. ............. (LN1) 100,000 ............. .............. ............. (IA) 90,000 920,000 739,400 ............. (EI) 7,500 1,000,000 400,000 ............. ............. 1,260,000 .............. (CV) 45,000 (EL) 765,000 ............. .............. ............. (D) 540,000 ............. .............. (D) 600,000 ............. (140,000) ............. ............. ............. (500,000)

(305,900) .............. .............. .............. ..............

(2,800,000) .............

.............. (200,000)

(CY3) (LN1) (LN1) (IA)

(EL)

900 5,000 100,000 90,000 ............. ............. 180,000

(CV)

Consolidated Income Statement .............. .............. .............. .............. .............. .............. .............. .............. .............. ..............

Controlling Consolidated Retained Balance Earnings Sheet ............. 60,500 ............. .............. ............. .............. ............. .............. ............. 385,000 ............. 1,651,900 ............. 1,400,000 ............. .............. ............. .............. ............. 600,000

NCI ............. ............. ............. ............. ............. ............. ............. ............. ............. .............

............. ............. ............. ............. .............

.............. .............. .............. .............. ..............

............. ............. ............. ............. .............

.............. .............. .............. (250,000) (500,000)

45,000 .............

.............. ..............

............. (2,845,000) (20,000) .............

.............. ..............

............. (650,000) (EL) 585,000 (NCI) 60,000 .............. (125,000) ............. .............. ............. 1,000 ............. (CY2) 900 .............. 100 ............. .............. (2,000,000) (650,000) (IS) 300,000 ............. (2,350,000) ............. ............. .............. (900) .............. (CY2) 900 ............. .............. ............. ............. .............. ............. 5,000 ............. (LN2) 5,000 .............. ............. ............. .............. (5,000) .............. (LN2) 5,000 ............. .............. ............. ............. .............. 1,500,000 400,000 (EI) 7,500 (IS) 300,000 1,607,500 ............. ............. .............. 45,000 ............. ............. 385,000 ............. ............. .............. 340,000 0 0 1,919,300 1,919,300 .............. ............. ............. .............. ............. ............. .............. Consolidated Net Income ...................................................................................................................................... (357,500) To NCI (see distribution schedule) ........................................................................................................................ 20,000 (20,000) ............. .............. To Controlling Interest (see distribution schedule) ................................................................................................ 337,500 ............. (337,500) .............. Total NCI ..................................................................................................................................................................................... (164,900) ............. (164,900) Retained Earnings—Controlling Interest, December 31, 2016 ......................................................................................................................... (3,182,500) (3,182,500) 0

part.

4–41

Ch. 4—Problems

Problem 4-9, Concluded Eliminations and Adjustments: (CV) (CY2) (CY3) (EL)

Adjust investment for change in Sunco retained earnings, 90% × $50,000 = $45,000. Eliminate the entry recording the parent’s share of the subsidiary’s cash dividend. Eliminate the intercompany dividend payable and receivable. Eliminate the parent’s (90%) share of Sunco Corporation equity against the investment. (D)/(NCI) Distribute excess and NCI adjustment according to the determination and distribution of excess schedule. (LN1) Eliminate intercompany note, interest payable, and receivable. (LN2) Eliminate intercompany interest expense and income (10% × 1/2 × $100,000). (IS) Eliminate intercompany sales of $300,000. (EI) Eliminate intercompany profit of $7,500 (10% × $75,000) in the ending inventory. (IA) Eliminate intercompany trade debt of $90,000. Subsidiary Sunco Corporation Income Distribution Internally generated net income .................................

$200,000

Adjusted income ........................ NCI share ................................... NCI .............................................

$200,000 × 10% $ 20,000

Parent Pettie Corporation Income Distribution Unrealized profit in ending inventory ........................ (EI) $7,500

Internally generated net income .................................... $165,000 90% × Sunco adjusted income of $200,000 ............................. 180,000 Controlling interest ...................... $337,500

Ch. 4—Problems

4–42

PROBLEM 4-10

Value Analysis Schedule Company fair value .................................................. Fair value of net assets excluding goodwill** ........... Goodwill ...................................................................

Company Implied Fair Value

Parent Price (80%)

NCI Value (20%)

$250,000* 237,500 $ 12,500

$200,000 190,000 $ 10,000

$50,000 47,500 $ 2,500

*$200,000/80% **Company value = $200,000 equity + $25,000 + $12,500 Determination and Distribution of Excess Schedule Company Implied Fair Value

Parent Price (80%)

NCI Value (20%)

$250,000

$200,000

$ 50,000

$200,000

$200,000 80% $160,000 $ 40,000

$200,000 20% $ 40,000 $ 10,000

Price paid for investment .................. Less book value of interest acquired: Total equity ............................ Interest acquired ......................... Book value of interest ....................... Excess of cost over book value ........

$ 50,000

Adjustment of identifiable accounts: Inventory ........................................... Equipment ......................................... Goodwill ............................................ Total adjustments ......................

Adjustment $12,500 25,000 12,500 $50,000

Worksheet Key debit D1 debit D2 debit D3

Periods 1 4

Amortization $12,500 6,250

Amortization Schedule Account adjustments to be amortized Inventory Equipment Total amortizations

Life 1 4

Annual Amount $12,500 6,250 $18,750

Current Year $ — 6,250 $6,250

Prior Years $12,500 6,250 $18,750

Total $12,500 12,500 $25,000

Key A1 A2

Parent Profit — —

Sub Amount $20,000 10,000

Sub % 50% 50%

Sub Profit $10,000 5,000

Intercompany Inventory Profit Deferral

Beginning Ending

Parent Amount — —

Parent % 0% 0%

4–43

Ch. 4—Problems

Problem 4-10, Continued Intercompany Fixed Asset Profit Deferral Original profit....................................................... Year of sale ......................................................... Realized in prior years ........................................ Balance, start of year .......................................... Realized in current year ......................................

Parent $15,000 1 3,000 $12,000 $ 3,000

Sub — — — — —

Subsidiary Salt Company Income Distribution Unrealized profit in ending inventory.............................. (EI) $5,000 Amortizations ............................ (A2) 6,250

Internally generated net income ............................. $105,000 Realized profit in beginning inventory .......................... (B1) 10,000 Adjusted income .................... NCI share............................... Controlling share....................

$103,750 20% $ 20,750

Parent Peanut Company Income Distribution Internally generated net income ............................... $100,000 80% of Salt’s adjusted income of $103,750 ........................ 83,000 Realized gain ........................... (F2) 3,000 Controlling interest ...................

$186,000

Ch. 4—Problems

4–44

Problem 4-10, Continued Peanut Company and Subsidiary Salt Company Consolidated Income Statement For Year Ended December 31, 2016 Trial Balance Peanut Salt Inventory, December 31 .................................. Other Current Assets ...................................... Investment in Salt Company ...........................

Eliminations and Adjustments Dr.

Cr.

Consolidated Income Statement

NCI

130,000 50,000 ............... (EI) 5,000 ............... ............... 241,000 235,000 ............... ............... ............... ............... 308,000 ................ ............... (CY1) 84,000 ............... ............... ............... ............... ............... ................ (CY2) 16,000 ............... ............... ................ ............... (EL) 200,000 ............... ............... (D) ............... ................ ............... 40,000 ............... ............... Other Long-Term Investments ........................ 20,000 ................ ............... ............... ............... ............... Land ................................................................ 140,000 .... 80,000 ............... ............... ............... ............... Buildings and Equipment ................................ 375,000 200,000 (D2) 25,000 (F1) 15,000 ............... ............... Accumulated Depreciation .............................. (120,000) (30,000) ............... (A2) 12,500 ............... ............... ............... ............... ............... ................ (F1) 3,000 ............... ............... ................ (F2) 3,000 ............... ............... ............... ............... ............... Other Intangible Assets ................................... ............... 20,000 ............... ............... ............... ............... Goodwill .......................................................... ............... ................ (D3) 12,500 ............... Current Liabilities ............................................ (150,000) (70,000) ............... ............... ............... ............... Bonds Payable ................................................ ............... (100,000) ............... ............... ............... ............... Other Long-Term Liabilities............................. (200,000) (50,000) ............... ............... ............... ............... ............... ................ ............... ............... ............... ............... ............... (10,000) Common Stock—Salt ...................................... ............... (50,000) (EL) 40,000 ............... ............... (10,000) Paid-In Capital in Excess of Par—Salt............ ............... (50,000) (EL) 40,000 ............... Retained Earnings—Salt ................................ ............... (150,000) (EL) 120,000 (NCI) 10,000 ............... ............... ............... ................ (BI) 2,000 ............... ............... ............... ............... ................ (D1) 2,500 ............... ............... ............... ............... (34,250) ............... ................ (A2) 1,250 ............... Common Stock—Peanut ................................ (200,000) ................ ............... ............... ............... ............... Paid-In Capital in Excess of Par—Peanut ...... (100,000) ................ ............... ............... ............... ............... Retained Earnings—Peanut ........................... (320,000) ................ (A2) 5,000 ............... ............... ............... ............... ................ (D1) 10,000 ............... ............... ............... ............... ............... ............... ................ (BI) 8,000 ............... ............... ................ (F1) 12,000 ............... ............... ............... Sales ............................................................... (600,000) (315,000) (IS) 40,000 ............... (875,000) ............... Cost of Goods Sold ......................................... 350,000 150,000 ............... (IS) 40,000 ............... ............... ............... ................ (EI) 5,000 (BI) 10,000 455,000 ............... ............... ............... Operating Expenses ....................................... 150,000 60,000 (A2) 6,250 ............... ............... ................ ............... (F2) 3,000 213,250 ............... Subsidiary Income ......................................... (84,000) ................ (CY1) 84,000 ............... ............... ............... Dividends Declared—Salt ............................... ............... 20,000 ............... (CY2) 16,000 ............... 4,000 Dividends Declared—Peanut .......................... 60,000 ................ ............... ............... ............... ............... 0 435,500 435,500 ............... ............... 0 ............... Consolidated Net Income ..................................................................................................................................................... (206,750) To NCI (see distribution schedule) ....................................................................................................................................... 20,750 (20,750) ............... To Controlling Interest (see distribution schedule)............................................................................................................... 186,000 Total NCI ....................................................................................................................................................................................................... (71,000) Retained Earnings—Controlling Interest, December 31, 2016 .............................................................................................................................................

Controlling Retained Earnings

Consolidated Balance Sheet

............... ............... ............... ............... ............... ............... ............... ............... ............... ............... ............... ............... ............... ............... ............... ............... ............... ............... ............... ............... ............... ............... ............... ............... ............... ............... ............... ............... ............... (285,000) ............... ............... ............... ............... ............... ............... ............... 60,000 ............... ............... ............... (186,000) ............... (411,000)

175,000 476,000 ............... ............... ............... ............... 20,000 220,000 585,000 ............... ............... (156,500) 20,000 12,500 (220,000) (100,000) (250,000) ............... ............... ............... ............... ............... ............... ............... (200,000) (100,000) ............... ............... ............... ............... ............... ............... ............... ............... ............... ............... ............... ............... ............... ............... ............... ............... (71,000) (411,000) 0

part.

4–45

Ch. 4—Problems

Problem 4-10, Concluded Eliminations and Adjustments: (CY1) Current-year subsidiary income. (CY2) Current-year dividend. (EL) Eliminate controlling interest in subsidiary equity. (D)/(NCI) Distribute excess and NCI adjustment. (A) Amortize excess, (A1) includes $12,500 inventory adjustment. (IS) Eliminate intercompany sales during current period. (BI) Eliminate beginning inventory profit. (EI) Defer ending inventory profit. (F1) Fixed asset profit at beginning of year. (F2) Fixed asset profit realized.

Ch. 4—Problems

4–46

PROBLEM 4-11

Company Implied Fair Value

Parent Price (80%)

NCI Value (20%)

$250,000* 237,500 $ 12,500

$200,000 190,000 $ 10,000

$50,000 47,500 $ 2,500

*$200,000/80% **Company value = $200,000 equity + $25,000 + $12,500 Determination and Distribution of Excess Schedule

Company Implied Fair Value

Parent Price (80%)

NCI Value (20%)

$250,000

$200,000

$ 50,000

200,000

$200,000 80% $160,000 $ 40,000

$200,000 20% $ 40,000 $ 10,000

$ 50,000

Adjustment $ 12,500 25,000 12,500 $ 50,000

Equity Conversion Retained earnings, January 1 current year ......... Retained earnings, acquisition ............................ Increase .............................................................. Ownership interest .............................................. Cost-to-equity conversion ...................................

Worksheet Key debit D1 debit D2 debit D3

Periods 1 4

Amortization $12,500 6,250

$150,000 100,000 $ 50,000 80% $ 40,000

4–47

Ch. 4—Problems

Problem 4-11, Continued Amortization Schedule Account adjustments to be amortized Inventory Equipment Total amortizations

Life 1 4

Annual Amount $12,500 6,250 $18,750

Current Year $ — 6,250 $ 6,250

Prior Years $12,500 6,250 $18,750

Total $12,500 12,500 $25,000

Key A1 A2

Parent Profit — —

Sub Amount $20,000 10,000

Sub % 50% 50%

Sub Profit $10,000 5,000

Parent $15,000 1 3,000 $12,000 $ 3,000

Sub — — — — —

Intercompany Inventory Profit Deferral

Beginning Ending

Parent Amount — —

Parent % 0% 0%

Intercompany Fixed Asset Profit Deferral Original profit....................................................... Year of sale ......................................................... Realized in prior years ........................................ Balance, start of year .......................................... Realized in current year ......................................

Subsidiary Salt Company Income Distribution Unrealized profit in ending inventory............................ (EI) $5,000 Amortizations .......................... (A2) 6,250

Internally generated net income ............................ $105,000 Realized profit in beginning inventory ......................... (BI) 10,000 Adjusted income ................... NCI share.............................. NCI .......................................

$103,750 20% $ 20,750

Parent Peanut Company Income Distribution Internally generated net income .............................. $100,000 80% of Salt adjusted income of $103,750 ....................... 83,000 Realized gain .......................... (F2) 3,000 Controlling interest ..................

$186,000

Ch. 4—Problems

4–48

Problem 4-11, Continued Peanut Company and Subsidiary Salt Company Consolidated Income Statement For Year Ended December 31, 2016 Trial Balance Peanut Salt Inventory, December 31 .................................. Other Current Assets ...................................... Investment in Salt Company ...........................

Eliminations and Adjustments Dr.

Cr.

Consolidated Income Statement

NCI

130,000 50,000 ............... (EI) 5,000 ............... ............... 241,000 235,000 ............... ............... ............... ............... 200,000 ................ (CV) 40,000 ............... ............... ............... ............... ................ ............... (EL) 200,000 ............... ............... ............... ................ ............... 40,000 ............... ............... (D) Other Long-Term Investments ........................ 20,000 ................ ............... ............... ............... ............... Land ................................................................ 140,000 80,000 ............... ............... ............... ............... Buildings and Equipment ................................ 375,000 200,000 (D2) 25,000 (F1) 15,000 ............... ............... Accumulated Depreciation .............................. (120,000) (30,000) ............... (A2) 12,500 ............... ............... ............... ................ (F1) 3,000 ............... ............... ............... ............... ................ (F2) 3,000 ............... ............... ............... Other Intangible Assets ................................... ............... 20,000 ............... ............... ............... ............... Goodwill .......................................................... ............... ................ (D3) 12,500 ............... ............... ............... Current Liabilities ............................................ (150,000) (70,000) ............... ............... ............... ............... Bonds Payable ................................................ ............... (100,000) ............... ............... ............... ............... ............... ............... Other Long-Term Liabilities............................. (200,000) (50,000) ............... ............... ............... ................ ............... ............... ............... ............... Common Stock—Salt ...................................... ............... (50,000) (EL) 40,000 ............... ............... (10,000) ............... (10,000) Paid-In Capital in Excess of Par—Salt............ ............... (50,000) (EL) 40,000 ............... Retained Earnings—Salt ................................ ............... (150,000) (EL) 120,000 (NCI) 10,000 ............... ............... ............... ................ (BI) 2,000 ............... ............... ............... ............... ................ (D1) 2,500 ............... ............... ............... ............... ................ (A2) 1,250 ............... ............... (34,250) Common Stock—Peanut ................................ (200,000) ................ ............... ............... ............... ............... Paid-In Capital in Excess of Par—Peanut ...... (100,000) ................ ............... ............... ............... ............... (CV) Retained Earnings—Peanut ........................... (280,000) ................ (A2) 5,000 40,000 ............... ............... ............... ................ (D1) 10,000 ............... ............... ............... ............... ................ (BI) 8,000 ............... ............... ............... ............... ................ (F1) 12,000 ............... ............... ............... Sales ............................................................... (600,000) (315,000) (IS) 40,000 ............... (875,000) ............... Cost of Goods Sold ......................................... 350,000 150,000 ............... (IS) 40,000 ............... ............... ............... ................ (EI) 5,000 (BI) 10,000 455,000 ............... Operating Expenses ....................................... 150,000 60,000 (A2) 6,250 ............... ............... ............... ............... ................ ............... (F2) 3,000 213,250 ............... Subsidiary Income ......................................... (16,000) ................ (CY2) 16,000 ............... ............... ............... Dividends Declared—Salt ............................... ............... 20,000 ............... (CY2) 16,000 ............... 4,000 Dividends Declared—Peanut .......................... 60,000 ................ ............... ............... ............... ............... 0 391,500 391,500 ............... ............... 0 Consolidated Net Income ..................................................................................................................................................... (206,750) ............... To NCI (see distribution schedule) ....................................................................................................................................... 20,750 (20,750) To Controlling Interest (see distribution schedule)............................................................................................................... 186,000 ............... Total NCI ....................................................................................................................................................................................................... (71,000) Retained Earnings—Controlling Interest, December 31, 2016 .............................................................................................................................................

Controlling Retained Earnings

Consolidated Balance Sheet

............... ............... ............... ............... ............... ............... ............... ............... ............... ............... ............... ............... ............... ............... ............... ............... ............... ............... ............... ............... ............... ............... ............... ............... ............... ............... ............... ............... (285,000) ............... ............... ............... ............... ............... ............... ............... 60,000 ............... ............... ............... (186,000) ............... (411,000)

175,000 476,000 ............... ............... ............... 20,000 220,000 585,000 ............... ............... (156,500) 20,000 12,500 (220,000) (100,000) (250,000) ............... ............... ............... ............... ............... ............... ............... (200,000) (100,000) ............... ............... ............... ............... ............... ............... ............... ............... ............... ............... ............... ............... ............... ............... ............... ............... (71,000) (411,000) 0

part.

4–49

Ch. 4—Problems

Problem 4-11, Concluded Eliminations and Adjustments: (CV) Convert from cost to equity. (CY1) Current-year subsidiary income. (CY2) Current-year dividend. (EL) Eliminate controlling interest in subsidiary equity. (D)/(NCI) Distribute excess and NCI adjustment. (A) Amortize excess, (A1) includes $12,500 inventory adjustment. (IS) Eliminate intercompany sales during current period. (BI) Eliminate beginning inventory profit. (EI) Defer ending inventory profit. (F1) Fixed asset profit at beginning of year. (F2) Fixed asset profit realized.

Ch. 4—Problems

4–50

PROBLEM 4-12

Company Implied Fair Value

Parent Price (80%)

NCI Value (20%)

$250,000* 237,500** $ 12,500

$200,000 190,000 $ 10,000

$50,000 47,500 $ 2,500

*$200,000/80% **Company value = $200,000 equity + $25,000 + $12,500 Determination and Distribution of Excess Schedule

Company Implied Fair Value

Parent Price (80%)

NCI Value (20%)

$250,000

$200,000

$ 50,000

200,000

$200,000 80% $160,000 $ 40,000

$200,000 20% $ 40,000 $ 10,000

$ 50,000

Adjustment $ 12,500 25,000 12,500 $ 50,000

Worksheet Key debit D1 debit D2 debit D3

Periods 1 4

Amortization $12,500 6,250

4–51

Ch. 4—Problems

Problem 4-12, Continued Amortization Schedule Account adjustments to be amortized Inventory Equipment Total amortizations

Life 1 4

Annual Amount $12,500 6,250 $18,750

Current Year $ — 6,250 $ 6,250

Prior Years $12,500 6,250 $18,750

Total $12,500 12,500 $25,000

Key A1 A2

Parent Profit — —

Sub Amount $20,000 10,000

Sub % 50% 50%

Sub Profit $10,000 5,000

Parent $15,000 1 3,000 $12,000 $ 3,000

Sub — — — — —

Intercompany Inventory Profit Deferral

Beginning Ending

Parent Amount — —

Parent % 0% 0%

Subsidiary Salt Company Income Distribution Unrealized profit in ending inventory.............................. (EI) $5,000 Amortizations ............................ (A2) 6,250

Internally generated net income ............................. $105,000 Realized profit in beginning inventory .......................... (Adj) 10,000 Adjusted income .................... NCI share............................... NCI ........................................

$103,750 20% $ 20,750

Parent Peanut Company Income Distribution Internally generated net income ................................ $100,000 80% of Salt adjusted income of $103,750 ......................... 83,000 Realized gain ............................ (F2) 3,000 Controlling interest ....................

$186,000

Ch. 4—Problems

4–52

Problem 4-12, Continued Peanut Company and Subsidiary Salt Company Consolidated Income Statement For Year Ended December 31, 2016 Trial Balance Peanut Salt Inventory, December 31 .................................. Other Current Assets ...................................... Investment in Salt Company ...........................

Eliminations and Adjustments Dr.

Cr.

Consolidated Income Statement

NCI

130,000 50,000 ............... (EI) 5,000 ............... ............... 241,000 235,000 ............... ............... ............... ............... 284,000 ................ ............... (CY1) 83,000 ............... ............... ............... ................ (CY2) 16,000 ............... ............... ............... ............... ................ ............... (EL) 192,000 ............... ............... ............... ................ ............... 25,000 ............... ............... (D) Other Long-Term Investments ........................ 20,000 ................ ............... ............... ............... ............... Land ................................................................ 140,000 80,000 ............... ............... ............... ............... Buildings and Equipment ................................ 375,000 200,000 (D2) 18,750 (F1) 15,000 ............... ............... Accumulated Depreciation .............................. (120,000) (30,000) ............... (A2) 6,250 ............... ............... ............... ................ (F1) 3,000 ............... ............... ............... ............... ................ (F2) 3,000 ............... ............... ............... Other Intangible Assets ................................... ............... 20,000 ............... ............... ............... ............... Goodwill .......................................................... ............... ................ (D3) 12,500 ............... ............... ............... Current Liabilities ............................................ (150,000) (70,000) ............... ............... ............... ............... ............... ............... Bonds Payable ................................................ ............... (100,000) ............... ............... Other Long-Term Liabilities............................. (200,000) (50,000) ............... ............... ............... ............... ............... ................ ............... ............... ............... ............... ............... (10,000) Common Stock—Salt ...................................... ............... (50,000) (EL) 40,000 ............... Paid-In Capital in Excess of Par—Salt............ ............... (50,000) (EL) 40,000 ............... ............... (10,000) Retained Earnings—Salt ................................ ............... (150,000) (Adj) 10,000 (NCI) 6,250 ............... ............... ............... ................ (EL) 112,000 ............... ............... (34,250) Common Stock—Peanut ................................ (200,000) ................ ............... ............... ............... ............... Paid-In Capital in Excess of Par—Peanut ...... (100,000) ................ ............... ............... ............... ............... Retained Earnings—Peanut ........................... (297,000) ................ (F1) 12,000 ............... ............... ............... Sales ............................................................... (600,000) (315,000) (IS) 40,000 ............... (875,000) ............... Cost of Goods Sold ......................................... 350,000 150,000 ............... (IS) 40,000 ............... ............... ............... ................ (EI) 5,000 (Adj) 10,000 455,000 ............... Operating Expenses ....................................... 150,000 60,000 (A2) 6,250 ............... ............... ............... ............... ................ ............... (F2) 3,000 213,250 ............... Subsidiary Income ......................................... (83,000) ................ (CY1) 83,000 ............... ............... ............... Dividends Declared—Salt ............................... ............... 20,000 ............... (CY2) 16,000 ............... 4,000 Dividends Declared—Peanut .......................... 60,000 ................ ............... ............... ............... ............... 0 0 401,500 401,500 ............... ............... ............... Consolidated Net Income ..................................................................................................................................................... (206,750) To NCI (see distribution schedule) ....................................................................................................................................... 20,750 (20,750) To Controlling Interest (see distribution schedule)............................................................................................................... 186,000 ............... Total NCI ....................................................................................................................................................................................................... (71,000) Retained Earnings—Controlling Interest, December 31, 2016 .............................................................................................................................................

Controlling Retained Earnings

Consolidated Balance Sheet

............... ............... ............... ............... ............... ............... ............... ............... ............... ............... ............... ............... ............... ............... ............... ............... ............... ............... ............... ............... ............... ............... ............... ............... (285,000) ............... ............... ............... ............... ............... ............... ............... 60,000 ............... ............... ............... (186,000) ............... (411,000)

175,000 476,000 ............... ............... ............... ............... 20,000 220,000 578,750 ............... ............... (150,250) 20,000 12,500 (220,000) (100,000) (250,000) ............... ............... ............... ............... ............... (200,000) (100,000) ............... ............... ............... ............... ............... ............... ............... ............... ............... ............... ............... ............... ............... (71,000) (411,000) 0

part.

4–53

Ch. 4—Problems

Problem 4-12, Concluded Eliminations and Adjustments: (Adj) Adjust subsidiary for $10,000 beginning inventory profit. (CY1) Current-year subsidiary income. (CY2) Current-year dividend. (EL) Eliminate controlling interest in subsidiary equity. The subsidiary retained earnings is adjusted for beginning inventory profit. (D/NCI) Distribute unamortized excess and NCI adjustment. (A) Amortize excess only for current year. (IS) Eliminate intercompany sales during current period. (EI) Defer ending inventory profit. (F1) Fixed asset profit at beginning of year. (F2) Fixed asset profit realized.

Ch. 4—Problems

4–54

PROBLEM 4-13 (1) Value Analysis Schedule Company fair value ........................................... Fair value of net assets excluding goodwill ...... Goodwill ............................................................

Company Implied Fair Value

Parent Price (80%)

NCI Value (20%)

$375,000* 270,000** $105,000

$300,000 216,000 $ 84,000

$75,000 54,000 $21,000

*$300,000/80% **$160,000 + $100,000 + $50,000 – $40,000 existing goodwill Determination and Distribution of Excess Schedule

Price paid for investment............. Less book value of interest acquired: Common stock ...................... Paid-in capital in excess of par Retained earnings ................. Total equity ...................... Interest acquired ................... Book value of interest.................. Excess of cost over book value...

Company Implied Fair Value

Parent Price (80%)

NCI Value (20%)

$375,000

$300,000

$ 75,000

$160,000 80% $128,000 $172,000

$160,000 20% $ 32,000 $ 43,000

$ 10,000 90,000 60,000 $160,000 $215,000

Adjustment of identifiable accounts: Buildings .................................... Equipment.................................. Goodwill ($105,000 – $40,000 book value) ............................. Total adjustments ...................

Adjustment $100,000 50,000 65,000 $215,000

Worksheet Key debit D1 debit D2

Periods 20 5

Amortization $ 5,000 10,000

debit D3

4–55

Ch. 4—Problems

Problem 4-13, Continued (2) Amortization Schedule Account adjustments to be amortized Buildings Equipment Total amortizations

Life 20 5

Annual Amount $ 5,000 10,000 $15,000

Current Year $ 5,000 10,000 $15,000

Prior Years $ 5,000 10,000 $15,000

Total $10,000 20,000 $30,000

Parent % $5,600 4,200

Sub Profit $12,000 16,000

Sub Sub Amount %Profit 25% $3,000 30% 4,800

Key A1 A2

Intercompany Inventory Profit Deferral

Beginning Ending

Parent $14,000 12,000

Parent Amount 40% 35%

Parent $40,000 1 5,000 $35,000 $ 5,000

Sub $24,000 2 — $24,000 $ 4,000

Subsidiary Salmon Company Income Distribution Unrealized profit in ending inventory ... (EI) $ 4,800 Equipment gain ........... (F1) 24,000 Amortizations .............. (A1–A2) 15,000 Adjusted loss .............. NCI share.................... NCI .............................

Internally generated net income ....................... Realized profit in beginning inventory .................... (BI) Realized gain ................... (F2)

$ 29,500 3,000 4,000

$ 7,300 20% $ 1,460

Parent Purple Company Income Distribution Unrealized profit in ending inventory .................... (EI) 80% of Salmon adjusted loss of $7,300 ............

$ 4,200 5,840

Internally generated net income ....................... $155,000 Realized profit in beginning inventory .................... (BI) 5,600 Realized gain ................... (F2) 5,000 Controlling interest...........

$155,560

Ch. 4—Problems

4–56

Problem 4-13, Continued Purple Company and Subsidiary Salmon Company Consolidated Income Statement For Year Ended December 31, 2016 Eliminations Consolidated Trial Balance and Adjustments Income Purple Salmon Dr. Cr. Statement NCI Cash ................................................................ 92,400 57,500 ............... ............... ............... ............... Accounts Receivable ...................................... 130,000 36,000 ............... (IA) 14,000 ............... ............... Inventory ......................................................... 105,000 76,000 ............... (EI) 9,000 ............... ............... Land ................................................................ 100,000 100,000 ............... ............... ............... ............... Investment in Salmon Company ..................... 381,200 ................ ............... (CY1) 23,600 ............... ............... ............... ................ (CY2) 8,000 ............... ............... ............... ............... ................ ............... (EL) 193,600 ............... ............... ............... ................ ............... (D) 172,000 ............... ............... Buildings ......................................................... 800,000 150,000 (D1) 100,000 ............... ............... ............... Accumulated Depreciation .............................. (250,000) (60,000) ............... (A1) 10,000 ............... ............... Equipment ....................................................... 210,000 220,000 (D2) 50,000 (F1) 64,000 ............... ............... Accumulated Depreciation .............................. (115,000) (80,000) ............... (A2) 20,000 ............... ............... ............... ................ (F1) 5,000 ............... ............... ............... ............... ................ (F2) 9,000 ............... ............... ............... Goodwill .......................................................... ............... 40,000 (D3) 65,000 ............... ............... ............... Accounts Payable ........................................... (70,000) (78,000) (IA) 14,000 ............... ............... ............... Bonds Payable ................................................ ............... (200,000) ............... ............... ............... ............... Common Stock—Salmon ................................ ............... (10,000) (EL) 8,000 ............... ............... (2,000) Paid-In Capital in Excess of Par—Salmon...... ............... (90,000) (EL) 72,000 ............... ............... (18,000) Retained Earnings—Salmon ........................... ............... (142,000) (EL) 113,600 (NCI) 43,000 ............... ............... ............... ................ (BI) 600 ............... ............... ............... ............... ................ ............... ............... ............... ............... ............... ................ (A1–A2) 3,000 ............... ............... (67,800) Common Stock—Purple ................................. (100,000) ................ ............... ............... ............... ............... Paid-In Capital in Excess of Par—Purple ....... (800,000) ................ ............... ............... ............... ............... ............... ............... Retained Earnings—Purple ............................ (325,000) ................ (A1–A2) 12,000 ............... ............... ................ (BI) 8,000 ............... ............... ............... ............... ................ (F1) 35,000 ............... ............... ............... Sales ............................................................... (800,000) (350,000) (IS) 90,000 ............... (1,060,000) ............... Cost of Goods Sold ......................................... 450,000 208,500 ............... (IS) 90,000 ............... ............... ............... ................ (EI) 9,000 (BI) 8,600 568,900 ............... Depreciation Expense—Buildings................... 30,000 5,000 (A1) 5,000 ............... 40,000 ............... Depreciation Expense—Equipment ................ 25,000 23,000 (A2) 10,000 ............... ............... ............... ............... ................ ............... (F2) 9,000 49,000 ............... Other Expenses .............................................. 140,000 92,000 ............... ............... 232,000 ............... Interest Expense ............................................. ............... 16,000 ............... ............... 16,000 ............... Gain on Sale of Fixed Assets .......................... ............... (24,000) (F1) 24,000 ............... ............... ............... Subsidiary Income .......................................... (23,600) ................ (CY1) 23,600 ............... ............... ............... Dividends Declared—Salmon ......................... ............... 10,000 ............... (CY2) 8,000 ............... 2,000 ................ ............... ............... ............... ............... Dividends Declared—Purple ........................... 20,000 0 664,800 664,800 ............... ............... 0 Consolidated Net Income ..................................................................................................................................................... (154,100) ............... To NCI (see distribution schedule)....................................................................................................................................... (1,460) 1,460 ............... To Controlling Interest (see distribution schedule)............................................................................................................... 155,560 Total NCI ....................................................................................................................................................................................................... (84,340) Retained Earnings—Controlling Interest, December 31, 2016 ............................................................................................................................................. .

Controlling Retained Earnings ............... ............... ............... ............... ............... ............... ............... ............... ............... ............... ............... ............... ............... ............... ............... ............... ............... ............... ............... ............... ............... ............... ............... ............... ............... ............... ............... (270,000) ............... ............... ............... ............... ............... ............... ............... ............... ............... ............... ............... 20,000 ............... ............... ............... (155,560) ............... (405,560) part.

Consolidated Balance Sheet 149,900 152,000 172,000 200,000 ............... ............... ............... ............... 1,050,000 (320,000) 416,000 ............... ............... (201,000) 105,000 (134,000) (200,000) ............... ............... ............... ............... ............... ............... (100,000) (800,000) ............... ............... ............... ............... ............... ............... ............... ............... ............... ............... ............... ............... ............... ............... ............... ............... ............... ............... ............... (84,340) (405,560) 0

4–57

Ch. 4—Problems

Problem 4-13, Concluded Eliminations and Adjustments: (CY1) Current-year subsidiary income. (CY2) Current-year dividend. (EL) Eliminate controlling interest in subsidiary equity. (D)/(NCI) Distribute excess and NCI adjustment. (A) Amortize excess. (IS) Eliminate intercompany sales during current period ($30,000 + $60,000). (IA) Eliminate intercompany unpaid trade accounts ($8,000 + $6,000). (BI) Eliminate beginning inventory profit ($5,600 + $3,000). (EI) Defer ending inventory profit ($4,800 + $4,200). (F1) Fixed asset profit at beginning of year. (F2) Fixed asset profit realized ($5,000 + $4,000).

Ch. 4—Problems

4–58

PROBLEM 4-14 (1) Value Analysis Schedule Company fair value ........................................... Fair value of net assets excluding goodwill ...... Goodwill ............................................................

Company Implied Fair Value

Parent Price (80%)

NCI Value (20%)

$375,000* 270,000** $105,000

$300,000 216,000 $ 84,000

$75,000 54,000 $21,000

*$300,000/80% **$160,000 + $100,000 + $50,000 – $40,000 existing goodwill Determination and Distribution of Excess Schedule

Price paid for investment............. Less book value of interest acquired: Common stock ...................... Paid-in capital in excess of par Retained earnings ................. Total equity ...................... Interest acquired ................... Book value of interest.................. Excess of cost over book value...

Company Implied Fair Value

Parent Price (80%)

NCI Value (20%)

$375,000

$300,000

$ 75,000

$160,000 80% $128,000 $172,000

$160,000 20% $ 32,000 $ 43,000

$ 10,000 90,000 60,000 $160,000 $215,000

Adjustment $100,000 50,000 65,000 $215,000

Worksheet Key debit D1 debit D2

Periods 20 5

Amortization $ 5,000 10,000

debit D3

4–59

Ch. 4—Problems

Problem 4-14, Continued (2) Amortization Schedule Year of consolidation 3 Account adjustments to be amortized Buildings Equipment Total amortizations

Life 20 5

Annual Amount $ 5,000 10,000 $15,000

Current Year $ 5,000 10,000 $15,000

Prior Years $10,000 20,000 $30,000

Total $15,000 30,000 $45,000

Key A1 A2

Sub Amount 30% 35%

Sub % Profit $4,800 7,000

Intercompany Inventory Profit Deferral

Beginning Ending

Parent $12,000 10,000

Parent Amount 35% 40%

Parent % $4,200 4,000

Sub Profit $16,000 20,000

Parent $40,000 1 10,000 $30,000 $ 5,000

Sub $24,000 2 4,000 $20,000 $ 4,000

Subsidiary Salmon Company Income Distribution Ending inventory profit ... (EI) $ 7,000 Internally generated net Amortizations ................. (A1–A2) 15,000 income ............................. $80,000 Beginning inventory profit ...... (BI) 4,800 Realized gain on equipment .. (F2) Adjusted income .................... NCI share ............................... NCI .........................................

4,000 $66,800 20% $13,360

Parent Purple Company Income Distribution Unrealized profit in ending inventory .................. (EI)

$4,000

Internally generated net income ............................... $115,000 80% of Salmon adjusted income of $66,800 .......................... 53,440 Realized profit in beginning inventory ............................ (BI) 4,200 Realized gain ........................... (F2) 5,000 Controlling interest ...................

$173,640

Ch. 4—Problems

4–60

Problem 4-14, Continued Purple Company and Subsidiary Salmon Company Consolidated Income Statement For Year Ended December 31, 2017 Eliminations Consolidated and Adjustments Income Trial Balance Purple Salmon Dr. Cr. Statement NCI Cash ................................................................ 195,400 53,500 ............... ............... ............... ........... Accounts Receivable ...................................... 140,000 53,000 ............... (IA) 14,000 ............... ........... Inventory ......................................................... 140,000 81,000 ............... (EI) 11,000 ............... ........... Land ................................................................ 100,000 60,000 ............... ............... ............... ........... Investment in Salmon Company ..................... 443,600 ................ ............... (CY1) 64,000 ............... ........... ............... ................ (CY2) 8,000 ............... ............... ........... ............... ................ ............... (EL) 215,600 ............... ........... ............... ................ ............... (D) 172,000 ............... ........... Buildings ......................................................... 800,000 150,000 (D1) 100,000 ............... ............... ........... Accumulated Depreciation .............................. (280,000) (65,000) ............... (A1) 15,000 ............... ........... Equipment ....................................................... 150,000 220,000 (D2) 50,000 (F1) 64,000 ............... ........... Accumulated Depreciation .............................. (115,000) (103,000) ............... (A2) 30,000 ............... ........... ............... ................ (F1) 14,000 ............... ............... ........... ............... ................ (F2) 9,000 ............... ............... ........... Goodwill .......................................................... ............... 40,000 (D3) 65,000 ............... ............... ........... Accounts Payable ........................................... (25,000) (50,000) (IA) 14,000 ............... ............... ........... Bonds Payable ................................................ ............... (100,000) ............... ............... ............... ........... Common Stock—Salmon ................................ ............... (10,000) (EL) 8,000 ............... ............... (2,000) Paid-In Capital in Excess of Par—Salmon...... ............... (90,000) (EL) 72,000 ............... ............... (18,000) Retained Earnings—Salmon ........................... ............... (169,500) (EL) 135,600 (NCI) 43,000 ............... ........... ............... ................ (BI) 960 ............... ............... ........... ............... ................ (F1) 4,000 ............... ............... ........... ............... ................ (A1–A2) 6,000 ............... ............... (65,940) Common Stock—Purple ................................. (100,000) ................ ............... ............... ............... ........... Paid-In Capital in Excess of Par—Purple ....... (800,000) ................ ............... ............... ............... ........... ............... ........... Retained Earnings—Purple ............................ (510,000) ................ (A1–A2) 24,000 ............... ............... ................ (BI) 8,040 ............... ............... ........... ............... ................ (F1) 46,000 ............... ............... ........... Sales ............................................................... (850,000) (500,000) (IS) 90,000 ............... (1,260,000) ........... Cost of Goods Sold ......................................... 480,000 290,000 ............... (IS) 90,000 ............... ........... ............... ................ (EI) 11,000 (BI) 9,000 682,000 ........... Depreciation Expense—Buildings................... 30,000 5,000 (A1) 5,000 ............... 40,000 ........... Depreciation Expense—Equipment ................ 15,000 23,000 (A2) 10,000 ............... ............... ........... ............... ................ ............... (F2) 9,000 39,000 ........... Other Expenses .............................................. 210,000 94,000 ............... ............... 304,000 ........... Interest Expense ............................................. ............... 8,000 ............... ............... 8,000 ........... Subsidiary Income .......................................... (64,000) ................ (CY1) 64,000 ............... ............... ........... Dividends Declared—Salmon ......................... ............... 10,000 ............... (CY2) 8,000 ............... 2,000 ................ ............... ............... ............... ........... Dividends Declared—Purple ........................... 40,000 0 0 744,600 744,600 ............... ........... ........... Consolidated Net Income ..................................................................................................................................................... (187,000) To NCI (see distribution schedule) ....................................................................................................................................... 13,360 (13,360) To Controlling Interest (see distribution schedule)............................................................................................................... 173,640 ........... Total NCI ....................................................................................................................................................................................................... (97,300) Retained Earnings—Controlling Interest, December 31, 2017 .............................................................................................................................................

Controlling Retained Earnings ............... ............... ............... ............... ............... ............... ............... ............... ............... ............... ............... ............... ............... ............... ............... ............... ............... ............... ............... ............... ............... ............... ............... ............... ............... ............... ............... (431,960) ............... ............... ............... ............... ............... ............... ............... ............... ............... ............... 40,000 ............... ............... ............... (173,640) ............. (565,600)

part.

Consolidated Balance Sheet 248,900 179,000 210,000 160,000 ............... ............... ............... ............... 1,050,000 (360,000) 356,000 ............... ............... (225,000) 105,000 (61,000) (100,000) ............... ............... ............... ............... ............... ............... (100,000) (800,000) ............... ............... ............... ............... ............... ............... ............... ............... ............... ............... ............... ............... ............... ............... ............... ............... ............... ............... (97,300) (565,600) 0

4–61

Ch. 4—Problems

Problem 4-14, Concluded (CY1) Current-year subsidiary income. (CY2) Current-year dividend. (EL) Eliminate controlling interest in subsidiary equity. (D)/(NCI) Distribute excess and NCI adjustment. (A) Amortize excess. (IS) Eliminate intercompany sales during current period. (IA) Eliminate intercompany unpaid trade accounts. (BI) Eliminate beginning inventory profit ($4,200 + $4,800). (EI) Defer ending inventory profit. (F1) Fixed asset profit at beginning of year ($35,000 + $20,000). (F2) Fixed asset profit realized.

Ch. 4—Problems

4–62

APPENDIX PROBLEMS PROBLEM 4A-1 Determination and Distribution of Excess Schedule

Fair value of subsidiary ..................... Less book value of interest acquired: Common stock ............................ Paid-in capital in excess of par ... Retained earnings ....................... Total equity ............................ Interest acquired ......................... Book value ........................................ Excess of fair value over book value

Company Implied Fair Value

Parent Price (100%)

$750,000

$400,000 80,000 156,000 $636,000 $114,000

NCI Value

$636,000 100% $636,000 $114,000

Adjustment of identifiable accounts: Machinery ......................................... Goodwill ............................................ Total adjustments ......................

Adjustment $ 54,000 60,000 $114,000

Worksheet Key debit D1 debit D2

Periods 6

Amortization $9,000

4–63

Ch. 4—Problems

Problem 4A-1, Continued Arther Corporation and Subsidiary Trent, Inc. Worksheet for Consolidated Financial Statements For Year Ended December 31, 2018 Eliminations and Adjustments

Trial Balance Arther Trent Income Statement: Net Sales .......................................... Divided Income (from Trent) ............. Cost of Goods Sold .......................... Operating Expenses (including depreciation) .................................. Consolidated Net Income ................. Retained Earnings Statement: Balance, January 1, 2018 ................. Net Income ....................................... Dividends Paid .................................. Balance, December 31, 2018 ........... Balance Sheet: Cash ................................................. Accounts Receivable (net)................ Inventories ........................................ Land, Building, and Equipment......... Accumulated Depreciation................ Investment in Trent, Inc. ...................

Cr.

Consolidated Balance

............... ............... 180,000

(3,220,000) ............... 1,888,000

4,000 ...............

995,000 (337,000)

50,000 ............... ............... ............... (CY2) 40,000 ...............

............... ............... (258,000) (337,000) ............... (595,000)

............... 75,000 18,000 30,000 27,000 ............... 686,000 114,000 ...............

435,000 705,000 922,000 1,364,000 ............... (412,000) ............... ............... 60,000

............... ............... ............... ............... 1,224,000

(1,139,000) (1,200,000) (140,000) (595,000) 0

(1,900,000) (40,000) 1,180,000

(1,500,000) ................ 870,000

(IS) (CY2) (EI)

180,000 40,000 18,000

550,000 (210,000)

440,000 (190,000)

(A1)

9,000 ................

(F2)

(250,000) ................ ................ (210,000) ................ (460,000)

(206,000) ................ ................ (190,000) 40,000 (356,000)

(EL) (A1) (F1)

206,000 18,000 24,000 ................ ................ ................

(CV)

285,000 430,000 530,000 660,000 (185,000) ................ 750,000 ................ ................

150,000 350,000 410,000 680,000 (210,000) ................ ................ ................ ................

Goodwill ............................................ Accounts Payable and Accrued Expenses ....................................... (670,000) Common Stock ($10 par) ................. (1,200,000) Paid-In Capital in Excess of Par ....... (140,000) Retained Earnings, December 31, 2018 (460,000) 0

Dr.

(544,000) (400,000) (80,000) (356,000) 0

(D1) (F1) (F2) (CV) (D2) (IA) (EL) (EL)

................ ................ ................ 54,000 6,000 4,000 50,000 ................ 60,000 75,000 400,000 80,000 ................ 1,224,000

(IS)

(IA) (EI) (F1) (A1) (EL) (D)

part.

Ch. 4—Problems

4–64

Problem 4A-1, Concluded Eliminations and Adjustments: (CV) Convert to equity method as of January 1, 2018, 100% × $50,000 increase. (CY2) Eliminate intercompany dividends. (EL) Eliminate subsidiary equity against investment account. (D) Distribute excess $54,000 to land, building, and equipment and $60,000 to goodwill. (A1) Amortize excess applicable to machine for two prior years and current year. (F1) Eliminate intercompany profit on warehouse at start of year: $10,000 for land $20,000 for building less one and one-half-years’ amortization of $4,000 per year (or $6,000). (F2) Correct depreciation for intercompany profit, $4,000. (IS) Eliminate intercompany sales, $180,000. (EI) Eliminate intercompany profit in ending inventory, 50% × $36,000. (IA) Eliminate intercompany trade debt.

Subsidiary Trent, Inc. Income Distribution Unrealized profit in ending inventory.......................... (EI) Amortization of excess attributed to machinery.... (A1)

$18,000

Internally generated net income ............................

$190,000

Adjusted income ...................

$163,000

9,000

Parent Arther Corporation Income Distribution Internally generated net income ............................ 100% × Trent adjusted income of $163,000 ..................... Gain realized through use of warehouse .................. (F2) Controlling interest ................

$170,000 163,000 4,000 $337,000

4–65

Ch. 4—Problems

PROBLEM 4-A2 Peanut Company and Subsidiary Salt Company Worksheet for Consolidated Financial Statements For Year Ended December 31, 2016 Financial Statements Peanut Salt

Eliminations and Adjustments Dr. Cr.

Consolidated NCI Balance

Income Statement: Net Sales ..................................... Cost of Goods Sold .....................

(600,000) (315,000) (IS) 40,000 ............. ............. 350,000 150,000 (EI) 5,000 (BI) 10,000 ............. ............... ................ ............. (IS) 40,000 ............. Operating Expenses .................... 150,000 60,000 (A2) 6,250 (F2) 3,000 ............. Subsidiary Income ....................... (84,000) ................ (CY1) 84,000 ............. ............. ............. ............. ............. Net Income (Loss) ........................... (184,000) (105,000) NCI .................................................................................................................................................... (20,750) Controlling Interest .................................................................................................................................................. Retained Earnings: Retained Earnings, January 1, 2016—Peanut ..........................

Retained Earnings, January 1, 2016—Salt ...............................

Net Income (from above) ............. Dividends Declared—Peanut....... Dividends Declared—Salt ............ Balance, December 31, 2016 .......... Consolidated Balance Sheet: Inventory, December 31 .............. Other Current Assets ................... Investment in Salt ........................ Other Long-Term Investments ..... Land ............................................ Building and Equipment ............... Accumulated Depreciation ........... Goodwill ....................................... Other Intangibles ......................... Current Liabilities ......................... Bonds Payable ............................ Other Long-Term Liabilities ......... Common Stock—Peanut ............. Other Paid-In Capital in Excess of Par—Peanut ........ Common Stock—Salt .................. Other Paid-In Capital in Excess of Par—Salt ............. Retained Earnings, December 31, 2016 (from above) .................... Total NCI ..................................... Balance ...........................................

(320,000) ................ ............... ................ ............... ................ ............... ................

(A2) (D1) (BI) (F1)

5,000 10,000 8,000 12,000

(875,000) 455,000 ............... 213,250 206,750 ............... ............... (186,000)

.............. .............. .............. ..............

............. ............. ............. .............

(285,000) ............... ............... ...............

............... (150,000) (EL) ............... ................ (BI) ............... ................ (A2) ............... ................ (D1) (184,000) (105,000) 60,000 ................ ............... 20,000 (444,000) (235,000)

120,000 (NCI) 2,000 1,250 2,500 ............. ............. ............. (CY2) .............

10,000 .............. .............. .............. .............. .............. 16,000 .............

............. (34,250) ............. ............. (20,750) ............. 4,000 (51,000)

............... ............... ............... ............... (186,000) 60,000 ............... (411,000)

130,000 50,000 241,000 235,000 308,000 ................ (CY2) ............... ................ ............... ................ 20,000 ................ 140,000 80,000 375,000 200,000 (D2) (120,000) (30,000) ............... ................ (F1) ............... ................ (F2) ............... ................ (D3) ............... 20,000 (150,000) (70,000) ............... (100,000) (200,000) (50,000) (200,000) ................

............. (EI) ............. 16,000 (CY1) ............. (EL) ............. (D) ............. ............. 25,000 (F1) ............. (A2) 3,000 3,000 12,500 ............. ............. ............. ............. .............

5,000 ............. 84,000 200,000 40,000 ............. ............. 15,000 12,500 ............. ............. ............. .............. .............. .............. .............. ..............

175,000 476,000 ............... ............... ............... 20,000 220,000 585,000 (156,500) ............... ............... 12,500 20,000 (220,000) (100,000) (250,000) (200,000)

(100,000) ................ ............... (50,000) (EL)

............. 40,000

.............. ..............

............. (10,000)

(100,000) ...............

40,000

..............

(10,000)

...............

............. ............. 435,500

.............. .............. 435,500

(51,000) 71,000 0

(411,000) (71,000) 0

...............

(50,000) (EL)

(444,000) (235,000) ............... ................ 0 0

Ch. 4—Problems

4–66

Problem 4A-2, Continued Eliminations and Adjustments: (CY1) Eliminate the current-year subsidiary income recorded by the parent. (CY2) Eliminate intercompany dividends. (EL) Eliminate 80% of the subsidiary company equity balances at the beginning of the year against the investment account. (D)/(NCI) Allocate the $50,000 excess of cost over book value to inventory, equipment, and goodwill. The $10,000 (80% of $12,500) write-up to inventory is charged to the parent’s retained earnings and $2,500 to the subsidiary’s retained earnings (for NCI) because FIFO is used. The $25,000 write-up to equipment is charged to buildings and equipment. The $12,500 remaining excess is charged to goodwill. (A2) Amortize the equipment write-up over four years, with $5,000 (80% × $6,250) for 2015 charged to the parent’s retained earnings and $1,250 to the subsidiary’s retained earnings, and $6,250 for 2016 to operating expenses. (BI) Eliminate the $10,000 of gross profit in the beginning inventory (80% × $10,000 = $8,000 charged to the parent’s retained earnings and $2,000 to the subsidiary’s retained earnings). (IS) Eliminate the entire intercompany sales of $40,000. (EI) Eliminate the $5,000 of gross profit in the ending inventory. (F1) Eliminate the $15,000 2015 gain on sale of equipment and restore the equipment account to cost; adjust for $3,000 realized in 2016. (F2) Eliminate the $3,000 of excess depreciation for 2016 on the transferred equipment.

Company Implied Fair Value

Parent Price (80%)

NCI Value (20%)

$250,000* 237,500** $ 12,500

$200,000 190,000 $ 10,000

$50,000 47,500 $ 2,500

*$200,000/80% **Company value = $200,000 equity + $25,000 + $12,500

4–67

Ch. 4—Problems

Problem 4A-2, Concluded Determination and Distribution of Excess Schedule

Company Implied Fair Value

Parent Price (80%)

NCI Value (20%)

$250,000

$200,000

$ 50,000

200,000

$200,000 80% $160,000 $ 40,000

$200,000 20% $ 40,000 $ 10,000

$ 50,000

Adjustment $12,500 25,000 12,500 $50,000

Worksheet Key debit D1 debit D2 debit D3

Amortization $12,500 6,250

Periods 1 4

Subsidiary Salt Company Income Distribution Ending inventory profit ................ (EI) $5,000 Amortizations .............................. (A2) 6,250

Internally generated net income ............................ $105,000 Beginning inventory profit ..... (BI) 10,000 Adjusted income ................... NCI share.............................. NCI .......................................

$103,750 × 20% $ 20,750

Parent Peanut Company Income Distribution Internally generated net income ............................. Realized gain on equipment Sale.................................. (F2) 80% × Salt adjusted income of $103,750 ......... Controlling interest .................

$100,000 3,000 83,000 $186,000

Ch. 4—Case

4–68

CASE CASE 4-1 To: Harvey Henderson From: Student Concerning: Cool Glass accounting issues Harvey, you are a minority shareholder and can look only to the income statement of the separate Henderson Window Company. You have no claim on the assets of the consolidated company. The controlling interest may well take actions that are wise for the consolidated controlling interest, but they may not be in your best interest. The price charged for glass is a direct part of Henderson’s cost of sales. A higher price reduces Henderson income and thus the 30% of Henderson income available to Henderson shareholders. The higher price increases the income of Cool Glass, all the benefits of which go to Cool Glass shareholders. In consolidation, the price charged is eliminated; only the purchases from the outside and the sales to the outside remain in the consolidated statements. The distribution of the combined income of the companies becomes more favorable to Cool Glass shareholders. They end up getting 100% of Cool Glass’s income and 70% of Henderson’s income. The sale of the warehouse to Cool Glass has the same effect. Cool Glass will carry it at a lower price and reduced depreciation. The Henderson shareholders will get a smaller gain. Again, profit is shifted away from the minority interest. The comment on not needing a gain on the warehouse is in error. The consolidated statements prepared for the Cool Glass shareholders will not show a gain. The gain is deferred and realized in the periods the asset is used, as lower depreciation. From the consolidated viewpoint, the gain will not appear on the financial statements. The payment for goodwill was not enjoyed by the Henderson shareholders and is no excuse for their being penalized by unfair intercompany prices. The goodwill was a payment for abovenormal Henderson income expected in future periods. Cool Glass might decide to divert that income to its own operations, which leaves the Cool Glass shareholders unaffected. The Henderson shareholders are, however, adversely affected.

CHAPTER 5 UNDERSTANDING THE ISSUES 4. In the current year, consolidated net income will include a gain on retirement of bonds of $4,000 ($100,000 – $96,000). In the current and each of the next four years, consolidated net income will be reduced by $800 ($4,000 ÷ 5 years), which represents amortization of the discount paid by the parent. In the current year, the NCI will receive $800 ($4,000 × 20%) of the gain on the retirement of bonds. In the current and each of the next four years, NCI share of income will be reduced by $160 ($800 × 20%).

1. The first approach that could be used to reduce the overall consolidated interest cost but maintain the subsidiary as the debtor would have the parent advancing $1,000,000 to the subsidiary so that the subsidiary may retire the bonds. The former debt is retired, and a new long-term intercompany debt originates. The intercompany interest expense would be eliminated during the consolidation process. Another approach would have the parent purchasing the subsidiary bonds from outside parties and holding them as an investment. From a consolidated viewpoint, the debt is retired. Therefore, interest expense would be eliminated during the consolidation process.

5. It is true that intercompany operating leases eliminated during the consolidation process will not have an effect on consolidated income. However, the excessive rent expense amounts will still appear on the subsidiary’s separately stated income statement and will reduce the NCI share of consolidated income. The high lease rates will shift income from the NCI to the controlling interest.

2. At the 6% annual interest rate, a loss on retirement of bonds will occur in the current year since the parent paid a premium to retire the subsidiary’s bonds. In the current and future years, consolidated net income will be increased by the difference between interest expense and interest revenue. This amount represents the amortization of the premium paid (creating a loss) by the parent. At the 9% annual interest rate, a gain on retirement of bonds will occur in the current year since the parent paid a price reflecting a discount to retire the subsidiary’s bonds. In the current and future years, consolidated net income will be reduced by the difference between interest revenue and interest expense. This amount represents the amortization of the discount paid (resulting in a gain) by the parent to retire the bonds.

6. Either type of lease can shift income to the controlling interest by incorporating a higher than market interest rate to calculate the payments. In a sales-type lease, the controlling interest can shift additional income by building a profit into the capitalized cost of the leased asset. 7. There is no difference in the consolidated company’s ability to recognize profit on selling equipment to its subsidiaries or leasing the equipment to its subsidiaries (only if the lease is sales-type). In both cases, the profit is deferred and amortized over the life of the asset or life of the lease. The controlling interest has the opportunity to increase its profit by leasing the asset to the subsidiary. The lessor can build in an interest rate in excess of its cost of funds.

3. Since Company S was the original issuer of the bonds, it will absorb the loss that results in the current year from the parent retiring the bonds at a premium. The noncontrolling interest will receive its share of this loss. In the current and future years, the subsidiary’s income will be increased by the difference between interest expense and interest revenue. The noncontrolling interest will receive its share of this amount.

Ch. 5—Exercises

5–2

EXERCISES EXERCISE 5-1 It is desirable to refinance for two reasons. First, interest rates are down, and it would be wise to lock in at the lower rate. Second, the parent firm can borrow funds at a lower interest rate. The simplest way to accomplish the refinancing is to have the parent incur the new debt and loan the proceeds to the subsidiary; the subsidiary would use the funds to retire its debt with a gain on retirement being recognized that would flow to the consolidated statements. The parent would not only enjoy a lower interest rate, but it could also structure the loan terms, including the maturity date, to meet its needs. The parent could decide what rate to charge Mercer Industries. The rate charged would affect the reported income of Mercer Industries and thus, impact the distribution of income between the noncontrolling and controlling interests. The intercompany debt would be eliminated in the preparation of consolidated statements. Model could incur new debt and use the proceeds to purchase Mercer Industries’ outstanding bonds. The bonds would remain as debt on the separate statements of Mercer Industries. The bonds would also appear as an investment on the books of Model. The intercompany bonds, however, would be eliminated in the consolidated statements. The consolidated income statement would show a gain on retirement in the year of the intercompany purchase. The NCI would share in the gain, but this would be offset by interest adjustments in future periods. EXERCISE 5-2 (a) (1) The consolidated income statement for 2017 will include a gain on retirement of the bonds of $25,000 ($975,000 paid for $1,000,000 debt). The interest expense of $80,000 will be eliminated as will the interest revenue of $84,000 ($80,000 nominal + $4,000 discount amortization) recorded by the parent. (2) The subsidiary income distribution schedule will get the benefit of the retirement gain of $25,000 in the year the bonds are purchased, but subsidiary income will be reduced each year for the amortization of the purchase discount recorded by the parent ($3,125). The net effect for 2017 is $21,875. The NCI would receive 20% of this increase. The balance flows to the controlling interest. (b) (1) The consolidated income statement includes nothing relative to the bonds. From a consolidated viewpoint, the bonds were retired in the prior period. The interest expense recorded by the subsidiary and the interest revenue recorded by the parent are eliminated. (2) The income distribution of the subsidiary is reduced by $3,125 for the amortization of the purchase discount recorded by the parent. In the end, this adjustment is shared 20% by the NCI and 80% by the controlling interest.

5–3

Ch. 5—Exercises

EXERCISE 5-3 (1) Eliminations and Adjustments at December 31, 2015: Interest Revenue ...................................................................... Bonds Payable ......................................................................... Loss on Retirement................................................................... Interest Expense .................................................................. Investment in Bonds ............................................................. Discount on Bonds Payable .................................................

7,750 100,000 3,900c 8,400 101,250a 2,000b

Interest Payable ........................................................................ Interest Receivable .............................................................. Loss remaining at year-end: Carrying value of bonds at December 31, 2015 ................... Investment in bonds at December 31, 2015 ........................ Loss amortized during the year: Interest revenue eliminated [($100,000 × 8%) – $250] ........ Interest expense eliminated [($100,000 × 8%) + $400] ....... Loss at January 1, 2015 ....................................................

8,000 8,000 $ 98,000b 101,250a $

7,750 8,400

$(3,250)

(650) $(3,900)

$101,500 – $100,000 = $1,500 premium at 1/1/15; $1,500 ÷ 6 years left = $250/yr. amortization; $101,500 – $250 = $101,250 investment balance at 12/31/15. b $100,000 – $96,000 = $4,000 discount at 1/1/11; $4,000 ÷ 10 years = $400/yr. amortization; $400 × 5 years = $2,000. $96,000 + $2,000 = $98,000 book value at 12/31/15. c $96,000 + ($400 × 4 years) = $97,600 book value at 1/1/15; $97,600 – $101,500 investment at 1/1/15 = $3,900 loss (to be amortized at $3,900/6 = $650/yr.). (2) Eliminations and Adjustments at December 31, 2016: Interest Revenue ...................................................................... Bonds Payable ......................................................................... Retained Earnings—Dove (80% × $3,250*) ............................. Retained Earnings—Cardinal (20% × $3,250*) ........................ Interest Expense .................................................................. Investment in Bonds [$101,500 – ($250 × 2 yrs.)] ............... Discount on Bonds Payable ($2,000 balance, 1/1/16 – $400)

7,750 100,000 2,600 650 8,400 101,000 1,600

*$3,900 original loss on 1/1/15 – $650 amortization in 2015 = $3,250 unamortized loss on 1/1/16 Interest Payable ........................................................................ Interest Receivable .............................................................. Loss remaining at year-end: Carrying value of bonds at December 31, 2016 ................... Investment in bonds at December 31, 2016 ........................ Loss amortized during the year: Interest revenue eliminated .................................................. Interest expense eliminated ................................................. Loss at January 1, 2016 .......................................................

8,000 8,000 $ 98,400 101,000 $

7,750 8,400

$(2,600)

(650) $(3,250)

Ch. 5—Exercises

5–4

EXERCISE 5-4 Gain on retirement (January 2, 2016): Balance on issuer’s books ......................................................... Less purchase price (cost to retire bonds) ................................. Gain on retirement ...............................................................

$48,734 47,513 $ 1,221

Schedule of interest adjustments: Year Ending

Intercompany Interest, Effective Interest on Purchase (10%)

Recorded Interest, Effective Interest on Issuance (9%)

Interest Expense Adjustment to Issuer Income Distribution Schedule

12/31/16 12/31/17 12/31/18

$4,751 4,826 4,909

$4,386 4,421 4,459

$ 365 405 450 $1,220*

*Does not add to gain on retirement due to rounding. EXERCISE 5-5 (1) Eliminations and Adjustments at December 31, 2017: Interest Revenue [(7% × $60,000) + ($6,400 ÷ 8)] ......................... Bonds Payable (60% × $100,000) .................................................. Premium on Bonds Payable (60% × $700) .................................... Interest Expense [($4,200 – (60% × $100)] ............................... Investment in Bonds [balance at year-end $53,600 + ($6,400/8)] Gain on Retirement* ...................................................................

5,000 60,000 420 4,140 54,400 6,880

*Book value of bonds on 1/2/17 [$101,000 – ($1,000/10 × 2) = $100,800] Purchased ($100,800 × 60%) ........ $60,480 Price paid ....................................... 53,600 Gain on retirement of bonds........... $ 6,880 Interest Payable ($60,000 × 7%) .................................................... Interest Receivable .................................................................... An alternative way to calculate the gain: Gain remaining at year-end: Carrying value of bonds at December 31, 2017 (60% × $100,700).................................................................... Investment in bonds at December 31, 2017 .............................. Gain amortized during the year: Interest revenue eliminated ........................................................ Interest expense eliminated ....................................................... Gain at January 1, 2017 ..........................................................

4,200 4,200

$60,420 54,400 $ 5,000 4,140

$6,020

860 $6,880

5–5

Ch. 5—Exercises

Exercise 5-5, Concluded (2) Eliminations and Adjustments at December 31, 2018: Interest Revenue ............................................................................ Bonds Payable ............................................................................... Premium on Bonds Payable (60% × $600) .................................... Interest Expense ........................................................................ Investment in Bonds (balance at year-end) ($54,400 + $800) ... Retained Earnings—Mirage ($6,020* × 80%) ............................ Retained Earnings—Carlton ($6,020* × 20%) ...........................

5,000 60,000 360 4,140 55,200 4,816 1,204

*Unamortized gain on retirement = $6,880 – ($860 amortization for 1 yr.) = $6,020 Interest Payable .............................................................................. Interest Receivable .................................................................... An alternative way to calculate the unamortized gain: Gain remaining at year-end: Carrying value of bonds at December 31, 2018 (60% × $100,600).................................................................... Investment in bonds at December 31, 2018 .............................. Gain amortized during the year: Interest revenue eliminated ........................................................ Interest expense eliminated ....................................................... Remaining gain at January 1, 2018.........................................

4,200 4,200

$60,360 55,200 $ 5,000 4,140

$5,160

860 $6,020

EXERCISE 5-6 Partial Schedule of Bond Premium Amortization 10-Year, 6% Bonds Sold to Yield 8% (Linco) Date

Cash Paid

Interest Expense

January 1, 2015 January 1, 2016 January 1, 2017 January 1, 2018 January 1, 2019

........ $6,000 6,000 6,000 6,000

....... $6,926 7,000 7,080 7,167

Premium Amortized

Carrying Amount of Bonds

........ $ 926 1,000 1,080 1,167

$86,580 87,506 88,506 89,586 90,753

Partial Schedule of Bond Discount Amortization 7-Year (remaining), 6% Bonds Sold to Yield 9% (Sharp) Date

Cash Received

Interest Revenue

Discount Amortized

Carrying Value of Bonds

January 2, 2018 January 1, 2019

........ $6,000

....... $7,641

........ $1,641

$84,901 86,542

Ch. 5—Exercises

5–6

Exercise 5-6, Concluded (1) Eliminations and Adjustments at December 31, 2018: Interest Revenue ...................................................................... Bonds Payable ......................................................................... Discount Bonds Payable ...................................................... Gain on Retirement ($89,586 – $84,901) ............................. Interest Expense .................................................................. Investment in Bonds .............................................................

7,641 100,000

Interest Payable ........................................................................ Interest Receivable ..............................................................

6,000

Gain remaining at year-end: Carrying value of bonds at December 31, 2018 ................... Investment in bonds at December 31, 2018 ........................ Gain amortized during the year: Interest expense eliminated ................................................. Interest revenue eliminated .................................................. Gain at January 1, 2018 ....................................................

9,247 4,685 7,167 86,542 6,000 $90,753 86,542 $ 7,167 7,641

$4,211

474 $4,685

(2) Subsidiary Linco Industries Income Distribution Interest adjustment ($7,641 – $7,167) ...................

$474

Internally generated net income ................................. $500,000 Retirement gain on bonds ......... 4,685 Adjusted income........................ $504,211 NCI share .................................. × 10% NCI ............................................ $ 50,421

5–7

Ch. 5—Exercises

EXERCISE 5-7 (1) 2015 entries for Grande Machinery Company: Machine .......................................................................................... Cash ...........................................................................................

60,000 60,000

Asset Under Operating Lease ........................................................ Machine ......................................................................................

60,000

Depreciation Expense..................................................................... Accumulated Depreciation—Asset Under Operating Lease ($60,000 ÷ 5 years) .....................................

12,000

Cash ............................................................................................... Rental Revenue .........................................................................

15,000

(2) 2015 entry for Sunshine Engineering Company: Rent Expense ................................................................................. Cash ........................................................................................... (3) 2015 consolidation worksheet eliminations and adjustments: Machine .......................................................................................... Accumulated Depreciation—Asset Under Operating Lease ........... Asset Under Operating Lease .................................................... Accumulated Depreciation ......................................................... Rent Revenue ................................................................................. Rent Expense ............................................................................. To eliminate the intercompany lease transactions.

60,000

12,000 15,000 15,000 15,000 60,000 12,000 60,000 12,000 15,000 15,000

EXERCISE 5-8 (1) Lease Payment Amortization Schedule Date January 1, 2015 January 1, 2015 January 1, 2016 January 1, 2017 January 1, 2018 Total

Payment $12,000 12,000 12,000 12,000 $48,000

Interest at 12% on Previous Balance

$3,459 2,434 1,285* $7,178

Reduction of Principal $12,000 8,541 9,566 10,715 $40,822

Principal Balance $40,822 28,822 20,281 10,715 0

*Adjusted for rounding.

Ch. 5—Exercises

5–8

Exercise 5-8, Concluded (2) Eliminations and Adjustments at December 31, 2015: Interest Revenue (see amortization schedule) ............................... Interest Expense ........................................................................ To eliminate intercompany interest revenue and expense.

3,459

Obligations Under Capital Lease ($40,822 – $12,000 first payment) Interest Payable .............................................................................. Unearned Interest Income [($2,434 + $1,285) or ($7,178 – $3,459)] Minimum Lease Payments Receivable ...................................... To eliminate intercompany debt recorded by lessee against net intercompany receivable of lessor.

28,822 3,459 3,719

Property, Plant, and Equipment ...................................................... Accumulated Depreciation—Assets Under Capital Lease ($40,822 ÷ 5 years) ............................................... Assets Under Capital Lease ....................................................... Accumulated Depreciation—Property, Plant, and Equipment .... To reclassify asset under capital lease and related accumulated depreciation as a productive asset owned by the consolidated entity.

40,822

3,459

36,000

8,164 40,822 8,164

(3) Eliminations and Adjustments at December 31, 2016: Interest Revenue (see amortization schedule) ............................... Interest Expense ........................................................................ To eliminate intercompany interest revenue and expense.

2,434

Obligations Under Capital Lease .................................................... Interest Payable .............................................................................. Unearned Interest Income .............................................................. Minimum Lease Payments Receivable ...................................... To eliminate intercompany debt recorded by lessees against net receivable of lessor.

20,281 2,434 1,285

Property, Plant, and Equipment ...................................................... Accumulated Depreciation—Assets Under Capital Lease (2 × $8,164) ....................................................................... Assets Under Capital Lease ....................................................... Accumulated Depreciation—Property, Plant, and Equipment .... To reclassify asset under capital lease and related accumulated depreciation as a productive asset owned by the consolidated entity.

40,822

2,434

24,000

16,328 40,822 16,328

5–9

Ch. 5—Exercises

EXERCISE 5-9 Eliminations and Adjustments at December 31, 2015: Interest Income (see amortization schedule) ................................... Interest Revenue ........................................................................ To eliminate intercompany interest revenue and expense.

2,690

Obligations Under Capital Lease ..................................................... Interest Payable ............................................................................... Unearned Interest Income (see amortization) ($7,480 – $2,690) .... Minimum Lease Payments Receivable [($8,096 × 4) + $2,000] To eliminate intercompany debt recorded by lessee against net intercompany receivable of lessor.

26,904 2,690 4,790

Property, Plant, and Equipment ....................................................... Accumulated Depreciation—Assets Under Capital Lease ($35,000/8 yrs.) ............................................................................. Assets Under Capital Lease....................................................... Accumulated Depreciation—Property, Plant, and Equipment.... To reclassify asset under capital lease and related accumulated depreciation as a productive asset owned by the consolidated entity. Asset is depreciated over 8-year life.

35,000

Sales Profit on Leases ..................................................................... Property, Plant, and Equipment ................................................. To eliminate unrealized profit on intercompany “sale” and to reduce asset to its cost to the consolidated entity.

10,000

Accumulated Depreciation—Property, Plant, and Equipment ($10,000/8 yrs.) ............................................................................. Depreciation Expense ................................................................ To reduce depreciation on leased asset to depreciation based on cost to consolidated entity. Maintenance Income........................................................................ Maintenance Expense................................................................ To eliminate intercompany rent revenue and expense due to executory costs on lease.

2,690

34,384

4,375 35,000 4,375

10,000

1,250 1,250

1,000 1,000

Ch. 5—Problems

5–10

PROBLEMS PROBLEM 5-1 (1) Bonds Payable ............................................................................... Interest Income ($3,500 + $250 amortization) ................................ Investment in Bonds ($48,000 + $250 amortization).................. Interest Expense ........................................................................ Gain on Extinguishment of Debt ................................................ (2)

Jones Corporation and Subsidiary Dancer Corporation Consolidated Income Statement For Year Ended December 31, 2016 Sales ..................................................................................................... Cost of goods sold ................................................................................ Gross profit ..................................................................................... Other expenses ($720,000 + $106,000) ............................................... Gain on debt retirement ........................................................................ Consolidated net income ......................................................................

50,000 3,750 48,250 3,500 2,000

$3,040,000 1,405,000 $1,635,000 (826,000) 2,000 $ 811,000

5–11

Ch. 5—Problems

PROBLEM 5-2 Parker Company and Subsidiary Stride Company Worksheet for Consolidated Financial Statements For Year Ended December 31, 2016 Eliminations Trial Balance and Adjustments Parker Stride Dr. Cr. 4,000 .......... .......... (B2) 4,000 246,400 315,200 .......... .......... 351,000 .......... (CV) 45,000 (EL) 360,000 .......... .......... .......... (D) 36,000 98,400 .......... .......... (B1) 98,400 80,000 60,000 .......... .......... 400,000 280,000 .......... .......... (120,000) (60,000) .......... .......... .......... .......... (D) 40,000 .......... .......... (4,000) (B2) 4,000 .......... (98,000) (56,000) .......... .......... .......... (100,000) (B1) 100,000 .......... .......... 4,800 .......... (B1) 4,800 (200,000) .......... .......... .......... (100,000) .......... .......... ..........

NCI .......... .......... .......... .......... .......... .......... .......... .......... .......... .......... .......... .......... .......... .......... ..........

Controlling Retained Earnings .......... .......... .......... .......... .......... .......... .......... .......... .......... .......... .......... .......... .......... .......... ..........

Consolidated Balance Sheet .......... 561,600 .......... .......... .......... 140,000 680,000 (180,000) 40,000 .......... (154,000) .......... .......... (200,000) (100,000)

.......... .......... .......... (10,000)

.......... .......... (406,760) ..........

(200,000) .......... .......... ..........

.......... (40,000) (EL) 36,000 .......... ......... (4,000) .......... .......... (260,000) (EL) 234,000 .......... ......... .......... .......... .......... .......... (B1) 360 (NCI) 4,000 ......... (29,640) .......... Net Sales ............................................... (640,000) (350,000) .......... .......... (990,000) .......... .......... Cost of Goods Sold ................................ 360,000 200,000 .......... .......... 560,000 .......... .......... Operating Expenses ............................... 168,400 71,400 .......... .......... 239,800 .......... .......... Interest Expense .................................... .......... 8,600 .......... (B1) 8,600 ......... .......... .......... Interest Income ...................................... (8,200) .......... (B1) 8,200 .......... ......... .......... .......... Dividend Income .................................... (27,000) .......... (CY2) 27,000 .......... ......... .......... .......... Dividends Declared—Parker .................. 50,000 .......... .......... .......... ......... .......... 50,000 30,000 .......... (CY2) 27,000 ......... 3,000 .......... Dividends Declared—Stride ................... .......... 0 587,800 587,800 ......... .......... .......... Total ................................................... 0 Consolidated Net Income ............................................................................................................................... (190,200) .......... .......... To NCI (see distribution schedule) ............................................................................................................. 7,040 (7,040) .......... .......... (183,160) To Controlling Interest (see distribution schedule)...................................................................................... 183,160 .......... Total NCI ............................................................................................................................................................................. (47,680) Retained Earnings—Controlling Interest, December 31, 2016 .................................................................................................................. (539,920) Totals ..........................................................................................................................................................................................................................

.......... .......... .......... .......... .......... .......... .......... .......... .......... .......... .......... .......... .......... .......... .......... (47,680) (539,920) 0

Interest Receivable ................................ Other Current Assets ............................. Investment in Stride Company ............... Investment in Stride Bonds .................... Land ....................................................... Buildings and Equipment ....................... Accumulated Depreciation ..................... Goodwill ................................................. Interest Payable ..................................... Other Current Liabilities ......................... Bonds Payable (8%) .............................. Discount on Bonds Payable ................... Other Long-Term Liabilities .................... Common Stock—Parker ........................ Other Paid-In Capital in Excess of Par—Parker ........................................ Retained Earnings—Parker ................... Common Stock—Stride .......................... Other Paid-In Capital in Excess of Par—Stride ......................................... Retained Earnings—Stride .....................

(200,000) (365,000) .......... ..........

.......... .......... .......... (100,000)

(B1) (EL)

.......... .......... 3,240 90,000

(CV)

.......... 45,000 .......... ..........

part.

Ch. 5—Problems

5–12

Problem 5-2, Continued Eliminations and Adjustments: (CV) Convert to simple equity method as of January 1, 2016. (CY2) Eliminate the current-year dividend income of parent against dividends declared by subsidiary. (EL) Eliminate 90% of the subsidiary company equity balances at the beginning of the year against the investment account. (D)/(NCI) Allocate the $36,000 excess of cost over book and $4,000 NCI adjustment to goodwill. (B1) Eliminate intercompany interest revenue and expense. Eliminate the balance in the investment in bonds against bonds payable and the discount on bonds payable. The loss on retirement at the start of the year is calculated as follows: Loss remaining at year-end: Investment in bonds at December 31, 2016 .......................... $98,400 Bonds payable ........................................ $100,000 Discount on bonds .................................. (4,800) 95,200 Loss amortized during year: Interest expense eliminated.................... $ 8,600 Interest revenue eliminated .................... 8,200 Remaining loss on January 1, 2016 ....... (B2)

$3,200 400 $3,600

Amortize loss 90% to controlling interest ($3,240) and 10% to NCI ($360). Eliminate $4,000 of intercompany interest receivable and payable.

5–13

Ch. 5—Problems

Problem 5-2, Concluded Determination and Distribution of Excess Schedule

Fair value of subsidiary ..................... Less book value of interest acquired: Total equity.................................. Interest acquired ............................... Book value ........................................ Excess of fair value over book value

Company Implied Fair Value

Parent Price (90%)

NCI Value (10%)

$390,000

$351,000

$ 39,000

350,000

$350,000 90% $315,000 $ 36,000

$350,000 10% $ 35,000 $ 4,000

$ 40,000

Adjustment of identifiable accounts:

Goodwill ............................................

Adjustment

Worksheet Key

$ 40,000

debit D

Life

Amortization per Year

Subsidiary Stride Company Income Distribution Internally generated net income................................... Interest adjustment .....................

$70,000 400

Adjusted income ......................... NCI share .................................... NCI ..............................................

$70,400 × 10% $ 7,040

Parent Parker Company Income Distribution Internally generated net income................................... 90% × Stride income of $70,400 ................................. Controlling interest ......................

$119,800 63,360 $183,160

Ch. 5—Problems

5–14

PROBLEM 5-3 Determination and Distribution of Excess Schedule

Fair value of subsidiary ..................... Less book value of interest acquired: Total equity.................................. Interest acquired ............................... Book value ........................................ Excess of fair value over book value............................................

Company Implied Fair Value

Parent Price (80%)

NCI Value (20%)

$2,125,000

$1,700,000

$ 425,000

1,875,000

$1,875,000 $1,875,000 80% 20% $1,500,000 $ 375,000

$ 250,000

$ 200,000

Adjustment

Worksheet Key

$ 250,000

debit D

50,000

Adjustment of identifiable accounts:

Goodwill ............................................

Life

Amortization per Year

5–15

Ch. 5—Problems

Problem 5-3, Continued General Appliances and Subsidiary Appliance Outlets Worksheet for Consolidated Financial Statements For Year Ended December 31, 2016

Cash ................................................................ Accounts Receivable (net) .............................. Interest Receivable ......................................... Inventory ......................................................... Investment in Appliance Outlets .....................

Trial Balance General Appliance Outlets Appliances

Dr.

404,486 752,500 9,625 1,950,000 1,700,000 ........... 254,000 175,000 9,000,000 (1,695,000) ........... (670,000) (18,333) (2,000,000) 10,470 ...........

........... ........... ........... ........... 256,000 ........... ........... ........... ........... 1,375 250,000 ........... 9,625 250,000 ........... 175,000

72,625 105,000 ............ 900,000 ............ ............ ............ ............ 2,950,000 (940,000) ............ (80,000) (9,625) (500,000) 12,000 (175,000)

Eliminations and Adjustments

(CV)

(LN2) (EL) (D) (B) (LN1) (F1)

Cr.

Consolidated Income Statement

........... ........... 9,625 ........... 1,756,000 200,000 254,000 175,000 27,500 ........... ........... ........... ........... ........... 6,000 ...........

........... ........... ........... ........... ........... ........... ........... ........... ........... ........... ........... ........... ........... ........... ........... ...........

NCI

Controlling Retained Earnings

Consolidated Balance Sheet

........... ........... ........... ........... ........... ........... ........... ........... ........... ........... ........... ........... ........... ........... ........... ...........

477,111 857,500 ........... 2,850,000 ........... ........... ........... ........... 11,922,500 (2,633,625) 250,000 (750,000) (18,333) (2,250,000) 16,470 ...........

Investment in 11% Bonds ............................... Investment in Mortgage .................................. Property, Plant, and Equipment ...................... Accumulated Depreciation .............................. (F2) Goodwill .......................................................... (D) Accounts Payable ........................................... Interest Payable .............................................. (LN2) Bonds Payable (11%) ..................................... (B) Discount on Bonds Payable ............................ (B) Mortgage Payable ........................................... (LN1) Common Stock ($5 par)— General Appliances..................................... (3,200,000) ........... ........... ........... ........... ........... ............ Paid-In Capital in Excess of Par— General Appliances..................................... (4,550,000) ............ ........... ........... ........... ........... ........... ............ (CV) Retained Earnings—General Appliances ....... (1,011,123) ........... 256,000 ........... ........... ........... ........... ............ 10,000 ........... ........... ........... (1,257,123) (B) Common Stock ($10 par)—Appliance Outlets ........... (800,000) (EL) 640,000 ........... ........... (160,000) ........... Paid-In Capital in Excess of Par— Appliance Outlets ........................................ ........... (625,000) (EL) 500,000 ........... ........... (125,000) ........... Retained Earnings—Appliance Outlets........... ........... (770,000) (EL) 616,000 (NCI) 50,000 ........... ........... ........... ........... ............ 2,500 ........... ........... (201,500) ........... (B) Sales ............................................................... (9,800,000) (3,000,000) ........... ........... (12,800,000) ........... ........... Gain on Sale of Building ................................. (27,500) ............ (F1) 27,500 ........... ........... ........... ........... Interest Income ............................................... (36,125) ............ 26,500 ........... ........... ........... ........... (B) ........... ............ (LN2) 9,625 ........... ........... ........... ........... ........... ........... ........... ........... Dividend Income ............................................. (48,000) ............ (CY2) 48,000 Cost of Goods Sold ......................................... 4,940,000 1,700,000 ........... ........... 6,640,000 ........... ........... Depreciation Expense ..................................... 717,000 95,950 ........... (F2) 1,375 811,575 ........... ........... Interest Expense ............................................. 223,000 67,544 ........... 29,000 ........... ........... ........... (B) ........... ............ ........... (LN2) 9,625 251,919 ........... ........... Other Expenses .............................................. 2,600,000 936,506 ........... ........... 3,536,506 ........... ........... 60,000 ........... (CY2) 48,000 ........... 12,000 320,000 Dividends Declared ......................................... 320,000 0 0 2,822,125 2,822,125 ........... ........... ........... Consolidated Net Income ..................................................................................................................................................... (1,560,000) ........... ........... To NCI (see distribution schedule)................................................................................................................................... 40,600 (40,600) ........... To Controlling Interest (see distribution schedule)........................................................................................................... 1,519,400 ............ (1,519,400) Total NCI ....................................................................................................................................................................................................... (515,100) ........... Retained Earnings—Controlling Interest, December 31, 2016 ............................................................................................................................................. (2,456,523) Totals ........................................................................................................................................................................................................................................................ .

part.

(3,200,000) (4,550,000) ........... ........... ........... ........... ........... ........... ........... ........... ........... ........... ........... ........... ........... ........... ........... ........... ........... ........... ........... ........... ........... (515,100) (2,456,523) 0

Ch. 5—Problems

5–16

Problem 5-3, Concluded Eliminations and Adjustments: (CV) Convert investment to equity, 80% × ($770,000 – $450,000) = $256,000. (CY2) Eliminate dividend income. (EL) Eliminate 80% of the subsidiary equity balances. (D)/(NCI) Distribute the excess and the NCI adjustment according to the determination and distribution of excess schedule. (B) Eliminate intercompany interest revenue and expense. Eliminate the balance in the investment in bonds against the bonds payable. The loss on retirement at the start of the year is calculated as follows: Loss remaining at year-end: Investment in bonds at December 31, 2016 ............. $254,000 Net carrying value of bonds at December 31, 2016 . 244,000 $10,000 Loss amortized during the year: Interest expense eliminated ..................................... $ 29,000 Interest revenue eliminated ...................................... 26,500 2,500 Remaining loss at January 1, 2016 .................... $12,500 The remaining unamortized loss is allocated 80% to the controlling retained earnings and 20% to the NCI retained earnings. (F1) Eliminate the intercompany gain on sale of building. (F2) Reduce depreciation expense on the building for one-half year, ($27,500 ÷ 10) × 1/2. (LN1) Eliminate the intercompany mortgage. (LN2) Eliminate the intercompany interest payable and receivable on mortgage. Eliminate the intercompany interest revenue and expense on mortgage, 1/2 × 11% × $175,000 = $9,625. Subsidiary Appliance Outlets Income Distribution Internally generated net income................................... Interest adjustment ($29,000 – $26,000) .............. Adjusted income ......................... NCI share .................................... NCI ..............................................

$200,000 3,000 $203,000 × 20% $ 40,600

Parent General Appliances Income Distribution Unrealized gain on sale of building ..............................

$27,500

Internally generated net income................................. $1,383,125 Gain realized through use of building for one-half year..... 1,375 80% × Appliance Outlets adjusted income of $203,000............. 162,400 Controlling interest .................... $1,519,400

5–17

Ch. 5—Problems

PROBLEM 5-4 Determination and Distribution of Excess Schedule

Company Implied Fair Value $500,000

Parent Price (80%) $400,000

NCI Value (20%) $100,000

215,000

$215,000 80% $172,000

$215,000 20% $ 43,000

$285,000

$228,000

$ 57,000

Worksheet Key debit D1 debit D2 debit D3

Life 20 5

Adjustment of identifiable accounts: Adjustment $ 80,000 50,000 155,000 $285,000

Buildings ........................................... Equipment ......................................... Goodwill ............................................ Total ............................................ Account Adjustments to Be Amortized Buildings ............................... Equipment ............................. Total amortizations ........

Life 20 5

Annual Amount $ 4,000 10,000 $14,000

Current Year $ 4,000 10,000 $14,000

Prior Years $ 4,000 10,000 $14,000

Intercompany Inventory Profit Deferral Parent Parent Parent Sub Amount Percent Profit Amount Beginning .............................. $15,000 Ending ................................... 20,000

30% 30

$4,500 6,000

— —

Amortization per Year $ 4,000 10,000

Total $ 8,000 20,000 $28,000

Key (A1) (A2)

Sub Sub Percent Profit 0% 0

— —

Ch. 5—Problems

5–18

Problem 5-4, Continued Subsidiary Stark Company Income Distribution Loss on bond retirement ............... Buildings depreciation ................... Equipment depreciation ................

$ 6,739 4,000 10,000

Internally generated net income..................................... Interest adjustment—bonds ..........

$24,672 1,123

Adjusted income ........................... NCI share ...................................... NCI ................................................

$ 5,056 × 20% $ 1,011

Parent Pontiac Company Income Distribution Ending inventory profit ..................

$6,000

Internally generated net income..................................... 80% share of Stark adjusted income of $5,056 ...... Beginning inventory profit ............. Controlling interest ........................

$42,845 4,045 4,500 $45,390

Proof for Bond Elimination Loss remaining at year-end: Investment in bonds at December 31, 2015 .............................. Carrying value at December 31, 2015 ....................................... Loss amortized during the year: Interest expense eliminated ....................................................... Interest revenue eliminated ........................................................ Loss at January 1, 2015 .......................................................

$103,975 98,359 $

8,328 7,205

$5,616

1,123 $6,739

5–19

Ch. 5—Problems

Problem 5-4, Continued Pontiac Company and Subsidiary Stark Company Worksheet for Consolidated Financial Statements For Year Ended December 31, 2015 Controlling Retained Earnings

Consolidated Balance Sheet

........... ........... ........... ........... ........... 17,870 32,031 90,000 60,000 ........... (IA) 10,000 ........... ........... ........... 100,000 30,000 ........... (EI) 6,000 ........... ........... ........... 150,000 45,000 ........... ........... ........... ........... ........... 435,738 ........... (CY1) 19,738 ........... ........... ........... ............ ........... ............ (CY2) 8,000 ........... ........... ........... ........... ........... ........... (EL) 196,000 ........... ........... ........... ............ ........... ............ (D) ........... 228,000 ........... ........... ........... Investment in Stark Bonds .............................. 103,975 ........... 103,975 ........... ........... ........... ............ (B) Buildings ......................................................... 500,000 250,000 (D1) 80,000 ........... ........... ........... ........... Accumulated Depreciation .............................. (300,000) (70,000) ........... (A1) 8,000 ........... ........... ........... ........... Equipment ....................................................... 200,000 120,000 (D2) 50,000 ........... ........... ........... Accumulated Depreciation .............................. (100,000) (84,000) ........... (A2) 20,000 ........... ........... ........... Goodwill .......................................................... ........... ............ (D3) 155,000 ........... ........... ........... ........... Accounts Payable ........................................... (55,000) (25,000) (IA) 10,000 ........... ........... ........... ........... (B) 100,000 ........... ........... ........... ........... Bonds Payable ................................................ ........... (100,000) ........... (B) Discount (premium) ......................................... ........... 1,641 1,641 ........... ........... ........... Common Stock ($10 par)—Stark .................... ........... (10,000) (EL) 8,000 ........... ........... (2,000) ........... Paid-In Capital in Excess of Par—Stark ......... ........... (90,000) (EL) 72,000 ........... ........... (18,000) ........... Retained Earnings—Stark .............................. ........... (145,000) (EL) 116,000 (NCI) 57,000 ........... ........... ........... ........... ............ (A1–A2) 2,800 ........... ........... (83,200) ........... Common Stock ($10 par)—Pontiac ................ (100,000) ........... ........... ........... ........... ........... ............ Paid-In Capital in Excess of Par—Pontiac ...... (600,000) ........... ........... ........... ........... ........... ............ Retained Earnings—Pontiac ........................... (400,000) ............ (A1–A2) 11,200 ........... ........... ........... ........... ........... ............ (BI) 4,500 ........... ........... ........... (384,300) Loss (Gain) on Bond Retirement ........... ............ (B) 6,739 ........... 6,739 ........... ........... Sales ............................................................... (600,000) (220,000) (IS) 50,000 ........... (770,000) ........... ........... Cost of Goods Sold ......................................... 410,000 120,000 ........... (IS) 50,000 ........... ........... ........... ........... ............ (EI) 6,000 (BI) 4,500 481,500 ........... ........... Depreciation Expense—Buildings................... 30,000 10,000 (A1) 4,000 ........... 44,000 ........... ........... Depreciation Expense—Equipment ................ 15,000 12,000 (A2) 10,000 ........... 37,000 ........... ........... ........... ........... 154,360 ........... ........... Other Expenses .............................................. 109,360 45,000 Interest Expense ............................................. ........... 8,328 (B) ........... 8,328 ........... ........... ........... Interest Revenue ............................................. (7,205) ............ 7,205 ........... ........... ........... ........... (B) Subsidiary Income .......................................... (19,738) ............ (CY1) 19,738 ........... ........... ........... ........... Dividends Declared—Stark ............................. ........... 10,000 ........... (CY2) 8,000 ........... 2,000 ........... ............ ........... ........... ........... ........... 20,000 Dividends Declared—Pontiac ......................... 20,000 0 721,182 721,182 ........... ........... ........... Totals .......................................................... 0 Consolidated Net Income ..................................................................................................................................................... (46,401) ........... ........... To NCI (see distribution schedule)................................................................................................................................... 1,011 (1,011) ........... To Controlling Interest (see distribution schedule)........................................................................................................... 45,390 ........... (45,390) Total NCI ....................................................................................................................................................................................................... (102,211) ........... Retained Earnings—Controlling Interest, December 31, 2015 ............................................................................................................................................. (409,690) Totals ........................................................................................................................................................................................................................................................

49,901 140,000 124,000 195,000 ........... ........... ........... ........... ........... 830,000 (378,000) 370,000 (204,000) 155,000 (70,000) ........... ........... ........... ........... ........... ........... (100,000) (600,000) ........... ........... ........... ........... ........... ........... ........... ........... ........... ........... ........... ........... ........... ........... ........... ........... ........... ........... (102,211) (409,690) 0

Trial Balance Stark Pontiac

Eliminations and Adjustments Dr.

Cr.

Consolidated Income Statement

NCI

part.

Ch. 5—Problems

5–20

Problem 5-4, Concluded Eliminations and Adjustments: (CY1) Current-year subsidiary income. (CY2) Current-year dividend. (EL) Eliminate controlling interest in subsidiary equity. (D)/(NCI) Distribute excess and NCI adjustment. (A1) Amortize excess—buildings. (A2) Amortize excess—equipment. (IS) Eliminate intercompany sale during current period. (IA) Eliminate intercompany unpaid trade accounts. (BI) Defer beginning inventory profit. (EI) Defer ending inventory profit. (B) Eliminate intercompany bonds. PROBLEM 5-5 Determination and Distribution of Excess Schedule

Company Implied Fair Value $500,000

Parent Price (80%) $400,000

NCI Value (20%) $100,000

215,000

$215,000 80% $172,000

$215,000 20% $ 43,000

$285,000

$228,000

$ 57,000

Worksheet Key debit D1 debit D2 debit D3

Life 20 5

Adjustment of identifiable accounts:

Adjustment $ 80,000 50,000 155,000 $285,000

Life 20 5

Amortization per Year $ 4,000 10,000

Annual Amount

Current Year

Prior Years

Total

Key

$ 4,000 10,000 $14,000

$ 8,000 20,000 $28,000

$12,000 30,000 $42,000

(A1) (A2)

5–21

Ch. 5—Problems

Problem 5-5, Continued Intercompany Inventory Profit Deferral Parent Amount

Parent Percent

Parent Profit

Sub Amount

Beginning .............................. $20,000 Ending ................................... 25,000

30% 30

$6,000 7,500

— —

Sub Sub Percent Profit 0% 0

— —

Subsidiary Stark Company Income Distribution Buildings depreciation ................. Equipment depreciation ..............

$ 4,000 10,000

Internally generated net income................................... Interest adjustment—bonds ........

$31,672 1,123

Adjusted income ......................... NCI share .................................... NCI ..............................................

$18,795 × 20% $ 3,759

Parent Pontiac Company Income Distribution Ending inventory profit ................

$7,500

Internally generated net income..................................... 80% share of Stark adjusted income of $18,795 .... Beginning inventory profit ............. Controlling interest ........................

$57,845 15,036 6,000 $71,381

Proof for Bond Retirement Loss remaining at year-end: Investment in bonds at December 31, 2016 .............................. Carrying value at December 31, 2016 ....................................... Loss amortized during the year: Interest expense eliminated ....................................................... Interest revenue eliminated ........................................................ Remaining loss at January 1, 2016 ......................................

$103,180 98,687 $

8,328 7,205

$4,493

1,123 $5,616

Ch. 5—Problems

5–22

Problem 5-5, Continued Pontiac Company and Subsidiary Stark Company Worksheet for Consolidated Financial Statements For Year Ended December 31, 2016 Controlling Retained Earnings

Consolidated Balance Sheet

........... ........... ........... ........... ........... 49,150 61,031 110,000 60,000 ........... (IA) 12,000 ........... ........... ........... 120,000 45,000 ........... (EI) 7,500 ........... ........... ........... 150,000 45,000 ........... ........... ........... ........... ........... 453,075 ........... (CY1) 25,337 ........... ........... ........... ............ ........... ............ (CY2) 8,000 ........... ........... ........... ........... ........... ........... (EL) 207,738 ........... ........... ........... ............ ........... ............ (D) ........... 228,000 ........... ........... ........... Investment in Stark Bonds .............................. 103,180 ........... 103,180 ........... ........... ........... ............ (B) Buildings ......................................................... 500,000 250,000 (D1) 80,000 ........... ........... ........... ........... Accumulated Depreciation .............................. (330,000) (80,000) ........... (A1) 12,000 ........... ........... ........... ........... Equipment ....................................................... 200,000 120,000 (D2) 50,000 ........... ........... ........... Accumulated Depreciation .............................. (115,000) (96,000) ........... (A2) 30,000 ........... ........... ........... Goodwill .......................................................... ........... ............ (D3) 155,000 ........... ........... ........... ........... Accounts Payable ........................................... (35,000) (25,000) (IA) 12,000 ........... ........... ........... ........... (B) 100,000 ........... ........... ........... ........... Bonds Payable ................................................ ........... (100,000) ........... (B) Discount (Premium) ........................................ ........... 1,313 1,313 ........... ........... ........... Common Stock ($10 par)—Stark .................... ........... (10,000) (EL) 8,000 ........... ........... (2,000) ........... Paid-In Capital in Excess of Par—Stark ......... ........... (90,000) (EL) 72,000 ........... ........... (18,000) ........... Retained Earnings—Stark .............................. ........... (159,672) (EL) 127,738 (NCI) 57,000 ........... ........... ........... ........... ............ (B) 1,123 ........... ........... (82,211) ........... ........... ............ (A1–A2) 5,600 ........... ........... ........... ........... Common Stock ($10 par)—Pontiac ................ (100,000) ........... ........... ........... ........... ........... ............ Paid-In Capital in Excess of Par—Pontiac ...... (600,000) ............ ........... ........... ........... ........... ........... Retained Earnings—Pontiac ........................... (442,223) ............ (A1–A2) 22,400 ........... ........... ........... ........... ........... ............ (BI) 6,000 ........... ........... ........... (409,330) ........... ............ 4,493 ........... ........... ........... ........... (B) Sales ............................................................... (700,000) (230,000) (IS) 60,000 ........... (870,000) ........... ........... Cost of Goods Sold ......................................... 480,000 125,000 ........... (IS) 60,000 ........... ........... ........... ........... ............ (EI) 7,500 (BI) 6,000 546,500 ........... ........... Depreciation Expense—Buildings................... 30,000 10,000 (A1) 4,000 ........... 44,000 ........... ........... ........... 37,000 ........... ........... Depreciation Expense—Equipment ................ 15,000 12,000 (A2) 10,000 Other Expenses .............................................. 124,360 43,000 ........... ........... 167,360 ........... ........... Interest Expense ............................................. ........... 8,328 ........... 8,328 ........... ........... ........... (B) Interest Revenue ............................................. (7,205) ............ 7,205 ........... ........... ........... ........... (B) Subsidiary Income .......................................... (25,337) ............ (CY1) 25,337 ........... ........... ........... ........... Dividends Declared—Stark ............................. ........... 10,000 ........... (CY2) 8,000 ........... 2,000 ........... ............ ............ ............ ........... ........... 20,000 Dividends Declared—Pontiac ......................... 20,000 Totals .......................................................... 0 0 766,396 766,396 ........... ........... ........... Consolidated Net Income ..................................................................................................................................................... (75,140) ........... ........... To NCI (see distribution schedule)................................................................................................................................... 3,759 (3,759) ........... To Controlling Interest (see distribution schedule)........................................................................................................... 71,381 ............ (71,381) Total NCI ....................................................................................................................................................................................................... (103,970) ............ Retained Earnings—Controlling Interest, December 31, 2016 ............................................................................................................................................. (460,711) Totals ........................................................................................................................................................................................................................................................

110,181 158,000 157,500 195,000 ........... ........... ........... ........... ........... 830,000 (422,000) 370,000 (241,000) 155,000 (48,000) ........... ........... ........... ........... ........... ........... ........... (100,000) (600,000) ........... ........... ........... ........... ........... ........... ........... ........... ........... ........... ........... ........... ........... ........... ........... ........... ........... ........... (103,970) (460,711) 0

Trial Balance Stark Pontiac

Eliminations and Adjustments Dr.

Cr.

Consolidated Income Statement

NCI

part.

5–23

Ch. 5—Problems

Problem 5-5, Concluded Eliminations and Adjustments: (CY1) Current-year subsidiary income. (CY2) Current-year dividend. (EL) Eliminate controlling interest in subsidiary equity. (D)/(NCI) Distribute excess and adjust NCI. (A) Amortize excess. (IS) Eliminate intercompany sales during current period. (IA) Eliminate intercompany unpaid trade accounts. (BI) Defer beginning inventory profit. (EI) Defer ending inventory profit. (B) Eliminate intercompany bonds. PROBLEM 5-6 Determination and Distribution of Excess Schedule

Fair value of subsidiary ..................... Less book value of interest acquired: Common stock ($1 par)............... Paid-in capital in excess of par ... Retained earnings ....................... Total equity ............................ Interest acquired ......................... Book value ........................................ Excess of fair value over book value............................................

Company Implied Fair Value $500,000 $ 10,000 90,000 100,000 $200,000

$300,000

Parent Price (80%) $400,000

NCI Value (20%) $100,000

$200,000 80% $160,000

$200,000 20% $ 40,000

$240,000

$ 60,000

Worksheet Key debit D1 debit D2 debit D3

Life 20 5

Adjustment of identifiable accounts:

Adjustment $130,000 50,000 120,000 $300,000

Amortization per Year $ 6,500 10,000

Ch. 5—Problems

5–24

Problem 5-6, Continued Account Adjustments to Be Amortized

Annual Amount

Current Year

Prior Years

Total

Key

$ 6,500 10,000 $16,500

$13,000 20,000 $33,000

(A1) (A2)

Intercompany Inventory Profit Deferral Parent Parent Parent Sub Amount Percent Profit Amount

Sub Percent

Sub Profit

25% 25

$2,250 3,000

Life

Buildings ............................... Equipment ............................. Total amortizations ..........

Beginning .............................. Ending ...................................

20 5

— —

0% 0

— —

$ 9,000 12,000

Subsidiary Spartan Company Income Distribution Amortizations .............................. Ending inventory profit ................ Interest adjustment, bonds..........

$16,500 3,000 920

Internally generated net income..................................... Beginning inventory profit ............. Gain on bond retirement ...............

$27,324 2,250 6,833

Adjusted income ........................... NCI share ...................................... NCI ................................................

$15,987 × 20% $ 3,197

Parent Postman Company Income Distribution Internally generated net income..................................... $173,596 80% × Spartan adjusted income of $15,987 ............................... 12,790 Controlling interest ........................ $186,386

5–25

Ch. 5—Problems

Problem 5-6, Continued Postman Company and Subsidiary Spartan Company Worksheet for Consolidated Financial Statements For Year Ended December 31, 2015 Eliminations Consolidated Trial Balance and Adjustments Income Postman Spartan Dr. Cr. Statement

Controlling Retained Earnings

Consolidated Balance Sheet

144,486 99,347 ........... ........... ........... ........... ........... 90,000 60,000 ........... (IA) 7,000 ........... ........... ........... 120,000 55,000 ........... (EI) 3,000 ........... ........... ........... 200,000 60,000 ........... ........... ........... ........... ........... 429,859 ........... (CY1) 21,859 ........... ........... ........... ............ ........... ............ (CY2) 8,000 ........... ........... ........... ........... ........... ........... (EL) 176,000 ........... ........... ........... ............ ........... ............ (D) ........... 240,000 ........... ........... ........... Investment in Spartan Bonds .......................... 96,110 ........... 96,110 ........... ........... ........... ............ (B) Buildings ......................................................... 600,000 100,000 (D1) 130,000 ........... ........... ........... ........... Accumulated Depreciation .............................. (310,000) (40,000) ........... (A1) 13,000 ........... ........... ........... Equipment ....................................................... 150,000 80,000 (D2) 50,000 ........... ........... ........... ........... Accumulated Depreciation .............................. (90,000) (50,000) ........... (A2) 20,000 ........... ........... ........... Goodwill .......................................................... ........... ............ (D3) 120,000 ........... ........... ........... ........... Accounts Payable ........................................... (55,000) (25,000) (IA) 7,000 ........... ........... ........... ........... (B) 100,000 ........... ........... ........... ........... Bonds Payable .... ........................................... ........... (100,000) (B) Discount (Premium) ........................................ ........... (2,023) 2,023 ........... ........... ........... ........... ........... ........... ........... ........... ........... ............ ........... Common Stock ($1 par)—Spartan .................. ........... (10,000) (EL) 8,000 ........... ........... (2,000) ........... Paid-In Capital in Excess of Par—Spartan ..... ........... (90,000) (EL) 72,000 ........... ........... (18,000) ........... Retained Earnings—Spartan .......................... ........... (120,000) (EL) 96,000 (NCI) 60,000 ........... ........... ........... ........... ............ (A1–A2) 3,300 ........... ........... ........... ........... ........... ............ (BI) ........... ........... (80,250) ........... 450 Common Stock ($1 par)—Postman ................ (100,000) ............ ........... ........... ........... ........... ........... Paid-In Capital in Excess of Par—Postman.... (800,000) ........... ........... ........... ........... ........... ............ Retained Earnings—Postman ......................... (300,000) ............ (A1–A2) 13,200 ........... ........... ........... ........... ........... ............ (BI) 1,800 ........... ........... ........... (285,000) Gain on Bond Retirement ............................... ........... ............ (B) ........... 6,833 (6,833) ........... ........... Sales ............................................................... (850,000) (320,000) (IS) 20,000 ........... (1,150,000) ........... ........... Cost of Goods Sold ......................................... 500,000 200,000 ........... (IS) 20,000 ........... ........... ........... ........... ............ (EI) 3,000 (BI) 2,250 680,750 ........... ........... Depreciation Expense—Buildings................... 30,000 5,000 (A1) 6,500 ........... 41,500 ........... ........... Depreciation Expense—Equipment ................ 15,000 10,000 (A2) 10,000 ........... 35,000 ........... ........... Other Expenses .............................................. 140,000 70,000 ........... ........... 210,000 ........... ........... Interest Expense ............................................. ........... 7,676 ........... 7,676 ........... ........... ........... (B) Interest Revenue ............................................. (8,596) ............ (B) 8,596 ........... ........... ........... ........... Subsidiary Income .......................................... (21,859) ............ (CY1) 21,859 ........... ........... ........... ........... Dividends Declared—Spartan ......................... ........... 10,000 ........... (CY2) 8,000 ........... 2,000 ........... ............ ............ ............ ........... ........... 20,000 Dividends Declared—Postman ....................... 20,000 Totals .......................................................... 0 0 681,728 681,728 ............ ........... ........... ........... ........... Consolidated Net Income ..................................................................................................................................................... (189,583) To NCI (see distribution schedule)................................................................................................................................... 3,197 (3,197) ........... To Controlling Interest (see distribution schedule)........................................................................................................... 186,386 ............ (186,386) Total NCI ....................................................................................................................................................................................................... (101,447) ............ Retained Earnings—Controlling Interest, December 31, 2015 ............................................................................................................................................. (451,386) Totals ........................................................................................................................................................................................................................................................

243,833 143,000 172,000 260,000 ........... ........... ........... ........... ........... 830,000 (363,000) 280,000 (160,000) 120,000 (73,000) ........... ........... ........... ........... ........... ........... ........... ........... (100,000) (800,000) ........... ........... ........... ........... ........... ........... ........... ........... ........... ........... ........... ........... ........... ........... ........... ........... ........... ........... (101,447) (451,386) 0

NCI

part.

Ch. 5—Problems

5–26

Problem 5-6, Concluded Eliminations and Adjustments: (CY1) Current-year subsidiary income. (CY2) Current-year dividend. (EL) Eliminate controlling interest in subsidiary equity. (D)/(NCI) Distribute excess and adjust NCI. (A) Amortize excess. (IS) Eliminate intercompany sales during current period. (IA) Eliminate intercompany unpaid trade accounts. (BI) Defer beginning inventory profit. (EI) Defer ending inventory profit. (B) Eliminate intercompany bonds. Proof for Bond Retirement Gain remaining at year-end: Carrying value at December 31, 2015 ....................................... Investment in bonds at December 31, 2015 .............................. Loss amortized during the year: Interest revenue eliminated ........................................................ Interest expense eliminated ....................................................... Gain at January 1, 2015 .......................................................

$102,023 96,110 $

8,596 7,676

$5,913

920 $6,833

5–27

Ch. 5—Problems

PROBLEM 5-7 Determination and Distribution of Excess Schedule Company Implied Fair Value $500,000

$ 10,000 90,000 100,000 $200,000

$300,000

Parent Price (80%) $400,000

NCI Value (20%) $100,000

$200,000 80% $160,000

$200,000 20% $ 40,000

$240,000

$ 60,000

Worksheet Key debit D1 debit D2 debit D3

Life 20 5

Adjustment of identifiable accounts:

Adjustment $130,000 50,000 120,000 $300,000

Life 20 5

Amortization per Year $ 6,500 10,000

Annual Amount

Current Year

Prior Years

Total

Key

$ 6,500 10,000 $16,500

$13,000 20,000 $33,000

$19,500 30,000 $49,500

(A1) (A2)

Ch. 5—Problems

5–28

Problem 5-7, Continued Intercompany Inventory Profit Deferral Parent Parent Parent Sub Amount Percent Profit Amount Beginning .............................. Ending ...................................

— —

0% 0

— —

$12,000 10,000

Sub Percent

Sub Profit

25% $3,000 25 2,500

Subsidiary Spartan Company Income Distribution Amortizations .............................. Ending inventory profit ................ Interest adjustment, bonds..........

$16,500 2,500 998

Internally generated net income..................................... Beginning inventory profit .............

$17,348 3,000

Adjusted income ........................... NCI share ...................................... NCI ................................................

$ × $

350 20% 70

Parent Postman Company Income Distribution Internally generated net income..................................... $178,650 80% × Spartan adjusted income of $350 .................................... 280 Controlling interest ........................ $178,930

5–29

Ch. 5—Problems

Problem 5-7, Continued Postman Company and Subsidiary Spartan Company Worksheet for Consolidated Financial Statements For Year Ended December 31, 2016 Eliminations Consolidated Trial Balance and Adjustments Income Postman Spartan Dr. Cr. Statement

Controlling Retained Earnings

Consolidated Balance Sheet

290,486 99,347 ........... ........... ........... ........... ........... 120,000 91,000 ........... (IA) 6,000 ........... ........... ........... 140,000 55,000 ........... (EI) 2,500 ........... ........... ........... 200,000 60,000 ........... ........... ........... ........... ........... 435,737 ........... (CY1) 13,878 ........... ........... ........... ............ ........... ............ (CY2) 8,000 ........... ........... ........... ........... ........... ........... (EL) 189,859 ........... ........... ........... ............ ........... ............ (D) ........... 240,000 ........... ........... ........... Investment in Spartan Bonds .......................... 96,760 ........... 96,760 ........... ........... ........... ............ (B) Buildings ........................................................ 600,000 100,000 (D1) 130,000 ........... ........... ........... ........... Accumulated Depreciation .............................. (340,000) (45,000) ........... (A1) 19,500 ........... ........... ........... Equipment ....................................................... 150,000 80,000 (D2) 50,000 ........... ........... ........... ........... Accumulated Depreciation .............................. (105,000) (60,000) ........... (A2) 30,000 ........... ........... ........... Goodwill .......................................................... ........... ............ (D3) 120,000 ........... ........... ........... ........... Accounts Payable ........................................... (40,000) (34,000) (IA) 6,000 ........... ........... ........... ........... (B) 100,000 ........... ........... ........... ........... Bonds Payable ................................................ ........... (100,000) (B) Discount (Premium) ........................................ ........... (1,675) 1,675 ........... ........... ........... ........... ........... ........... ........... ........... ........... ............ ........... Common Stock ($1 par)—Spartan .................. ........... (10,000) (EL) 8,000 ........... ........... (2,000) ........... Paid-In Capital in Excess of Par—Spartan ..... ........... (90,000) (EL) 72,000 ........... ........... (18,000) ........... Retained Earnings—Spartan .......................... ........... (137,324) (EL) 109,859 (NCI) 60,000 ........... ........... ........... ........... ............ (A1–A2) 6,600 1,183 ........... ........... ........... (B) ........... ............ (BI) ........... ........... (81,448) ........... 600 Common Stock ($1 par)—Postman ................ (100,000) ............ ........... ........... ........... ........... ........... Paid-In Capital in Excess of Par—Postman.... (800,000) ........... ........... ........... ........... ........... ............ Retained Earnings—Postman ......................... (475,455) ............ (A1–A2) 26,400 ........... ........... ........... ........... ........... ............ (BI) 2,400 ........... ........... ........... (451,385) ........... ............ (B) ........... 4,730 ........... ........... ........... Sales ............................................................... (900,000) (350,000) (IS) 25,000 ........... (1,225,000) ........... ........... Cost of Goods Sold ......................................... 530,000 230,000 ........... (IS) 25,000 ........... ........... ........... ........... ............ (EI) 2,500 (BI) 3,000 734,500 ........... ........... Depreciation Expense—Buildings................... 30,000 5,000 (A1) 6,500 ........... 41,500 ........... ........... Depreciation Expense—Equipment ................ 15,000 10,000 (A2) 10,000 ........... 35,000 ........... ........... Other Expenses .............................................. 155,000 80,000 ........... ........... 235,000 ........... ........... Interest Expense ............................................. ........... 7,652 ........... 7,652 ........... ........... ........... (B) Interest Revenue ............................................. (8,650) ............ (B) 8,650 ........... ........... ........... ........... Subsidiary Income .......................................... (13,878) ............ (CY1) 13,878 ........... ........... ........... ........... Dividends Declared—Spartan ......................... ........... 10,000 ........... (CY2) 8,000 ........... 2,000 ........... ............ ........... ........... ........... ........... 20,000 Dividends Declared—Postman ....................... 20,000 Totals .......................................................... 0 0 708,062 708,062 ........... ........... ........... ........... ........... Consolidated Net Income ..................................................................................................................................................... (179,000) To NCI (see distribution schedule)................................................................................................................................... 70 (70) ........... To Controlling Interest (see distribution schedule)........................................................................................................... 178,930 .......... (178,930) Total NCI ....................................................................................................................................................................................................... (99,518) ............ Retained Earnings—Controlling Interest, December 31, 2016 ............................................................................................................................................. (610,315) Totals ........................................................................................................................................................................................................................................................

389,833 205,000 192,500 260,000 ........... ........... ........... ........... ........... 830,000 (404,500) 280,000 (195,000) 120,000 (68,000) ........... ........... ........... ........... ........... ........... ........... ........... (100,000) (800,000) ........... ........... ........... ........... ........... ........... ........... ........... ........... ........... ........... ........... ........... ........... ........... ........... ........... ........... (99,518) (610,315) 0

NCI

part.

Ch. 5—Problems

5–30

Problem 5-7, Concluded Eliminations and Adjustments: (CY1) Current-year subsidiary income. (CY2) Current-year dividend. (EL) Eliminate controlling interest in subsidiary equity. (D)/(NCI) Distribute excess and adjust NCI. (A) Amortize excess. (IS) Eliminate intercompany sales during current period. (IA) Eliminate intercompany unpaid trade accounts. (BI) Defer beginning inventory profit. (EI) Defer ending inventory profit. (B) Eliminate intercompany bonds. $5,913 = $1,183 NCI portion + $4,730 controlling portion Proof: Gain remaining at year-end: Carrying value at December 31, 2016 ....................................... Investment in bonds at December 31, 2016 .............................. Loss amortized during the year: Interest revenue eliminated ........................................................ Interest expense eliminated ....................................................... Remaining gain at January 1, 2016 .....................................

$101,675 96,760 $

8,650 7,652

$4,915

998 $5,913

5–31

Ch. 5—Problems

PROBLEM 5-8 (1) (a) $10,000 decrease in income. The $15,000 gain is eliminated. Depreciation expense is reduced by ⅓ of the gain, $5,000. (b) $10,000 decrease in income. The profit in the ending inventory is deferred. The profit would be ⅓ gross profit × ½ of inventory sold × $60,000 sales for the year. (c) $4,500 increase in income. The intercompany bonds are retired on the worksheet which creates a $4,500 gain in 2016. $94,000 was paid to retire bonds with a book value of $98,500 (50% of $200,000 – $3,000 discount) (2) a

–

(Sean’s 10% is included in NCI.)

–

(Sean’s 10% is included in NCI; however, the NCI may appear in a separate column of a retained earnings statement.)

–

[Same note as for (g) above.]

–

Elimination of the intercompany sale reduces cost of that asset. 50% of the bonds are treated as retired when consolidating.

Bonds were purchased on 12/31, so intercompany interest is not eliminated.

Ch. 5—Problems

5–32

PROBLEM 5-9 Determination and Distribution of Excess Schedule

Fair value of subsidiary ..................... Less book value of interest acquired: Total equity.................................. Interest acquired ............................... Book value ........................................ Excess of fair value over book value............................................

Company Implied Fair Value $750,000

Parent Price (90%) $675,000

NCI Value (10%) $ 75,000

600,000

$600,000 90% $540,000

$600,000 10% $ 60,000

$150,000

$135,000

$ 15,000

Adjustment $150,000

Worksheet Key debit D

Life

Adjustment of identifiable accounts:

Goodwill ............................................

Amortization per Year

Subsidiary Sundown Company Income Distribution Interest adjustment ($10,702 – $9,621) ................

$1,081

Internally generated net income................................... Realized equipment gain ............

$8,758 2,000

Adjusted income ......................... NCI share .................................... NCI ..............................................

$9,677 × 10% $ 968

Parent Princess Company Income Distribution Ending inventory profit ................

$6,000

Internally generated net income..................................... 90% × Sundown adjusted income of $9,677 ................................. Controlling interest ........................

$60,702 8,709 $63,411

5–33

Ch. 5—Problems

Problem 5-9, Continued Princess Company and Subsidiary Sundown Company Worksheet for Consolidated Financial Statements For Year Ended December 31, 2016

Inventory ................................................ Equipment .............................................. Accumulated Depreciation ..................... Investment in Sundown Stock ................ Investment in Sundown Bonds ............... Goodwill ................................................. Bonds Payable (9%) .............................. Discount on Bonds Payable ................... Common Stock ($10 par)— Princess .............................................. Paid-In Capital in Excess of Par— Princess .............................................. Retained Earnings, January 1, 2016— Princess ..............................................

Trial Balance Princess Sundown 25,000 80,000 371,190 1,522,413 (200,000) (600,000) .......... .......... 675,000 .......... .......... .......... 90,888 .......... .......... .......... .......... (200,000) .......... 6,345

(F1) (F2) (CV) (D) (B)

Eliminations and Adjustments Dr. Cr. .......... (EI) 6,000 .......... (F1) 10,000 4,000 .......... 2,000 .......... 180,000 (EL) 720,000 .......... (D) 135,000 .......... (B) 90,888 150,000 .......... 100,000 .......... .......... (B) 3,173

Consolidated Income Statement ......... ......... ......... ......... ......... ......... ......... ......... ......... .........

NCI .......... .......... .......... .......... .......... .......... .......... .......... .......... ..........

Controlling Retained Earnings .......... .......... .......... .......... .......... .......... .......... .......... .......... ..........

Consolidated Balance Sheet 99,000 1,883,603 (794,000) .......... .......... .......... .......... 150,000 (100,000) 3,172

(200,000)

..........

.........

..........

(200,000)

(300,000)

..........

.........

..........

(300,000)

(401,376) .......... ..........

.......... .......... (200,000)

(F1) (EL)

.......... 5,400 180,000

180,000 6,318 ..........

......... ......... .........

.......... .......... (20,000)

(582,294) .......... ..........

.......... .......... ..........

..........

(100,000)

(EL)

90,000

..........

.........

(10,000)

..........

.......... (500,000) (EL) 450,000 (B) 702 ......... .......... .......... .......... .......... (F1) 600 (NCI) 15,000 ......... (65,102) .......... Sales ...................................................... (300,000) (260,000) (IS) 50,000 .......... (510,000) .......... .......... Cost of Goods Sold ................................ 100,000 72,000 (EI) 6,000 (IS) 50,000 128,000 .......... .......... Interest Income ...................................... (10,702) .......... (B) 10,702 .......... ......... .......... .......... Other Expenses ..................................... 150,000 160,000 .......... (F2) 2,000 308,000 .......... .......... 19,242 .......... (B) 9,621 9,621 .......... .......... Interest Expense .................................... ........... 0 0 1,228,702 1,228,702 ......... .......... .......... .......... .......... Consolidated Net Income ............................................................................................................................... (64,379) To NCI (see distribution schedule) ............................................................................................................. 968 (968) .......... To Controlling Interest (see distribution schedule)...................................................................................... 63,411 .......... (63,411) Total NCI ............................................................................................................................................................................. (96,070) .......... Retained Earnings—Controlling Interest, December 31, 2016 .................................................................................................................. (645,705) Totals ..........................................................................................................................................................................................................................

.......... .......... .......... .......... .......... .......... .......... .......... .......... .......... .......... (96,070) (645,705) 0

Common Stock ($10 par)—Sundown ..... Paid-In Capital in Excess of Par— Sundown ............................................ Retained Earnings, January 1, 2016— Sundown ............................................

(CV) (B)

part.

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Ch. 5—Problems

5–34

Problem 5-9, Concluded Eliminations and Adjustments: (CV) Conversion entry, 90% × ($500,000 – $300,000) = $180,000. (EL) Eliminate pro rata share of subsidiary equity balances against the investment account. (D)/(NCI) Distribute the excess and adjust NCI according to the determination and distribution of excess schedule. (F1) Reduce machine to cost to consolidated entity. Unrecognized gain of $6,000 remaining at beginning of year is split 90% to controlling retained earnings and 10% to NCI retained earnings. (F2) Reduce current-year depreciation expense due to sale of machine, $10,000 ÷ 5 years = $2,000. (B) Eliminate intercompany interest revenue and expense. Eliminate the balance in the investment in bonds against the bonds payable. The gain on retirement at the start of the year is calculated as follows: Gain remaining at year-end: Carrying value of bonds at December 31, 2016 [($200,000 – $6,345) × ½] ................................................. Investment in bonds at December 31, 2016 ......................... Gain amortized during the year: Interest revenue eliminated ($89,186 × 12%) .............................. Interest expense eliminated [($200,000 – $7,582) × ½ × 10%].... Remaining gain at January 1, 2016 ......................................

(IS) (EI)

$96,827 90,888 $10,702 9,621

$5,939

1,081 $7,020

The remaining unamortized gain is allocated 90% to the controlling retained earnings and 10% to the NCI retained earnings. Eliminate intercompany merchandise sales. Eliminate intercompany profit in ending inventory, 30% × $20,000 = $6,000.

5–35

Ch. 5—Problems

PROBLEM 5-10 Paratec Corporation and Subsidiary Sym Corporation Worksheet for Consolidated Financial Statements For Year Ended December 31, 2018

Cash ................................................. Accounts Receivable (net) ............... Inventory .......................................... Prepaid Rent on Equipment ............. Investment in Bonds ......................... Investment in Sym Corporation ........

Trial Balance Paratec Sym 190,000 40,000 738,350 142,000 75,000 500,000 7,000 ............. 65,000 250,000 400,000 ............ ............. ............ ............. ............ 85,000 250,000 1,950,000 295,000

Eliminations and Adjustments Dr. Cr. ............. ............. ............. ............. ............. ............. ............. (CL1) 7,000 ............. ............. ............. (CV) 160,000 ............. (EL) 510,000 (D) ............. 50,000 ............. ............. ............. 120,000 (CL2)

Consolidated Income Statement ............. ............. ............. ............. ............. ............. ............. ............. ............. .............

Controlling Retained Earnings ............ ............ ............ ............ ............ ............ ............ ............ ............ ............

Land ................................................. Plant and Equipment ........................ Accumulated Depreciation— ............ Plant and Equipment .................... (250,000) (60,000) ............. (CL2) 36,000 ............. Equipment Under Operating Lease .. 120,000 ............ ............. (CL2) 120,000 ............ ............. Accumulated Depreciation— 36,000 ............. Assets Under Operating Lease ..... (36,000) ............ (CL2) ............. ............ (D) 50,000 ............. ............. ............ Goodwill ........................................... ............. ............ ............. Accounts Payable ............................ (385,000) (52,000) ............. ............. ............ 7,000 ............. Deferred Rent Revenue ................... (7,000) ............ (CL1) ............. ............ ............. ............ ............. Common Stock (no par)—Paratec ... (2,000,000) ............ ............. Retained Earnings, January 1, 2018 —Paratec ...................................... (1,076,350) ............ ............. (CV) 160,000 ............. (1,236,350) Common Stock (no par)—Sym ........ ............. (200,000) (EL) ............. ............ 200,000 ............. Retained Earnings, January 1, 2018 ............. ............ —Sym ........................................... ............. (310,000) (EL) 310,000 ............. Sales ................................................ (4,720,000) (500,000) ............. ............. (5,220,000) ............ Rental Income .................................. (12,000) ............ (CL1) ............. ............ 12,000 ............. ............. ............ Cost of Goods Sold .......................... 3,068,000 300,000 ............. 3,368,000 12,000 ............. Rent Expense ................................... ............. ............. (CL1) 12,000 ............ 826,000 Other Expenses ............................... 725,000 101,000 ............. ............. ............ ............ ............. ............. ............. 295,000 Dividends Declared .......................... 295,000 0 895,000 895,000 ............. ............ Total .............................................. 0 (1,026,000) Consolidated Net Income ..................................................................................................................................... (1,026,000) Consolidated Retained Earnings, December 31, 2018 ................................................................................................................ (1,967,350) Totals ...............................................................................................................................................................................................................

part.

Consolidated Balance Sheet 230,000 880,350 575,000 ............ 315,000 ............ ............ ............ 335,000 2,365,000 (346,000) ............ ............ 50,000 (437,000) ............ (2,000,000) ............ ............ ............ ............ ............ ............ ............ ............ ............ ............ ............ (1,967,350) 0

Ch. 5—Problems

5–36

Problem 5-10, Concluded Eliminations and Adjustments: (CV) (EL) (D) (CL1) (CL2)

Convert to equity method as of January 1, 2018, 100% × ($310,000 – $150,000). Eliminate the parent’s investment in the subsidiary and the subsidiary equity accounts. Establish the goodwill. Eliminate the prepaid rent, the deferred rent revenue, and the current-year rent expense and income. Reclassify the equipment under operating lease and its related accumulated depreciation to the plant and equipment account and related accumulated depreciation. PROBLEM 5-11

Determination and Distribution of Excess Schedule Company Implied Fair Value $562,500

$ 10,000 190,000 190,000 $390,000

$172,500

Parent Price (80%) $450,000

NCI Value (20%) $112,500

$390,000 80% $312,000

$390,000 20% $ 78,000

$138,000

$ 34,500

Worksheet Key debit D1 debit D2

Life 20

Adjustment of identifiable accounts:

Buildings ........................................... Goodwill ............................................ Total ............................................ Account Adjustments to Be Amortized Buildings ............................... Total amortizations ..........

Adjustment $100,000 72,500 $172,500

Life 20

Amortization per Year $5,000

Annual Amount

Current Year

Prior Years

Total

Key

$5,000 $5,000

$10,000 $10,000

(A1)

5–37

Ch. 5—Problems

Problem 5-11, Continued Intercompany Inventory Profit Deferral Parent Parent Parent Sub Amount Percent Profit Amount Beginning .............................. Ending ...................................

— —

Sub Percent

Sub Profit

25% 25

$2,500 3,000

Internally generated net income..................................... Beginning inventory profit .............

$40,804 2,500

Adjusted income ........................... NCI share ...................................... NCI ................................................

$35,304 × 20% $ 7,061

0% 0

— —

$10,000 12,000

Subsidiary Simon Company Income Distribution Ending inventory profit ................ Amortization ................................

$3,000 5,000

Parent Press Company Income Distribution Internally generated net income..................................... $174,196 80% × Simon adjusted income of $35,304 ............................... 28,243 Controlling interest ........................ $202,439

Ch. 5—Problems

5–38

Problem 5-11, Continued

Cash ................................................. Accounts Receivable........................ Inventory........................................... Land ................................................. Investment in Simon.........................

Press Company and Subsidiary Simon Company Worksheet for Consolidated Financial Statements For Year Ended December 31, 2016 Eliminations Consolidated Trial Balance and Adjustments Income Press Statement Simon Dr. Cr. 72,363 ......... ........ 73,637 ......... 45,000 72,000 ......... (IA) 6,000 ........ 56,000 120,000 ......... (EI) 3,000 ........ ......... ........ 100,000 ......... 100,000 506,643 ......... ......... (CY1) 32,643 ........ 8,000 ......... ......... (CY2) ......... ........ ......... ......... (EL) 344,000 ........ ......... ......... ......... (D) 138,000 ........ .........

Minimum Lease Payments Receivable .................................... 103,452 Unearned Interest ............................ (17,619) Buildings .......................................... 800,000 Accumulated Depreciation ............... (220,000) Equipment ........................................ 150,000 ......... Accumulated Depreciation ............... (90,000) ......... Equipment—Capital Lease .............. ......... Accumulated Depreciation— Capital Lease ................................ ......... Goodwill............................................ ......... Accounts Payable ............................ (60,000) Bonds Payable ................................. ......... Discount (Premium) ......................... ......... Obligation Under Capital Lease ....... ......... Accrued Interest—Capital Lease ..... ......... Common Stock ($1 par)—Simon ..... ......... Paid-In Capital in Excess of Par —Simon ........................................ ......... Retained Earnings—Simon .............. ......... ......... ......... ......... .

NCI ......... ......... ......... ......... ......... ......... ......... .........

Controlling Consolidated Retained Balance Earnings Sheet ......... 146,000 ......... 111,000 ......... 173,000 ......... 200,000 ......... ........ ......... ........ ......... ........ ......... ........

......... ......... 400,000 (220,000) 100,000 ......... (50,000) ......... 100,000

......... (CL2) 17,619 (D1) 100,000 ......... ......... (CL3) 100,000 ......... ......... .........

(CL2) 103,452 ......... ......... (A1) 10,000 ......... ......... ......... (CL3) 18,000 (CL3) 100,000

........ ........ ........ ........ ........ ........ ........ ........ ........

......... ......... ......... ......... ......... ......... ......... ......... .........

........ ........ 1,300,000 (450,000) 350,000 ........ ........ (158,000) ........

(18,000) ......... (40,000) ......... ......... (76,637) (9,196) (10,000)

(CL3) (D2) (IA)

18,000 72,500 6,000 ......... ......... 76,637 9,196 8,000

......... ......... ......... ......... ......... ......... ......... .........

........ ........ ........ ........ ........ ........ ........ ........

......... ......... ......... ......... ......... ......... ......... (2,000)

......... ......... ......... ......... ......... ......... ......... .........

........ 72,500 (94,000) ........ ........ ........ ........ ........

(190,000) (230,000) ......... ......... .........

(EL) 152,000 (EL) 184,000 (BI) 500 1,000 (A1) .........

......... ......... 34,500 ......... .........

........ ........ ........ ........ ........

(38,000) ......... ......... ......... (79,000)

......... ......... ......... ......... .........

........ ........ ........ ........ ........

(CL2) (CL2) (EL)

(NCI)

part.

5–39

Ch. 5—Problems

Problem 5-11, Continued Press Company and Subsidiary Simon Company Worksheet for Consolidated Financial Statements For Year Ended December 31, 2016 (Concluded) Eliminations Consolidated Controlling Consolidated Trial Balance and Adjustments Income Retained Balance Press Statement Simon Dr. Cr. NCI Earnings Sheet Common Stock ($1 par)—Press ...... (100,000) ......... ......... ........ ......... ......... (100,000) ......... Paid-In Capital in Excess of Par ......... —Press ......................................... (800,000) ......... ......... ........ ......... ......... (800,000) ......... ........ ......... ......... ........ 4,000 Retained Earnings—Press ............... (450,000) ......... (A1) 2,000 ......... ......... (BI) ......... ........ ......... ......... ........ ......... ......... ......... ......... ........ ......... (444,000) ........ ......... (1,160,000) ......... ......... ........ 40,000 Sales ................................................ (800,000) (400,000) (IS) Cost of Goods Sold .......................... 450,000 ......... (IS) 40,000 ........ ......... ......... ........ 240,000 ......... ......... (EI) 3,000 (BI) 2,500 650,500 ......... ......... ........ ......... 45,000 ......... ......... ........ 5,000 Depreciation Expense—Buildings .... 30,000 10,000 (A1) Depreciation Expense—Equipment 15,000 ......... ........ ......... ......... ........ 28,000 ......... ......... ......... ......... ......... 43,000 ......... ......... ........ 72,000 ......... Other Expenses ............................... 140,000 ......... 212,000 ......... ......... ........ ......... (CL1) 9,196 ........ ......... ......... ........ 9,196 Interest Expense .............................. ......... 9,196 Interest Revenue .............................. (9,196) ......... (CL1) ......... ........ ......... ......... ........ ......... ......... ......... ......... ........ ......... ......... ........ ......... ........ ......... ......... ........ Subsidiary Income............................ (32,643) ......... (CY1) 32,643 10,000 2,000 Dividends Declared—Simon ............ ......... ......... (CY2) 8,000 ........ ......... ........ ......... ......... ......... ........ ......... 20,000 ........ Dividends Declared—Press ............. 20,000 0 849,291 849,291 ........ ......... ......... ........ Totals ............................................ 0 ......... ......... ........ Consolidated Net Income ................................................................................................................ (209,500) To NCI (see distribution schedule) .............................................................................................. 7,061 (7,061) ......... ........ ......... (202,439) ........ To Controlling Interest (see distribution schedule) ...................................................................... 202,439 ......... (124,061) Total NCI ............................................................................................................................................................ (124,061) (626,439) Retained Earnings—Controlling Interest, December 31, 2016 .............................................................................................. (626,439) Totals ...................................................................................................................................................................................................... 0

part.

Ch. 5—Problems

5–40

Problem 5-11, Concluded Eliminations and Adjustments: (CY1) Current-year subsidiary income. (CY2) Current-year dividend. (EL) Eliminate controlling interest in subsidiary equity. (D)/(NCI) Distribute excess. (A) Amortize excess. (IS) Eliminate intercompany sales during current period. (IA) Eliminate intercompany unpaid trade accounts. (BI) Defer beginning inventory profit. (EI) Defer ending inventory profit. (CL1) Intercompany interest on capital lease. (CL2) Eliminate obligation under capital lease plus accrued interest against minimum lease payments receivable and unearned interest. (CL3) Reclassify leased asset as owned asset.

5–41

Ch. 5—Problems

PROBLEM 5-12 Determination and Distribution of Excess Schedule Company Implied Fair Value $562,500

$ 10,000 190,000 190,000 $390,000

$172,500

Parent Price (80%) $450,000

NCI Value (20%) $112,500

$390,000 80% $312,000

$390,000 20% $ 78,000

$138,000

$ 34,500

Worksheet Key debit D1 debit D2

Life 20

Adjustment of identifiable accounts:

Buildings ........................................... Goodwill ............................................ Total ............................................ Account Adjustments to Be Amortized

Amortization per Year $5,000

Annual Amount

Current Year

Prior Years

Total

$5,000 $5,000

$10,000 $10,000

$15,000 $15,000

(A1)

Intercompany Inventory Profit Deferral Parent Parent Parent Sub Amount Percent Profit Amount

Sub Percent

Sub Profit

25% 25

$3,000 2,000

Life

Buildings ............................... Total amortizations ..........

Beginning .............................. Ending ...................................

Adjustment $100,000 72,500 $172,500

— —

0% 0

— —

$12,000 8,000

Key

Ch. 5—Problems

5–42

Problem 5-12, Continued Subsidiary Simon Company Income Distribution Ending inventory profit ................ Amortization ................................

$2,000 5,000

Internally generated net income..................................... Beginning inventory profit..............

$22,504 3,000

Adjusted income ........................... NCI share ...................................... NCI ................................................

$18,504 20% $ 3,701

Parent Press Company Income Distribution Internally generated net income..................................... $152,496 80% × Simon adjusted income of $18,504 ............................... 14,803 Controlling interest ........................ $167,299

5–43

Ch. 5—Problems

Problem 5-12, Continued Press Company and Subsidiary Simon Company Worksheet for Consolidated Financial Statements For Year Ended December 31, 2017

Trial Balance Press Simon 140,000 78,274 87,000 55,000 170,000 66,000 168,726 100,000 516,646 ............ ............ ............ ............ ............ ............ ............

Minimum Lease Payments Receivable .................................... 80,089 Unearned Interest—Minimum Lease Payment ........................................ (10,123) Buildings .......................................... 800,000 Accumulated Depreciation —Buildings. ................................... (250,000) Equipment ........................................ 150,000 ............ Accumulated Depreciation —Equipment ............................... (105,000) Equipment—Capital Lease .............. ............ Accumulated Depreciation— Capital Lease ................................ ............ Goodwill............................................ ............ Accounts Payable ............................ (60,000) Bonds Payable ................................. ............ Discount (Premium) ......................... ............ ............ Obligation Under Capital Lease ....... ............ Accrued Interest—Capital Lease ..... ............

Eliminations Consolidated and Adjustments Income Statement Dr. Cr. ............. ............ ............ ............. (IA) 7,000 ............ ............. (EI) 2,000 ............ ............. ............ ............ ............. (CY1) 18,003 ............ (CY2) 8,000 ............ ............ ............. (EL) 368,643 ............ ............. (D) 138,000 ............ 80,089

............

.............

............

............ ............

............. .............

............ 1,300,000

15,000 ............ ............

............ ............ ............

............. ............. .............

(495,000) 350,000 ............

............. .............

(CL3) 36,000 (CL3) 100,000

............ ............

............. .............

(201,000) ............

36,000 72,500 7,000 ............. ............. ............. (CL2) 62,470 (CL2) 7,496

............ ............ ............ ............ ............ ............ ............ ............

............. ............. ............. ............. ............. ............. ............. .............

............ 72,500 (83,000) ............ ............ ............ ............ ............

............

.............

............ 400,000

(CL2) 10,123 (D1) 100,000

(230,000) 100,000 ............

............. ............. (CL3) 100,000

(60,000) 100,000 (36,000) ............ (30,000) ............ ............ ............ (62,470) (7,496)

NCI ............ ............ ............ ............ ............ ............ ............ ............

Controlling Consolidated Retained Balance Earnings Sheet ............. 218,274 ............. 135,000 ............. 234,000 ............. 268,726 ............ ............. ............. ............ ............. ............ ............. ............

(CL3) (D2) (IA)

(CL2)

(A1)

(continued)

part.

Ch. 5—Problems

5–44

Problem 5-12, Continued

Common Stock ($1 par)—Simon ..... Paid-In Capital in Excess of Par—Simon ................................... Retained Earnings—Simon ..............

Press Company and Subsidiary Simon Company Worksheet for Consolidated Financial Statements For Year Ended December 31, 2017 (Concluded) Eliminations Consolidated Trial Balance and Adjustments Income Press Statement Simon Dr. Cr. ............ (10,000) (EL) 8,000 ............ ............

Controlling Consolidated Retained Balance NCI Earnings Sheet (2,000) ............. ............

............ (190,000) (EL) 152,000 ............ ............ (38,000) ............. ............ (260,804) (EL) 208,643 ............ ............ ............ ............. ............ ............ (BI) 600 (NCI) 34,500 ............ ............ ............. ............ ............ (A1) 2,000 ............ ............ ............ ............. ............ ............ ............. ............ ............ (84,061) ............. Common Stock ($1 par)—Press ...... (100,000) ............ ............. ............ ............ ............ ............. Paid-In Capital in Excess of Par —Press ......................................... (800,000) ............ ............. ............ ............ ............ ............. Retained Earnings—Press ............... (636,839) ............ (A1) 8,000 ............ ............ ............ ............. ............ ............ (BI) 2,400 ............ ............ ............ ............. ............ ............ ............. ............ ............ ............ (626,439) Sales ................................................ (900,000) (450,000) (IS) 35,000 ............ (1,315,000) ............ ............. Cost of Goods Sold .......................... 550,000 290,000 ............. (IS) 35,000 ............ ............ ............. ............ ............ (EI) 2,000 (BI) 3,000 804,000 ............ ............. Depreciation Expense—Buildings .... 30,000 10,000 (A1) 5,000 ............ 45,000 ............ ............. Depreciation Expense—Equipment 15,000 28,000 ............. ............ ............ ............ ............. ............ ............ ............. ............ 43,000 ............ ............. Other Expenses ............................... 160,000 92,000 ............. ............ 252,000 ............ ............. Interest Expense .............................. ............ 7,496 ............. (CL1) 7,496 ............ ............ ............. Interest Revenue .............................. (7,496) ............ (CL1) 7,496 ............ ............ ............ ............. Subsidiary Income............................ (18,003) ............ (CY1) 18,003 ............ ............ ............ ............. Dividends Declared—Simon ............ ............ 10,000 ............. (CY2) 8,000 ............ 2,000 ............. ............ ............. ............ ............ ............ 20,000 Dividends Declared—Press ............. 20,000 0 852,731 852,731 ............ ............ ............. Totals ............................................ 0 ............ ............. Consolidated Net Income ................................................................................................................ (171,000) To NCI (see distribution schedule) .............................................................................................. 3,701 (3,701) ............. ............ (167,299) To Controlling Interest (see distribution schedule) ...................................................................... 167,299 Total NCI ............................................................................................................................................................ (125,762) ............. Retained Earnings—Controlling Interest, December 31, 2017 .............................................................................................. (773,738) Totals ...................................................................................................................................................................................................... .

part.

............ ............ ............ ............ ............ (100,000) (800,000) ............ ............ ............ ............ ............ ............ ............ ............ ............ ............ ............ ............ ............ ............ ............ ............ ............ ............ ............ (125,762) (773,738) 0

5–45

Ch. 5—Problems

Problem 5-12, Concluded Eliminations and Adjustments: (CY1) (CY2) (EL) (D) (A) (IS) (IA) (BI) (EI) (CL1) (CL2) (CL3)

Current-year subsidiary income. Current-year dividend. Eliminate controlling interest in subsidiary equity. Distribute excess. Amortize excess. Eliminate intercompany sales during current period. Eliminate intercompany unpaid trade accounts. Defer beginning inventory profit. Defer ending inventory profit. Intercompany interest on capital lease. Eliminate obligation under capital lease plus accrued interest against minimum lease payments receivable and unearned interest. Reclassify leased asset as owned asset. PROBLEM 5-13

Determination and Distribution of Excess Schedule

Company Implied Fair Value $562,500 $ 10,000 190,000 190,000 $390,000

$172,500

Parent Price (80%) $450,000

NCI Value (20%) $112,500

$390,000 80% $312,000

$390,000 20% $ 78,000

$138,000

$ 34,500

Ch. 5—Problems

5–46

Problem 5-13, Continued Adjustment of identifiable accounts: Adjustment $100,000 72,500 $172,500

Buildings ........................................... Goodwill ............................................ Total ............................................ Account Adjustments to Be Amortized

Worksheet Key debit D1 debit D2

Life 20

Amortization per Year $5,000

Annual Amount

Current Year

Prior Years

Total

$5,000 $5,000

$10,000 $10,000

(A1)

Intercompany Inventory Profit Deferral Parent Parent Parent Sub Amount Percent Profit Amount

Sub Percent

Sub Profit

Life

Buildings ............................... Total amortizations ..........

Beginning .............................. Ending ...................................

— —

0% 0

— —

$10,000 12,000

Key

25% $2,500 25 3,000

Subsidiary Simon Company Income Distribution Ending inventory profit ................ Amortization ................................

$3,000 5,000

Internally generated net income..................................... Beginning inventory profit .............

$40,804 2,500

Adjusted income ........................... NCI share ...................................... NCI ................................................

$35,304 × 20% $ 7,061

Parent Press Company Income Distribution Equipment gain ...........................

$15,000

Internally generated net income..................................... $174,196 80% × Simon adjusted income of $35,304 ............................... 28,243 Realized gain ................................ 3,000 Controlling interest ........................ $190,439

5–47

Ch. 5—Problems

Problem 5-13, Continued Press Company and Subsidiary Simon Company Worksheet for Consolidated Financial Statements For Year Ended December 31, 2016

Minimum Lease Payments Receivable .................................... 103,452 Unearned Interest ............................ (17,619) Buildings ........................................... 800,000 Accumulated Depreciation ............... (220,000) Equipment ........................................ 150,000 ............ Accumulated Depreciation ............... (90,000) ............ ............ ............ Equipment—Capital Lease .............. ............ Accumulated Depreciation— Capital Lease ................................ ............ Goodwill............................................ ............ Accounts Payable ............................ (60,000) Bonds Payable ................................. ............ Discount (Premium) ......................... ............ ............ Obligation Under Capital Lease ....... ............ Accrued Interest—Capital Lease ..... ............ Common Stock ($1 par)—Simon ..... ............

Eliminations Consolidated and Adjustments Income Statement Dr. Cr. ............. ............ ............ ............. (IA) 6,000 ............ ............. (EI) 3,000 ............ ............. ............ ............ ............. (CY1) 32,643 ............ (CY2) 8,000 ............ ............ ............. (EL) 344,000 ............ ............. (D) 138,000 ............

NCI ............ ............ ............ ............ ............ ............ ............ ............

Controlling Consolidated Retained Balance Earnings Sheet ............. 146,000 ............. 111,000 ............. 173,000 ............. 200,000 ............ ............. ............. ............ ............. ............ ............. ............

............ ............ 400,000 (220,000) 100,000 ............ (50,000) ............ ............ ............ 100,000

............. (CL2) 17,619 (D1) 100,000 ............. ............. (CL3) 100,000 ............. ............. (F2) 3,000 ............. .............

(18,000) ............ (40,000) ............ ............ ............ (76,637) (9,196) (10,000)

(CL3) (D2) (IA)

Trial Balance Press Simon 72,363 73,637 72,000 45,000 120,000 56,000 100,000 100,000 506,643 ............ ............ ............ ............ ............ ............ ............

18,000 72,500 6,000 ............. ............. ............. (CL2) 76,637 (CL2) 9,196 (EL) 8,000

(CL2) 103,452 ............ ............ (A1) 10,000 (F1) 15,000 ............ ............ ............ ............ (CL3) 18,000 (CL3) 100,000

............ ............ ............ ............ ............ ............ ............ ............ ............ ............ ............

............. ............. ............. ............. ............. ............. ............. ............. ............. ............. .............

............ ............ 1,300,000 (450,000) 335,000 ............ ............ ............ ............ (155,000) ............

............ ............ ............ ............ ............ ............ ............ ............ ............

............ ............ ............ ............ ............ ............ ............ ............ (2,000)

............. ............. ............. ............. ............. ............. ............. ............. .............

............ 72,500 (94,000) ............ ............ ............ ............ ............ ............ (continued)

part.

Ch. 5—Problems

5–48 Problem 5-13, Continued Press Company and Subsidiary Simon Company Worksheet for Consolidated Financial Statements For Year Ended December 31, 2016 (Concluded) Eliminations Consolidated Trial Balance and Adjustments Income Press Statement Simon Dr. Cr.

Paid-In Capital in Excess of Par —Simon ....................................... Retained Earnings—Simon ..............

NCI

............ (190,000) (EL) 152,000 ............ ............ (38,000) ............ (230,000) (EL) 184,000 ............ ............ ............ ............ ............ (BI) 500 (NCI) 34,500 ............ ............ ............ ............ (A1) 1,000 ............ ............ ............ ............ ............ ............. ............ ............ (79,000) Common Stock ($1 par)—Press ...... (100,000) ............ ............. ............ ............ ............ Paid-In Capital in Excess of Par —Press ......................................... (800,000) ............ ............. ............ ............ ............ Retained Earnings—Press ............... (450,000) ............ (A1) 4,000 ............ ............ ............ ............ ............ (BI) 2,000 ............ ............ ............ ............ ............ ............. ............ ............ ............ Sales ................................................ (800,000) (400,000) (IS) 40,000 ............ (1,160,000) ............ Cost of Goods Sold .......................... 465,000 240,000 ............. (IS) 40,000 ............ ............ ............ ............ (EI) 3,000 (BI) 2,500 665,500 ............ Depreciation Expense—Buildings .... 30,000 10,000 (A1) 5,000 ............ 45,000 ............ Depreciation Expense—Equipment 15,000 28,000 ............. ............ ............ ............ ............ ............ ............. (F2) 3,000 40,000 ............ Other Expenses ............................... 140,000 72,000 ............. ............ 212,000 ............ Interest Expense ............ 9,196 ............. (CL1) 9,196 ............ ............ Interest Revenue .............................. (9,196) ............ (CL1) 9,196 ............ ............ ............ Gain on Fixed Asset Sale................. (15,000) ............ (F1) 15,000 ............ ............ ............ Subsidiary Income............................ (32,643) ............ (CY1) 32,643 ............ ............ ............ Dividends Declared—Simon ............ 10,000 ............. (CY2) 8,000 ............ 2,000 ............ ............. ............ ............ ............ Dividends Declared—Press ............. 20,000 0 867,291 867,291 ............ ............ Totals ............................................ 0 ............ Consolidated Net Income ................................................................................................................ (197,500) To NCI (see distribution schedule) .............................................................................................. 7,061 (7,061) ............ To Controlling Interest (see distribution schedule) ...................................................................... 190,439 Total NCI ............................................................................................................................................................ (124,061) Retained Earnings—Controlling Interest, December 31, 2016 ..............................................................................................

Controlling Consolidated Retained Balance Earnings Sheet ............. ............. ............. ............. ............. .............

............ ............ ............ ............ ............ (100,000)

............. ............. ............. (444,000) ............. ............. ............. ............. ............. ............. ............. ............. ............. ............. ............. ............. 20,000 ............. ............. ............. (190,439) ............. (614,439)

(800,000) ............ ............ ............ ............ ............ ............ ............ ............ ............ ............ ............ ............ ............ ............ ............ ............ ............ ............ ............ ............ (124,061) (614,439)

Totals ..........................................................................................................................................................................................................................

part.

5–49

Ch. 5—Problems

Problem 5-13, Concluded Eliminations and Adjustments: (CY1) Current-year subsidiary income. (CY2) Current-year dividend. (EL) Eliminate controlling interest in subsidiary equity. (D)/(NCI) Distribute excess. (A) Amortize excess. (IS) Eliminate intercompany sales during current period. (IA) Eliminate intercompany unpaid trade accounts. (BI) Defer beginning inventory profit. (EI) Defer ending inventory profit. (F1) Fixed asset profit at beginning of year. (F2) Fixed asset profit realized. (CL1) Intercompany interest on capital lease. (CL2) Eliminate obligation under capital lease plus accrued interest against minimum lease payments receivable and unearned interest. (CL3) Reclassify leased asset as owned asset. PROBLEM 5-14 Determination and Distribution of Excess Schedule

Company Implied Fair Value

Parent Price (80%)

NCI Value (20%)

$562,500

$450,000

$112,500

$390,000 80% $312,000

$390,000 20% $ 78,000

$138,000

$ 34,500

$ 10,000 190,000 190,000 $390,000

$172,500

Ch. 5—Problems

5–50

Problem 5-14, Continued Adjustment of identifiable accounts:

Buildings ........................................... Goodwill ............................................ Total ............................................ Account Adjustments to Be Amortized

Adjustment $100,000 72,500 $172,500

Worksheet Key debit D1 debit D2

Life 20

Amortization per Year $5,000

Annual Amount

Current Year

Prior Years

Total

$5,000 $5,000

$10,000 $10,000

$15,000 $15,000

(A1)

Intercompany Inventory Profit Deferral Parent Parent Parent Sub Amount Percent Profit Amount

Sub Percent

Sub Profit

Life

Buildings ............................... Total amortizations ..........

Beginning .............................. Ending ...................................

— —

0% 0

— —

$12,000 8,000

Key

25% $3,000 25 2,000

Subsidiary Simon Company Income Distribution Ending inventory profit ................ Amortization ................................

$2,000 5,000

Internally generated net income..................................... Beginning inventory profit .............

$22,504 3,000

Adjusted income ........................... NCI share ...................................... NCI ................................................

$18,504 × 20% $ 3,701

Parent Press Company Income Distribution Internally generated net income..................................... $152,496 80% × Simon adjusted income of $18,504 ............................... 14,803 Realized gain ................................ 3,000 Total .............................................. $170,299

5–51

Ch. 5—Problems

Problem 5-14, Continued Press Company and Subsidiary Simon Company Worksheet for Consolidated Financial Statements For Year Ended December 31, 2017

NCI ............ ............ ............ ............ ............ ............ ............ ............

............ ............ 400,000 (230,000) 100,000 ............ (60,000) ............ ............ ............ 100,000

............. (CL2) 10,123 (D1) 100,000 ............. ............. (CL3) 100,000 ............. (F1) 3,000 (F2) 3,000 ............. .............

(36,000) ............ (30,000) ............ ............ ............ (62,470) (7,496)

(CL3) (D2) (IA)

Trial Balance Press Simon 140,000 78,274 87,000 55,000 170,000 66,000 168,726 100,000 516,646 ............ ............ ............ ............ ............ ............ ............

Minimum Lease Payments Receivable .................................... 80,089 Unearned Interest ............................ (10,123) Buildings ........................................... 800,000 Accumulated Depreciation ............... (250,000) Equipment ........................................ 150,000 ............ Accumulated Depreciation ............... (105,000) ............ ............ ............ Equipment—Capital Lease .............. ............ Accumulated Depreciation— Capital Lease ................................ ............ Goodwill............................................ ............ Accounts Payable ............................ (60,000) Bonds Payable ................................ ............ Discount (Premium) ........................ ............ ............ Obligation Under Capital Lease ....... ............ Accrued Interest—Capital Lease ..... ............

36,000 72,500 7,000 ............. ............. ............. (CL2) 62,470 (CL2) 7,496

80,089 ............ ............ (A1) 15,000 (F1) 15,000 ............ ............ ............ ............ (CL3) 36,000 (CL3) 100,000

............ ............ ............ ............ ............ ............ ............ ............ ............ ............ ............

............. ............. ............. ............. ............. ............. ............. ............. ............. ............. .............

............ ............ 1,300,000 (495,000) 335,000 ............ ............ ............ ............ (195,000) ............

............ ............ ............ ............ ............ ............ ............ ............

............. ............. ............. ............. ............. ............. ............. .............

............ 72,500 (83,000) ............ ............ ............ ............ ............

(CL2)

(continued)

part.

Ch. 5—Problems

5–52

Problem 5-14, Continued

Common Stock ($1 par)—Simon ..... Paid-In Capital in Excess of Par —Simon ....................................... Retained Earnings—Simon ..............

Controlling Consolidated Retained Balance NCI Earnings Sheet (2,000) ............. ............

............ (190,000) (EL) 152,000 ............ ............ (38,000) ............. ............ (260,804) (EL) 208,643 ............ ............ ............ ............. ............ ............ (BI) 600 (NCI) 34,500 ............ ............ ............. ............ ............ (A1) 2,000 ............ ............ (84,061) ............. Common Stock ($1 par)—Press ...... (100,000) ............ ............. ............ ............ ............ ............. Paid-In Capital in Excess of Par —Press ......................................... (800,000) ............ ............. ............ ............ ............ ............. Retained Earnings—Press ............... (636,839) ............ (A1) 8,000 ............ ............ ............ ............. ............ ............ (BI) 2,400 ............ ............ ............ ............. ............ ............ (F1) 12,000 ............ ............ ............ (614,439) Sales ................................................ (900,000) (450,000) (IS) 35,000 ............ (1,315,000) ............ ............. Cost of Goods Sold .......................... 550,000 290,000 ............. (IS) 35,000 ............ ............ ............. ............ ............ (EI) 2,000 (BI) 3,000 804,000 ............ ............. Depreciation Expense—Buildings .... 30,000 10,000 (A1) 5,000 ............ 45,000 ............ ............. Depreciation Expense—Equipment 15,000 28,000 ............. (F2) 3,000 40,000 ............ ............. Other Expenses ............................... 160,000 92,000 ............. ............ 252,000 ............ ............. Interest Expense .............................. ............ 7,496 ............. (CL1) 7,496 ............ ............ ............. Interest Revenue .............................. (7,496) ............ (CL1) 7,496 ............ ............ ............ ............. ............ ............ ............. ............ ............ ............ ............. Subsidiary Income............................ (18,003) ............ (CY1) 18,003 ............ ............ ............ ............. Dividends Declared—Simon ............ ............ 10,000 ............. (CY2) 8,000 ............ 2,000 ............. ............ ............. ............ ............ ............ 20,000 Dividends Declared—Press ............. 20,000 0 870,731 870,731 ............ ............ ............. Totals ............................................ 0 ............ ............. Consolidated Net Income ................................................................................................................ (174,000) To NCI (see distribution schedule) .............................................................................................. 3,701 (3,701) ............. ............ (170,299) To Controlling Interest (see distribution schedule) ...................................................................... 170,299 Total NCI ............................................................................................................................................................ (125,762) ............. Retained Earnings—Controlling Interest, December 31, 2017 .............................................................................................. (764,738) Totals ......................................................................................................................................................................................................

part.

............ ............ ............ ............ (100,000) (800,000) ............ ............ ............ ............ ............ ............ ............ ............ ............ ............ ............ ............ ............ ............ ............ ............ ............ ............ ............ (125,762) (764,738) 0

5–53

Ch. 5—Problems

Problem 5-14, Concluded Eliminations and Adjustments: (CY1) Current-year subsidiary income. (CY2) Current-year dividend. (EL) Eliminate controlling interest in subsidiary equity. (D)/(NCI) Distribute excess. (A) Amortize excess. (IS) Eliminate intercompany sales during current period. (IA) Eliminate intercompany unpaid trade accounts. (BI) Defer beginning inventory profit. (EI) Defer ending inventory profit. (F1) Fixed asset profit at beginning of year. (F2) Fixed asset profit realized. (CL1) Intercompany interest on capital lease. (CL2) Eliminate obligation under capital lease plus accrued interest against minimum lease payments receivable and unearned interest. (CL3) Reclassify leased asset as owned asset. PROBLEM 5-15 Determination and Distribution of Excess Schedule

Fair value of subsidiary ..................... Less book value of interest acquired: Total equity.................................. Interest acquired ............................... Book value ........................................ Excess of fair value over book value............................................

Company Implied Fair Value

Parent Price (80%)

NCI Value (20%)

$400,000

$320,000

$ 80,000

380,000

$380,000 80% $304,000

$380,000 20% $ 76,000

$ 20,000

$ 16,000

Adjustment $20,000

Worksheet Key debit D

4,000

Adjustment of identifiable accounts:

Goodwill ............................................

Life

Amortization per Year

Ch. 5—Problems

5–54

Problem 5-15, Continued Subsidiary Slammer Company Income Distribution Internally generated net income.................................

$42,937

Adjusted income ....................... NCI share .................................. NCI ............................................

$42,937 × 20% $ 8,587

Parent Plessor Industries Income Distribution Sales profit on leases..................

$7,298

Internally generated net income................................. Profit realized through use of machine........................... 80% × Slammer adjusted income of $42,937............... Controlling interest ....................

$129,361 912 34,350 $157,325

5–55

Ch. 5—Problems

Problem 5-15, Continued

Cash....................................................... Accounts Receivable.............................. Inventory ................................................ Minimum Lease Payments Receivable .. Unearned Interest Income ...................... Investment in Slammer Company .......... Assets Under Capital Lease ................... Accumulated Depreciation—Assets Under Capital Lease ...........................

Plessor Industries and Subsidiary Slammer Company Worksheet for Consolidated Financial Statements For Year Ended December 31, 2017 Eliminations Consolidated Trial Balance and Adjustments Income Plessor Slammer Dr. Cr. Statement 60,000 40,745 .......... .......... ......... 97,778 76,000 .......... .......... ......... 140,000 120,000 .......... .......... ......... 127,000 .......... .......... (CL2a) 80,000 ......... .......... .......... .......... (CL2b) 47,000 ......... (14,417) .......... (CL2a) 9,191 .......... ......... .......... .......... (CL2b) 5,226 .......... ......... 320,000 .......... (CV) 40,000 (EL) 344,000 ......... .......... .......... .......... (D) 16,000 ......... .......... 156,068 .......... (CL3a) 103,770 ......... .......... .......... .......... (CL3b) 52,298 .........

.......... .......... Property, Plant, and Equipment ............. 1,900,000 .......... Accumulated Depreciation—Property, Plant, and Equipment ......................... (1,077,000) .......... Goodwill ................................................. .......... Accounts Payable .................................. (148,000) .......... Obligations Under Capital Lease............ .......... ..........

(27,291) .......... 310,000 ..........

(CL3a) 20,754 (CL3b) 6,537 (CL3a) 103,770 (CL3b) 52,298

(72,000) .......... .......... (45,065) .......... (100,520) ..........

(F2) (D) (CL2a) (CL2b) (CL2a) (CL2b)

912 .......... 20,000 7,587 4,476 63,222 37,298

(F1) (CL3a) (CL3b)

NCI .......... .......... .......... .......... .......... .......... .......... .......... .......... .......... ..........

Controlling Retained Earnings .......... .......... .......... .......... .......... .......... .......... .......... .......... .......... ..........

Consolidated Balance Sheet 100,745 173,778 260,000 ............. ............. ............. ............. ............. ............. ............. .............

.......... .......... 7,298 ..........

......... ......... ......... .........

.......... .......... .......... ..........

............. ............. ............. 2,358,770

20,754 6,537 .......... .......... .......... .......... ..........

......... ......... ......... ......... ......... ......... .........

.......... .......... .......... .......... .......... .......... ..........

............. (1,175,379) 20,000 ............. (181,002) ............. .............

(continued)

part.

Ch. 5—Problems

5–56

Problem 5-15, Continued Plessor Industries and Subsidiary Slammer Company Worksheet for Consolidated Financial Statements For Year Ended December 31, 2017 (Concluded) Consolidated Eliminations and Adjustments Income Trial Balance Plessor Slammer Dr. Cr. Statement (700,000) .......... .......... .......... .........

Controlling Retained Earnings ..........

NCI Common Stock ($10 par)—Plessor........ .......... Paid-In Capital in Excess of Par —Plessor ............................................ (325,000) .......... .......... .......... ......... .......... .......... Retained Earnings—Plessor .................. (295,000) .......... .......... (CV) 40,000 ......... .......... (335,000) Common Stock ($10 par)—Slammer ..... .......... (300,000) (EL) 240,000 .......... ......... (60,000) .......... Retained Earnings—Slammer ................ .......... (130,000) (EL) 104,000 (NCI) 4,000 ......... (30,000) .......... Sales ...................................................... (1,400,000) (600,000) .......... .......... (2,000,000) .......... .......... Sales Profit on Leases ........................... (7,298) .......... (F1) 7,298 .......... ......... .......... .......... Interest Income ...................................... (12,063) .......... (CL1a) 7,587 .......... ......... .......... .......... .......... .......... (CL1b) 4,476 .......... ......... .......... .......... Cost of Goods Sold ................................ 780,000 380,000 .......... .......... 1,160,000 .......... .......... Interest Expense .................................... .......... 12,063 .......... (CL1a) 7,587 ......... .......... .......... .......... .......... .......... (CL1b) 4,476 ......... .......... .......... Other Expenses ..................................... 510,000 165,000 .......... (F2) 912 674,088 .......... .......... Dividend Income .................................... (12,000) .......... (CY2) 12,000 .......... ......... .......... .......... 15,000 .......... (CY2) 12,000 ......... 3,000 56,000 Dividends Declared ................................ 56,000 0 0 746,632 746,632 ......... .......... .......... .......... .......... Consolidated Net Income ............................................................................................................................... (165,912) To NCI (see distribution schedule) ............................................................................................................. 8,587 (8,587) .......... To Controlling Interest (see distribution schedule)...................................................................................... 157,325 .......... (157,325) Total NCI ............................................................................................................................................................................. (95,587) .......... Retained Earnings—Controlling Interest, December 31, 2017 .................................................................................................................. (436,325) Totals ..........................................................................................................................................................................................................................

Eliminations and Adjustments: (CV) Conversion to equity as of beginning of year, 80% × ($130,000 – $80,000) = $40,000. (CY2) Eliminate the intercompany dividends. (EL) Eliminate 80% of the subsidiary equity. (D)/(NCI) Distribute the excess and NCI adjustment to goodwill.

part.

Consolidated Balance Sheet (700,000) (325,000) ............. ............. ............. ............. ............. ............. ............. ............. ............. ............. ............. ............. ............. ............. ............. ............. ............. (95,587) (436,325) 0

5–57

Ch. 5—Problems

Problem 5-15, Concluded (CL1a)

(CL2a)

(CL3a) (CL1b) (CL2b)

(CL3b) (F1) (F2)

Eliminate the intercompany interest expense and revenue on factory lease: Original balance ........................................................................... $103,770 First lease payment ...................................................................... (25,000) First-year interest (12% × $78,770) .............................................. 9,452 Second lease payment ................................................................. (25,000) Balance for second year ....................................................... $ 63,222 Interest for second year (12% × $63,222) ............................ $ 7,587 Eliminate obligation under capital lease plus accrued interest payable against minimum lease payments receivable and unearned interest income: Obligations balance, January 1, 2017: Original balance ........................................................................... $103,770 Principal, January 1, 2016 ............................................................ (25,000) Principal, January 1, 2017 ($25,000 – $9,452) ............................ (15,548) Balance ................................................................................ $ 63,222 Accrued interest payable ...................................................... $ 7,587 Minimum lease payments, January 1, 2017: 3 × $25,000 plus $5,000 option .................................................... $ 80,000 Unearned interest income, January 1, 2017: Original balance, $130,000* – $103,770 principal balance .......... $ 26,230 Earned in 2016 ............................................................................. (9,452) Earned in 2017 ............................................................................. (7,587) Balance ................................................................................ $ 9,191 *($25,000 × 5) + $5,000 Reclassify asset under capital lease and related accumulated depreciation for two years. Depreciation is $103,770 ÷ 10, or $10,377 per year. Eliminate the intercompany interest expense and revenue on equipment lease. Interest is 12% × ($52,298 original balance – $15,000 first payment), or $4,476. Eliminate obligation under capital lease ($52,298 – $15,000, or $37,298) and accrued interest payable, $4,476, against minimum lease payments receivable (3 × $15,000 + $2,000 purchase option, or $47,000) and unearned interest income: Unearned interest income at December 31, 2017: Original balance, $62,000* – $52,298 principal balance .............. $ 9,702 Earned in 2017 ............................................................................. 4,476 Balance ................................................................................ $ 5,226 *($15,000 × 4) + $2,000 Reclassify the asset and related accumulated depreciation. Depreciation is $52,298 ÷ 8, or $6,537 per year. Eliminate the sales profit on intercompany equipment lease and reduce equipment to its cost to the consolidated entity. Reduce the depreciation to depreciation based on cost of equipment to consolidated entity: Recorded depreciation expense for 1 year ($52,298 ÷ 8) ............ $ 6,537 Depreciation expense based on cost ($45,000 ÷ 8) ..................... 5,625 Depreciation adjustment ....................................................... $ 912

Ch. 5—Problems

5–58

PROBLEM 5-16 Determination and Distribution of Excess Schedule

Fair value of subsidiary ..................... Less book value of interest acquired: Total equity.................................. Interest acquired ............................... Book value ........................................ Excess of fair value over book value............................................

Company Implied Fair Value

Parent Price (80%)

NCI Value (20%)

$600,000

$480,000

$120,000

500,000

$500,000 80% $400,000

$500,000 20% $100,000

$100,000

$ 80,000

$ 20,000

Adjustment $100,000

Worksheet Key debit D

Adjustment of identifiable accounts:

Goodwill ............................................

Life

Amortization per Year

Subsidiary Swing Company Income Distribution Internally generated net income................................... Realized gain on machine ...........

$17,440 509

Adjusted income ......................... NCI share .................................... NCI ..............................................

$17,949 × 20% $ 3,590

Parent Patter, Inc., Income Distribution Internally generated loss ............... $16,440

80% × Swing adjusted income of $17,949.................

$14,359

Controlling interest ........................ $ 2,081

5–59

Ch. 5—Problems

Problem 5-16, Continued

Cash....................................................... Inventory ................................................ Property, Plant, and Equipment ............. Accumulated Depreciation—Property, Plant, and Equipment ......................... Assets Under Capital Lease ................... Accumulated Depreciation—Assets Under Capital Lease ........................... Assets Under Operating Lease .............. Accumulated Depreciation— Assets Under Operating Lease........... Minimum Lease Payments Receivable .. Unearned Interest Income on Leases .... Goodwill ................................................. Investment in Swing Company ............... Accounts Payable .................................. Obligations Under Capital Lease............ Interest Payable ..................................... Common Stock ($10 par)—Patter .......... Paid-In Capital in Excess of Par—Patter Retained Earnings—Patter ....................

Patter, Inc., and Subsidiary Swing Company Worksheet for Consolidated Financial Statements For Year Ended December 31, 2015 Eliminations Trial Balance and Adjustments Patter Swing Dr. Cr. 91,013 26,050 .......... .......... 70,000 20,000 .......... .......... 320,000 50,000 (OL2) 140,000 (F1) 3,560 .......... .......... (CL3a) 17,560 .......... .......... .......... (CL2b) 23,116 .......... (70,000) .......... .......... 40,676 ..........

(20,000) .......... .......... .......... ..........

(F1) (F2)

509 509 .......... .......... ..........

(10,796) .......... ..........

.......... .......... 420,000

(CL3a) (CL3b)

5,017 5,779 ..........

.......... .......... .......... .......... .......... .......... 480,000 .......... (130,000) (24,560) .......... (4,440) .......... (200,000) (300,000) (278,333) ..........

(80,000) 412,000 .......... (4,000) .......... .......... .......... .......... (180,000) .......... .......... .......... .......... .......... .......... .......... ..........

(OL2) (CL2a) (CL2b) (D) (CV) (CL2a) (CL2b) (CL2a) (CL2b)

(F1)

18,000 .......... .......... 1,139 2,861 100,000 101,288 .......... .......... 9,444 15,116 1,417 3,023 .......... .......... .......... 2,441

Consolidated Income Statement ......... ......... ......... ......... .........

NCI .......... .......... .......... .......... ..........

Controlling Retained Earnings .......... .......... .......... .......... ..........

Consolidated Balance Sheet 117,063 90,000 .......... .......... 547,116

(OL2) (CL3a) (CL3b) (CL3a) (CL2b)

18,000 5,017 5,779 17,560 23,116

......... ......... ......... ......... .........

.......... .......... .......... .......... ..........

.......... .......... (117,778) .......... ..........

(OL2)

.......... .......... 140,000

......... ......... .........

.......... .......... ..........

.......... .......... 280,000

.......... 12,000 21,000 .......... .......... .......... 501,288 80,000 .......... .......... .......... .......... .......... .......... .......... 101,288 ..........

......... ......... ......... ......... ......... ......... ......... ......... ......... ......... ......... ......... ......... ......... ......... ......... .........

.......... .......... .......... .......... .......... .......... .......... .......... .......... .......... .......... .......... .......... .......... .......... .......... ..........

.......... .......... .......... .......... .......... .......... .......... .......... .......... .......... .......... .......... .......... .......... .......... .......... (377,180)

(62,000) .......... 379,000 .......... .......... 100,000 .......... .......... (310,000) .......... .......... .......... .......... (200,000) (300,000) .......... ..........

(CL2a) (CL2b)

(EL) (D)

(CV)

(continued)

part.

Ch. 5—Problems

5–60

Problem 5-16, Continued Patter, Inc. and Subsidiary Swing Company Worksheet for Consolidated Financial Statements For Year Ended December 31, 2015 (Concluded) Eliminations and Adjustments Trial Balance Patter Swing Dr. Cr. .......... (100,000) (EL) 80,000 .......... .......... (300,000) (EL) 240,000 ..........

Controlling Retained Earnings .......... ..........

Consolidated Balance Sheet .......... ..........

.......... (226,610) (EL) 181,288 (NCI) 20,000 ......... .......... .......... .......... .......... (F1) 610 .......... ......... (64,712) .......... Sales ...................................................... (300,000) (130,000) .......... .......... (430,000) .......... .......... Rent Income ........................................... .......... (34,000) (OL1) 11,000 .......... (23,000) .......... .......... Interest Income—Capital Lease ............. .......... (4,440) (CL1a) 1,417 .......... ......... .......... .......... .......... .......... (CL1b) 3,023 .......... ......... .......... .......... Depreciation Expense ............................ 41,000 23,000 .......... (F2) 509 ......... .......... .......... .......... .......... .......... .......... 63,491 .......... .......... Interest Expense .................................... 4,440 .......... .......... (CL1a) 1,417 ......... .......... .......... .......... .......... .......... (CL1b) 3,023 ......... .......... .......... Selling and General Expense ................. 70,000 38,000 .......... .......... 108,000 .......... .......... Cost of Goods Sold ................................ 190,000 90,000 .......... .......... 280,000 .......... .......... Rent Expense......................................... 11,000 .......... .......... (OL1) 11,000 ......... .......... .......... 0 964,557 964,557 ......... .......... .......... 0 Consolidated Net Income ............................................................................................................................... (1,509) .......... .......... To NCI (see distribution schedule) ............................................................................................................. 3,590 (3,590) .......... To Controlling Interest (see distribution schedule)...................................................................................... (2,081) .......... 2,081 .......... Total NCI ............................................................................................................................................................................. (148,302) Retained Earnings—Controlling Interest, December 31, 2015 .................................................................................................................. (375,099) Totals ..........................................................................................................................................................................................................................

Common Stock ($10 par)—Swing .......... Paid-In Capital in Excess of Par—Swing

Consolidated Income Statement ......... .........

NCI (20,000) (60,000)

Retained Earnings—Swing ....................

part.

5–61

Ch. 5—Problems

Problem 5-16, Continued Eliminations and Adjustments: (CV) (EL)

Conversion to equity at the beginning of the year [80% × ($226,610 – $100,000)]. Eliminate the 80% ownership portion of the subsidiary equity accounts against the investment. (D)/(NCI) Distribute the excess cost to goodwill. (OL1) Eliminate the intercompany rent revenue and expense on operating lease. (OL2) Reclassify the asset under the operating lease and the related accumulated depreciation to productive asset owned by the consolidated entity (3 years at $6,000). (CL1a) Eliminate the intercompany interest expense/revenue on machine: Original balance ........................................................................... First lease payment ...................................................................... First-year interest (15% × $12,560) .............................................. Second lease payment ................................................................. Balance ................................................................................ Interest for second year (15% × $9,444) .............................. (CL2a)

Eliminate the obligation under capital lease plus accrued interest payable against minimum lease payments receivable and unearned interest income: Obligations balance, January 1, 2015: Original balance ................................................................... Principal, January 1, 2014 .................................................... Principal, January 1, 2015 ($5,000 – $1,884)....................... Balance...........................................................................

$17,560 (5,000) (3,116) $ 9,444

Minimum lease payments, January 1, 2015: (2 × $5,000) + $2,000 option ................................................

$12,000

Unearned interest income, January 1, 2015: Original balance ($22,000* – $17,560) ................................. Earned in 2014 ..................................................................... Earned in 2015 ..................................................................... Balance........................................................................... *($5,000 × 4) + $2,000 (CL3a) (F1)

(F2)

$17,560 (5,000) 1,884 (5,000) $ 9,444 $ 1,417

$ 4,440 (1,884) (1,417) $ 1,139

Reclassify the machine under the capital lease and related depreciation. Cost, $17,560; accumulated depreciation, [($17,560 ÷ 7) × 2] = $5,017. Defer remaining gain on asset at the beginning of the year, $3,560* less one year’s amortization of $509** = $3,051. Because profit was recorded by the subsidiary, the retained earnings adjustment is allocated to NCI ($3,051 × 20% = $610) and controlling interest ($3,051 × 80% = $2,441). *$17,560 – $14,000 = $3,560 **$3,560/7 = $509 Adjust the current year’s depreciation for 1/7 of the gain, $509.

Ch. 5—Problems

5–62

Problem 5-16, Concluded (CL1b)

Eliminate intercompany interest expense/revenue on truck lease: Original balance ............................................................... Initial payment .................................................................. Balance .................................................................... First-year interest at 20% ................................................. Payment at start of second year....................................... Balance .................................................................... Remaining minimum payments ($8,000 + $5,000) .......... Future unearned interest ..........................................

(CL2b)

(CL3b)

$23,116 8,000 $15,116 3,023 Entry (CL1b) (8,000) $10,139 13,000 $ 2,861 Entry (CL2b)

Eliminate present value of obligation under capital lease, $15,116; current interest payable, $3,023; and future unearned interest of $2,861 against minimum lease payments of $21,000 [($8,000 × 2) + $5,000]. Reclassify the asset as an owned productive asset. Reclassify and adjust the depreciation as applicable to the owned asset, $23,116 ÷ 4 = $5,779.

5–63

Ch. 5—Problems

APPENDIX PROBLEMS PROBLEM 5A-1

Cash....................................................... Accounts Receivable (net) ..................... Inventory ................................................ Minimum Lease Payments Receivable .. Unguaranteed Residual Value ............... Unearned Interest Income ...................... Assets Under Capital Lease ................... Accumulated Depreciation—Assets Under Capital Lease ...........................

Paulz Heavy Equipment and Subsidiary Steven Truck Company Worksheet for Consolidated Financial Statements For Year Ended December 31, 2016 Eliminations Consolidated and Adjustments Income Trial Balance Paulz Steven Dr. Cr. Statement 90,485 123,307 .......... .......... ......... 228,000 120,000 .......... .......... ......... 200,000 140,000 .......... .......... ......... 97,000 10,000 .......... (CL2s) 10,000 ......... .......... .......... .......... (CL2p) 97,000 ......... .......... 6,000 .......... (CL2s) 6,000 ......... (9,673) (444) (CL2s) 1,237 (CL1s) 412 ......... .......... .......... (CL2p) 9,673 (CL1s) 381 ......... 27,833 109,388 .......... (CL2s) 27,833 ......... .......... .......... .......... (CL3p) 109,388 .........

(18,556) (13,674) .......... .......... Property, Plant, and Equipment ............. 2,075,000 1,145,000 .......... .......... Accumulated Depreciation—Property, Plant, and Equipment ......................... (713,000) (160,000) .......... .......... Investment in Steven Truck Company ... 1,045,800 .......... .......... .......... Accounts Payable .................................. (100,000) (85,000) Interest Payable ..................................... (740) (7,939) .......... .......... Obligations Under Capital Lease............ (9,260) (79,388) .......... .......... Common Stock ($5 par)—Paulz............. (1,800,000) .......... Retained Earnings—Paulz ..................... (864,834) .......... Common Stock ($5 par)—Steven .......... .......... (800,000) Retained Earnings—Steven ................... .......... (387,250) .......... .......... Sales ...................................................... (3,200,000) (1,400,000) Gain on Sale of Assets........................... .......... (60,000) Interest Income ...................................... (7,939) (1,152) .......... ..........

(CL3s) 18,556 (CL3p) 13,674 (CL2s) 32,596 (CL3p) 109,388 (F2) (CY2) (CL2s) (CL2p) (CL2s) (CL2p) (CL1s) (EL) (EL) (CL1s) (F1) (CL1s) (CL1p)

750 .......... 28,000 .......... .......... 740 7,939 9,260 79,388 .......... 305 640,000 309,800 76 .......... 60,000 1,152 7,939

NCI .......... .......... .......... .......... .......... .......... .......... .......... .......... ..........

Controlling Retained Earnings .......... .......... .......... .......... .......... .......... .......... .......... .......... ..........

Consolidated Balance Sheet 213,792 348,000 340,000 ............. ............. ............. ............. ............. ............. .............

.......... .......... 60,000 ..........

......... ......... ......... .........

.......... .......... .......... ..........

............. ............. ............. 3,301,984

(CL3s) 17,730 (CL3p) 13,674 (CY1) 124,000 (EL) 949,800 .......... .......... .......... .......... .......... .......... (CL3s) 330 .......... (CL3s) 83 .......... .......... .......... .......... ..........

......... ......... ......... ......... ......... ......... ......... ......... ......... ......... ......... ......... ......... ......... (4,600,000) ......... ......... .........

.......... .......... .......... .......... .......... .......... .......... .......... .......... .......... .......... (160,000) (77,457) .......... .......... .......... .......... ..........

.......... .......... .......... .......... .......... .......... .......... .......... .......... .......... (864,859) .......... .......... .......... .......... .......... .......... ..........

............. (903,654) ............. ............. (185,000) ............. ............. ............. ............. (1,800,000) ............. ............. ............. ............. ............. ............. ............. .............

(F1)

(continued)

part.

Ch. 5—Problems

5–64

Problem 5A-1, Continued Paulz Heavy Equipment and Subsidiary Steven Truck Company Worksheet for Consolidated Financial Statements For Year Ended December 31, 2016 (Concluded) Consolidated Controlling Eliminations and Adjustments Income Retained Trial Balance Paulz Steven Dr. Cr. Statement NCI Earnings (2,182) .......... (CL4p) 2,182 .......... ......... .......... .......... Rent Income ........................................... Cost of Goods Sold ................................ 1,882,000 770,000 .......... .......... 2,652,000 .......... .......... Interest Expense .................................... 740 7,939 .......... (CL1s) 740 ......... .......... .......... .......... .......... .......... (CL1p) 7,939 ......... .......... .......... Depreciation Expense ............................ 135,000 45,000 .......... (F2) 750 ......... .......... .......... .......... .......... .......... (CL3s) 413 178,837 .......... .......... Other Expenses ..................................... 924,326 483,213 .......... (CL4p) 2,182 1,405,357 .......... .......... Subsidiary Income.................................. (124,000) .......... (CY1) 124,000 .......... ......... .......... .......... Dividends Declared ................................ 144,000 35,000 .......... (CY2) 28,000 ......... 7,000 144,000 0 0 1,456,655 1,456,655 ......... .......... .......... .......... .......... Consolidated Net Income ............................................................................................................................... (363,806) To NCI (see distribution schedule) ............................................................................................................. 19,150 (19,150) .......... To Controlling Interest (see distribution schedule)...................................................................................... 344,656 .......... (344,656) Total NCI ............................................................................................................................................................................. (249,607) ............. Retained Earnings—Controlling Interest, December 31, 2016 .................................................................................................................. (1,065,515) Totals ..........................................................................................................................................................................................................................

Consolidated Balance Sheet ............. ............. ............. ............. ............. ............. ............. ............. ............. ............. ............. ............. ............. (249,607) (1,065,515) 0

Eliminations and Adjustments: (CY1) (CY2) (EL) (CL1s) (CL2s)

Eliminate the current-year subsidiary income to the investment account. Eliminate the current-year dividends to the investment account. Eliminate 80% of the subsidiary equity balances. Eliminate intercompany interest expense/revenue recorded on truck, $740, and interest on residual value. [See table in entry (CL2s).] Eliminate the interest on the unguaranteed residual value recorded in 2015. Eliminate the intercompany debt, the unguaranteed residual value, and reclassify the asset at cost: Lessee

Lessor

Date

Payment

Interest (8%)

January 1, 2015 January 1, 2016 January 1, 2017 January 1, 2018

$10,000 10,000 10,000 ............

............ $1,427 740 ............

Balance

Payment

Interest (8%)

Balance

$17,833 9,260 ............ ............

$10,000 10,000 10,000 6,000

............ $1,808 1,152 444

$22,596 14,404 5,556 ............

part.

Interest Difference .......... $ 381 412 444 $1,237

5–65

Ch. 5—Problems

Problem 5A-1, Continued (CL3s) (CL1p) (CL2p)

Reclassify and adjust the depreciation on the truck, ($27,833 ÷ 3) versus ⅓ × ($32,596 – $6,000 residual). Adjust past and current year by $413 ($9,278 – $8,865). Eliminate interest revenue and expense on equipment lease, 10% × ($109,388 original balance – $30,000 payment, January 1, 2016), or $7,939. Eliminate obligation under capital lease ($109,388 – $30,000) plus accrued interest payable ($7,939) against minimum lease payments receivable, [(3 × $30,000) + $7,000 purchase option, or $97,000], and unearned interest income, computed as follows: Original balance of payments receivable ......................... Original principal balance ................................................. Interest earned in 2016 ............................................ Unearned interest income, December 31, 2016 .......

(CL3p) (CL4p)

$127,000 109,388

Reclassify the equipment under capital lease and related accumulated depreciation for one year. Annual depreciation is $109,388 ÷ 8, or $13,674. Eliminate the intercompany rent revenue and expense, $2,182, which is $1,500 executory costs plus $682 contingent payment, computed as follows: Previous growth rate of net income ......................................................... (2015 net income, $81,650 ÷ 2014 net income of $75,600, or 1.08; 2014 net income, $75,600 ÷ 2013 net income of $70,000, or 1.08) 2016 net income, excluding gain on asset sale....................................... Less 1.08 × $81,650, 2015 net income ................................................... Increase in income due to cost saving ............................................ Contingent payment, 10% of increase ............................................

(F1) (F2)

$17,612 (7,939) $ 9,673

8% $95,000 88,182 $ 6,818 $ 682

Eliminate the gain on the intercompany sale of warehouse and reduce the asset to its cost to the consolidated entity. Adjust current year’s depreciation for one-quarter year, or $750 ($60,000 gain ÷ 20-year life = $3,000 annual depreciation adjustment).

Ch. 5—Problems

5–66

Problem 5A-1, Concluded Subsidiary Steven Truck Company Income Distribution Unrealized gain on sale of warehouse......................... Unearned interest on residual..................................

$60,000 412

Internally generated net income................................. Gain realized through use of warehouse....................... Adjustment of depreciation on lease............................... Adjusted income ....................... NCI share .................................. NCI ............................................

$155,000 750 413 $ 95,751 × 20% $ 19,150

Parent Paulz Heavy Equipment Income Distribution Internally generated net income................................. 80% × Steven adjusted income of $95,751............... Controlling interest ....................

$268,055 76,601 $344,656

PROBLEM 5A-2 (1) Eliminations and Adjustments at December 31, 2015: Interest Income ............................................................................... Interest Expense ........................................................................ Unearned Interest Income .......................................................... To eliminate intercompany interest revenue and expense.

5,136

Property, Plant, and Equipment (original cost to lessor)................. Obligations Under Capital Lease .................................................... Interest Payable .............................................................................. Unearned Interest Income (includes above $513 adjustment) ....... Minimum Lease Payments Receivable ...................................... Unguaranteed Residual Value ................................................... Assets Under Capital Lease ....................................................... To eliminate intercompany debt, the unguaranteed residual value, and the asset under the capital lease.

50,098 28,894 4,623 4,279

Accumulated Depreciation—Assets Under Capital Lease (⅓ × $46,894) ............................................................................. Accumulated Depreciation—Property, Plant, and Equipment [⅓ × ($50,098 – $5,000 residual)] ................... Depreciation Expense .......................................................... To reclassify accumulated depreciation.

4,623 513

36,000 5,000 46,894

15,631 15,033 598

5–67

Ch. 5—Problems

Problem 5A-2, Concluded (2) Eliminations and Adjustments at December 31, 2016: Interest Income ............................................................................... Interest Expense ........................................................................ Unearned Interest Income .......................................................... To eliminate intercompany interest revenue and expense.

3,077

Retained Earnings—Penn .............................................................. Unearned Interest Income .......................................................... To adjust for interest income recorded on residual value in 2015.

513

Property, Plant, and Equipment ...................................................... Obligations Under Capital Lease .................................................... Interest Payable .............................................................................. Unearned Interest Income (includes $513 and $595 adjustments) Minimum Lease Payments Receivable ...................................... Unguaranteed Residual Value ................................................... Assets Under Capital Lease ....................................................... To eliminate intercompany debt, the unguaranteed residual value, and the asset under the capital lease.

50,098 15,517 2,483 1,796

Accumulated Depreciation—Assets Under Capital Lease (2 × $15,631) ....................................................... Accumulated Depreciation—Property, Plant, and Equipment (2 × $15,033) ................................................... Depreciation Expense .......................................................... Retained Earnings—Penn .................................................... To reclassify accumulated depreciation.

2,483 594

513

18,000 5,000 46,894

31,262 30,066 598 598

Ch. 5—Cases

5–68

CASES CASE 5-1 First, let’s consider the existing outstanding bonds. There is a major difference in interest rates between those available to Power Pro and Swift-Craft. To the extent possible, the debt should be directly or indirectly retired. Direct retirement would be accomplished by Power Pro lending funds to Swift-Craft, which Swift-Craft would in turn use to retire the bonds. The other alternative is for Power Pro to purchase the existing bonds that it could and then hold them as an investment. Assuming the current borrowing rate is 11% for Swift-Craft, the bonds would trade near face value. The direct borrowing route would allow the parent to choose the interest rate it wanted to charge. Any rate under 11% would benefit the NCI share of income because it would increase the subsidiary’s reported income. The intercompany debt and interest revenue/expense would be eliminated in consolidation. The indirect route (purchasing the Swift-Craft bonds) would probably leave the NCI shareholders in the same position they are in now. The parent receives the 11% interest and can borrow at 7.5%. The bonds are retired for consolidation purposes in the period in which they are purchased by Power Pro. The intercompany interest revenue/expense on the bonds is eliminated. It would appear that Power Pro will build and equip the new plant. It can add a reasonable profit. The higher the price, the greater the shift of income from the subsidiary to the parent. When consolidating, the profit is removed from the gain account and the asset accounts. It is deferred over the period of use as a decrease in depreciation expense. Power Pro could sell the assets to Swift-Craft in return for a long-term mortgage. Again, any rate under 11% is a bonus to the NCI shareholders. Again, the intercompany debt and interest revenue/expense are eliminated in the consolidation process. The best situation might be for Power Pro to lease the assets to Swift-Craft under a financingtype lease. It would be a sales-type lease; thus, the profit would be deferred in the same manner as if the asset were sold to Swift-Craft. This would allow Power Pro to determine the interest rate and would provide it with control over the accounting for the assets. Any rate below 11% is beneficial to the NCI, and any profit below that charged by outside parties is a plus to the NCI shareholders. The intercompany debt and the interest revenue/expense resulting from the lease are eliminated in the consolidation process. The assets under the lease are reclassified to appear as normal, owned assets.

5–69

Ch. 5—Cases

CASE 5-2 (1) Option (a): Consolidated Income Statement Sales ..................................................................................................... Cost of goods sold ................................................................................ Gross profit ..................................................................................... Expenses .............................................................................................. Interest expense ................................................................................... Gain on bond retirement ....................................................................... Net income......................................................................................

$ 320,000 (220,000) $ 100,000 (40,000) (20,000) 15,000 $ 55,000

Consolidated Balance Sheet Assets Cash .................................... Other current assets ............ Plant and equipment ............ Accumulated depreciation ... Total ...............................

Liabilities and Equity $ 173,000 250,000 1,300,000 (500,000) $1,223,000

Current liabilities ................. NCI ..................................... Common stock (par) ........... Retained earnings .............. Total ..............................

45,000 82,000* 300,000 796,000** $1,223,000

*NCI = 20% × ($100,000 + $285,000 + $10,000 income + $15,000 gain on bond retirement) **Retained earnings = $746,000 + $30,000 Magna income + [80% × ($10,000 Metros income + $15,000 gain on bond retirement)] (2) Option (b): There would be no difference. The bonds would still be retired from a consolidated viewpoint with the parent paying $185,000 to retire the bonds. The gain would still be credited to the subsidiary income distribution schedule and thus would be allocated 20% to the NCI and 80% to the parent. The bonds would still be eliminated from the consolidated balance sheet.

Ch. 5—Cases

5–70

CASE 5-3 (1) Entries: Pannier: Notes Receivable............................................................................ Sales .......................................................................................... Cost of Goods Sold......................................................................... Inventory ....................................................................................

125,000 125,000 100,000 100,000

Jodestar: Equipment....................................................................................... Notes Payable ............................................................................

125,000 125,000

(2) Consolidated statements: Consolidated Income Statement Sales ..................................................................................................... Cost of goods sold ................................................................................ Gross profit ..................................................................................... Expenses .............................................................................................. Interest expense ................................................................................... Net income......................................................................................

$ 320,000 (220,000) $ 100,000 (40,000) (20,000) $ 40,000

Consolidated Balance Sheet Assets Cash .................................... Inventory .............................. Other current assets ............ Plant and equipment ............ Accumulated depreciation ... Total ...............................

Liabilities and Equity $ 358,000 90,000 210,000 1,250,000 (500,000) $1,408,000

Current liabilities ................. Long-term debt ................... NCI ..................................... Common stock (par) ........... Retained earnings .............. Total ..............................

45,000 200,000 79,000* 300,000 784,000** $1,408,000

*NCI = 20% × ($100,000 + $285,000 + $10,000 Jodestar income) Inventory is reduced by $100,000 and equipment is increased by $100,000 for the cost of the equipment sold to the subsidiary. **$746,000 + $30,000 + (80% × $10,000)

5–71

Ch. 5—Cases

Case 5-3, Concluded (3) Entries: Pannier: Minimum Lease Payments Receivable (4 × $29,977) .................... Cash ............................................................................................... Inventory .................................................................................... Unearned Interest Income .......................................................... Sales-Type Profit on Lease ........................................................

119,908 29,977 100,000 24,885 25,000

Jodestar: Asset Under Capital Lease ............................................................. Cash ........................................................................................... Obligation Under Capital Lease .................................................

125,000 29,977 95,023

(4) There would be no difference in the consolidated statements.

CHAPTER 6 UNDERSTANDING THE ISSUES 1. (a) Investing activities—Purchase of Sub Company ($900,000 – $50,000) ................ (b) Investing activities—Purchase of Sub Company ($500,000 – $50,000) ................ Noncash financing activities—Issuance of notes payable ..................................... (c) Investing activities—Cash acquired in purchase of Sub Company ........................ Noncash financing activities—Issuance of stock....................................................

$(850,000) $(450,000) 400,000 $ 50,000 900,000

2. Any amortizations of the $200,000 excess of cost over book value will need to be included in cash– operating activities as an adjustment to income. The means of purchasing Sub Company will have an effect on the consolidated statement of cash flows in subsequent years. 3. Determination and Distribution of Excess Schedule, Investment in Company S Determination and Distribution of Excess Schedule

Fair value of subsidiary ..................... Less book value of interest acquired: Total equity ................................. Interest acquired ............................... Book value ........................................ Excess of fair value over book value ...........................................

Company Implied Fair Value

Parent Price (80%)

NCI Value (20%)

$800,000

$640,000

$160,000

600,000

$600,000 80% $480,000

$600,000 20% $120,000

$200,000

$160,000

$ 40,000

Adjustment $200,000

Worksheet Key debit D3

Life

Adjustment of identifiable accounts:

Goodwill ............................................

Amortization per Year

(a) Investing activities—Purchase of S Company ($640,000 – $50,000) .................... Noncash financing activities—Noncontrolling interest ........................................... (b) Investing activities—Purchase of S Company ($400,000 – $50,000) .................... Noncash financing activities—Issuance of notes payable ..................................... Noncash financing activities—Noncontrolling interest ........................................... (c) Investing activities—Cash acquired in purchase of S Company ............................ Noncash financing activities—Issuance of stock.................................................... Noncash financing activities—Noncontrolling interest ...........................................

$(590,000) 160,000 $(350,000) 240,000 160,000 $ 50,000 640,000 160,000

4. (a) Consolidated basic EPS = ($250,000 + $60,000) ÷ 100,000 shares = $3.10 (b) Consolidated basic EPS = [$250,000 + (80% × $60,000)] ÷ 100,000 shares = $2.98 5. (a) Consolidated DEPS = [$200,000 + (40,000 × $1.43)] ÷ 100,000 shares = $2.57 Subsidiary DEPS = $60,000 ÷ (40,000 + 2,000) = $1.43 (b) Consolidated DEPS = [$200,000 + (40,000 × $1.50)] ÷ (100,000 + 2,000) = $2.55 Subsidiary DEPS = $60,000 ÷ 40,000 shares = $1.50 (c) Consolidated DEPS = [$200,000 + (40,000 × $1.50)] ÷ (100,000 + 2,000) = $2.55 Subsidiary DEPS = $60,000 ÷ 40,000 shares = $1.50

6–2 6. (a) Consolidated net income = ($100,000 + $40,000) × 70% = $98,000 Distribution to NCI = ($40,000 × 20%) × 70% = $5,600 Distribution to controlling interest = [$100,000 + ($40,000 × 80%)] × 70% = $92,400 (b) Consolidated net income = [($100,000 + $40,000) × 70%] – ($40,000 × 70% × 80% × 20% × 30%) = $96,656 Distribution to NCI = ($40,000 × 20%) × 70% = $5,600 Distribution to controlling interest = {[$100,000 + ($40,000 × 80%)] × 70%} – ($40,000 × 70% × 80% × 20% × 30%) = $91,056 7. (a) Taxes would not be paid on this intercompany profit. Taxes are based on consolidated income after the elimination of the profit. (b) Taxes will have been paid on this intercompany profit. The taxes paid become a deferred tax asset (DTA) and are amortized over the period of depreciation. The following adjustment is needed in the period of sale: Deferred Tax Asset ($50,000 × 30%) ................. Provision for Income Tax .................................

15,000 15,000

At each period-end, the DTA would be converted to a tax expense as follows: Provision for Income Tax ($15,000 ÷ 5) ............. Deferred Tax Asset ..........................................

3,000 3,000

6–3

Ch. 6—Exercises

EXERCISES EXERCISE 6-1 Determination and Distribution of Excess Schedule, Investment in Roland Company

Fair value of subsidiary ..................... Less book value of interest acquired: Common stock ............................ Retained earnings ....................... Total equity ............................ Interest acquired ......................... Book value ........................................ Excess of fair value over book value............................................

Company Implied Fair Value $825,000

Parent Price (80%) $660,000

NCI Value (20%) $165,000

$500,000 80% $400,000

$500,000 20% $100,000

$325,000

$260,000

$ 65,000

Adjustment

Worksheet Key

Life

$325,000

debit D

$200,000 300,000 $500,000

Adjustment of identifiable accounts:

Goodwill ($825,000 fair – $500,000 book value)..................

Amortization per Year

Ch. 6—Exercises

6–4

Exercise 6-1, Concluded Born Company and Subsidiary Roland Company Consolidated Statement of Cash Flows For Year Ended December 31, 2017 Cash flows from operating activities: Consolidated net income ($150,000 + $10,000 NCI share) ....... Adjustments to reconcile net income to net cash: Depreciation expense* ......................................................... Increase in inventory ($220,000 + $140,000 – $454,000).... Increase in current liabilities [$284,000 – ($160,000 + $110,000)] ..................................................... Total adjustments ........................................................... Net cash provided by operating activities .......................

$ 160,000 $120,000 (94,000) 14,000 40,000 $ 200,000

Cash flows from investing activities: Payment for purchase of Roland Company, net of cash acquired ............................................................. Cash flows from financing activities: Sale of stock (5,000 shares × $70) ............................................ Dividend payments to controlling interests................................. Dividend payments to NCI ($5,000 × 20%) ................................ Net cash used in financing activities .................................... Net decrease in cash ....................................................................... Cash at beginning of year ................................................................ Cash at year-end .............................................................................

(640,000) $350,000 (10,000) (1,000) 339,000 $(101,000) 300,000 $ 199,000

*2017 depreciation is equal to the difference between the sum of the December 31, 2016, net plant asset balances [$800,000 (parent) and $550,000 (subsidiary), or $1,350,000] and the December 31, 2017, consolidated net plant assets of $1,230,000. Schedule of noncash investing activity: Born Company purchased 80% of the capital stock of Roland Company for $660,000. In conjunction with the acquisition, liabilities were assumed and a noncontrolling interest created as follows: Adjusted value of assets acquired ($710,000 book value + $325,000 excess) ..........................................................

$1,035,000

Cash paid .........................................................................................

660,000

Balance ............................................................................................

$ 375,000

Liabilities assumed...........................................................................

$ 210,000

Noncontrolling interest** ..................................................................

$ 165,000

**This is the NCI at the beginning of the year (date of acquisition). Current-year charges to the total NCI are included in the consolidated net income and the dividends paid.

6–5

Ch. 6—Exercises

EXERCISE 6-2 Determination and Distribution of Excess Schedule, Investment in Panda Corporation

Company Implied Fair Value $306,250 $150,000 50,000 $200,000

$106,250

Parent Price (80%) $245,000*

NCI Value (20%) $ 61,250

$200,000 80% $160,000

$200,000 20% $ 40,000

$ 85,000

$ 21,250

Worksheet Key debit D1 debit D2

Life 4

Adjustment of identifiable accounts:

Equipment ......................................... Goodwill ............................................ Total ............................................

Adjustment $ 20,000 86,250 $106,250

Amortization per Year $5,000

*(5,000 shares × $18) + $155,000

Ch. 6—Exercises

6–6

Exercise 6-2, Concluded Duckworth Corporation and Subsidiary Panda Corporation Consolidated Statement of Cash Flows For Year Ended December 31, 2017 Cash flows from operating activities: Consolidated net income............................................................ Adjustments to reconcile net income to net cash: Depreciation ($92,000 + $28,000 + $5,000 of equipment excess) ............................................................ Decrease in inventory .......................................................... Increase in current liabilities ................................................. Total adjustments ........................................................... Net cash provided by operating activities ........................................ Cash flows from investing activities: Cash payment for purchase of Panda Corporation, net of cash acquired ($155,000 – $30,000) ......................... Purchase of production equipment .................................................. Net cash used in investing activities ................................................ Cash flows from financing activities: Decrease in long-term debt ........................................................ Dividends paid: By Duckworth Corporation ................................. $(30,000) By Panda, to NCI ............................................... (3,000) Net cash used in financing activities ................................................

$ 103,200 $ 125,000 5,800 5,000 135,800 $ 239,000

$(125,000) (76,000) $(201,000) $ (10,000) (33,000) (43,000)

Net decrease in cash ....................................................................... Cash at beginning of year ................................................................ Cash at year-end .............................................................................

$ (5,000) 100,000 $ 95,000

Schedule of noncash investing activity: Duckwell Corporation acquired 80% of the common stock of Panda Corporation in exchange for $245,000. In conjunction with the acquisition, liabilities were assumed and a noncontrolling interest was created as follows: Adjusted value of assets acquired ($270,000 book value + $106,250 excess) .................................................

$376,250

Cash payment ..................................................................................

155,000

Balance ............................................................................................

$221,250

Common stock issued......................................................................

$ 90,000

Liabilities assumed...........................................................................

$ 70,000

Noncontrolling interest (see D&D schedule) ....................................

$ 61,250

6–7

Ch. 6—Exercises

EXERCISE 6-3 (1) None, goodwill is not amortized. (2) The cash from shares sold to the NCI shareholders, $90,000 (1,000 shares × $90), would appear as cash flow in the financing activities section. The 1,000 shares purchased by the parent would not appear in the cash flow statement. (3) The bonds were held by parties outside the consolidated company. They are now retired by the consolidated company. The $102,000 would appear as a cash outflow in the financing activities section of the cash flow statement. (4) This is a transaction within the consolidated company, and it would have no impact on the consolidated statement of cash flows.

EXERCISE 6-4 Marco Company: Provision for Income Tax ........................................................... Income Tax Payable ............................................................ 30% × $110,000 = $33,000.

33,000 33,000

Tole Company: Optional entry to record tax effect of subsidiary tax: Subsidiary Investment Income ................................................... Investment in Marco Company ............................................ 80% × $33,000 tax. Provision for Income Tax ........................................................... Income Tax Payable ............................................................ Deferred Tax Liability ...........................................................

26,400 26,400 33,000

Internally generated income .................................................................................... Tax at 30% .............................................................................................................. Less DTL on goodwill [0.30 × ($80,000/15)] ........................................................... Tax currently payable ..............................................................................................

31,400 1,600 $110,000 $ 33,000 (1,600) $ 31,400

Ch. 6—Exercises

6–8

EXERCISE 6-5 Deko Company and Subsidiary Farwell Company Consolidated Income Statement For Year Ended December 31, 2019 Sales (less $50,000 intercompany sales) .......................................................... Cost of goods sold ($290,000 – $50,000 intercompany sales – $8,000 beginning inventory profit + $2,400 ending inventory profit) ........................ Expenses ($60,000 + $9,375 patent amortization from D&D – $1,000 depreciation adjustment) .............................................................................. Income before taxes .......................................................................................... Provision for income tax (see schedule) ............................................................ Consolidated net income ................................................................................... Distributed to noncontrolling interest .................................................................. Distributed to controlling interest........................................................................

$ 370,000 $ (234,400) (68,375) $ 67,225 (20,730) $ 46,495 309 $ 46,186

Determination and Distribution of Excess Schedule

Fair value of subsidiary ..................... Less book value of interest acquired: Total equity ....................................... Interest acquired ......................... Book value ........................................ Excess of fair value over book value............................................

Company Implied Fair Value $1,062,500

Parent Price (80%) $850,000

NCI Value (20%) $212,500

968,750

$968,750 80% $775,000

$968,750 20% $193,750

93,750

$ 75,000

$ 18,750

Adjustment $93,750

Worksheet Key debit D1

Life 10

Adjustment of identifiable accounts:

Patent................................................

Sales ......................... Cost of goods sold .... Gain on machine ....... Expenses .................. Amortization of patent Income before tax ..... Tax provision............. Net income ................ To NCI....................... To controlling ............

Deko $(300,000) 200,000 (5,000) 40,000 $ (65,000)

Farwell Dr. Cr. $(120,000) (IS) $50,000 90,000 (IS) $50,000 (EI) 2,400 (BI) 8,000 (F1) 5,000 20,000 (F2) 1,000 (A1) 9,375 $ (10,000)

Amortization per Year $9,375 Consolidated Income $(370,000) 234,400 0 59,000 9,375 $ (67,225) 20,730 $ (46,495) 309 $ 46,186

6–9

Ch. 6—Exercises

Exercise 6-5, Concluded Tax provision: Consolidated income before tax..................................... Add nondeductible patent amortization on NCI ($9,375 × 20%)......................................................... Taxable income .............................................................. Tax at 30% .....................................................................

$67,225 1,875 $69,100 $20,730

Subsidiary Farwell Company Income Distribution Ending inventory ......................... Patent amortization .....................

$2,400 9,375

Internally generated income ...... Beginning inventory...................

$10,000 8,000

Adjusted income........................ Tax provision (see schedule) .... Net income ................................ NCI share (see schedule) ......... Controlling share .......................

$ 6,225 (2,430) $ 3,795 309 $ 3,486

Subsidiary tax schedule: (1) Total adjusted income................................... (2) NCI share of asset adjustments.................... (3) Taxable income ............................................ (4) Tax (30% of taxable income) ........................ (5) Net of tax share of income (line 1 – line 4) ...

Controlling $4,980 $4,980 $1,494 $3,486

NCI $ 1,245 1,875 $ 3,120 $ 936 $ 309

Total $6,225* 1,875 $8,100 $2,430 $3,795

*From subsidiary’s IDS. Parent Deko Company Income Distribution Machine gain...............................

$5,000

Internally generated income ...... Gain realized .............................

$ 65,000 1,000

Adjusted income........................ Tax provision ($61,000 × 30%) Net of tax ................................... Share of sub income (net of tax) Controlling share .......................

$ 61,000 (18,300) $ 42,700 3,486 $ 46,186

Ch. 6—Exercises

6–10

EXERCISE 6-6 Dunker Company and Subsidiary Fennig Company Consolidated Income Statement For Year Ended December 31, 2019 Sales (less $50,000 intercompany sales) .......................................................... Cost of goods sold ($290,000 – $50,000 intercompany sales – $8,000 beginning inventory profit + $2,400 ending inventory profit) ........................ Expenses ($60,000 + $9,375 patent amortization from D&D – $1,000 depreciation adjustment) .............................................................................. Income before taxes .......................................................................................... Provision for income tax (see schedule) ............................................................ Consolidated net income ................................................................................... Distributed to noncontrolling interest .................................................................. Distributed to controlling interest........................................................................

$ 370,000 (234,400) (68,375) $ 67,225 (20,939) $ 46,286 309 $ 45,977

Determination and Distribution of Excess Schedule

Company Implied Fair Value $1,062,500

Parent Price (80%) $850,000

NCI Value (20%) $212,500

968,750

$968,750 80% $775,000

$968,750 20% $193,750

93,750

$ 75,000

$ 18,750

Adjustment $93,750

Worksheet Key debit D1

Life 10

Adjustment of identifiable accounts:

Patent................................................

Dunker $(300,000) 200,000 (5,000) 40,000 $ (65,000)

Fennig Dr. Cr. $(120,000) (IS) $50,000 90,000 (IS) $50,000 (EI) 2,400 (BI) 8,000 (F1) 5,000 20,000 (F2) 1,000 (A1) 9,375 $ (10,000)

Amortization per Year $9,375 Consolidated Income $(370,000) 234,400 0 59,000 9,375 $ (67,225) 20,939 $ (46,286) 309 $ 45,977

6–11

Ch. 6—Exercises

Exercise 6-6, Concluded Tax provision: Consolidated income before tax..................................... Add nondeductible patent amortization on NCI.............. Taxable income .............................................................. First tax at 30% .............................................................. Second tax (from controlling IDS) .................................. Total tax provision ..........................................................

$67,225 1,875 $69,100 $20,730 209 $20,939

Subsidiary Fennig Company Income Distribution Ending inventory ......................... Patent amortization .....................

$2,400 9,375

Internally generated income ........ Beginning inventory.....................

$10,000 8,000

Adjusted income.......................... Tax provision (see schedule) ...... Net income .................................. NCI share (see schedule) ........... Controlling share .........................

$ 6,225 (2,430) $ 3,795 309 $ 3,486

Controlling $4,980 $4,980 $1,494 $3,486

NCI $ 1,245 1,875 $ 3,120 $ 936 $ 309

Total $6,225* 1,875 $8,100 $2,430 $3,795

*From subsidiary’s IDS Parent Dunker Company Income Distribution Machine gain...............................

$5,000

Internally generated income ........ Gain realized ...............................

$ 65,000 1,000

Adjusted income.......................... Tax provision ($61,000 × 30%) ... Net of tax adjusted income.......... Share of sub income (net of first tax) ...................... Second tax (0.2 × 0.3 × $3,486).. Controlling interest ......................

$ 61,000 (18,300) $ 42,700 3,486 (209) $ 45,977

Ch. 6—Exercises

6–12

EXERCISE 6-7 Adjustment to January 1, 2017, retained earnings: Machine depreciation: Retained Earnings—Coors (1½ yrs. × $5,000 × 60%) ......... Retained Earnings—Vespa (1½ yrs. × $5,000 × 40%) ........ Accumulated Depreciation—Equipment............................

4,500 3,000

Machine sale: Retained Earnings—Coors .................................................. Retained Earnings—Vespa .................................................. Equipment .........................................................................

2,400 1,600

7,500

4,000

Tax: Deferred Tax Asset .............................................................. Retained Earnings—Coors................................................ Retained Earnings—Vespa ...............................................

2,651* 2,171* 480*

*Increase in Deferred Tax Assets: Gain on machine (net) ($4,000 × 30%) ..................................... Secondary tax ($4,000 × 70% × 60% × 30% × 20%)** ............. Equipment depreciation ($4,500 parent share × 30%).............. Total .....................................................................................

Total

Controlling

NCI

$1,200 101 1,350 $2,651

$ 720 101 1,350 $2,171

$480 $480

**100% – 80% dividend exclusion Adjustments to income: Sales .......................................................................................... Cost of Goods Sold ..............................................................

15,000

Cost of Goods Sold .................................................................... Inventory ..............................................................................

500

Depreciation Expense—Machine ............................................... Accumulated Depreciation—Machine ..................................

5,000

Accumulated Depreciation—Machine ........................................ Depreciation Expense—Machine .........................................

1,000

15,000 500 5,000 1,000

Tax: Deferred Tax Asset** ................................................................. Provision for Tax ..................................................................

725 725

**Increase in Deferred Tax Assets: Total Machine gain realized (30% × $1,000) ................................... $(300) Secondary tax ($1,000 × 70% × 60% × 30% × 20%) ............. (25) Inventory (30% × $500) .......................................................... 150 Machine depreciation (30% × $5,000 × 60% parent share) ........................................................................ 900 Total ........................................................................................ $ 725

Controlling

NCI

$(180) (25) 150

$(120)

900 $ 845

$(120)

6–13

Ch. 6—Problems

PROBLEMS PROBLEM 6-1 Determination and Distribution of Excess Schedule, Investment in Marion Company

Company Implied Fair Value $850,000

Parent Price (80%) $680,000

NCI Value (20%) $170,000

650,000

$650,000 80% $520,000

$650,000 20% $130,000

$200,000

$160,000

$ 40,000

Worksheet Key debit D1 debit D2

Life 5

Adjustment of identifiable accounts:

Equipment ......................................... Goodwill ............................................ Total ............................................

Adjustment $ 50,000 150,000 $200,000

Amortization per Year $10,000

Ch. 6—Problems

6–14

Problem 6-1, Concluded Lange Company and Subsidiary Marion Company Consolidated Statement of Cash Flows For Year Ended December 31, 2016 Cash flows from operating activities: Consolidated net income ($262,000 + $15,000) ........................ Adjustments to reconcile net income to net cash: Depreciation expense ($1,292,000 – $1,086,000) ............... Increase in inventory ............................................................ Increase in accounts receivable ........................................... Increase in accounts payable ............................................... Equity income from Charles Corporation in excess of dividends* ...................................................................... Total adjustments ........................................................... Net cash provided by operating activities ............................. Cash flows from investing activities: Purchase of building................................................................... Purchase of equipment .............................................................. Investment in Charles ................................................................ Net cash used in investing activities .................................... Cash flows from financing activities: Proceeds of bond sale ............................................................... Dividend payments to controlling interests................................. Dividend payments to NCI ($15,000 × 20%) .............................. Net cash provided by financing activities ............................. Net increase in cash ........................................................................ Cash at beginning of year ................................................................ Cash at year-end .............................................................................

$ 277,000 $ 206,000 (40,000) (100,000) 83,000 (14,500) 134,500 $ 411,500 $(350,000) (70,000) (230,000) (650,000) $ 350,000 (100,000) (3,000) 247,000 8,500 16,000 $ 24,500 $

*Equity income from the investment in Charles provides funds only to the extent of dividends received. The excess equity income must be deducted from consolidated net income in determining funds provided by net income. 30% of reported Charles income (30% × $80,000) ........................ Less amortization of excess {[$230,000 – ($700,000 × 30%)]/10 years} ..................................................... Equity income ................................................................................. Less dividends received (30% × $25,000) ..................................... Noncash income.............................................................................

$24,000 2,000 $22,000 7,500 $14,500

6–15

Ch. 6—Problems

PROBLEM 6-2 Determination and Distribution of Excess Schedule, Investment in Rush Corporation

Company Implied Fair Value $550,000 $150,000 300,000 $450,000

$100,000

Parent Price (90%) $495,000

NCI Value (10%) $ 55,000

$450,000 90% $405,000

$450,000 10% $ 45,000

$ 90,000

$ 10,000

Worksheet Key debit D1 debit D2

Life 5

Adjustment of identifiable accounts:

Equipment ......................................... Goodwill ............................................ Total ............................................

Adjustment $ 20,000 80,000 $100,000

Amortization per Year $4,000

Ch. 6—Problems

6–16

Problem 6-2, Concluded Billing Enterprises and Subsidiary Rush Corporation Consolidated Statement of Cash Flows For Year Ended December 31, 2015 Cash flows from operating activities: Consolidated net income............................................................ Adjustments to reconcile net income to net cash: Depreciation expense (includes amortization of excess on equipment) ................................................ Decrease in accounts receivable ......................................... Decrease in accounts payable ............................................. Total adjustments ........................................................... Net cash provided by operating activities ............................. Cash flows from investing activities: Payment for purchase of Rush Corporation, $95,000 cash net of $60,000 cash acquired ..................................................... Cash flows from financing activities: Sale of bonds ($500,000 increase – $400,000 issued to Rush) .................................................................... Dividends paid to noncontrolling shareholders .......................... Decrease in long-term liabilities ................................................. Net increase in cash................................................................... Cash at beginning of year .......................................................... Cash at year-end........................................................................

$ 92,300 $ 72,400* 54,000 (17,000) 109,400 $201,700 (35,000) $ 100,000 (1,000) (160,000)

(61,000) $105,700 82,000 $187,700

*$870,000 Billing + $460,000 Rush + $20,000 adjustment for excess less current balance of $1,277,600 = $72,400 depreciation. Schedule of noncash investing activity: Billing Enterprises acquired 90% of the capital stock of Rush Corporation for $495,000. In conjunction with the acquisition, liabilities were assumed and a noncontrolling interest created as follows: Adjusted value of assets acquired ($615,000 book value + $100,000 excess) .................................................

$715,000

Cash paid .........................................................................................

95,000

Balance ............................................................................................

$620,000

Bonds issued ...................................................................................

$400,000

Liabilities assumed...........................................................................

$165,000

Noncontrolling interest (see D&D schedule) ....................................

$ 55,000

6–17

Ch. 6—Problems

PROBLEM 6-3 Bush, Inc., and Subsidiary Dorr Corporation Consolidated Statement of Cash Flows For Year Ended December 31, 2016 Cash flows from operating activities: Consolidated net income............................................................ Adjustments to reconcile net income to net cash: Gain on sale of equipment ................................................... Depreciation expense .......................................................... Reduction of negative allowance for marketable securities . Decrease in accounts receivable ......................................... Increase in inventory ............................................................ Increase in accounts payable ............................................... Increase in deferred income tax ........................................... Total adjustments ........................................................... Net cash provided by operating activities ............................. Cash flows from investing activities: Purchase of equipment .............................................................. Sale of equipment ...................................................................... Net cash used in investing activities .................................... Cash flows from financing activities: Sale of treasury stock................................................................. Dividend payments to controlling interests................................. Dividend payments to NCI ......................................................... Payment on long-term note payable .......................................... Net cash used in financing activities .................................... Net increase in cash ........................................................................ Cash at beginning of year ................................................................ Cash at year-end .............................................................................

$ 234,000 $

(6,000) 82,000 (11,000) 22,000 (70,000) 121,000 12,000 150,000 $ 384,000

$(127,000) 40,000 (87,000) $ 44,000 (58,000) (15,000) (150,000) (179,000) $ 118,000 195,000 $ 313,000

Schedule of noncash investing and financing activities: Bush, Inc., issued 10,000 shares of its common stock for land with a fair value of $215,000 on January 20, 2016.

Ch. 6—Problems

6–18

Problem 6-3, Concluded Bush, Inc. and Subsidiary Dorr Corporation Worksheet for Analysis of Cash Flows: Indirect Method For Year Ended December 31, 2016

Marketable Equity Securities ........... Allowance, Lower Cost or Market.... Accounts Receivable (net) .............. Inventory ......................................... Land ................................................ Plant and Equipment ....................... Accumulated Depreciation .............. Goodwill (net) .................................. Current Portion, Long-Term Debt .... Accounts Payable and Accrued Liabilities .................................. Note Payable, Long-Term ............... Deferred Income Taxes ................... NCI .................................................. Common Stock ($10 par) ................ Paid-In Capital in Excess of Par ......

Account Change Debit Credit 0 .......... 11,000 .......... .......... 22,000 70,000 .......... 215,000 .......... 65,000 .......... .......... 54,000 .......... 0 .......... 0 .......... 150,000 .......... .......... .......... .......... .......... .......... ......... 511,000 118,000

121,000 .......... 12,000 18,000 100,000 123,000 .......... 143,000 36,000 629,000 0

.......... .......... ..........

Net Cash from Operations ..............

.......... .......... .......... .......... .......... .......... ..........

Cash from Investing: Purchase Equipment ....................... Sale of Equipment ........................... Net Cash from Investing ..................

.......... .......... ..........

Net Cash from Financing ................

.......... .......... .......... .......... .......... ..........

Net Cash Provided ..........................

..........

Retained Earnings........................... Treasury Stock (at cost) .................. Net Change in Cash ........................ Cash from Operations: Net Income ...................................... Gain on Equipment ......................... Increase in Deferred Tax ................. Decrease in Allowance—Short-Term Marketable Securities .................. Decrease in Accounts Receivable... Depreciation Expense ..................... Increase in Inventory ....................... Increase in Accounts Payable .........

Cash from Financing: Sale of Treasury Stock .................... Pay Dividend ................................... Subsidiary Dividend ........................ Payment on Long-Term Note Payable

(9) (12) (2) (5) (6)

(14) (7)

(4)

(1) (8) (10) (11) (13)

(6)

(3)

Explanations Debit .......... 11,000 .......... (10) 70,000 215,000 127,000 (6) 28,000 (11) .......... ..........

Credit ......... ......... 22,000 ......... ......... 62,000 82,000 ......... .........

Balance 0 0 0 0 0 0 0 0 0

.......... 150,000 .......... 15,000 .......... .......... .......... 58,000 .......... 674,000 118,000

(8) (1) (2) (2) (3) (1) (3)

121,000 ......... 12,000 33,000 100,000 115,000 8,000 201,000 36,000 792,000 0

0 0 0 0 0

(6)

......... 6,000 .........

234,000 .......... 12,000 .......... 22,000 82,000 .......... 121,000 471,000 384,000 .......... 40,000 .......... 44,000 .......... .......... .......... .......... .......... 118,000

(13)

(9) (12)

(5)

(4) (7) (14)

0 0 0

11,000 ......... ......... 70,000 ......... 87,000 ......... 127,000 ......... 87,000 ......... 58,000 15,000 150,000 223,000 179,000 .........

Schedule of noncash investing and financing activities: Explanation

Item

Amount

Stock for land ..................................

(2)

215,000

6–19

Ch. 6—Problems

PROBLEM 6-4 Subsidiary calculations: BEPS

DEPS =

$56,000

$4,000 preferred dividends = $4.33 12,000

$52,000 + $4,000 preferred dividends = $4.12 12,000 + 1,600 a

Preferred stock is dilutive, $4,000 ÷ 1,600 = $2.50 Shares = 800 preferred shares × 2 shares of common

Consolidated calculations: BEPS = =

$55,000

$500 preferred dividends + (9,600b × $4.33) 20,000

$55,000

$500 + $41,568 20,000

= $4.80 b

12,000 Sunny shares × 80% interest

DEPS = =

$55,000

$500 preferred dividends + (10,560 c × $4.12 Sunny DEPS) 20,000 + 245d

$55,000 $500 + $43,507 20,000 + 245

= $4.84 c

9,600 common stock shares + 60% of 1,600 common shares assumed issued on conversion of convertible preferred stock

Quarter 1 2 3 4

Dilutive no no yes yes

Shares Outstanding

Total Shares Acquired

Share Adjustment

3,000 3,000

$36,000 ÷ 13 = 2,769 $36,000 ÷ 16 = 2,250

231 750 981 245

Average (for four quarters) =

Ch. 6—Problems

6–20

PROBLEM 6-5 Determination and Distribution of Excess Schedule, Investment in Mercer Company Company Implied Fair Value $375,000

Fair value of subsidiary ..................... Less book value of interest acquired: Common stock ($2 par)............... Paid-in capital in excess of par ... Retained earnings ....................... Total equity ............................ Interest acquired ......................... Book value ........................................ Excess of fair value over book value............................................

$ 20,000 50,000 100,000 $170,000

$205,000

Parent Price (80%) $300,000

NCI Value (20%) $ 75,000

$170,000 80% $136,000

$170,000 20% $ 34,000

$164,000

$ 41,000

Worksheet Key debit D1 debit D2

Life 8

Adjustment of identifiable accounts:

Equipment ......................................... Goodwill ............................................ Total ............................................

Sales ..................................... Less cost of goods sold ........ Gross profit ........................... Expenses ..............................

Adjustment $100,000 105,000 $205,000

Dawn $(1,000,000) 800,000

80,000

Mercer $(600,000) 375,000

185,000

Eliminations and Adjustments (IS) $50,000 (IS) (50,000) (BI) (1,425) (EI) 2,430 (F2) (A)

(8,000) 12,500

Income before tax ................. Less provision for tax ........... Consolidated net income ...... Less NCI ............................... Controlling interest ................ Tax provision: Consolidated income before tax..................................... Add, amortization applicable to NCI, 20% × $12,500 .... Taxable income .............................................................. Tax provision at 30%......................................................

Amortization per Year $12,500

Consolidated Income Statement $(1,550,000) 1,126,005 $ (423,995) 269,500 $ (154,495) 47,098 $ (107,397) 3,083 $ (104,314)

$154,495 2,500 $156,995 $ 47,098

6–21

Ch. 6—Problems

Problem 6-5, Concluded

Eliminations and Adjustments: (IS) (BI)

Eliminate intercompany sales. Adjustment for beginning inventory profit: Sold by Mercer (0.25 × $2,500) = $ 625 Sold by Dawn (0.40 × $2,000) = 800 Total $1,425

(EI)

Adjustment for ending inventory profit: Sold by Mercer (0.25 × $3,000) = $ 750 Sold by Dawn (0.40 × $4,200) = 1,680 Total $2,430

(F2) (A)

Reduce depreciation for profit on machine sale, $40,000 ÷ 5 = $8,000. Amortize $12,500 excess. Subsidiary Mercer Company Income Distribution

Profit in ending inventory ...... (EI) $ 750 Depreciation adjustment ....... (A) 12,500

Internally generated income ... $40,000 Profit, beginning inventory ..... (BI) 625 Adjusted income .................... Tax provision (see schedule) Net income ............................. NCI share of income (see schedule)..................

Subsidiary tax schedule: (1) Total adjusted income................................... (2) NCI share of asset adjustments.................... (3) Taxable income ............................................ (4) Tax ................................................................ (5) Net of tax share of income (line 1 – line 4) ...

Controlling $21,900 $21,900 $ 6,570 $15,330

NCI $5,475 2,500 $7,975 $2,392 $3,083

$27,375 8,962 $18,413 $ 3,083 Total $27,375* 2,500 $29,875 $ 8,962 $18,413

*From subsidiary’s IDS. Parent Dawn Corporation Income Distribution Profit in ending inventory ...... (EI)

$1,680

Internally generated income ... $120,000 Profit, beginning inventory ..... (BI) 800 Gain realized through use of machine........................ (F2) 8,000 Adjusted income .................... Tax provision (30%) ............... Net income ............................. Share of sub net-of-tax income (see schedule).................. Controlling interest .................

$127,120 38,136 $ 88,984 15,330 $104,314

Ch. 6—Problems

6–22

PROBLEM 6-6 Determination and Distribution of Excess Schedule, Investment in Salty Company

Company Implied Fair Value $337,500

Parent Price (80%) $270,000

NCI Value (20%) $ 67,500

300,000

$300,000 80% $240,000

$300,000 20% $ 60,000

$ 37,500

$ 30,000

Adjustment $37,500

Worksheet Key debit D

7,500

Adjustment of identifiable accounts:

Goodwill ............................................

Life

Amortization per Year

6–23

Ch. 6—Problems

Problem 6-6, Continued Pepper Company and Subsidiary Salty Company Worksheet for Consolidated Financial Statements For Year Ended December 31, 2015 Eliminations Consolidated Controlling Trial Balance and Adjustments Income Retained Pepper Salty Dr. Cr. Statement NCI Earnings Inventory, December 31 ......................... 100,000 50,000 .......... (EI) 4,000 ......... .......... .......... Other Current Assets ............................. 198,000 200,000 .......... .......... ......... .......... .......... Investment in Salty Company ................ 302,000 .......... (CY2) 8,000 (CY1) 40,000 ......... .......... .......... .......... .......... .......... (EL) 240,000 ......... .......... .......... .......... .......... .......... (D) 30,000 ......... .......... .......... Land ....................................................... 240,000 100,000 .......... (F1) 10,000 ......... .......... .......... Buildings and Equipment ....................... 300,000 200,000 .......... .......... ......... .......... .......... Accumulated Depreciation ..................... (80,000) (60,000) .......... .......... ......... .......... .......... Goodwill ................................................. .......... .......... (D) 37,500 .......... ......... .......... .......... Current Liabilities ................................... (150,000) (50,000) .......... .......... ......... .......... .......... Long-Term Liabilities .............................. (200,000) (100,000) .......... .......... ......... .......... .......... Common Stock—Pepper ....................... (100,000) .......... .......... .......... ......... .......... .......... Paid-In Capital in Excess of Par—Pepper (180,000) .......... .......... .......... ......... .......... .......... Retained Earnings—Pepper .................. (320,000) .......... .......... .......... ......... .......... (320,000) Common Stock—Salty ........................... .......... (50,000) (EL) 40,000 .......... ......... (10,000) .......... Paid-In Capital in Excess of Par—Salty .......... (100,000) (EL) 80,000 .......... ......... (20,000) .......... Retained Earnings—Salty ...................... .......... (150,000) (EL) 120,000 (NCI) 7,500 ......... (37,500) .......... Sales ...................................................... (500,000) (300,000) (IS) 50,000 .......... (750,000) .......... .......... Cost of Goods Sold ................................ 300,000 180,000 (EI) 4,000 (IS) 50,000 434,000 .......... .......... Operating Expenses ............................... 100,000 80,000 .......... .......... 180,000 .......... .......... Subsidiary Income.................................. (40,000) .......... (CY1) 40,000 .......... ......... .......... .......... Gain on Sale of Land ............................. .......... (10,000) (F1) 10,000 .......... ......... .......... .......... Dividends Declared—Pepper ................. 30,000 .......... .......... .......... ......... .......... 30,000 2,000 .......... Dividends Declared—Salty .................... .......... 10,000 .......... (CY2) 8,000 ......... Consolidated Income Before Tax ........... .......... .......... .......... .......... (136,000) .......... .......... Provision for Income Taxes (30%) ......... .......... .......... (T) 40,800 .......... 40,800 .......... .......... Income Taxes Payable........................... .......... .......... (DTL) 600 (T) 40,800 ......... .......... .......... DTL ........................................................ .......... .......... .......... (DTL) 600 ......... .......... .......... 0 430,900 430,900 ......... .......... .......... 0 Consolidated Net Income ............................................................................................................................... (95,200) .......... .......... To NCI (see distribution schedule) ............................................................................................................. 5,600 (5,600) .......... To Controlling Interest (see distribution schedule)...................................................................................... 89,600 .......... (89,600) ............ Total NCI ............................................................................................................................................................................. (71,100) Retained Earnings—Controlling Interest, December 31, 2015 .................................................................................................................. (379,600) Totals ..........................................................................................................................................................................................................................

part.

Consolidated Balance Sheet 146,000 398,000 .......... .......... .......... 330,000 500,000 (140,000) 37,500 (200,000) (300,000) (100,000) (180,000) .......... .......... .......... .......... .......... .......... .......... .......... .......... .......... .......... .......... .......... (40,200) (600) .......... .......... .......... .......... (71,100) (379,600) 0

Ch. 6—Problems

6–24

Problem 6-6, Concluded

Subsidiary Salty Company Income Distribution Gain on sale of land .............. (F1) $10,000

Internally generated income ....

$50,000

Adjusted income ..................... Tax provision (30%) ................ Net income .............................. NCI share ................................ NCI ..........................................

$40,000 12,000 $28,000 × 20% $ 5,600

Parent Pepper Company Income Distribution Profit, ending inventory ......... (EI)

$4,000

Internally generated income ....

$100,000

Adjusted income ..................... Tax at 30% .............................. 80% × Salty net income of $28,000 ......................... Controlling interest ..................

$ 96,000 (28,800) 22,400 $ 89,600

Eliminations and Adjustments: (CY1) (CY2) (EL)

Eliminate the current-year subsidiary income against the investment account. Eliminate parent’s share of subsidiary’s dividends. Eliminate 80% of the Salty Company equity balances at the beginning of the year against the investment account. (D)/(NCI) Allocate the $30,000 excess of cost and $7,500 NCI adjustment over book value to goodwill. (IS) Eliminate intercompany sales of $50,000. (EI) Eliminate the $4,000 of gross profit in the ending inventory. (F1) Eliminate the $10,000 gain on the sale of land against the land account. (T) Record 30% provision for income tax ($12,000 + $28,800). (DTL) Goodwill amortization for tax is $30,000 ÷ 15 years = $2,000. Tax deferral, 30% = $600.

6–25

Ch. 6—Problems

PROBLEM 6-7 Determination and Distribution of Excess Schedule Company Implied Fair Value $1,112,500

Parent Price (80%) $890,000

NCI Value (20%) $222,500

800,000

$800,000 80% $640,000

$800,000 20% $160,000

$ 312,500

$250,000

$ 62,500

Worksheet Key debit D1 debit D2

Life 20

Adjustment of identifiable accounts: Adjustment $200,000 112,500 $312,500

Buildings ........................................... Goodwill ............................................ Total ............................................

Account Adjustments to Be Amortized

Life

Buildings ............................... Total amortizations ..........

Annual Amount

Current Year

Prior Years

Total

Key

$10,000 $10,000

$20,000 $20,000

$30,000 $30,000

(A1)

Intercompany Inventory Profit Deferral Parent Parent Parent Sub Amount Percent Profit Amount

Beginning .............................. $40,000 Ending ................................... 30,000

Amortization per Year $10,000

50% 50

$20,000 15,000

— —

Sub Sub Percent Profit

0% 0

— —

Ch. 6—Problems

6–26

Problem 6-7, Continued

Subsidiary Stark Company Income Distribution Amortizations ................................ $10,000

Internally generated income ........ Realized gain ..............................

$ 60,000 8,000

Adjusted income ......................... Tax provision ............................... Net income .................................. NCI share (see schedule) ........... Controlling share of .....................

$ 58,000 (18,000) $ 40,000 7,520 $ 32,480

Subsidiary tax schedule: (1) Total adjusted income................................... (2) NCI share of asset adjustments ($10,000 × 20%) .................................................... (3) Taxable income ............................................ (4) Tax ................................................................ (5) Net of tax share of income (line 1 – line 4) ...

Controlling $46,400

NCI $11,600

Total $58,000

$46,400 $13,920 $32,480

2,000 $13,600 $ 4,080 $ 7,520

2,000 $60,000 $18,000 $40,000

Parent Pillar Company Income Distribution Ending inventory profit ..................

$15,000 Internally generated net income................................... Beginning inventory profit ........... Adjusted income ......................... Tax provision ............................... Net income .................................. Controlling share of subsidiary .............................. Controlling interest ......................

$100,000 20,000 $105,000 (31,500) $ 73,500 32,480 $105,980

6–27

Ch. 6—Problems

Problem 6-7, Continued Pillar Company and Subsidiary Stark Company Worksheet for Consolidated Financial Statements For Year Ended December 31, 2017

Cash....................................................... Accounts Receivable.............................. Inventory ................................................ Investment in Stark ................................ Plant and Equipment .............................. Accumulated Depreciation ..................... Goodwill ................................................. Liabilities ................................................ Deferred Tax Liability ............................. Common Stock—Stark ........................... Retained Earnings, January 1, 2017 —Stark ............................................... Common Stock—Pillar ........................... Retained Earnings, January 1, 2017 —Pillar ................................................

Trial Balance Pillar Stark 208,600 380,000 130,000 150,000 120,000 80,000 1,098,000 .......... .......... .......... .......... .......... 600,000 900,000 (350,000) (300,000) .......... .......... .......... .......... .......... .......... (205,000) (150,000) (3,600) .......... .......... (300,000)

(D1) (F1) (F2) (D2) (IA) (EL)

Eliminations and Adjustments Dr. Cr. .......... .......... .......... (IA) 8,000 .......... (EI) 15,000 .......... (CY1) 48,000 .......... (EL) 800,000 .......... (D) 250,000 200,000 (F1) 40,000 .......... (A1) 30,000 16,000 .......... 8,000 .......... 112,500 .......... 8,000 .......... .......... (DTL) 1,800 240,000 ..........

.......... .......... .......... (500,000)

(700,000) .......... .......... ..........

(EL) (A1) (F2)

560,000 4,000 4,800 ..........

(950,000) .......... ..........

.......... .......... ..........

(A1) (BI) (F1)

16,000 20,000 19,200

(NCI)

Consolidated Income Statement ......... ......... ......... ......... ......... ......... ......... ......... ......... ......... ......... ......... ......... .........

NCI .......... .......... .......... .......... .......... .......... .......... .......... .......... .......... .......... .......... .......... (60,000)

Controlling Retained Earnings .......... .......... .......... .......... .......... .......... .......... .......... .......... .......... .......... .......... .......... ..........

Consolidated Balance Sheet 588,600 272,000 185,000 .......... .......... .......... 1,660,000 .......... .......... (656,000) 112,500 (347,000) (5,400) ..........

62,500 .......... .......... ..........

......... ......... ......... .........

.......... .......... (193,700) ..........

.......... .......... .......... ..........

.......... .......... .......... (500,000)

.......... .......... ..........

......... ......... .........

.......... .......... ..........

.......... .......... (894,800)

.......... .......... ..........

part.

Ch. 6—Problems

6–28

Problem 6-7, Concluded Pillar Company and Subsidiary Stark Company Worksheet for Consolidated Financial Statements For Year Ended December 31, 2017 (Concluded) Trial Balance Pillar Stark Sales ...................................................... (800,000) (550,000) Cost of Goods Sold ................................ 430,000 320,000 .......... .......... Depreciation Expense ............................ 60,000 50,000 .......... .......... Other Expenses ..................................... 210,000 120,000 .......... .......... .......... Subsidiary Income.................................. (48,000) Totals .................................................. 0 0 Consolidated Income Before Tax ................................................... Consolidated Tax Provision ........................................................... Income Tax Payable ...................................................................... Consolidated Net Income ............................................................... To NCI (see distribution schedule) ............................................. To Controlling Interest (see distribution schedule)...................... Total NCI ........................................................................................ Retained Earnings—Controlling Interest, December 31, 2017 ....... Totals ..........................................................................................

Eliminations and Adjustments Dr. Cr. (IS) 70,000 .......... .......... (IS) 70,000 (EI) 15,000 (BI) 20,000 (A1) 10,000 .......... .......... (F2) 8,000 .......... .......... .......... .......... (CY1) 48,000 .......... .......... .......... .......... .......... (T) 49,500 .......... (DTL) 1,800 (T) 49,500 .......... .......... .......... .......... .......... .......... .......... .......... .......... .......... 1,402,800 1,402,800

Consolidated Income Statement (1,280,000) ......... 675,000 ......... 112,000 330,000 ......... ......... ......... (163,000) 49,500 ......... (113,500) 7,520 105,980

Controlling Retained NCI Earnings .......... .......... .......... .......... .......... .......... .......... .......... .......... .......... .......... .......... .......... .......... .......... .......... .......... .......... .......... .......... .......... .......... .......... .......... .......... .......... (7,520) .......... .......... (105,980) .......... (261,220) (1,000,780)

Consolidated Balance Sheet .......... .......... .......... .......... .......... .......... .......... .......... .......... .......... .......... (47,700) .......... .......... .......... (261,220) (1,000,780) 0

Eliminations and Adjustments: (CY1) Current-year subsidiary income. (EL) Eliminate controlling interest in subsidiary equity. (D)/(NCI) Distribute excess and adjust NCI per D&D schedule. (A) Amortize excess. (IS) Eliminate intercompany sales during current period. (IA) Eliminate intercompany unpaid trade accounts. (BI) Defer beginning inventory profit.

(EI) (F1) (F2) (T) (DTL)

Defer ending inventory profit. Fixed asset profit at beginning of year. Fixed asset profit realized. Subsidiary share of tax from IDS plus parent share of tax from IDS ($18,000 + $31,500). Goodwill amortization for tax, [(80% × $112,500)/15 × 30% tax rate].

part.

6–29

Ch. 6—Problems

PROBLEM 6-8

(1) Determination and Distribution of Excess Schedule Company Implied Fair Value Fair value of subsidiary .............. $625,000 Less book value of interest acquired: Common stock ...................... $ 10,000 Paid-in capital in excess of par 190,000 Retained earnings ................. 170,000 Total equity ...................... $370,000 Interest acquired ................... Book value ................................. Excess of fair value over book value ...................................... $255,000

Parent Price (80%) $500,000

NCI Value (20%) $125,000

$370,000 80% $296,000

$370,000 20% $ 74,000

$204,000

$ 51,000

Adjustment of identifiable accounts: Adjustment $ 70,000 50,000 135,000 $255,000

Buildings .................................... Equipment.................................. Goodwill ..................................... Total ......................................

Worksheet Key debit D1 debit D2 debit D3

Life 20 5

Amortization per Year $ 3,500 10,000

(2) Worksheet and Support Schedules Account Adjustments to Be Amortized

Life

Buildings ........................ Equipment...................... Total amortizations ....

20 5

Annual Amount

Current Year

Prior Years

Total

Key

$ 3,500 10,000 $13,500

$ 7,000 20,000 $27,000

(A1) (A2)

Intercompany Inventory Profit Deferral Parent Parent Parent Sub Amount Percent Profit Amount

Beginning ....................... Ending ...........................

— —

0% 0

— —

$12,000 16,000

Sub Sub Percent Profit

30% $3,600 30 4,800

Ch. 6—Problems

6–30

Problem 6-8, Continued

Subsidiary Solar Company Income Distribution Ending inventory profit ................ Amortizations ..............................

$ 4,800 13,500

Subsidiary tax schedule: (1) Total adjusted income ............................. (2) NCI share of asset adjustments .............. (3) Taxable income ...................................... (4) Tax .......................................................... (5) Net of tax share of income (line 1 – line 4) ........................................

Internally generated income ........ Beginning inventory profit ............

$ 42,000 3,600

Adjusted income .......................... Tax provision ............................... Net income................................... NCI share (see schedule) ............ Controlling share..........................

$ 27,300 (12,000) $ 15,300 2,196 $ 13,104

$21,840 $ 8,736

NCI $5,460 2,700 $8,160 $3,264

$27,300 $12,000

$13,104

$2,196

$15,300

Controlling $21,840

Total $27,300

Parent Parson Company Income Distribution Internally generated income ........ Realized gain ...............................

$205,000 6,000

Adjusted income .......................... Tax provision ............................... Net income................................... Controlling share of subsidiary (net of tax)............. Controlling interest .......................

$211,000 (84,400) $126,600 13,104 $139,704

6–31

Ch. 6—Problems

Problem 6-8, Continued Parson Company and Subsidiary Solar Company Worksheet for Consolidated Financial Statements For Year Ended December 31, 2016

Cash......................................................... Accounts Receivable................................ Inventory .................................................. Land ......................................................... Investment in Solar .................................. ............................................................. ............................................................. ............................................................. Buildings .................................................. Accumulated Depreciation ....................... Equipment ................................................ Accumulated Depreciation ....................... Goodwill ................................................... Accounts Payable .................................... Bonds Payable ......................................... Deferred Tax Liability ............................... Common Stock—Solar ............................. Paid-In Capital in Excess of Par—Solar ... Retained Earnings—Solar ........................ ............................................................. ............................................................. ............................................................. Common Stock—Parson .......................... Paid-In Capital in Excess of Par—Parson Retained Earnings—Parson .....................

Eliminations Trial Balance and Adjustments Parson Solar Dr. Cr. 46,080 54,000 .......... .......... 150,600 90,000 .......... (IA) 6,000 105,000 90,000 .......... (EI) 4,800 100,000 150,000 .......... .......... 567,200 .......... .......... (CY1) 33,600 .......... .......... (CY2) 8,000 .......... .......... .......... .......... (EL) 337,600 .......... .......... .......... (D) 204,000 800,000 250,000 (D1) 70,000 .......... (250,000) (70,000) .......... (A1) 7,000 210,000 120,000 (D2) 50,000 (F1) 30,000 (115,000) (90,000) .......... (A2) 20,000 .......... .......... (F1) 6,000 .......... .......... .......... (F2) 6,000 .......... .......... .......... (D3) 135,000 .......... (70,000) (40,000) (IA) 6,000 .......... .......... (100,000) .......... .......... (2,880) .......... .......... (DTL) 2,880 .......... (10,000) (EL) 8,000 .......... .......... (190,000) (EL) 152,000 .......... .......... (222,000) (EL) 177,600 (NCI) 51,000 .......... .......... (BI) 720 .......... .......... .......... (A1–A3) 2,700 .......... .......... .......... .......... .......... (100,000) .......... .......... .......... (600,000) .......... .......... .......... (622,400) .......... (A1–A3) 10,800 .......... .......... .......... (BI) 2,880 .......... .......... .......... (F1) 24,000 ..........

NCI .......... .......... .......... .......... .......... .......... .......... .......... .......... .......... .......... .......... .......... .......... .......... .......... .......... .......... (2,000) (38,000) .......... .......... .......... (91,980) .......... .......... .......... .......... ..........

part.

Consolidated Balance Sheet 100,080 234,600 190,200 250,000 .......... .......... .......... .......... 1,120,000 (327,000) 350,000 .......... .......... (213,000) 135,000 (104,000) (100,000) (5,760) .......... .......... .......... .......... .......... .......... (100,000) (600,000) .......... .......... ..........

Ch. 6—Problems

6–32

Problem 6-8, Concluded Parson Company and Subsidiary Solar Company Worksheet for Consolidated Financial Statements For Year Ended December 31, 2016 (Concluded) Trial Balance Parson Solar Sales ........................................................ (890,000) (350,000) Cost of Goods Sold .................................. 480,000 220,000 ............................................................. .......... .......... Depreciation Expense—Buildings ............ 30,000 10,000 Depreciation Expense—Equipment ......... 25,000 10,000 ............................................................. .......... .......... Other Expenses ....................................... 150,000 60,000 Interest Expense ...................................... .......... 8,000 Subsidiary Income.................................... (33,600) .......... Dividends Declared—Solar ...................... .......... 10,000 Dividends Declared—Parson ................... 20,000 .......... 0 Totals .................................................... 0 Consolidated Income Before Tax ................................................... Consolidated Tax Provision ........................................................... Income Tax Payable ...................................................................... Consolidated Net Income ............................................................... To NCI (see distribution schedule) ............................................. To Controlling Interest (see distribution schedule)...................... Total NCI ........................................................................................ Retained Earnings—Controlling Interest, December 31, 2016 ....... Totals ..........................................................................................

(IS) (EI) (A1) (A2)

(CY1)

(T) (DTL)

Eliminations and Adjustments Dr. Cr. 30,000 .......... .......... (IS) 30,000 4,800 (BI) 3,600 3,500 .......... 10,000 .......... .......... (F2) 6,000 .......... .......... .......... .......... 33,600 .......... .......... (CY2) 8,000 .......... .......... .......... .......... .......... .......... 96,400 .......... 2,880 (T) 96,400 .......... .......... .......... .......... .......... .......... .......... .......... .......... .......... 840,880 840,880

Consolidated Income Statement (1,210,000) ......... 671,200 43,500 ......... 39,000 210,000 8,000 ......... ......... ......... ......... (238,300) 96,400 ......... (141,900) 2,196 139,704

NCI .......... .......... .......... .......... .......... .......... .......... .......... .......... 2,000 .......... .......... .......... .......... .......... .......... (2,196) .......... (132,176)

Controlling Retained Earnings .......... .......... .......... .......... .......... .......... .......... .......... .......... .......... 20,000 .......... .......... .......... .......... .......... .......... (139,704) .......... (704,424)

Consolidated Balance Sheet .......... .......... .......... .......... .......... .......... .......... .......... .......... .......... .......... .......... .......... .......... (93,520) .......... .......... .......... (132,176) (704,424) 0

Eliminations and Adjustments: (CY1) Current-year subsidiary income. Current-year dividend. (CY2) (EL) Eliminate controlling interest in subsidiary equity. (D)/(NCI) Distribute excess and adjust NCI per D&D schedule. (A) Amortize excess. (IS) Eliminate intercompany sales during current period. (IA) Eliminate intercompany unpaid trade accounts.

(BI) (EI) (F1) (F2) (T) (DTL)

Defer beginning inventory profit. Defer ending inventory profit. Fixed asset profit at beginning of year. Fixed asset profit realized. Taxation as consolidated firm ($12,000 + $84,400 = $96,400). Goodwill amortization for tax, $135,000/15 = $9,000. $9,000 × 80% × 40% tax = $2,880 per year.

part.

6–33

Ch. 6—Problems

PROBLEM 6-9

(1) Determination and Distribution of Excess Schedule Company Implied Fair Value Fair value of subsidiary .............. $625,000 Less book value of interest acquired: Common stock ....................... $ 10,000 Paid-in capital in excess of par 190,000 Retained earnings .................. 170,000 Total equity ......................... $370,000 Interest acquired..................... Book value ................................. Excess of fair value over book value ....................................... $255,000

Parent Price (80%) $500,000

NCI Value (20%) $125,000

$370,000 80% $296,000

$370,000 20% $ 74,000

$204,000

$ 51,000

Worksheet Key debit D1 debit D2 debit D3

Life 20 5

Adjustment of identifiable accounts: Adjustment $ 70,000 50,000 135,000 $255,000

Buildings .................................... Equipment.................................. Goodwill ..................................... Total ......................................

(2)

Account Adjustments to Be Amortized

Buildings ........................ Equipment...................... Total amortizations ....

Life

20 5

Annual Amount

Current Year

Prior Years

Total

Key

$ 3,500 10,000 $13,500

$ 7,000 20,000 $27,000

$10,500 30,000 $40,500

(A1) (A2)

Intercompany Inventory Profit Deferral Parent Parent Parent Sub Amount Percent Profit Amount

Beginning ....................... $ — Ending ........................... 15,000

Amortization per Year $ 3,500 10,000

0% 40

$ — 6,000

$16,000 10,000

Sub Sub Percent Profit

30% $4,800 30 3,000

Ch. 6—Problems

6–34

Problem 6-9, Continued

Subsidiary Solar Company Income Distribution Amortizations .............................. Ending inventory profit ................ Equipment gain ...........................

$13,500 3,000 25,000

Internally generated income ........ Beginning inventory profit ............ Realized gain ...............................

$ 72,000 4,800 5,000

Adjusted income .......................... Tax provision (see schedule) ....... Net income................................... NCI share (see schedule) ............ Controlling share..........................

$ 40,300 (17,200) $ 23,100 3,756 $ 19,344

$32,240 $12,896

NCI $ 8,060 2,700 $10,760 $ 4,304

$40,300 $17,200

$19,344

$ 3,756

$23,100

Controlling $32,240

Total $40,300

Parent Parson Company Income Distribution Ending inventory profit ................... $6,000

Internally generated income ........ Realized gain ...............................

$159,000 6,000

Adjusted income .......................... Tax provision (40%) ..................... Net income................................... Controlling share of subsidiary (net of tax)............. Controlling interest .......................

$159,000 63,600) $ 95,400 19,344 $114,744

6–35

Ch. 6—Problems

Problem 6-9, Continued Parson Company and Subsidiary Solar Company Worksheet for Consolidated Financial Statements For Year Ended December 31, 2016

Cash....................................................... Accounts Receivable.............................. Inventory ................................................ Land ....................................................... Investment in Solar ................................

Buildings ................................................ Accumulated Depreciation ..................... Equipment .............................................. Accumulated Depreciation ..................... Goodwill ................................................. Accounts Payable .................................. Bonds Payable ....................................... Deferred Tax Liability ............................. Common Stock—Solar ........................... Paid-In Capital in Excess of Par—Solar . Retained Earnings—Solar ......................

Common Stock—Parson ........................ Paid-In Capital in Excess of Par —Parson ............................................ Retained Earnings—Parson ...................

Eliminations Trial Balance and Adjustments Parson Solar Dr. Cr. 49,760 80,000 .......... .......... 150,600 100,000 .......... (IA) 18,000 115,000 120,000 .......... (EI) 9,000 100,000 150,000 .......... .......... 604,000 .......... .......... (CY1) 57,600 .......... .......... (CY2) 8,000 .......... .......... .......... .......... (EL) 350,400 .......... .......... .......... (D) 204,000 900,000 250,000 (D1) 70,000 .......... (290,000) (80,000) .......... (A1) 10,500 210,000 120,000 (D2) 50,000 (F1) 55,000 (140,000) (100,000) .......... (A2) 30,000 .......... .......... (F1) 12,000 .......... .......... .......... (F2) 11,000 .......... .......... .......... (D3) 135,000 .......... (50,000) (40,000) (IA) 18,000 .......... .......... (100,000) .......... .......... (5,760) .......... .......... (DTL) 2,880 .......... (10,000) (EL) 8,000 .......... .......... (190,000) (EL) 152,000 .......... .......... (238,000) (EL) 190,400 (NCI) 51,000 .......... .......... (BI) 960 .......... .......... .......... (A1–A2) 5,400 .......... .......... .......... .......... .......... (100,000) .......... .......... .......... (600,000) (747,000) .......... ..........

.......... .......... .......... ..........

(A1–A2) (BI) (F1)

.......... 21,600 3,840 18,000

.......... .......... .......... ..........

NCI .......... .......... .......... .......... .......... .......... .......... .......... .......... .......... .......... .......... .......... .......... .......... .......... .......... .......... (2,000) (38,000) .......... .......... .......... (92,240) ..........

Consolidated Balance Sheet 129,760 232,600 226,000 250,000 .......... .......... .......... .......... 1,220,000 (380,500) 325,000 .......... .......... (247,000) 135,000 (72,000) (100,000) (8,640) .......... .......... .......... .......... .......... .......... (100,000)

.......... .......... .......... ..........

.......... .......... .......... (703,560)

(600,000) .......... .......... ..........

part.

Ch. 6—Problems

6–36

Problem 6-9, Concluded Parson Company and Subsidiary Solar Company Worksheet for Consolidated Financial Statements For Year Ended December 31, 2016 (Concluded) Trial Balance Parson Solar Sales ...................................................... (950,000) (400,000) Cost of Goods Sold ................................ 550,000 250,000 .......... .......... Depreciation Expense—Buildings ......... 40,000 10,000 Depreciation Expense—Equipment ....... 25,000 10,000 .......... .......... Other Expenses ..................................... 176,000 75,000 Interest Expense .................................... .......... 8,000 Gain on Sale of Fixed Asset ................... .......... (25,000) Subsidiary Income.................................. (57,600) .......... Dividends Declared—Solar .................... .......... 10,000 .......... Dividends Declared—Parson ................. 20,000 Totals .................................................. 0 0 Consolidated Income Before Tax ................................................... Consolidated Tax Provision ........................................................... Income Tax Payable ...................................................................... Consolidated Net Income ............................................................... To NCI (see distribution schedule) ............................................. To Controlling Interest (see distribution schedule)...................... Total NCI ........................................................................................ Retained Earnings—Controlling Interest, December 31, 2017 ....... Totals ..........................................................................................

(IS) (EI) (A1) (A2)

(F1) (CY1)

(T) (DTL)

Eliminations and Adjustments Dr. Cr. 100,000 .......... .......... (IS) 100,000 9,000 (BI) 4,800 3,500 .......... 10,000 .......... .......... (F2) 11,000 .......... .......... .......... .......... 25,000 .......... 57,600 .......... .......... (CY2) 8,000 .......... .......... .......... .......... .......... .......... 80,800 .......... 2,880 (T) 80,800 .......... .......... .......... .......... .......... .......... .......... .......... .......... .......... 992,980 992,980

Consolidated Income Statement (1,250,000) ......... 704,200 53,500 ......... 34,000 251,000 8,000 ......... ......... ......... ......... ......... (199,300) 80,800 ......... (118,500) 3,756 114,744

NCI .......... .......... .......... .......... .......... .......... .......... .......... .......... .......... 2,000 .......... .......... .......... .......... .......... .......... (3,756) .......... (133,996)

Controlling Retained Earnings .......... .......... .......... .......... .......... .......... .......... .......... .......... .......... .......... 20,000 .......... .......... .......... .......... .......... .......... (114,744) .......... (798,304)

Consolidated Balance Sheet .......... .......... .......... .......... .......... .......... .......... .......... .......... .......... .......... .......... .......... .......... .......... (77,920) .......... .......... .......... (133,996) (798,304 0

Eliminations and Adjustments: (CY1) Current-year subsidiary income. (CY2) Current-year dividend. (EL) Eliminate controlling interest in subsidiary equity. (D)/(NCI) Distribute excess and adjust NCI per D&D schedule. (A) Amortize excess. (IS) Eliminate intercompany sales during current period. (IA) Eliminate intercompany unpaid trade accounts.

(BI) Defer beginning inventory profit. (EI) Defer ending inventory profit. (F1) Fixed asset profit at beginning of year. (F2) Fixed asset profit realized. Taxation as consolidated firm ($17,200 + $63,600 = $80,800). (T) (DTL) Goodwill amortization for tax, $135,000/15 = $9,000. $9,000 × 80% × 40% tax = $2,880.

part.

6–37

Ch. 6—Problems

PROBLEM 6-10 Determination and Distribution of Excess Schedule

Company Implied Fair Value $550,000

Parent Price (70%) $385,000

NCI Value (30%) $165,000

422,000

$422,000 70% $295,400

$422,000 30% $126,600

$128,000

$ 89,600

$ 38,400

Adjustment $128,000

Worksheet Key debit D

Life

Adjustment of identifiable accounts:

Goodwill ............................................

Intercompany Inventory Profit Deferral Parent Parent Parent Sub Amount Percent Profit Amount

Beginning .............................. Ending ...................................

— —

0% 0

— —

Amortization per Year

Sub Sub Percent Profit

$10,000 20,000

30% $3,000 30 6,000

Subsidiary Solan Company Income Distribution Ending inventory profit ..................

$6,000

Internally generated income ........ Beginning inventory profit ...........

$ 80,000 3,000

Adjusted income ......................... Tax provision (30%) .................... Net income .................................. NCI share .................................... Controlling share .........................

$ 77,000 (23,100) $ 53,900 16,170 $ 37,730

Ch. 6—Problems

6–38

Problem 6-10, Continued

Parent Perko Company Income Distribution Internally generated income ........ Realized gain ..............................

$100,000 7,000

Adjusted income ......................... Tax provision (30%) .................... Net income .................................. Controlling share of subsidiary (net of first tax) ..... Second tax on subsidiary income................................... Controlling interest ......................

$107,000 (32,100) $ 74,900

DTA/DTL adjustments: To beginning retained earnings: Subsidiary transactions: Beginning inventory............................................ Remaining fixed asset profit ............................... Total ................................................................... First tax .............................................................. Second tax ......................................................... Parent transactions: Beginning inventory............................................ Remaining fixed asset profit ............................... Total ................................................................... First tax .............................................................. Increase (Decrease) in retained earnings and DTA .

To current year: Subsidiary transactions: Beginning inventory............................................ Ending inventory ................................................ Fixed asset sale ................................................. Realized fixed asset ........................................... Total ................................................................... First tax .............................................................. Second tax ......................................................... Parent transactions: Beginning inventory............................................ Ending inventory ................................................ Fixed asset sale ................................................. Remaining fixed asset profit ............................... Total ................................................................... First tax .............................................................. Increase (Decrease) in DTA ....................................

Parent $ 3,000 — $ 3,000 $ 900 $ 88

(2,264) $110,366

Sub

630 88

$ — 21,000 $21,000 6,300 $ 7,288

6,300 $ 7,018

$ (3,000) 6,000 — — $ 3,000 $ 900 $ 88

$ $

— — — (7,000) $ (7,000) $ (2,100)

37,730

630 88

270

$ (2,100)

6–39

Ch. 6—Problems

Problem 6-10, Continued Perko Company and Subsidiary Solan Company Worksheet for Consolidated Financial Statements For Year Ended December 31, 2016

Accounts Receivable.............................. Inventory ................................................ Land ....................................................... Investment in Solan................................

Buildings ................................................ Accumulated Depreciation ..................... Equipment .............................................. Accumulated Depreciation ..................... Goodwill ................................................. Accounts Payable .................................. Current Tax Liability ............................... Bond Payable ......................................... Discount (Premium) ............................... Deferred Tax Liability ............................. Common Stock—Solan .......................... Paid-In Capital in Excess of Par—Solan Retained Earnings—Solan ..................... Common Stock—Perko .......................... Paid-In Capital in Excess of Par—Perko Retained Earnings—Perko .....................

Trial Balance Perko Solan 282,576 295,000 110,000 85,000 150,000 90,000 422,800 .......... .......... .......... .......... .......... .......... .......... 200,000 200,000 (100,000) (50,000) 120,000 80,000 (35,000) (20,000) .......... .......... .......... .......... .......... .......... (120,000) (80,000) (31,260) (24,000) (200,000) (100,000) .......... .......... .......... .......... (2,268) .......... .......... .......... .......... (10,000) .......... (190,000) .......... (250,000) .......... .......... .......... .......... (100,000) .......... (200,000) .......... (450,000) .......... .......... .......... .......... ..........

(CY2)

(F2) (D)

(T1) (EL) (EL) (EL) (BI)

(BI (F1)

Eliminations and Adjustments Dr. Cr. .......... .......... .......... (EI) 6,000 .......... .......... .......... (CY1) 39,200 21,000 .......... .......... (EL) 315,000 .......... (D) 89,600 .......... .......... .......... .......... .......... (F1) 21,000 .......... .......... .......... .......... 7,000 .......... 128,000 .......... .......... .......... .......... .......... .......... .......... .......... .......... .......... .......... 7,288 .......... (T2) 1,112 7,000 .......... 133,000 .......... 175,000 (NCI) 38,400 900 (T1) 270 .......... .......... .......... .......... .......... .......... .......... .......... 2,100 (T1) 7,018 21,000 ..........

NCI .......... .......... .......... .......... .......... .......... .......... .......... .......... .......... .......... .......... .......... .......... .......... .......... .......... .......... .......... .......... .......... (3,000) (57,000) .......... .......... (112,770) .......... .......... .......... .......... ..........

part.

Consolidated Balance Sheet 577,576 189,000 240,000 .......... .......... .......... .......... 400,000 (150,000) 179,000 .......... .......... (48,000) 128,000 (200,000) (55,260) (300,000) .......... .......... .......... 3,908 .......... .......... .......... .......... .......... (100,000) (200,000) .......... .......... ..........

Ch. 6—Problems

6–40

Problem 6-10, Concluded Perko Company and Subsidiary Solan Company Worksheet for Consolidated Financial Statements For Year Ended December 31, 2016 (Concluded) Eliminations Consolidated Controlling Trial Balance and Adjustments Income Retained Perko Solan Dr. Cr. Statement NCI Earnings Sales ...................................................... (590,000) (370,000) (IS) 60,000 .......... (900,000) .......... .......... Cost of Goods Sold ................................ 340,000 220,000 .......... (IS) 60,000 ......... .......... .......... .......... .......... (EI) 6,000 (BI) 3,000 503,000 .......... .......... Depreciation Expense—Buildings .......... 15,000 8,000 .......... .......... ......... .......... .......... Depreciation Expense—Equipment ....... 20,000 12,000 .......... .......... 23,000 .......... .......... .......... .......... .......... (F2) 7,000 25,000 .......... .......... Other Expenses ..................................... 115,000 50,000 .......... .......... 165,000 .......... .......... Interest Expense .................................... .......... .......... .......... .......... ......... .......... .......... .......... .......... .......... .......... ......... .......... .......... Provision for Tax .................................... 32,352 24,000 (T2) 1,112 .......... 57,464 .......... .......... Subsidiary Income.................................. (39,200) .......... (CY1) 39,200 .......... ......... .......... .......... Dividends Declared—Solan ................... .......... 30,000 .......... (CY2) 21,000 ......... 9,000 .......... Dividends Declared—Perko ................... 60,000 .......... .......... .......... ......... .......... 60,000 0 608,600 608,600 ......... .......... .......... Totals .................................................. 0 Consolidated Net Income ............................................................................................................................... (126,536) .......... .......... (16,170) .......... To NCI (see distribution schedule) ............................................................................................................. 16,170 To Controlling Interest (see distribution schedule)...................................................................................... 110,366 .......... (110,366) .......... Total NCI ............................................................................................................................................................................. (179,940) Retained Earnings—Controlling Interest, December 31, 2016 .................................................................................................................. (484,284) Totals ..........................................................................................................................................................................................................................

Consolidated Balance Sheet .......... .......... .......... .......... .......... .......... .......... .......... .......... .......... .......... .......... .......... .......... .......... .......... .......... (179,940) (484,284) 0

Eliminations and Adjustments: (CY1) Current-year subsidiary income. Current-year dividend. (CY2) (EL) Eliminate controlling interest in subsidiary equity. (D)/(NCI) Distribute excess and adjust NCI per D&D schedule. (IS) Eliminate intercompany sales during current period. (BI) Defer beginning inventory profit. (EI) Defer ending inventory profit.

(F1) (F2) (T1) (T2)

Fixed asset profit at beginning of year. Fixed asset profit realized. Deferred tax asset (liability) applicable to beginning retained earnings. Deferred tax asset (liability) applicable to current year.

part.

6–41

Ch. 6—Problems

PROBLEM 6-11

(1) Determination and Distribution of Excess Schedule Company Implied Fair Value Fair value of subsidiary .............. $562,500 Less book value of interest acquired: Common stock ...................... $ 10,000 Paid-in capital in excess of par 190,000 Retained earnings ................. 170,000 Total equity ...................... $370,000 Interest acquired ................... Book value ................................. Excess of fair value over book value ...................................... $192,500

Parent Price (80%) $450,000

NCI Value (20%) $112,500

$370,000 80% $296,000

$370,000 20% $ 74,000

$154,000

$ 38,500

Worksheet Key debit D1 debit D2 debit D3

Life 20 5

Adjustment of identifiable accounts: Adjustment $100,000 50,000 42,500 $192,500

Buildings .................................... Equipment.................................. Goodwill ..................................... Total ...................................... (2)

Account Adjustments to Be Amortized

Buildings ........................ Equipment...................... Total amortizations ....

Life

20 5

Annual Amount

Current Year

Prior Years

Total

Key

$ 5,000 10,000 $15,000

$10,000 20,000 $30,000

(A1) (A2)

Intercompany Inventory Profit Deferral Parent Parent Parent Sub Amount Percent Profit Amount

Beginning ....................... Ending ...........................

— —

Amortization per Year $ 5,000 10,000

0% 0

— —

$12,000 16,000

Sub Sub Percent Profit

30% $3,600 30 4,800

Ch. 6—Problems

6–42

Problem 6-11, Continued

Subsidiary Stock Company Income Distribution Amortizations .............................. Ending inventory profit ................

$15,000 4,800

Subsidiary tax schedule: (1) Total adjusted income ............................. (2) NCI share of asset adjustments ($15,000 × 20%) .................................. (3) Taxable income ...................................... (4) Tax .......................................................... (5) Net income ..............................................

Internally generated income ........ Beginning inventory profit ............

$ 42,000 3,600

$ 25,800 (11,520) $ 14,280 1,896 $ 12,384

Controlling $20,640

NCI $5,160

Total $25,800

$20,640 $ 8,256 $12,384

3,000 $8,160 $3,264 $1,896

3,000 $28,800 $11,520 $14,280

Parent Penske Company Income Distribution Internally generated income ........ Realized gain ..............................

$205,000 8,000

Adjusted income ......................... Tax provision (40%) .................... Net income .................................. Controlling share of subsidiary (net of first tax) ..... Second tax on subsidiary income................................... Controlling interest ......................

$213,000 (85,200) $127,800 12,384 (991)* $139,193

*$12,384 × 20% × 40%

6–43

Ch. 6—Problems

Problem 6-11, Continued DTA/DTL adjustments: To beginning retained earnings: Subsidiary transactions: Beginning inventory............................................ Remaining fixed asset profit ............................... Amortizations (80%) ........................................... Total ................................................................... First tax .............................................................. Second tax [20% × 40% × ($14,880 – $5,952)] . Parent transactions: Beginning inventory............................................ Remaining fixed asset profit ............................... Total ................................................................... First tax .............................................................. Total retained earnings adjustments ........................

To current year: Subsidiary transactions: Beginning inventory............................................ Ending inventory ................................................ Fixed asset sale ................................................. Realized fixed asset ........................................... Amortizations (80%) ........................................... Total ................................................................... First tax .............................................................. Second tax [20% × 40% × ($12,960 – $5,184)] . Parent transactions: Beginning inventory............................................ Ending inventory ................................................ Fixed asset sale ................................................. Realized fixed asset profit .................................. Total ................................................................... First tax .............................................................. Total adjustment to provision ...................................

Total

Parent

Sub

$ 3,600 — 12,000 $15,600 $ 6,240 $ 714

$ 2,880 — 12,000 $14,880 $ 5,952 $ 714

$ 720 —

$ — 32,000 $32,000 12,800 $19,754

12,800 $19,466

$ 288

$ (2,880) 3,840

$(720) 960

12,000 $12,960 $ 5,184 $ 622

$ 240 $ 96

$ (3,600) 4,800 — — 12,000 $13,200 $ 5,280 $ 622 — — — (8,000) $ (8,000) $ (3,200) $ 2,702

$ 720 $ 288

$ (3,200) $ 2,606

$ 96

Ch. 6—Problems

6–44

Problem 6-11, Continued Penske Company and Subsidiary Stock Company Worksheet for Consolidated Financial Statements For Year Ended December 31, 2016

Cash....................................................... Accounts Receivable.............................. Inventory ................................................ Land ....................................................... Investment in Stock ................................

Buildings ................................................ Accumulated Depreciation ..................... Equipment .............................................. Accumulated Depreciation ..................... Goodwill ................................................. Accounts Payable .................................. Current Tax Liability ............................... Bonds Payable ....................................... Deferred Tax Liability ............................. Common Stock—Stock .......................... Paid-In Capital in Excess of Par—Stock Retained Earnings—Stock .....................

Common Stock—Penske ....................... Paid-In Capital in Excess of Par —Penske ............................................ Retained Earnings—Penske ..................

Eliminations Trial Balance and Adjustments Penske Stock Dr. Cr. 92,400 53,200 .......... .......... 150,600 90,000 .......... (IA) 6,000 105,000 90,000 .......... (EI) 4,800 100,000 120,000 .......... .......... 503,120 .......... .......... (CY1) 20,160 .......... .......... (CY2) 8,000 .......... .......... .......... .......... (EL) 336,960 .......... .......... .......... (D) 154,000 800,000 250,000 (D1) 100,000 .......... (250,000) (70,000) .......... (A1) 10,000 210,000 120,000 (D2) 50,000 (F1) 40,000 (115,000) (90,000) .......... (A2) 20,000 .......... .......... (F1) 8,000 .......... .......... .......... (F2) 8,000 .......... .......... 30,000 (D3) 42,500 .......... (70,000) (40,000) (IA) 6,000 .......... (82,640) (16,800) .......... .......... .......... (100,000) .......... .......... (4,250) .......... (T1) 19,754 .......... .......... .......... (T2) 2,702 .......... .......... (10,000) (EL) 8,000 .......... .......... (190,000) (EL) 152,000 .......... .......... (221,200) (EL) 176,960 (NCI) 38,500 .......... .......... (BI) 720 (T1) 288 .......... .......... (A1–A2) 3,000 .......... .......... .......... .......... .......... (100,000) .......... .......... .......... (600,000) (617,683) .......... ..........

.......... .......... .......... ..........

(A1–A2) (BI) (F1)

.......... 12,000 2,880 32,000

(T1)

.......... .......... 19,466 ..........

NCI .......... .......... .......... .......... .......... .......... .......... .......... .......... .......... .......... .......... .......... .......... .......... .......... .......... .......... .......... .......... (2,000) (38,000) .......... .......... .......... (79,308) ..........

Consolidated Balance Sheet 145,600 234,600 190,200 220,000 ........... ........... ........... ........... 1,150,000 (330,000) 340,000 ........... ........... (209,000) 72,500 (104,000) (99,440) (100,000) ........... 18,206 ........... ........... ........... ........... ........... ........... (100,000)

.......... .......... .......... ..........

.......... .......... .......... (590,269)

(600,000) ........... ........... ...........

part.

6–45

Ch. 6—Problems

Problem 6-11, Concluded Penske Company and Subsidiary Stock Company Worksheet for Consolidated Financial Statements For Year Ended December 31, 2016 (Concluded) Eliminations Consolidated Controlling Trial Balance and Adjustments Income Retained Penske Stock Dr. Cr. Statement NCI Earnings Sales ...................................................... (890,000) (350,000) (IS) 30,000 .......... (1,210,000) .......... .......... Cost of Goods Sold ................................ 480,000 220,000 .......... (IS) 30,000 ......... .......... .......... .......... .......... (EI) 4,800 (BI) 3,600 671,200 .......... .......... Depreciation Expense—Buildings .......... 30,000 10,000 (A1) 5,000 .......... 45,000 .......... .......... Depreciation Expense—Equipment ....... 25,000 10,000 (A2) 10,000 .......... ......... .......... .......... .......... .......... .......... (F2) 8,000 37,000 .......... .......... Other Expenses ..................................... 150,000 60,000 .......... .......... 210,000 .......... .......... Interest Expense .................................... .......... 8,000 .......... .......... 8,000 .......... .......... .......... .......... .......... .......... ......... .......... .......... Provision for Income Tax ....................... 83,613 16,800 .......... (T2) 2,702 97,711 .......... .......... Subsidiary Income.................................. (20,160) .......... (CY1) 20,160 .......... ......... .......... .......... Dividends Declared—Stock ................... .......... 10,000 .......... (CY2) 8,000 ......... 2,000 .......... Dividends Declared—Penske................. 20,000 .......... .......... .......... ......... .......... 20,000 0 702,476 702,476 ......... .......... .......... Totals .................................................. 0 Consolidated Net Income ............................................................................................................................... (141,089) .......... .......... (1,896) .......... To NCI (see distribution schedule) ............................................................................................................. 1,896 To Controlling Interest (see distribution schedule)...................................................................................... 139,193 .......... (139,193) .......... Total NCI ............................................................................................................................................................................. (119,204) Retained Earnings—Controlling Interest, December 31, 2016 .................................................................................................................. (709,462) Totals ..........................................................................................................................................................................................................................

Consolidated Balance Sheet ........... ........... ........... ........... ........... ........... ........... ........... ........... ........... ........... ........... ........... ........... ........... ........... .......... (119,204) (709,462) 0

(BI) (EI) (F1) (F2) (T1) (T2)

Defer beginning inventory profit. Defer ending inventory profit. Fixed asset profit at beginning of year. Fixed asset profit realized. Deferred tax asset (liability) applicable to beginning retained earnings. Deferred tax asset (liability) applicable to current year.

part.

Ch. 6—Problems

6–46

PROBLEM 6-12

(1) Determination and Distribution of Excess Schedule Company Implied Fair Value $562,500

Fair value of subsidiary .............. Less book value interest acquired: Common stock ....................... Paid-in capital in excess of par Retained earnings .................. Total equity ......................... Interest acquired ........................ Book value ................................. Excess of fair value over book value .......................................

Parent Price (80%) $450,000

NCI Value (20%) $112,500

$370,000 80% $296,000

$370,000 20% $ 74,000

$154,000

$ 38,500

Worksheet Key debit D1 debit D2 debit D3

Life 20 5

$ 10,000 190,000 170,000 $370,000

$192,500

Adjustment of identifiable accounts: Adjustment $100,000 50,000 42,500 $192,500

Buildings .................................... Equipment.................................. Goodwill ..................................... Total ...................................... (2)

Account Adjustments to Be Amortized

Buildings ........................ Equipment...................... Total amortizations ....

Life

20 5

Annual Amount

Current Year

Prior Years

Total

Key

$ 5,000 10,000 $15,000

$10,000 20,000 $30,000

$15,000 30,000 $45,000

(A1) (A2)

Intercompany Inventory Profit Deferral Parent Parent Parent Sub Amount Percent Profit Amount

Beginning ....................... $ — Ending ........................... 15,000

Amortization per Year $ 5,000 10,000

0% 40

— 6,000

$16,000 10,000

Sub Sub Percent Profit

30% 30

$4,800 3,000

6–47

Ch. 6—Problems

Problem 6-12, Continued

Subsidiary Stock Company Income Distribution Amortizations .............................. Ending inventory profit ................ Equipment gain ...........................

$15,000 3,000 25,000

Internally generated income ........ Beginning inventory profit ............ Realized gain ...............................

$ 72,000 4,800 5,000

$ 38,800 (16,720) $ 22,080 3,456 $ 18,624

Controlling $31,040 $31,040 $12,416 $18,624

NCI $ 7,760 3,000 $10,760 $ 4,304 $ 3,456

Total $38,800 3,000 $41,800 $16,720 $22,080

Parent Penske Company Income Distribution Ending inventory profit ..................

$6,000

Internally generated income ........ Realized gain ..............................

$159,000 8,000

$161,000 (64,400) $ 96,600 18,624 (1,490)* $113,734

*$18,624 × 20% × 40%

Ch. 6—Problems

6–48

Problem 6-12, Continued DTA/DTL adjustments: To beginning retained earnings: Subsidiary transactions: Beginning inventory............................................ Remaining fixed asset profit ............................... Amortizations (80%) ........................................... Total ................................................................... First tax .............................................................. Second tax [20% × 40% × ($27,840 – $11,136)] Parent transactions: Beginning inventory............................................ Remaining fixed asset profit ............................... Total ................................................................... First tax .............................................................. Total RE adjustments...............................................

To current year: Subsidiary transactions: Beginning inventory............................................ Ending inventory ................................................ Fixed asset sale ................................................. Realized fixed asset ........................................... Amortizations (80%) ........................................... Total ................................................................... First tax .............................................................. Second tax [20% × 40% × ($26,560 – $10,624)] Parent transactions: Beginning inventory............................................ Ending inventory ................................................ Fixed asset sale ................................................. Realized fixed asset profit .................................. Total ................................................................... First tax .............................................................. Total adjustment to provision ...................................

Parent

Sub

$ 4,800 — 24,000 $28,800 $11,520 $ 1,336

$ 3,840 — 24,000 $27,840 $11,136 $ 1,336

$ — 24,000 $24,000 9,600 $22,456

9,600 $22,072

$ (4,800) 3,000 25,000 (5,000) 12,000 $30,200 $12,080 $ 1,275

$ (3,840) 2,400 20,000 (4,000) 12,000 $26,560 $10,624 $ 1,275

— 6,000 — (8,000) $ (2,000) $ (800) $12,555

$ 960 — $ 960 $ 384

$ 384

$ (960) 600 5,000 (1,000) $ 3,640 $ 1,456

$ (800) $11,099

$1,456

6–49

Ch. 6—Problems

Problem 6-12, Continued Penske Company and Subsidiary Stock Company Worksheet for Consolidated Financial Statements For Year Ended December 31, 2017 Eliminations Trial Balance and Adjustments Penske Stock Dr. Cr. Cash....................................................... 91,760 78,400 .......... .......... Accounts Receivable.............................. 150,600 100,000 .......... (IA) 18,000 Inventory ................................................ 115,000 120,000 .......... (EI) 9,000 Land ....................................................... 100,000 120,000 .......... .......... Investment in Stock ................................ 529,680 .......... .......... (CY1) 34,560 .......... .......... (CY2) 8,000 .......... .......... .......... .......... (EL) 349,120 .......... .......... .......... (D) 154,000 Buildings ................................................ 900,000 250,000 (D1) 100,000 .......... Accumulated Depreciation ..................... (290,000) (80,000) .......... (A1) 15,000 Equipment .............................................. 210,000 120,000 (D2) 50,000 (F1) 65,000 Accumulated Depreciation ..................... (140,000) (100,000) .......... (A2) 30,000 .......... .......... (F1) 16,000 .......... .......... .......... (F2) 13,000 .......... Goodwill ................................................. .......... 30,000 (D3) 42,500 .......... Accounts Payable .................................. (50,000) (40,000) (IA) 18,000 .......... Current Tax Liability ............................... (64,240) (28,800) .......... .......... Bonds Payable ....................................... .......... (100,000) .......... .......... Deferred Tax Liability ............................. (6,375) .......... (T1) 22,456 .......... .......... .......... (T2) 12,555 .......... Common Stock—Stock .......................... .......... (10,000) (EL) 8,000 .......... Paid-In Capital in Excess of Par—Stock .......... (190,000) (EL) 152,000 .......... Retained Earnings—Stock ..................... .......... (236,400) (EL) 189,120 (NCI) 38,500 .......... .......... (BI) 960 (T1) 384 .......... .......... (A1–A2) 6,000 .......... .......... .......... .......... .......... Common Stock—Penske ....................... (100,000) .......... .......... .......... Paid-In Capital in Excess of Par—Penske (600,000) .......... .......... .......... Retained Earnings—Penske .................. (739,230) .......... (A1–A2) 24,000 .......... .......... .......... (BI) 3,840 (T1) 22,072 .......... .......... (F1) 24,000 ..........

NCI .......... .......... .......... .......... .......... .......... .......... .......... .......... .......... .......... .......... .......... .......... .......... .......... .......... .......... .......... .......... (2,000) (38,000) .......... .......... .......... (79,204) .......... .......... .......... .......... ..........

part.

Consolidated Balance Sheet 170,160 232,600 226,000 220,000 .......... .......... .......... .......... 1,250,000 (385,000) 315,000 .......... .......... (241,000) 72,500 (72,000) (93,040) (100,000) .......... 28,636 .......... .......... .......... .......... .......... .......... (100,000) (600,000) .......... .......... ..........

Ch. 6—Problems

6–50

Problem 6-12, Concluded Penske Company and Subsidiary Stock Company Worksheet for Consolidated Financial Statements For Year Ended December 31, 2017 (Concluded) Eliminations Consolidated Controlling Trial Balance and Adjustments Income Retained Penske Stock Dr. Cr. Statement NCI Earnings Sales ...................................................... (950,000) (400,000) (IS) 100,000 .......... (1,250,000) .......... .......... Cost of Goods Sold ................................ 550,000 250,000 .......... (IS) 100,000 ......... .......... .......... .......... .......... (EI) 9,000 (BI) 4,800 704,200 .......... .......... Depreciation Expense—Buildings .......... 40,000 10,000 (A1) 5,000 .......... 55,000 .......... .......... Depreciation Expense—Equipment ....... 25,000 10,000 (A2) 10,000 .......... ......... .......... .......... .......... .......... .......... (F2) 13,000 32,000 .......... .......... Other Expenses ..................................... 176,000 75,000 .......... .......... 251,000 .......... .......... Interest Expense .................................... .......... 8,000 .......... .......... 8,000 .......... .......... Gain on Sale of Fixed Asset ................... .......... (25,000) (F1) 25,000 .......... ......... .......... .......... Provision for Income Taxes .................... 66,365 28,800 .......... (T2) 12,555 82,610 .......... .......... Subsidiary Income.................................. (34,560) .......... (CY1) 34,560 .......... ......... .......... .......... Dividends Declared—Stock ................... .......... 10,000 .......... (CY2) 8,000 ......... 2,000 .......... Dividends Declared—Penske................. 20,000 .......... .......... .......... ......... .......... 20,000 0 873,991 873,991 ......... .......... .......... Totals .................................................. 0 Consolidated Net Income ............................................................................................................................... (117,190) .......... .......... (3,456) .......... To NCI (see distribution schedule) ............................................................................................................. 3,456 To Controlling Interest (see distribution schedule)...................................................................................... 113,734 .......... (113,734) .......... NCI ...................................................................................................................................................................................... (120,660) Retained Earnings—Controlling Interest, December 31, 2017 .................................................................................................................. (803,196) Totals ..........................................................................................................................................................................................................................

(BI) (EI) (F1) (F2) (T1) (T2)

Consolidated Balance Sheet .......... .......... .......... .......... .......... .......... .......... .......... .......... .......... .......... .......... .......... .......... .......... .......... .......... (120,660) (803,196) 0

part.

CHAPTER 7 UNDERSTANDING THE ISSUES 1. Equity prior to sale of new shares ................................................................................. Equity gained by sale .................................................................................................... Total equity after sale.................................................................................................... Parent interest ............................................................................................................... Parent equity ................................................................................................................. Price paid ...................................................................................................................... Excess of cost over book value .................................................................................... Excess will likely be attributed to goodwill.

$200,000 650,000 $850,000 × 60% $510,000 650,000 $140,000

2. Determination and Distribution of Excess Schedule

Fair value of subsidiary ........................ Less book value of interest acquired: Total equity .................................... Interest acquired .................................. Book value ........................................... Excess of fair value over book value ...

Company Implied Fair Value

Parent Price (80%)

NCI Value (20%)

$600,000

$480,000

$120,000

450,000 ............ ............ $150,000

$450,000 80% $360,000 $120,000

$450,000 20% $ 90,000 $ 30,000

Adjustment of identifiable accounts:

Equipment.........................................

Adjustment $40,000

Worksheet Key debit D

Life 10

Amortization per Year $15,000

2016: Parent income ........................................................... Subsidiary income ..................................................... Equipment depreciation ............................................ Total income.............................................................. Income purchased [1/2 year × 0.10 × ($50,000 – $15,000 amortization)] ........................................ Consolidated net income .......................................... NCI [10% × ($50,000 – $15,000 amortization)] ........ Controlling: Internally generated ............................................ 80% × 1 × ($50,000 – $15,000).......................... 10% × 1/2 × ($50,000 – $15,000)....................... Total controlling interest ............................................

$120,000 50,000 (15,000) $155,000 (1,750) $153,250 $ 3,500 $120,000 $28,000 1,750

29,750 $149,750

7–2 3. Determination and Distribution of Excess Schedule

Company Implied Fair Value

Parent Price (80%)

NCI Value (20%)

$1,000,000

$800,000

$200,000

900,000 ............ ............

$900,000 80% $720,000

$900,000 20% $180,000

$ 100,000

$ 80,000

$ 20,000

Adjustment $100,000

Worksheet Key debit D

Life 10

Adjustment of identifiable accounts:

Equipment.........................................

Amortization per Year $10,000

2015: Cost of investment .................................................... Equity increase: Equity at July 1, 2019, with 1/2 year income ......... Equity at January 1, 2015 ...................................... Increase .................................................................... Interest ...................................................................... Equipment depreciation ($10,000 × 4.5 × 80%) ....... Adjusted cost.............................................................

$ 800,000 $1,300,000 900,000 $ 400,000 × 80%

320,000 (36,000) $1,084,000

Sale of 8,000 shares a. Gain on sale of investment (could be discontinued operation): Sale price ($150 × 8,000) ................................... $ 1,200,000 Adjusted cost ...................................................... (1,084,000) Gain .................................................................... $ 116,000 b. There will be no consolidated statements. c. The parent will report investment income (perhaps gain on discontinued operations): Income for 6 months ........................................... $100,000 Equipment depreciation (1/2 × 80% × $10,000). (4,000) Income ................................................................ $ 96,000

7–3 3. (Continued) Sale of 2,000 shares a. Increase in paid-in equity on sale of investment: Sale price ($150 × 2,000) ........................................... Adjusted cost (1/4 × $1,084,000) ............................... Equity increase ........................................................... b. Consolidated statements are prepared as follows: Parent income ............................................................ Subsidiary income ($200,000 – $10,000 depreciation) Consolidated net income ............................................ NCI: (20% × 1 × $190,000) ............................................ (20% × 1/2 × $190,000) ......................................... Total NCI interest ........................................................ Controlling: Internally generated .................................................... Subsidiary: (60% × 1 × $190,000) ............................................ (20% × 1/2 × $190,000) ......................................... Total controlling interest ............................................. c.

$ 300,000 (271,000) $ 29,000 $150,000 190,000 $340,000 $ 38,000 19,000 $ 57,000 $150,000 114,000 19,000 $283,000

Not applicable

Sale of 6,000 shares a. Gain on sale of investment (would not be discontinued operation): Sale price ($150 × 6,000) .............................. $ 900,000 Adjusted cost (3/4 × $1,084,000) .................. (813,000) Gain ............................................................... $ 87,000 b. There will be no consolidated statements. c. The parent will report investment income under the equity method. Amount Period Interest Income $190,000 × 1/2 × 60% $57,000 190,000 × 1 × 20% 38,000 Total $95,000

7–4 4. Determination and Distribution of Excess Schedule

Fair value of subsidiary ..................... Less book value of interest acquired: Common stock ($1 par) ................. Paid-in capital in excess of par ..... Retained earnings ......................... Preferred dividends in arrears ....... Total equity ................................. Interest acquired ............................ Book value ........................................ Excess of fair value over book value ...........................................

Company Implied Fair Value

Parent Price (80%)

NCI Value (20%)

$1,750,000

$1,400,000

$ 350,000

$1,488,000 80% $1,190,400

$1,488,000 20% $ 297,600

$ 262,000

$ 209,600

Adjustment $262,000

Life

$ 100,000 900,000 500,000 (12,000) $1,488,000

52,400

Adjustment of identifiable accounts:

Goodwill ............................................

Parent income ........................................................... Subsidiary income ..................................................... Consolidated net income .......................................... NCI (20% × $68,000) ................................................ NCI preferred (6% × $200,000) ................................ Controlling {$120,000 + [0.80 × ($80,000 – $12,000)]}

Amortization per Year

Worksheet Key debit D

$120,000 80,000 $200,000 $13,600 12,000

$ 25,600 $174,400

Income would be as follows if Company P owns 1/2 of preferred stock: Parent income ........................................................... Subsidiary income ..................................................... Consolidated net income .......................................... NCI [20% × ($80,000 – $12,000)] ............................. NCI preferred (6% × $100,000) ................................ Controlling {$120,000 + [0.80 × ($80,000 – $12,000)] + (6% × $100,000)}.............................................

$120,000 80,000 $200,000 $13,600 6,000

$ 19,600 $180,400

7–5

Ch. 7—Exercises

EXERCISES EXERCISE 7-1 Determination and Distribution of Excess Schedule Company Implied Fair Value Fair value of subsidiary ........................ $2,150,000 Less book value of interest acquired: Common stock ($5 par) ................... $ 100,000 Retained earnings ........................... 360,000 New proceeds.................................. 1,350,000 Total equity.................................. $1,810,000 Interest acquired .............................. Book value ........................................... Excess of fair value over book value ... $ 340,000

Parent Price (60%) $1,350,000

NCI Value (40%) $ 800,000*

$1,810,000 60% $1,086,000 $ 264,000

$1,810,000 40% $ 724,000 $ 76,000

*20,000 shares × $40 per share fair value Adjustment of identifiable accounts:

Building ............................................. Goodwill ............................................ Total..............................................

Adjustment $200,000 140,000 $340,000

Worksheet Key debit D1 debit D2

Life 20

Amortization per Year 10,000

Prestar Corporation and Subsidiary Saturn Corporation Consolidated Balance Sheet January 2, 2018 Assets Current assets ($600,000 + $100,000 + $1,350,000) ...................... Goodwill ........................................................................................... Long-lived assets: Land ........................................................................................... Property, plant, and equipment (add $200,000)......................... Total assets......................................................................................

$2,050,000 140,000 $ 210,000 1,300,000

1,510,000 $3,700,000

Liabilities and Stockholders’ Equity Current liabilities .............................................................................. Bonds payable ................................................................................. Stockholders’ equity: NCI [(40% × $1,780,000) + $88,000] ......................................... Common stock ($5 par).............................................................. Retained earnings ...................................................................... Total liabilities and stockholders’ equity ...........................................

$ 350,000 1,350,000 800,000 $ 400,000 800,000

1,200,000 $3,700,000

Ch. 7—Exercises

7–6

EXERCISE 7-2 Determination and Distribution of Excess Schedule Company Implied Fair Value Fair value of subsidiary ........................ $225,000 Less book value of interest acquired: Common stock ($10 par) ................. $100,000 Retained earnings ........................... 20,000 Total equity.................................. $120,000 Interest acquired .............................. Book value ........................................... Excess of fair value over book value ... $105,000

Parent Price (60%) $135,000

NCI Value (40%) $ 90,000

$120,000 60% $ 72,000 $ 63,000

$120,000 40% $ 48,000 $ 42,000

Adjustment of identifiable accounts:

Equipment .........................................

Adjustment $105,000

Worksheet Key debit D

Life 10

Amortization per Year $10,500

Analysis of 20% Interest, January 1, 2017 Price paid for additional investment in Hardee ................................ Less interest acquired: Common stock ($10 par)............................................................ Retained earnings ...................................................................... Total stockholders’ equity ..................................................... Interest acquired ........................................................................ Excess ............................................................................................. Equipment adjustment (8 remaining years × $10,500 × 20%) ......... Parent paid-in capital in excess of par from stock retirement ..........

$ 40,000 $100,000 50,000 $150,000 × 20%

30,000 $ 10,000 (16,800) $ 6,800

7–7

Ch. 7—Exercises

Exercise 7-2, Concluded Baker Corporation and Subsidiary Hardee Company Consolidated Balance Sheet December 31, 2019 Assets Current assets.................................................................................. Long-lived assets: Property, plant, and equipmenta ................................................. Total assets...................................................................................... a $740,000 + $240,000 + $105,000 – (5 × $10,500 amortization) Liabilities and Stockholders’ Equity Current liabilities .............................................................................. Stockholders’ equity: NCIb ............................................................................................ Common stock ($10 par)............................................................ Paid-in capital in excess of par from stock retirement................ Retained earningsc ..................................................................... Total liabilities and stockholders’ equity ........................................... b 20% × $220,000 ................................................ $ 44,000 Remaining share of excess, 5 X 20% X $10,500 10,500 Total .................................................................... 54,500 c

$ 365,000 1,032,500 $1,397,500

$ 500,000 54,500 $500,000 6,800 336,200

843,000 $1,397,500

Conversion: 60% interest [60% × ($120,000 – $20,000)] = $ 60,000 20% interest [20% × ($120,000 – $50,000)] = 14,000 Share of retained earnings ............................ $ 74,000 Amortizations: 2 years × 60% × $10,500 .............................. (12,600) 3 years × 80% × $10,500 .............................. (25,200) Net adjustment .................................................. $ 36,200 Parent retained earnings balance, December 31, 2019....................................... 300,000 Total................................................................... $336,200

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Ch. 7—Exercises

7–8

EXERCISE 7-3 Determination and Distribution of Excess Schedule Company Implied Fair Value Fair value of subsidiary ........................ $465,000 Less book value of interest acquired: Common stock ($10 par) ................. $100,000 Retained earnings ........................... 250,000 Total equity.................................. $350,000 Interest acquired .............................. Book value ........................................... Excess of fair value over book value ... $115,000

Parent Price (60%) $418,500

NCI Value (40%) $ 46,500

$350,000 90% $315,000 $103,500

$350,000 10% $ 35,000 $ 11,500

Adjustment of identifiable accounts:

Equipment .........................................

Adjustment $115,000

Worksheet Key debit D

Life 20

Amortization per Year $5,570

Entries Investment in Venus Company ........................................................ 195,300 Retained Earnings* .................................................................... Investment Income** .................................................................. To convert the investment to the equity method. This includes 10% interest that is to be adjusted to sophisticated equity balance. Cash................................................................................................. Investment in Venus Company [8/9 × ($418,500 cost + $195,300 adjustment)] ........................................................... Gain on Sale of Investment ........................................................ To record the sale of the 8,000 shares of Venus stock.

137,475 57,825

700,000 545,600 154,400

Adjustments to the investment account: *Retained earnings account = 90% × $170,000 change in retained earnings – 3 years of equipment depreciation (3 × 90% × $5,750) = $137,475. **Investment income = 90% × ($70,000 – $5,750 equipment depreciation) = $57,825.

7–9

Ch. 7—Exercises

EXERCISE 7-4 Entries on Carpenter’s books, January 1, 2016: Investment in Hinckley Company ..................................................... Retained Earnings—Carpenter .................................................. To adjust investment to equity for shares sold. Remaining shares may remain at cost, because they will be consolidated.

2,960

Cash................................................................................................. Investment in Hinckley Company ............................................... Paid-In Capital in Excess of Par—Carpenter ............................. To record sale of shares. Investment eliminated = [(2,000 ÷ 40,000) × $160,000 original cost] plus $2,960 equity adjustment.

40,000

2,960

10,960 29,040

Determination and Distribution of Excess Schedule Company Implied Fair Value Fair value of subsidiary ........................ $200,000 Less book value of interest acquired: Total equity.................................. 150,000 Interest acquired .............................. Book value ........................................... Excess of fair value over book value ... $ 50,000

Parent Price (60%) $160,000

NCI Value (40%) $ 40,000

$150,000 80% $120,000 $ 40,000

$150,000 20% $ 30,000 $ 10,000

Adjustment of identifiable accounts:

Machine ............................................ Goodwill ............................................ Total..............................................

Adjustment $ 20,000 30,000 $ 50,000

Worksheet Key debit D1 debit D2

Equity adjustment: Income ....................................................................................... Amortization of excess (4 years × $4,000) ................................. Dividends ................................................................................... Interest sold (2,000 ÷ 50,000) ....................................................

Life 5

Amortization per Year $4,000

$110,000 (16,000) (20,000) $ 74,000 × 4% $ 2,960

Ch. 7—Exercises

7–10

EXERCISE 7-5 (1) Retained Earnings (3 × 80% × $5,000) ...................................... Investment in Bruce Corporation ........................................... To adjust for building depreciation to December 31, 2017.

12,000

Investment in Bruce Corporation................................................ Investment Income ................................................................ To adjust current year’s share of income and investment account for one-half of the year’s building depreciation [(80% × $35,000) – (1/2 × 80% × $5,000)].

26,000

Cash ........................................................................................... Investment in Bruce Corporation* .......................................... Gain on Sale of Subsidiary .................................................... To record the sale and the gain on the 24,000 shares of Bruce stock.

890,000

12,000

26,000

878,000 12,000

*($864,000 – $12,000 + $26,000) (2) Retained Earnings (3 × 80% × $5,000) ...................................... Investment in Bruce Corporation ........................................... To adjust for building depreciation to December 31, 2017.

12,000 12,000

Investment in Bruce Corporation................................................ 13,000 Investment Income ................................................................ To adjust one-half of current year’s share of income for the first half of the year and one-half of the year’s building depreciation, {1/2 × [(80% × $35,000) – (1/2 × 80% × $5,000)]}.

13,000

Note: A sophisticated equity adjustment for the other half of the investment will be necessary at year-end. Cash ........................................................................................... Investment in Bruce Corporation* .......................................... Gain on Sale of Investment ................................................... To record the sale and the gain on the 12,000 shares of Bruce stock.

455,000 439,000 16,000

*[1/2 × ($864,000 – $12,000)] + $13,000

7–11

Ch. 7—Exercises

Exercise 7-5, Concluded (3) Only the 20% portion sold (25% of the investment) needs adjustment; the remaining 60% of the investment will be adjusted at year-end when consolidated statements are prepared. Retained Earnings [(3 × 80% × $5,000)* × 1/4] ......................... Investment in Bruce Corporation ........................................... To adjust for building depreciation to December 31, 2017.

3,000

Investment in Bruce Corporation................................................ Investment Income ................................................................ To adjust 25% of the current year’s share of income for the first half of the year and 25% of the one-half year’s building depreciation, {1/4 × [(80% × $35,000) – (1/2 × 80% × $5,000)]}.

6,500

Cash ........................................................................................... Investment in Bruce Corporation* .......................................... Paid-In Capital in Excess of Par ............................................ To record the sale and the gain on the 6,000 shares of Bruce stock.

232,500

3,000

6,500

219,500 13,000

*[(1/4 × $864,000) – $3,000 + $6,500] EXERCISE 7-6 (1) Determination and Distribution of Excess Schedule Company Implied Fair Value Fair value of subsidiary ........................ $350,000 Less book value of interest acquired: Common stock ($10 par) ................. $200,000 Retained earnings ........................... 90,000 Preferred dividends in arrears ......... (6,000) Total equity.................................. $284,000 Interest acquired .............................. Book value ........................................... Excess of fair value over book value ... $ 66,000

Parent Price (80%) $280,000

NCI Value (20%) $ 70,000

$284,000 80% $227,200 $ 52,800

$284,000 20% $ 56,800 $ 13,200

Adjustment of identifiable accounts:

Goodwill ............................................

Adjustment $ 66,000

Worksheet Key debit D

Life

Amortization per Year

Ch. 7—Exercises

7–12

Exercise 7-6, Concluded (2) Determination and Distribution of Excess Schedule Company Implied Fair Value Fair value of subsidiary ........................ $350,000 Less book value of interest acquired: Common stock ($10 par) ................. $200,000 Retained earnings ........................... 90,000 Preferred dividend share of retained earnings ...................................... (30,000) Total equity.................................. $260,000 Interest acquired .............................. Book value ........................................... Excess of fair value over book value ... $ 90,000

Parent Price (80%) $280,000

NCI Value (20%) $ 70,000

$260,000 80% $208,000 $ 72,000

$260,000 20% $ 52,000 $ 18,000

Adjustment of identifiable accounts:

Goodwill ............................................

Adjustment $ 90,000

Worksheet Key debit D

Life

Amortization per Year

*$90,000 retained earnings × 100/300 shares (preferred plus common stock) (3) Determination and Distribution of Excess Schedule Company Implied Fair Value Fair value of subsidiary ........................ $350,000 Less book value of interest acquired: Common stock ($10 par) ................. $200,000 Retained earnings ........................... 90,000 Preferred dividends share of retained earnings ...................................... (22,000) Total equity.................................. $268,000 Interest acquired .............................. Book value ........................................... Excess of fair value over book value ... $ 82,000

Parent Price (80%) $280,000

NCI Value (20%) $ 70,000

$268,000 80% $214,400 $ 65,600

$268,000 20% $ 53,600 $ 16,400

Adjustment of identifiable accounts:

Goodwill ............................................

Adjustment $ 82,000

Worksheet Key debit D

Life

Amortization per Year

*(2 years × $6,000) + (10% × $100,000 par value)

7–13

Ch. 7—Exercises

EXERCISE 7-7 (1) Determination and Distribution of Excess Schedule Company Implied Fair Value Fair value of subsidiary ........................ $900,000 Less book value of interest acquired: Common stock ($10 par) ................. $800,000 Retained earnings ........................... 100,000 Preferred dividends in arrears ......... (30,000) Total equity.................................. $870,000 Interest acquired .............................. Book value ........................................... Excess of fair value over book value ... $ 30,000

Parent Price (80%) $720,000

NCI Value (20%) $180,000

$870,000 80% $696,000 $ 24,000

$870,000 20% $174,000 $ 6,000

Adjustment of identifiable accounts:

Goodwill ............................................

Adjustment $ 30,000

Worksheet Key debit D

(2) Investment in Brian .................................................................... Retained Earnings ................................................................. To adjust for 80% of subsidiary income for 2015 and 2016 applicable to common stock, equal to 80% × ($110,000 – $60,000 current cumulative claim of preferred stock).

Life

Amortization per Year

40,000 40,000

Ch. 7—Exercises

7–14

EXERCISE 7-8 Determination and Distribution of Excess Schedule Company Implied Fair Value Fair value of subsidiary ........................ $525,000 Less book value of interest acquired: Common stock ($10 stated value) ... $300,000 Retained earnings ........................... 160,000 Preferred dividends in arrears ......... (32,000) Total equity.................................. $428,000 Interest acquired .............................. Book value ........................................... Excess of fair value over book value ... $ 97,000

Parent Price (80%) $420,000

NCI Value (20%) $105,000

$428,000 80% $342,400 $ 77,600

$428,000 20% $ 85,600 $ 19,400

Adjustment of identifiable accounts:

Goodwill ............................................

Adjustment $ 97,000

Worksheet Key debit D

Life

Amortization per Year

(1) Equity claim on Kim Company retained earnings: Retained earnings, January 1, 2017 .......................................... Preferred claim (4 years × $16,000) .......................................... Common shareholders’ claim ................................................

$210,000 64,000 $146,000

(2) Cost-to-simple-equity conversion for preferred stock: Preferred stockholders’ claim on retained earnings; January 1, 2015, through January 1, 2017 (2 years × $16,000) ............................................................... Ownership interest ..................................................................... Cost-to-simple-equity conversion ...............................................

$32,000 × 50% $16,000

Investment in Kim Company Preferred Stock ............................ Retained Earnings—Zigler..................................................... To adjust investment to simple equity.

16,000

Preferred Stock—Kim Company (50% × $200,000) .................. Retained Earnings—Kim Company (50% × $64,000 applicable to preferred stock) .................................................. Investment in Kim Company Preferred Stock ($90,000 cost + $16,000 adjusted).................................... Paid-In Capital in Excess of Par—Retirement of Preferred Stock ............................................................. To eliminate the investment in preferred stock.

100,000

16,000

32,000 106,000 26,000

7–15

Ch. 7—Exercises

Exercise 7-8, Concluded (3) Cost-to-simple-equity conversion for common stock: Retained earnings, January 1, 2017 .......................................... Less preferred claim—4 years × 8% × $200,000 ....................... Retained earnings, December 31, 2014 ................................ Less preferred claim—2 years × 8% × $200,000 .................. Increase in retained earnings, common stock ....................... Ownership interest ............................................................ Cost-to-simple-equity conversion ......................................

$210,000 64,000 $160,000 32,000

$146,000 128,000 $ 18,000 × 80% $ 14,400

Entries: Investment in Kim Company Common Stock............................. Retained Earnings—Zigler..................................................... To adjust investment to equity.

14,400

Common Stock—Kim Company ($300,000 × 80%) ................... Retained Earnings—Kim Company (80% × $146,000 applicable to common stock) ................................................. Goodwill ..................................................................................... Investment in Kim Company Common Stock ........................ NCI ........................................................................................ To eliminate investment, adjust NCI, and record goodwill.

240,000

14,400

116,800 97,000 434,400 19,400

Ch. 7—Problems

7–16

PROBLEMS PROBLEM 7-1 (1) Price paid ................................................................................... Less interest acquired: Common stock ($10 par) ...................................................... Retained earnings ................................................................ Total stockholders’ equity ............................................... Interest acquired .................................................................. Excess ....................................................................................... Equipment adjustment {[$50,000 – (2 years × $5,000)] × 20%} ................................................................................. Goodwill adjustment, $90,000 × 20% ........................................ Debit parent retained earnings ...................................................

$70,000 $100,000 85,000 $185,000 × 20%

37,000 $33,000 8,000 18,000 $ 7,000

(2) See worksheet on page 389. Eliminations and Adjustments: (CY1) Eliminate intercompany income. (CY2) Eliminate intercompany dividends. (EL) Eliminate the controlling interest in the subsidiary equity. (D1,D2)/ (NCI) Distribute the excess on the original 60% investment to equipment and goodwill. (D3) Distribute the excess on the 20% investment to parent retained earnings. (A) Depreciate the excess for 4 years as follows: Share retained earnings, 2 years at 40% and 1 year at 20% of 5,000 ..... $ 5,000 Parker retained earnings, 2 years at 60% and 1 year at 80% of 5,000 .... 10,000 Depreciation expense ............................................................................... 5,000 Subsidiary Sharon Company Income Distribution Depreciation ............................. (A)

$5,000

Internally generated net income ...............................

$35,000

Adjusted net income ................ NCI share ................................ NCI ..........................................

$30,000 × 20% $ 6,000

Parent Palmer Company Income Distribution Internally generated net income ............................... 80% × Share adjusted income of $30,000 ............. Controlling interest...................

$100,000 24,000 $124,000

7–17

Ch. 7—Problems

Problem 7-1, Concluded (2)

Palmer Company and Subsidiary Sharon Company Worksheet for Consolidated Financial Statements For Year Ended December 31, 2015 Controlling Retained Earnings

Consolidated Balance Sheet

160,000 80,000 ................. ................. ................. ................. ................. 301,000 ................. (CY2) 4,000 (CY1) 28,000 ................. ................. ................. ................. ................. ................. (EL) 160,000 ................. ................. ................. ................. ................. ................. (D1) 84,000 ................. ................. ................. ................. ................. ................. (D3) 33,000 ................. ................. ................. Property, Plant, and Equipment (net) ............. 450,000 170,000 (D1) 50,000 (A) 20,000 ................. ................. ................. Goodwill ......................................................... ................. ................. (D2) 90,000 ................. ................. ................. ................. Current Liabilities ........................................... (110,000) (20,000) ................. ................. ................. ................. ................. Common Stock ($10 par)—Palmer ................ (500,000) ................. ................. ................. ................. ................. ................. Retained Earnings—Palmer ........................... (198,000) ................. (A) 10,000 ................. ................. ................. ................. ................. ................. (D3) 7,000 ................. ................. ................. (181,000) Common Stock ($10 par)—Sharon ................ ................. (100,000) (EL) 80,000 ................. ................. (20,000) ................. Retained Earnings—Sharon .......................... ................. (100,000) (EL) 80,000 (NCI) 56,000 ................. (45,000) ................. ................. ................. (A) 5,000 ................. ................. ................. ................. ................. ................. (D3) 26,000 ................. ................. ................. ................. Sales .............................................................. (400,000) (110,000) ................. ................. (510,000) ................. ................. Subsidiary Income.......................................... (28,000) ................. (CY1) 28,000 ................. ................. ................. ................. Cost of Goods Sold ........................................ 200,000 60,000 ................. ................. 260,000 ................. ................. Other Expenses ............................................. 100,000 15,000 (A) 5,000 ................. ................. ................. ................. ................. ................. ................. ................. 120,000 ................. ................. 5,000 ................. (CY2) 4,000 ................. 1,000 25,000 Dividends Declared ........................................ 25,000 0 0 385,000 385,000 ................. ................. ................. ................. ................. Consolidated Net Income ........................................................................................................................................ (130,000) To NCI ................................................................................................................................................................. 6,000 (6,000) ................. To Controlling Interest ......................................................................................................................................... 124,000 ................. (124,000) Total NCI ........................................................................................................................................................................................ (70,000) ................. Retained Earnings—Controlling Interest, December 31, 2015 .............................................................................................................................. (280,000) Totals .........................................................................................................................................................................................................................................

240,000 ................. ................. ................. ................. 650,000 90,000 (130,000) (500,000) ................. ................. ................. ................. ................. ................. ................. ................. ................. ................. ................. ................. ................. ................. ................. ................. (70,000) (280,000) 0

Trial Balance Palmer Sharon

Eliminations and Adjustments Dr.

Cr.

Consolidated Income Statement

NCI

Current Assets ............................................... Investment in Share Company .......................

part.

Ch. 7—Problems

7–18

PROBLEM 7-2 (1) Determination and Distribution of Excess Schedule

Fair value of subsidiary ..................... Less book value of interest acquired: Common stock ............................ Other paid-in capital in excess of par ............................................... Retained earnings ....................... Total equity ............................ Interest acquired ......................... Book value ........................................ Excess of fair value over book value............................................

Company Implied Fair Value $350,000

Parent Price (70%) $245,000

NCI Value (30%) $105,000

$300,000 70% $210,000

$300,000 30% $ 90,000

$ 35,000

$ 15,000

Worksheet Key debit D1 debit D2

Life 4

$ 50,000 100,000 150,000 $300,000

$ 50,000

Adjustment of identifiable accounts:

Equipment ......................................... Goodwill ............................................ Total ............................................

Adjustment $ 20,000 30,000 $ 50,000

Amortization per Year $5,000

Analysis of 20% Interest: Price paid ......................................................................................... Less interest acquired: Common stock ..................................................................... Other paid-in capital in excess of par ................................... Retained earnings ................................................................ Income for 4 months ............................................................ Total stockholders’ equity ............................................... Interest acquired .................................................................. Excess........................................................................................ Equipment adjustment {[$20,000 – (1 1/3 years × $5,000)] × 20%} .................................................................................. Debit parent retained earnings ...................................................

$92,000 $ 50,000 100,000 190,000 30,000 $370,000 × 20%

74,000 $ 18,000 (2,667) $15,333

7–19

Ch. 7—Problems

Problem 7-2, Continued (2) Entries under the simple equity method: Investment in Craft Company................ Subsidiary Income ......................... Cash ...................................................... Investment in Craft Company ........

2016

2015 Debit 42,000 (1)

Credit

Debit 75,000 (2)

42,000 14,000 (3)

Credit 75,000

27,000 (4) 14,000

27,000

(1) 70% of $60,000 net income (2) 70% of $30,000 (first 4 months) net income plus 90% of $60,000 (second 8 months) net income (3) 70% of $20,000 dividends (4) 90% of $30,000 dividends (3) Balance in Investment in Craft Company: $245,000 + $42,000 – $14,000 + $92,000 + $75,000 – $27,000 = $413,000 Balance in Subsidiary Income (2016 only): 70% of $30,000 (January 1 thru April 30) + 90% of $60,000 (May 1 thru December 31, 2016) = $75,000.

Ch. 7—Problems

7–20

Problem 7-2, Continued (4)

James Company and Subsidiary Craft Company Worksheet for Consolidated Financial Statements For Year Ended December 31, 2016

NCI

Controlling Retained Earnings

50,000 ................. 180,000 ................. ................. (CY2) 27,000 ................. ................. ................. ................. ................. ................. 50,000 ................. 320,000 (D1) 20,000 (60,000) ................. ................. (D1) 30,000 ................. ................. (40,000) ................. (100,000) ................. ................. ................. ................. .................

3,000 ................. (CY1) 75,000 (EL) 312,000 (D1) 35,000 (D2) 18,000 ................. ................. (A) 10,000 ................. ................. ................. ................. ................. .................

147,000 306,000 ................. ................. ................. ................. 100,000 690,000 (170,000) 30,000 20,000 (160,000) (100,000) (200,000) (200,000)

(100,000) ................. ................. (214,000) ................. (A) 3,500 ................. ................. (D2) 15,333 ................. (50,000) (EL) 45,000

................. ................. ................. .................

................. ................. ................. (5,000)

................. (195,167) ................. .................

(100,000) ................. ................. .................

................. (100,000) (EL) 90,000 ................. ................. (10,000) ................. ................. (190,000) (EL) 171,000 (NCI) 15,000 ................. (29,833) ................. ................. ................. (A) 1,500 ................. ................. ................. ................. ................. ................. (D2) 2,667 ................. ................. ................. ................. Net Sales ....................................................... (520,000) (450,000) (IS) 50,000 ................. (920,000) ................. ................. Cost of Goods Sold ........................................ 300,000 260,000 (EI) 3,000 (IS) 50,000 513,000 ................. ................. Operating Expenses ...................................... 120,000 100,000 (A) 5,000 ................. 225,000 ................. ................. Subsidiary Income ......................................... (75,000) ................. (CY1) 75,000 ................. ................. ................. ................. Dividends Declared ........................................ 50,000 30,000 ................. (CY2) 27,000 ................. 3,000 50,000 Purchased Income ......................................... ................. ................. (EL) 6,000 ................. 6,000 ................. ................. 0 545,000 545,000 ................. ................. Total ........................................................... 0 Consolidated Net Income........................................................................................................................................ (176,000) ................. ................. To NCI (see distribution schedule) ...................................................................................................................... 8,200 (8,200) ................. ................. (167,800) To Controlling Interest (see distribution schedule) .............................................................................................. 167,800 Total NCI........................................................................................................................................................................................ (50,033) ................. Retained Earnings—Controlling Interest, December 31, 2016 .............................................................................................................................. (312,967) Totals ........................................................................................................................................................................................................................................

Trial Balance James Craft Inventory, December 31................................. Other Current Assets ..................................... Investment in Craft Company ........................

Land ............................................................... Buildings and Equipment ............................... Accumulated Depreciation ............................. Goodwill ......................................................... Other Intangibles ........................................... Current Liabilities ........................................... Bonds Payable ............................................... Other Long-Term Liabilities............................ Common Stock—James ................................ Other Paid-In Capital in Excess of Par —James ..................................................... Retained Earnings—James ........................... Common Stock—Craft ................................... Other Paid-In Capital in Excess of Par —Craft ........................................................ Retained Earnings—Craft ..............................

100,000 126,000 413,000 ................. ................. ................. 50,000 350,000 (100,000) ................. 20,000 (120,000) ................. (200,000) (200,000)

Eliminations and Adjustments Dr.

Cr.

(EI)

Consolidated Income Statement

part.

Consol. Balance Sheet

7–21

Ch. 7—Problems

Problem 7-2, Concluded Eliminations and Adjustments: (CY1) Eliminate the current-year entries for subsidiary income. (CY2) Eliminate current-year entries for subsidiary dividends. (EL) Eliminate 90% of Craft Company equity balances at the beginning of the year against the investment account. Also, eliminate 20% of the January through April 2016 income ($30,000) with a debit of $6,000 to Purchased Income. (D1)/(NCI) Distribute the $35,000 excess cost and $15,000 NCI adjustment as required by the determination and distribution of excess schedules to equipment and goodwill. (A) Depreciate the write-up to equipment over two years. Charge the 2015 depreciation against January 1, 2016, retained earnings of James Company and Craft Company and the 2016 adjustment against operating expenses. (D2) Distribute excess on 20% investment. Eliminate NCI of $2,667 and debit James Company’s Retained Earnings for $15,333. (IS) Eliminate the intercompany sale and purchase. (EI) Eliminate the $3,000 of gross profit in the ending inventory. Subsidiary Craft Company Income Distribution Ending inventory profit ............. (EI) $3,000 Equipment depreciation ........... (A) 5,000

Internally generated net income ...........................

$90,000

Adjusted net income ............ NCI share ............................ NCI ......................................

$82,000 × 10% $ 8,200

Parent James Company Income Distribution Internally generated net income ........................... $100,000 90% of Craft income ............ 73,800 Less purchased income....... (EL) (6,000) Controlling interest...............

$167,800

Ch. 7—Problems

7–22

PROBLEM 7-3 Determination and Distribution of Excess Schedule Company Implied Fair Value Price paid for investment ...................... $475,500 Less book value of interest acquired: Common stock ................................ $100,000 Retained earnings ........................... 400,000 Total equity ................................ $500,000 Interest acquired ............................. Book value ............................................ Excess of fair value over book value .... $ (24,500)

Parent Price (70%) $325,500

NCI Value (30%) $150,000*

$500,000 70% $350,000 $ (24,500)

$500,000 30% $150,000

Adjustment of identifiable accounts: Adjustment Gain on acquisition ............................... $ (24,500)

Worksheet Key credit D

Life

Amortization per Year

*NCI value cannot be less than fair (equal to book) value of interest in net assets. Analysis of September 30, 2017, purchase: Price paid ....................................................................................... Less interest acquired: Common stock ....................................................................... Retained earnings, January 1 ................................................ Income, January–September ................................................. Total stockholders’ equity ............................................... Interest acquired .................................................................... Excess ...........................................................................................

$105,000 $100,000 400,000 25,000 $525,000 × 20%

105,000 $ 0

Eliminations and Adjustments: (CY1) Eliminate the subsidiary income. (CY2) Eliminate the intercompany dividends. (EL) Eliminate 90% of Stallward’s equity against the investment. (D) Distribute excess to gain on acquisition. (PI) Eliminate purchased income from the investment, $25,000 × 20% = $5,000. (LN) Eliminate the intercompany accounts resulting from the 12% note: (1) Payment of installment and interest on December 31 was made by Stallward but not received by Away. (2) Balance on note. (3) Interest income and expense. (S) (1) Eliminate intercompany services. (2) Eliminate profit in deferred charges, $16,500 × 1/3 = $5,500. (IS) Eliminate intercompany sales of $60,000. (EI) Eliminate the intercompany profit in ending inventory: Away’s Percent Profit: =

Sales

Cost of Goods Sold $450,000 = = 25% Sales $1,800,000

25% × $10,000 = $2,500

7–23

Ch. 7—Problems

Problem 7-3, Continued

(F1) (F2)

Eliminate the gain on the sale of tools. Adjust the depreciation on tools: Depreciation taken [($25,000 ÷ 5) × 1/2] .................................................... Less correct depreciation [($15,000 ÷ 5) × 1/2] .......................................... Depreciation adjustment.............................................................................

$2,500 1,500 $1,000

Subsidiary Stallward, Inc., Income Distribution Unrealized profit on Internally generated net engineering services .......... (S2) $5,500 income ............................... Adjusted income ...................... NCI share ................................ NCI ..........................................

$48,000 $42,500 × 10% $ 4,250

Parent Away Company Income Distribution Unrealized gain on sale Internally generated net of tools ................................ (F1) $10,000 income ............................... $202,000 Unrealized profit in ending 70% interest in income of inventory ............................. (EI) 2,500 Stallward for full year (70% × $42,500) ................ 29,750 20% interest in income for one-quarter year [($42,500 – $25,000) × 20%] ................ 3,500 Gain on acquisition .................. 24,500 Depreciation adjustment on tools .............................. (F2) 1,000 Controlling interest...................

$248,250

Ch. 7—Problems

7–24

Problem 7-3, Continued Away Company and Subsidiary Stallward, Inc. Worksheet for Consolidated Financial Statements For Year Ended December 31, 2017 Trial Balance Away Stallward Cash .............................................................. Notes Receivable ........................................... Accounts Receivable ..................................... Interest Receivable ........................................ Dividends Receivable .................................... Inventories ..................................................... Investment in Stallward, Inc. ......................... Property, Plant, and Equipment ..................... Accumulated Depreciation ............................. Deferred Charges .......................................... Patents and Licenses..................................... Cash in Transit............................................... Accounts Payable .......................................... Notes Payable ............................................... Dividends Payable ......................................... Capital Stock—Away ..................................... Retained Earnings—Away ............................. Capital Stock—Stallward ............................... Retained Earnings—Stallward ....................... Sales and Services ........................................ Subsidiary Income ......................................... Interest Income .............................................. Cost of Goods Sold ........................................ Administrative and Selling Expenses ............. Interest Expense ............................................

99,500 100,000 ................. 200,000 3,000 4,500 924,000 469,200 ................. ................. 1,250,000 (500,000) 25,000 ................. ................. (425,000) ................. ................. (300,000) (1,605,000) ................. ................. (1,800,000) ................. ................. (43,200) (3,000) 1,350,000 ................. 251,000 ................. .................

Eliminations and Adjustments Dr.

78,000 ................. ................. ................. (LN1) ................. ................. (LN2) 100,000 ................. ................. ................. (LN1) ................. ................. (CY1) 125,000 ................. (EI) ................. (D) 24,500 (CY1) ................. (CY2) 4,500 (EL) ................. ................. (PI) 500,000 ................. (F1) (150,000) (F2) 1,000 ................. ................. (S2) 50,000 ................. ................. (LN1) 28,000 (80,000) ................. (75,000) (LN2) 75,000 (5,000) (CY1) 4,500 ................. ................. ................. ................. (100,000) (EL) 90,000 (400,000) (EL) 360,000 (750,000) (S1) 40,000 ................. (IS) 60,000 ................. (F1) 10,000 ................. (CY1) 43,200 ................. (LN3) 3,000 525,000 ................. ................. (EI) 2,500 (IS) 174,000 (S2) 5,500 (S1) ................. ................. (F2) 3,000 ................. (LN3)

Cr.

Consolidated Income Statement

................. 25,000 75,000 ................. 3,000 4,500 2,500 43,200 450,000 5,000 10,000 ................. 5,500 ................. ................. ................. ................. ................. ................. ................. ................. ................. ................. ................. ................. ................. ................. ................. 60,000 40,000 1,000 3,000

................. ................. ................. ................. ................. ................. ................. ................. ................. ................. ................. ................. ................. ................. ................. ................. ................. ................. ................. ................. ................. ................. ................. ................. (2,440,000) ................. ................. ................. 1,817,500 ................. 389,500 .................

NCI

Controlling Retained Earnings

Consolidated Balance Sheet

................. ................. ................. ................. ................. ................. ................. ................. ................. ................. ................. ................. ................. ................. ................. ................. ................. ................. ................. ................. (10,000) (40,000) ................. ................. ................. ................. ................. ................. ................. ................. ................. .................

................. ................. ................. ................. ................. ................. ................. ................. ................. ................. ................. ................. ................. ................. ................. ................. ................. ................. ................. (1,605,000) ................. ................. ................. ................. ................. ................. ................. ................. ................. ................. ................. .................

177,500 ................. ................. 300,000 ................. ................. 1,046,500 ................. ................. ................. 1,740,000 (649,000) 19,500 50,000 28,000 (505,000) ................. (500) (300,000) ................. ................. ................. ................. ................. ................. ................. ................. ................. ................. ................. ................. .................

part.

7–25

Ch. 7—Problems

Problem 7-3, Concluded Away Company and Subsidiary Stallward, Inc. Worksheet for Consolidated Financial Statements For Year Ended December 31, 2017 (Concluded) Controlling Retained Earnings

Consolidated Balance Sheet

................. ................. ................. (D) 24,500 (24,500) ................. ................. ................. 5,000 ................. (CY2) 4,500 ................. 500 ................. ................. ................. (PI) 5,000 ................. 5,000 ................. ................. 0 756,700 756,700 ................. ................. ................. 0 Consolidated Net Income........................................................................................................................................ (252,500) ................. ................. To NCI (see distribution schedule) ...................................................................................................................... 4,250 (4,250) ................. To Controlling Interest (see distribution schedule) .............................................................................................. 248,250 ................. (248,250) Total NCI........................................................................................................................................................................................ (53,750) ................. Retained Earnings—Controlling Interest, December 31, 2017 .............................................................................................................................. (1,853,250) Totals ........................................................................................................................................................................................................................................

................. ................. ................. ................. ................. ................. ................. (53,750) (1,853,250) 0

Trial Balance Away Stallward

Eliminations and Adjustments Dr.

Cr.

Consolidated Income Statement

NCI

Gain on Acquisition ........................................ Dividends Declared ........................................ Purchased Income .........................................

part.

Ch. 7—Problems

7–26

PROBLEM 7-4 Determination and Distribution of Excess Schedule Company Implied Fair Value Fair value of subsidiary ........................ $560,000 Less book value of interest acquired: Common stock ($5 par).................. $100,000 Paid-in capital in excess of par ...... 300,000 Retained earnings .......................... 100,000 Total equity ............................... $500,000 Interest acquired ............................ Book value ........................................... Excess of fair value over book value ... $ 60,000

Parent Price (90%) $504,000

NCI Value (10%) $ 56,000

$500,000 90% $450,000 $ 54,000

$500,000 10% $ 50,000 $ 6,000

Adjustment of identifiable accounts: Adjustment Buildings .............................................. $ 60,000

Worksheet Key debit D

Entries of July 1, 2017: Investment in Dower [10% × ($30,000 income – $10,000 dividends) – (10% × $3,000 amortization × 1/2 year)] ................................. Investment Income ................................................................ To record the increase in the investment account for the portion sold of income not received in dividends. Investment in Dower [(10% × $100,000 change)] – (10% × 4 years × $3,000 amortization) ............................................................... Retained Earnings ................................................................. To convert the portion of the investment sold to equity by recording undistributed income less amortization for previous years. Cash................................................................................................. Investment in Dower [(1/9 × $504,000) + $1,850 + $8,800] ....... Paid-In Capital in Excess of Par—Carlos................................... To record sale of 10% interest. Entries on December 31, 2017: Investment in Dower [80% × ($70,000 income – $20,000 dividends) – (80% × $3,000 amortization)] ................................ Investment Income ................................................................ To record the increase in the investment account for the portion sold for income not received in dividends.

Life 20

Amortization per Year $3,000

1,850 1,850

8,800 8,800

100,000 66,650 33,350

37,600 37,600

7–27

Ch. 7—Problems

Problem 7-4, Concluded

Investment in Dower (80% × $100,000 change) – (80% × 4 years × $3,000 amortization) ...................................... Retained Earnings ................................................................. To convert the portion of the investment sold to equity by recording undistributed income less amortizations for previous years. Cash................................................................................................. Loss on Sale of Investment* ............................................................ Investment in Doer [(8/9 × $504,000) + $37,600 + $70,400] ..... To record sale of 8/9 interest. *The loss could be a result of a discontinued operation.

70,400 70,400

540,000 16,000 556,000

PROBLEM 7-5

Adjustments for investment in preferred stock: Investment in Channel Preferred Stock ........................................... Subsidiary Income—Preferred Stock ......................................... To record dividend preference for 2015. Adjustments for investment in common stock: From cost to fair value on January 1, 2013 Fair value, 1,000 shares ($140,000 purchase cost/5,000 shares) Cost ............................................................................................ Adjustment to fair value on control date ..................................... Investment in Channel Company ..................................................... Unrealized Gain on Investments ................................................ Adjustment for 2013–2014: Retained Earnings ........................................................................... Investment in Channel Common Stock ...................................... Net correction for equity adjustments on common: 2013–2014: Failure to deduct preferred dividend claims from net income to arrive at income available to common. Decrease investment and retained earnings (2 × $3,000 × 60% interest) = $(3,600). Adjustment for 2015: Retained Earnings ........................................................................... Investment in Channel Common Stock ...................................... Deduct dividends accumulated on preferred from income available to common and from investment (80% × $3,000) = $(2,400).

1,800 1,800

$28,000 25,000 $ 3,000 3,000 3,000

3,600 3,600

2,400 2,400

Ch. 7—Problems

7–28

Problem 7-5, Concluded

Adjustment for sale of 10% interest: Adjusted cost of shares, January 1, 2013, 1,000 shares × $28 .... Share of income (10% × $75,000) ................................................ Common dividends (10% × $5,000).............................................. Deduction for preferred dividends paid or accrued (10% × $9,000) ....................................................................... Equity-adjusted cost......................................................................

$28,000 7,500 (500) (900) $34,100

Entry to correct sale: Investment in Channel Common Stock ......................................... 900 Paid-In Capital in Excess of Par—Billings............................... 900 Calculation of balance: Original cost ...................................................................................................... $25,000 Income (10% × $130,000) (2011 thru 2015) ..................................................... 13,000 Common dividends paid (10% × $11,000) (2012 and 2013)............................. (1,100) Preferred dividends paid or accrued (10% × $15,000) (2011 thru 2015) .......... (1,500) Balance in investment account, December 31, 2015 ........................................ $35,400 Entry to correct sale: Gain on Sale of Investment........................................................... Investment in Channel Company ($35,400 balance – $35,000 removed) .........................

400 400

PROBLEM 7-6 Determination and Distribution of Excess Schedule, December 31, 2013 Company Implied Fair Value Fair value of subsidiary ........................ $900,000 Less book value of interest acquired: Common stock ($20 par)................ $750,000 Retained earnings .......................... 50,000 Preferred arrearage (2 years × $8,000) ..................................... (16,000) Total equity ............................... $784,000 Interest acquired ............................ Book value ........................................... Excess of fair value over book value ... $116,000

Parent Price (80%) $720,000

NCI Value (20%) $180,000

$784,000 80% $627,200 $ 92,800

$784,000 20% $156,800 $ 23,200

Adjustment of identifiable accounts: Adjustment Building ................................................ $ 28,000 Goodwill ............................................... 88,000 Total ............................................... $116,000

Worksheet Key debit D1 debit D2

Life 20

Amortization per Year $1,400

7–29

Ch. 7—Problems

Problem 7-6, Continued Marsha Corporation and Subsidiary Transam Corporation Worksheet for Consolidated Financial Statements For Year Ended December 31, 2016 Controlling Retained Earnings

Consolidated Balance Sheet

806,400 463,250 ................. ................. ................. ................. ................. 720,000 ................. (CV) 59,200 (EL) 686,400 ................. ................. ................. ................. ................. ................. (D) 92,800 ................. ................. ................. Land ............................................................... 400,000 210,000 ................. ................. ................. ................. ................. Building .......................................................... 950,000 500,000 (D1) 28,000 ................. ................. ................. ................. Accumulated Depreciation—Building ............. (200,000) (160,000) ................. (A1) 4,200 ................. ................. ................. Equipment ...................................................... 1,500,000 740,000 ................. (F1) 25,000 ................. ................. ................. Accumulated Depreciation—Equipment ........ (400,000) (200,000) (F1) 5,000 ................. ................. ................. ................. ................. ................. (F2) 5,000 ................. ................. ................. ................. Goodwill ......................................................... ................. ................. (D2) 88,000 ................. ................. ................. ................. Liabilities ........................................................ (800,000) (550,000) ................. ................. ................. ................. ................. Common Stock ($20 par)—Marsha ............... (2,000,000) ................. ................. ................. ................. ................. ................. Retained Earnings—Marsha .......................... (860,000) ................. (A1) 2,240 (CV) 59,200 ................. ................. ................. ................. ................. (F1) 20,000 ................. ................. ................. (896,960) Preferred Stock ($100 par)—Transam ........... ................. (100,000) ................. ................. ................. (100,000) ................. Common Stock ($20 par)—Transam ............. ................. (750,000) (EL) 600,000 (NCI) 23,200 ................. (150,000) ................. Retained Earnings (common)—Transam....... ................. (124,000) (PS) 16,000 ................. ................. ................. ................. ................. ................. (EL) 86,400 ................. ................. (44,240) ................. ................. ................. (A1) 560 ................. ................. ................. ................. Retained Earnings (preferred)—Transam ...... ................. ................. ................. (PS) 16,000 ................. (16,000) ................. Sales .............................................................. (2,100,000) (1,000,000) ................. ................. (3,100,000) ................. ................. Subsidiary Dividend Income .......................... (21,400) ................. (CY) 21,400 ................. ................. ................. ................. Cost of Goods Sold ........................................ 1,155,000 600,000 ................. ................. 1,755,000 ................. ................. Other Expenses ............................................. 650,000 320,000 (A1) 1,400 (F2) 5,000 966,400 ................. ................. Dividends Declared ........................................ 200,000 50,750 ................. (CY) 21,400 ................. 29,350 200,000 0 933,200 933,200 ................. ................. ................. 0 Consolidated Net Income........................................................................................................................................ (378,600) ................. ................. To NCI (see distribution schedule) ...................................................................................................................... 22,120 (22,120) ................. To Controlling Interest (see distribution schedule) .............................................................................................. 356,480 ................. (356,480) Total NCI........................................................................................................................................................................................ (303,010) ................. Retained Earnings—Controlling Interest, December 31, 2016 .............................................................................................................................. (1,053,440) Totals ........................................................................................................................................................................................................................................

1,269,650 ................. ................. 610,000 1,478,000 (364,200) 2,215,000 (590,000) ................. 88,000 (1,350,000) (2,000,000) ................. ................. ................. ................. ................. ................. ................. ................. ................. ................. ................. ................. ................. ................. ................. ................. ................. (303,010) (1,053,440) 0

Trial Balance Marsha Transam

Eliminations and Adjustments Dr.

Cr.

Consolidated Income Statement

NCI

Current Assets ............................................... Investment in Transam Corporation ...............

part.

Ch. 7—Problems

7–30

Problem 7-6, Continued

Eliminations and Adjustments: (CV) Convert the investment to the equity method as of January 1: Retained earnings applicable to common stock on January 1, 2016 ($124,000 – $16,000 arrearage for 2014 and 2015) ............................................................... Less retained earnings applicable to common stock on December 31, 2013 ($50,000 – $16,000) ........................ Change in retained earnings ...................................................... Parent’s interest ......................................................................... Equity conversion .......................................................................

$108,000 34,000 $ 74,000 × 80% $ 59,200

(CY) (PS)

Eliminate the intercompany common stock dividends for 2016 (80% × $26,750). Remove the retained earnings applicable to preferred stock on January 1, 2016, from the retained earnings of Transam Corporation, 2 years × $8,000. (EL) Eliminate the parent’s 80% share of subsidiary common stock equity. (D)/(NCI) Distribute the excess and NCI adjustment according to the determination and distribution of excess schedule. (D1) Building. (D2) Goodwill. Amortize the excess: (A1) Adjust the depreciation on the building—two past years and one current year. (F1) Adjust equipment for $25,000 gain. Reduce prior year depreciation $5,000. Eliminate $20,000 gain on January 1 from Marsha retained earnings. (F2) Reduce current depreciation by $5,000 for 1/5 of current gain on sale.

7–31

Ch. 7—Problems

Problem 7-6, Concluded

Subsidiary Transam Corporation Income Distribution Building depreciation ................ (A1) $1,400 Internally generated net income ............................... Less preferred claim to NCI (2016 dividends) .........

$80,000 8,000

Adjusted income ...................... NCI share ................................ NCI .......................................... Add preferred claim .................

$70,600 × 20% $14,120 8,000

Total NCI .................................

$22,120

Parent Marsha Corporation Income Distribution Internally generated income ............................... Share of Transam adjusted income (80% × $70,600) ... Realized gain on equipment through use ........................ Controlling interest...................

$295,000 56,480 5,000 $356,480

Ch. 7—Problems

7–32

PROBLEM 7-7

(1) Adjustment of investment account: July 1, 2018 Implied fair value of 5,000 shares [($226,200/15,000 shares) × 5,000] ................ Book value ($71,400 + $12,000 – $9,000) ............................................................ Unrealized gain ..................................................................................................... Correcting entry: Investment in Boat Corporation .......................................................... Unrealized Gain on Investment ...................................................

$ 75,400 74,400 $ 1,000

1,000 1,000

(2) Supporting schedules for worksheet: Determination and Distribution of Excess Schedule, July 31, 2018 Company Implied Fair Value Fair value of subsidiary ........................ $377,000 Less book value of interest acquired: Common stock ($10 par)................ $250,000 Retained earnings .......................... 107,000 January 1–June 20 income ............ 20,000 Total equity ............................... $377,000 Interest acquired ............................ Book value ........................................... Excess of fair value over book value ... $ 0

Parent Price (80%) $301,600*

NCI Value (20%) $ 75,400

$377,000 80% $301,600 $ 0

$377,000 20% $ 75,400 $ 0

*$74,400 + $1,000 gain + $226,200 January 2, 2018, Engine Corporation preferred, 250 shares: Price paid ................................................................................... Less interest acquired: Preferred stock ................................................................... Retained earnings, preferred stock, [$50,000/($200,000 + $50,000)] × $100,000 retained earnings on January 1, 2018 .......................... Total stockholders’ equity ....................................... Interest acquired (250 ÷ 2,500) ........................................... Excess........................................................................................

$7,000 $ 50,000 20,000 $ 70,000 × 10% $

7,000 0

7–33

Ch. 7—Problems

Problem 7-7, Continued

January 2, 2018, Engine Corporation common, 14,000 shares (14,000 shares/20,000 shares = 70%): Determination and Distribution of Excess Schedule Company Implied Fair Value Fair value of subsidiary ........................ $280,000 Less book value of interest acquired: Common stock ($10 par)................ $200,000 Retained earnings (for common shares ...................................... 80,000* Total equity ............................... $280,000 Interest acquired ............................ Book value ........................................... Excess of fair value over book value ... $ 0

Parent Price (70%) $196,000

NCI Value (30%) $ 84,000

$280,000 70% $196,000 $ 0

$280,000 30% $ 84,000 $ 0

*($200,000/250,000) × $100,000

Ch. 7—Problems

7–34

Problem 7-7, Continued Titan Corporation and Subsidiaries Boat Corporation and Engine Corporation Worksheet for Consolidated Financial Statements For Year Ended December 31, 2018

Titan Cash ........................................... Accounts Receivable .................. Inventories .................................. Advance to Boat Corporation ...... Dividends Receivable ................. Property, Plant, and Equipment .. Accumulated Depreciation .......... Investment in Boat Corporation: 6% Bonds .............................. Common Stock ......................

Investment in Engine Corporation: Preferred Stock .....................

Consolidated Income Statement

NCI Boat

NCI Engine

Controlling Retained Earnings

Consol. Balance Sheet

.............. .............. (IA) .............. (EI) .............. (LN) .............. (DP) .............. ..............

............. 22,400 6,400 17,000 24,000 ............. .............

................. ................. ................. ................. ................. ................. .................

............... ............... ............... ............... ............... ............... ...............

................ ................ ................ ................ ................ ................ ................

282,000 450,800 488,600 ................. ................. 1,572,600 (395,000)

............... .............. (B) 23,800 ............... .............. ............. ............... (CY2) 24,000 (CY1a) 16,000 ............... .............. (PI) 16,000 ............... .............. (EL1) 285,600

................. ................. ................. ................. .................

............... ............... ............... ............... ...............

................ ................ ................ ................ ................

................. ................. ................. ................. .................

............... ............... ............... ............... (44,000) (86,000) (IA) ............... (LN) (125,000) (B) ............... ............... (DP) ............... ............... ............... ............... (EL1) ............... (EL1)

................. ................. ................. ................. (103,000) ................. (312,600) (535,000) 8,000 (28,000) (400,000) (600,000) ................. ................. .................

100,000 87,000 95,000 158,200 210,000 105,000 290,000 90,000 115,000 17,000 ............... ............... 24,000 ............... ............... 777,600 325,000 470,000 (180,000) (55,000) (160,000) 23,800 293,600 ................. ................. .................

................ ................ ................ ................ ................

7,400 ................ ................. ................ Common Stock ...................... 207,200 ................ ................. ................ Notes Payable ............................ (45,000) (14,000) Accounts Payable ....................... (170,000) (96,000) ................. ............... Bonds Payable ............................ (285,000) (150,000) Discount on Bonds Payable ........ 8,000 ............... Dividends Payable ...................... (22,000) (30,000) Preferred Stock ($20 par)—Titan (400,000) ............... Common Stock ($10 par)—Titan (600,000) ............... Retained Earnings—Titan ........... (154,600) ............... Common Stock ($10 par)—Boat . ................. (250,000) Retained Earnings—Boat ........... ................. (107,000) Preferred Stock ($20 par) —Engine ................................ ................. ................ Common Stock ($10 par) —Engine ................................ ................. ................ Retained Earnings (common)— Engine ................................... ................. ................ ................. ................

Eliminations and Adjustments Dr. Cr.

Trial Balance Boat Engine

.............. (PS2) 7,000 .............. (PS) 400 .............. (CY1b) 11,200 .............. (EL2) 196,000 .............. ............. 22,400 ............. 17,000 ............. 25,000 ............. .............. ............. 24,000 ............. .............. ............. .............. ............. .............. ............. 200,000 ............. 85,600 .............

(50,000) (PS2)

5,000

.............

.................

...............

(45,000) ................

.................

(200,000) (EL2)

140,000

.............

.................

...............

(60,000) ................

.................

(100,000) (PS1) ............... (EL2)

20,000 56,000

............. .............

................. .................

............... ...............

............... ................ (24,000) ................

................. .................

part.

7–35

Ch. 7—Problems

Problem 7-7, Continued Titan Corporation and Subsidiaries Boat Corporation and Engine Corporation Worksheet for Consolidated Financial Statements For Year Ended December 31, 2018 (Concluded)

Titan

Trial Balance Boat Engine

Eliminations and Adjustments Dr. Cr.

Consolidated Income Statement

NCI Boat

NCI Engine

Controlling Retained Earnings

Retained Earnings (preferred)— Engine ................................... ................. ................ ............... (PS2) 2,000 (PS1) 20,000 ................. ............... (18,000) ................ Sales ........................................... (1,050,000) (500,000) (650,000) (IS) 22,400 ............. (2,177,600) ............... ............... ................ Other Revenue ........................... (2,100) ............... ............... (B) 1,050 ............. (1,050) ............... ............... ................ Gain on Bond Retirement ........... ................. ............... ............... .............. (B) 1,500 (1,500) ............... ............... ................ Unrealized Gain on Investment ... (1,000) ............... ............... .............. ............. (1,000) ............... ............... ................ Subsidiary Income: Common Stock—Boat ........... (16,000) ............... ............... (CY1a) 16,000 ............. ................. ............... ............... ................ Preferred Stock—Engine ....... (400) ............... ............... (PS) 400 ............. ................. ............... ............... ................ Common Stock—Engine ....... (11,200) ............... ............... (CY1b) 11,200 ............. ................. ............... ............... ................ Cost of Goods Sold ..................... 650,000 300,000 400,000 (EI) 6,400 (IS) 22,400 1,334,000 ............... ............... ................ Other Expenses .......................... 358,500 160,000 230,000 .............. (B) 750 747,750 ............... ............... ................ Dividends Declared ..................... 22,000 30,000 ............... .............. (CY2) 24,000 ................. 6,000 ............... 22,000 Purchased Income ...................... ................. ............... ............... (PI) 16,000 ............. 16,000 ............... ............... ................ 0 0 0 694,450 694,450 ................. ............... ............... ................ Consolidated Net Income............................................................................................................................... (83,400) ............... ............... ................ To NCI—Boat (see distribution schedule) ................................................................................................ 6,960 (6,960) ............... ................ To NCI—Engine (see distribution schedule) ............................................................................................. 8,400 ............... (8,400) ................ To Controlling Interest (see distribution schedule) ................................................................................... 68,040 ............... ............... (68,040) NCI—Boat ............................................................................................................................................................................ (72,360) ............... ................ NCI—Engine ........................................................................................................................................................................................... (155,400) ................ Retained Earnings—Controlling Interest, December 31, 2018 ................................................................................................................................... (200,640) Totals.........................................................................................................................................................................................................................................

part.

Consol. Balance Sheet ................. ................. ................. ................. ................. ................. ................. ................. ................. ................. ................. ................. ................. ................. ................. ................. ................. (72,360) (155,400) (200,640) 0

Ch. 7—Problems

7–36

Problem 7-7, Continued

Eliminations and Adjustments: (CY1a) Eliminate the current year’s income from the investment in Boat Corporation. (CY1b) Eliminate the current year’s income from investment in Engine Corporation— Common Stock. (CY2) Eliminate intercompany dividends. (PI) Eliminate the income purchased on July 1, 2018, from the investment in Boat Corporation (80% × $20,000). (EL1) Eliminate the parent’s interest in the equity of Boat Corporation. (PS1) Segregate Engine Corporation Retained Earnings to common and preferred. Preferred pro rata interest in Retained Earnings: $50,000 × $100,000 = $20,000 $250,000 (PS2) Eliminate the parent’s 10% interest in preferred stock and Retained Earnings (preferred)—Engine, against Investment in Engine Corporation—Preferred Stock. Eliminate the income from Preferred Stock—Engine against investment. (EL2) Eliminate the parent’s interest in Engine Corporation common stock. Retained earnings applicable to common stock: $200,000 $100,000 × = $80,000. Parent’s share 70% × $80,000 = $56,000. $250,000 (IS) Eliminate the intercompany sale of merchandise from Boat Corporation to Engine Corporation. (IA) Eliminate the intercompany receivable and payable from sale of merchandise from Boat Corporation to Engine Corporation. (EI) Eliminate the profit from Engine ending inventory: $22,400 – ($22,400 ÷ 1.4) = $6,400. (B) Eliminate the intercompany interest revenue and expense. Eliminate the balance of the investment in bonds account against the bonds payable account. The gain on retirement as of the date that consolidation is required is calculated as follows: Gain remaining at year-end: Carrying value of bonds at December 31, 2018 ............. Investment in bonds at December 31, 2018 ................... Gain amortized during the year: Interest revenue eliminated ($750 stated interest for half year + 1/2 year amortization of discount of $300*) ....... Interest expense eliminated (1/2 year × 6% × $25,000) ......................................... Gain at July 1, 2018 .............................................................

$25,000 23,800

$1,200

$ 1,050 750

300 $1,500

*$1,200/2 years left = $600; $600 × ½ year = $300 (DP) (LN)

Eliminate the intercompany dividends receivable and payable. Eliminate advance to Boat Corporation.

7–37

Ch. 7—Problems

Problem 7-7, Concluded

Subsidiary Boat Corporation Income Distribution Interest adjustment ($1,050 – $750) .................. (B) Unrealized profit in ending inventory ............................. (EI)

Internally generated net income ........................... $40,000 Gain on retirement of 6,400 bonds ............................. (B) 1,500

$ 300

Adjusted income .................. NCI share ............................ NCI ......................................

$34,800 × 20% $ 6,960

Subsidiary Engine Corporation Income Distribution Internally generated net income ...............................

$20,000

Adjusted income ...................... Less preferred interest: NCI [90% × ($50,000/$250,000) × $20,000]............................. Controlling (10% × 1/5 × $20,000)............................. Common stock interest ............ NCI share (30%) ......................

$20,000

Total NCI ($3,600 + $4,800) ....

$ 8,400

3,600 400 $16,000 4,800

Parent Titan Corporation Income Distribution Internally generated net income ............................... 80% × Boat Corporation income for one-half year [($34,800 – $20,000) × 80%] Controlling share of Engine’s preferred stock income ...... 70% × common stock interest in income of Engine (70% × $16,000) ................ Total controlling interest ..........

$44,600 11,840 400 11,200 $68,040

Ch. 7—Problems

7–38

PROBLEM 7-8

(1) Determination and Distribution of Excess Schedule Company Implied Fair Value Fair value of subsidiary ........................ $185,000 Less book value of interest acquired: Common stock ($10 par)................ $100,000 Paid-in capital in excess of par ...... 20,000 Retained earnings .......................... 30,000 Preferred arrearage (2 years × $4,000) ..................................... (8,000) Total equity ............................... $142,000 Interest acquired ............................ Book value ........................................... Excess of fair value over book value ... $ 43,000

Parent Price (60%) $111,000

NCI Value (40%) $ 74,000

$142,000 60% $ 85,200 $ 25,800

$142,000 40% $ 56,800 $ 17,200

Adjustment of identifiable accounts: Adjustment Equipment ............................................ $ 43,000

Worksheet Key debit D

Life 8

Amortization per Year $5,375

7–39

Ch. 7—Problems

Problem 7-8, Continued Black Jack Corporation and Subsidiary Zeppo Company Worksheet for Consolidated Financial Statements For Year Ended December 31, 2018 Trial Balance Black Jack Zeppo Cash .............................................................. Accounts Receivable (net) ............................. Inventories ..................................................... Other Current Assets ..................................... Property, Plant, and Equipment ..................... Accumulated Depreciation ............................. Investment in Zeppo Preferred Stock ............ Investment in Zeppo Common Stock ............. Liabilities ........................................................ Common Stock—Black Jack .......................... Paid-In Capital in Excess of Par—Black Jack Retained Earnings—Black Jack ..................... Preferred Stock ($100 par)—Zeppo ............... Common Stock ($10 par)—Zeppo ................. Paid-In Capital in Excess of Par—Zeppo ....... Retained Earnings (preferred)—Zeppo .......... Retained Earnings—Zeppo............................

Sales .............................................................. Cost of Goods Sold ........................................ Other Expenses ............................................. Dividends Declared ........................................

30,400 80,000 230,000 20,000 1,450,000 ................. (420,000) ................. 56,000 121,200 ................. ................. (350,000) (1,000,000) ................. (195,000) ................. ................. ................. ................. ................. ................. ................. ................. ................. ................. ................. (420,000) 300,000 ................. 80,000 25,000

Eliminations and Adjustments Dr.

Cr.

10,000 ................. ................. 76,000 ................. (IA) 8,000 44,000 ................. (EI) 2,600 8,000 ................. ................. 122,000 (D) 43,000 ................. ................. ................. (F1) 5,000 (25,000) (F1) 1,000 (A) 10,750 ................. (F2) 1,000 ................. ................. ................. (ELP) 56,000 ................. ................. (CY1b) 3,600 ................. ................. (ELC) 91,800 ................. ................. (D) 25,800 (18,000) (IA) 8,000 ................. ................. ................. ................. ................. ................. (ELP) 2,000 ................. (A) 3,225 ................. ................. (F1) 2,400 ................. ................. (BI) 1,070 ................. (50,000) (ELP) 50,000 ................. (100,000) (ELC) 60,000 ................. (20,000) (ELC) 12,000 ................. ................. (ELP) 8,000 (PS) 8,000 (41,000) (PS) 8,000 (NCI) 17,200 ................. (ELC) 19,800 ................. ................. (F1) 1,600 ................. ................. (BI) 180 ................. ................. (A) 2,150 ................. (96,000) (IS) 28,000 ................. 60,000 (EI) 2,600 (IS) 28,000 ................. ................. (BI) 1,250 26,000 (A) 5,375 (F2) 1,000 4,000 ................. (CY1a) 4,000

Consolidated Income Statement ................. ................. ................. ................. ................. ................. ................. ................. ................. ................. ................. ................. ................. ................. ................. ................. ................. ................. ................. ................. ................. ................. ................. ................. ................. ................. ................. (488,000) ................. 333,350 110,375 .................

NCI

Controlling Retained Earnings

Consolidated Balance Sheet

................. ................. ................. ................. ................. ................. ................. ................. ................. ................. ................. ................. ................. ................. ................. ................. ................. ................. ................. (40,000) (8,000) ................. (26,470) ................. ................. ................. ................. ................. ................. ................. ................. .................

................. ................. ................. ................. ................. ................. ................. ................. ................. ................. ................. ................. ................. ................. ................. ................. ................. (188,305) ................. ................. ................. ................. ................. ................. ................. ................. ................. ................. ................. ................. ................. 25,000

40,400 148,000 271,400 28,000 1,610,000 ................. ................. (453,750) ................. ................. ................. ................. (360,000) (1,000,000) (2,000) ................. ................. ................. ................. ................. ................. ................. ................. ................. ................. ................. ................. ................. ................. ................. ................. .................

part.

Ch. 7—Problems

7–40

Problem 7-8, Continued Black Jack Corporation and Subsidiary Zeppo Company Worksheet for Consolidated Financial Statements For Year Ended December 31, 2018 (Concluded) Controlling Retained Earnings

Consolidated Balance Sheet

(4,000) ................. (CY1a) 4,000 ............... ................. ................. ................. 3,600 ............... ................. ................. ................. (3,600) ................. (CY1b) 0 0 265,000 265,000 ................. ................. ................. ................. Consolidated Net Income........................................................................................................................................ (44,275) ................. To NCI (see distribution schedule) ...................................................................................................................... 590 (590) ................. To Controlling Interest (see distribution schedule) .............................................................................................. 43,685 ................. (43,685) Total NCI........................................................................................................................................................................................ (75,060) ................. Retained Earnings—Controlling Interest, December 31, 2018 .............................................................................................................................. (206,990) Totals ........................................................................................................................................................................................................................................

................. ................. ................. ................. ................. ................. (75,060) (206,990) 0

Trial Balance Black Jack Zeppo

Eliminations and Adjustments Dr.

Cr.

Consolidated Income Statement

NCI

Subsidiary Income—Preferred ....................... Subsidiary Income—Common .......................

part.

7–41

Ch. 7—Problems

Problem 7-8, Continued

Eliminations and Adjustments: (CY1a) Eliminate the entries made concerning the investment in preferred stock during 2018. (CY1b) Eliminate the entries made concerning the investment in common stock during 2018. (PS) Distribute retained earnings at the beginning of the year; preferred share is $4,000 × 2 years of arrearage. (ELP) Eliminate the investment in preferred stock: Adjustment to paid-in capital in excess of par resulting from retirement of preferred stock on January 1, 2017: Price paid ........................................................... Book value: Par ..................................................................... $ 50,000 Dividend arrearage ............................................ 8,000 Gain to paid-in capital in excess of par ..............

$ 56,000 58,000 $ 2,000

(ELC)

Eliminate 60% of subsidiary equity against the investment in common stock. This equity includes 60% of the January 1, 2018, retained earnings applicable to common stock ($41,000 less $8,000 preferred claim). (D)/(NCI) Distribute the excess of book value to plant asset (see schedule). (A) Amortize the decrease in depreciation for one past year and for the current year. (F1) Eliminate the gain on equipment sale ($5,000), less one year’s depreciation of $1,000 at the beginning of the year. (F2) Decrease depreciation for the current year. (IS) Eliminate intercompany sales. (IA) Eliminate intercompany trade debt. (BI) Eliminate the beginning inventory profit: Black Jack Corporation, $800, deduct from controlling retained earnings. Zeppo Company, $450, allocate 40% to NCI and 60% to controlling retained earnings. (BI) (Parent seller) $2,800 – ($2,800/1.4) = $800 profit (BI) (Subsidiary seller) $1,200 – ($1,200/1.6) = $450 profit (EI) Eliminate profit in ending inventory: Black Jack, $2,000; Zeppo, $600. (EI) (Parent seller) $7,000 – ($7,000/1.4) = $2,000 profit. (EI) (Subsidiary seller) $1,600 – ($1,600/1.6) = $600 profit.

Ch. 7—Problems

7–42

Problem 7-8, Concluded

Subsidiary Zeppo Company Income Distribution Unrealized gross profit in ending inventory ............ (EI) Depreciation adjustment ......... (A)

Internally generated $ 600 income ............................... 5,375 Realized gross profit in beginning inventory...... (BI) Realized profit on equipment sale ........... (F1) Adjusted income ...................... Less preferred share ............... ........................................... NCI share ................................ NCI ..........................................

$10,000 450 1,000 $ 5,475 4,000 $ 1,475 × 40% $ 590

Parent Black Jack Corporation Income Distribution Unrealized gross profit in ending inventory ............ (EI)

Internally generated $2,000 income ..................................... Share of Zeppo common income (60% × $1,475) ........................ Realized gross profit in beginning inventory............ (BI) Subsidiary preferred income ..................................... Controlling interest.........................

$40,000 885 800 4,000 $43,685

(2) Entries to record sale: (a) Adjust investment for amortization of excess cost: Retained Earnings ($5,375 × 2 years × 60% ownership) ......... Investment in Zeppo Common Stock ................................... (b) Adjust the investment account for unrealized profit on inventory sales, 60% × $600: Retained Earnings .................................................................... Investment in Zeppo Common Stock ................................... (c) To record the sale: Cash ......................................................................................... Investment in Zeppo Common Stock* .................................. Gain on Sale of Subsidiary Interest ......................................

6,450 6,450

360 360 130,000 114,390 15,610

*Equity balance on December 31, 2018 [$121,200 – ($6,450 + $360)]. Note: The gain on the sale and subsidiary income on the common stock would be shown in the discontinued segment section of the income statement for 2018.

7–43

Ch. 7—Problems

APPENIDIX PROBLEMS PROBLEM 7A-1

Analysis of 30% purchase September 1, 2019: Price paid ....................................................................... Less interest acquired: Equity, December 31, 2019 .................................... Add dividends declared December 31 ................... Deduct income for last 4 months ............................ Total stockholders’ equity, September 1, 2019 Interest acquired ..................................................... Debit Marley retained earnings. .....................................

$100,000 $252,000 40,000 (32,000) $260,000 × 30%

78,000 $ 22,000

Marley Corporation and Subsidiary Foster Corporation Worksheet for Consolidated Balance Sheet December 31, 2019 Balance Sheet Marley Foster

Eliminations and Adjustments Dr. Cr.

NCI

Cash ........................................ 167,250 101,000 (IA) 8,000 .............. ................ Accounts Receivable............... 170,450 72,000 ............. (IA) 8,000 ................ Notes Receivable .................... 87,500 28,000 ............. .............. ................ Dividends Receivable.............. 36,000 ............... ............. (CY) 36,000 ................ Inventories ............................... 122,000 68,000 ............. (EI) 10,000 ................ Property, Plant, and Equipment ............................ 487,000 252,000 ............. (F) 9,000 ................ Accumulated Depreciation ...... (117,000) (64,000) (F) 225 .............. ................ Investment in Foster Corporation .......................... 248,800 ............... ............. (EL) 226,800 ................ ............... ............... ............. (D) 22,000 ................ Accounts Payable ................... (222,000) (76,000) ............. .............. ................ Notes Payable ......................... (79,000) (89,000) ............. .............. ................ Dividends Payable .................. ............... (40,000) (CY) 36,000 .............. ................ Common Stock ($10 par)— Marley .................................. (400,000) ............... ............. .............. ................ Common Stock ($10 par)— Foster ................................... ............... (100,000) (EL) 90,000 .............. (10,000) Retained Earnings—Marley .... (501,000) ............... (D) 22,000 .............. ................ ............... ............... (EI) 10,000 .............. ................ ............... ............... (F) 8,775 .............. ................ Retained Earnings—Foster ..... ............... (152,000) (EL) 136,800 .............. (15,200) 0 0 311,800 311,800 ................ NCI ........................................................................................................................................ (25,200) Totals .....................................................................................................................................................

Consolidated Balance Sheet

276,250 234,450 115,500 ............... 180,000 730,000 (180,775) ............... ............... (298,000) (168,000) (4,000) (400,000) ............... ............... ............... (460,225) ............... ............... (25,200) 0

Ch. 7—Problems

7–44

Problem 7A-1, Concluded

Eliminations and Adjustments: (CY) Eliminate intercompany dividends. (EL) Eliminate the pro rata equity at year-end. (D) Adjust parent retained earnings for excess cost on 30% investment. (EI) Eliminate the ending inventory profit by Marley, 25% × $40,000 = $10,000. (F) Equipment profit, $9,000 ÷ 10 years = $900 per year. Amortize to date, $900 × 1/4 = $225. (IA) $8,000 payment in transit. PROBLEM 7A-2

(1) Determination and Distribution of Excess Schedule Company Implied Fair Value Fair value of subsidiary ........................ $2,600,000 Less book value of interest acquired: Common stock ($25 par)................ $1,000,000 Paid-in capital in excess of par ...... 190,000 Retained earnings .......................... 980,000 Total equity ............................... $2,170,000 Interest acquired ............................ Book value ........................................... Excess of fair value over book value ... $ 430,000

Parent Price (100%) $2,600,000

NCI Value (0%) NA

$2,170,000 100% $2,170,000 $ 430,000

Adjustment of identifiable accounts: Adjustment Goodwill ............................................... $ 430,000

Worksheet Key debit D

Life

Amortization per Year

7–45

Ch. 7—Problems

Problem 7A-2, Continued

Book, Inc. and Subsidiary Cray, Inc. Worksheet for Consolidated Balance Sheet December 31, 2014 Trial Balance Book Cray

Cash ......................................... Accounts and Other Current Receivables .......................... Inventories ................................ Land ......................................... Depreciable Assets (net) .......... Goodwill.................................... Investment in Cray, Inc. ........... Long-Term Investments and Other Assets ......................... Accounts Payable and Other Current Liabilities ..................

Eliminations and Adjustments Dr. Cr.

825,000

330,000

.................

2,140,000 .................. 2,310,000 650,000 4,575,000 .................. 2,860,000 ..................

835,000 ................... 1,045,000 300,000 1,980,000 ................... ................... ...................

................. ................. ................. ................. ................. (D) 430,000 ................. .................

865,000

385,000

.................

(2,465,000) .................. Long-Term Debt ....................... (1,900,000) Common Stock ($25 par) ......... (3,200,000) Additional Paid-In Capital in Excess of Par ................... (3,260,000) Retained Earnings.................... (3,400,000) .................. .................. Totals .................................... 0

Consolidated Balance Sheet

.................

1,155,000

720,000 8,000 90,000 ................. ................. ................. (EL) 2,430,000 (D) 430,000

.................. 2,247,000 3,265,000 950,000 6,555,000 430,000 .................. ..................

(IA) (B2) (EI)

(B1)

320,000

930,000

(1,145,000) (IA) 720,000 ................... (B2) 8,000 (1,300,000) (B1) 320,000 (1,000,000) (EL) 1,000,000

................. ................. ................. .................

.................. (2,882,000) (2,880,000) (3,200,000)

(190,000) (EL) 190,000 (1,240,000) (EL) 1,240,000 ................... (EI) 90,000 ................... ................. 0 3,998,000

................. ................. ................. ................. 3,998,000

(3,260,000) (3,310,000) .................. .................. 0

Eliminations and Adjustments: (EL) Eliminate the parent’s investment in the subsidiary and the subsidiary equity accounts. (D) Distribute excess to goodwill. (B1) Eliminate the intercompany long-term debt. There is no adjustment to retained earnings because issue and repurchase of the bonds were at face value. (B2) Eliminate the intercompany receivable and payable for interest bonds (1/2 year × 10% × 1/2 interest period × $320,000). (EI) Eliminate the unearned gross profit in Cray’s ending inventory, $180,000 × 1/2 = $90,000. (IA) Eliminate the intercompany receivable and payable for the full price of $720,000.

Ch. 7—Problems

7–46

Problem 7A-2, Concluded

(2)

Book, Inc. and Subsidiary Cray, Inc. Consolidated Statement of Retained Earnings December 31, 2014: Balance, January 1, 2014 ...................................................... Consolidated net income ($890,000 + $260,000 – $90,000 inventory profit) .............................................................. Dividends declared: Book ............................................................................... Balance, December 31, 2018.................................................

$2,506,000 1,060,000 (256,000) $3,310,000

PROBLEM 7A-3 Determination and Distribution of Excess Schedule Company Implied Fair Value Fair value of subsidiary ........................ $360,000 Less book value of interest acquired: Total equity ............................... 270,000 Interest acquired ............................ Book value ........................................... Excess of fair value over book value ... $ 90,000

Parent Price (90%) $324,000

NCI Value (10%) $ 36,000

$270,000 90% $243,000 $ 81,000

$270,000 10% $ 27,000 $ 9,000

Adjustment of identifiable accounts:

Land ..................................................... Building ................................................ Goodwill ............................................... Total ...............................................

Adjustment $ 20,000 40,000 30,000 $ 90,000

Worksheet Key debit D1 debit D2 debit D3

Life

Amortization per Year

$2,000

7–47

Ch. 7—Problems

Problem 7A-3, Continued Press Company and Subsidiary Soap Company Worksheet for Consolidated Balance Sheet For Year Ended December 31, 2016 Trial Balance Press Soap Assets: Accounts Receivable ........................................................... Bond Interest Receivable .................................................... Minimum Lease Payments Receivable ............................... Unearned Interest Income ................................................... Inventory ............................................................................. Other Current Assets........................................................... Investment in Soap Company ............................................. Investment in Soap Bonds .................................................. Land .................................................................................... Buildings and Equipment ..................................................... Accumulated Depreciation—Buildings and Equipment ....... Equipment Under Capital Lease ......................................... Accumulated Depreciation—Equipment Under Lease ........ Goodwill .............................................................................. Totals ...................................................................................... Liabilities and Equity: Accounts Payable ............................................................... Bond Interest Payable ......................................................... Lease Interest Payable........................................................ Other Current Liabilities....................................................... Lease Obligation Payable ................................................... Bonds Payable .................................................................... Premium on Bonds .............................................................. Common Stock—Press ....................................................... Other Paid-In Capital in Excess of Par—Press ................... Retained Earnings—Press .................................................. Common Stock—Soap ........................................................ Other Paid-In Capital in Excess of Par—Soap .................... Retained Earnings—Soap ................................................... NCI.......................................................................................... Totals ...................................................................................... .

65,000 1,500 80,000 (2,961) 86,000 60,236 351,000 ............... 59,225 60,000 300,000 ............... (100,000) ............... ............... ............... ............... 960,000

50,000 ............... ............... ............... 80,000 183,668 ............... ............... ............... 30,000 230,000 ............... (50,000) ............... 111,332 (35,000) ............... 600,000

78,000 ............... ............... 57,000 ............... 150,000 ............... 200,000 150,000 325,000 ............... ............... ............... ............... ............... ............... ............... 960,000

70,000 2,500 5,707 48,911 71,332 100,000 1,550 ............... ............... ............... ............... 100,000 70,000 130,000 ............... ............... ............... 600,000

Dr.

(L1)

(D1) (L2) (D2)

(L3) (D3)

(IA) (BI) (L1) (L1) (B2) (B2) (A) (EI) (EL) (EL) (EL) (EI) (A)

Eliminations and Adjustments

............. ............. ............. 2,961 ............. ............. ............. ............. ............. 20,000 111,332 40,000 ............. ............. ............. 35,000 30,000

8,000 1,500 5,707 ............. 71,332 60,000 930 ............. ............. 3,600 5,400 90,000 63,000 117,000 600 400 ............. 666,762

(IA) (B1) (L1) (EI) (EL) (D) (B2)

(A) (L3) (L2)

(B2)

(NCI) (B2)

Consolidated Balance Sheet Dr. Cr.

Cr.

NCI

8,000 1,500 80,000 ............. 6,000 ............. 270,000 81,000 59,225 ............. ............. ............. 4,000 35,000 111,332 ............. .............

107,000 ................. ................. ................. 160,000 243,904 ................. ................. ................. 110,000 ................. 681,332 ................. ................. ................. ................. 30,000

............. ............. ............. ............. ............. ............. ............. ............. ............. 1,535 ............. ............. ............. 9,000 170 ............. ............. 666,762

............. ............. ............. ............. ............. ............. ............. ............. ............. ............. ............. 10,000 7,000 21,170 ............. ............. 38,170

140,000 1,000 ................. 105,911 ................. 190,000 620 200,000 150,000 317,535 ................. ................. ................. ................. ................. ................. 38,170 1,332,236

part.

Ch. 7—Problems

7–48

Problem 7A-3, Concluded Eliminations and Adjustments: (EL) Eliminate 90% of the subsidiary equity accounts against the investment in subsidiary account. (D)/(NCI) Distribute the excess of cost over book value and NCI adjustment to net assets as required by the determination and distribution of excess schedule. (A) Depreciate the write-up to building for two years. (EI) Eliminate the intercompany gross profit in the ending inventory. (IA) Eliminate the intercompany receivable and payable. (B1) Eliminate the bond interest receivable against 60% of bond interest payable. (B2) Eliminate the bond investment against 60% of bonds payable and premium on bonds. The resulting gain of $1,705 is allocated 90% and 10% to retained earnings of parent and subsidiary, respectively. (L1) Eliminate the lease payable (lease obligation payable plus lease interest payable) against the lease receivable (minimum lease payments receivable less unearned interest income). (L2) Reclassify the leased equipment. (L3) Reclassify the accumulated depreciation on the leased equipment.

CHAPTER 8 UNDERSTANDING THE ISSUES 1. The stock dividend will result in the following entry being made by the subsidiary: Retained Earnings (10,000 shares × $50 per share)................... Common Stock ($1 par, 10,000 shares × $1) .......................... Paid-In Capital in Excess of Par ($500,000 – $10,000 par value) ............................................

500,000 10,000 490,000

The parent need make no adjustment to its investment account since there has been no change in the total subsidiary equity. When eliminating the investment in subsidiary account, the parent will now simply eliminate its share of the revised (but equal in total) subsidiary equity accounts. 2. The parent shares in any equity increases from the excess of the current book value of $40 per share ($4,000,000/100,000 shares) that the subsidiary receives. The parent does not record as income the increase in equity that results. Rather, it is an increase in the parent’s paid-in capital in excess of par. The calculation in this case would be as follows: Equity after sale {(90,000 shares/120,000 shares = 75%) × [$4,000,000 + ($45 × 20,000 shares)]}............................................. Equity prior to sale (90% × $4,000,000) ............................................. Increase in equity interest ...................................................................

$ 3,675,000 3,600,000 $ 75,000

3. The subsidiary is selling the additional shares at $45 each, which is in excess of the current book value of $40 per share ($4,000,000/100,000 shares). (a) If the parent buys less than its current ownership percentage of shares, it will increase its equity to the extent others pay more than book value. The increase will be credited to Paid-In Capital in Excess of Par. (b) If the parent maintains its percentage, there is no impact other than an increase in the investment account equal to the price paid. The parent will supply 90% of the funds and will own 90% of the equity provided by the new funds. (c) If the parent buys more than 90% of the shares issued, it will adjust its investment based on the impact of the sale. A sale at more than book value will cause a reduction in the investment. The debit will be to the parent’s Paid-In Capital in Excess of Par (or Retained Earnings, if no paid-in capital in excess of par exists).

8–2 4. Control, in this example, is a “chain link” process. If A controls B and B, in turn, controls C, then all three are under common ownership, and B and C are controlled by A. In the distribution of Company C’s $10,000 income, 40% (or $4,000) will flow to the NCI of Company C, and 60% (or $6,000) will flow to Company B, the controlling interest. That $6,000 will flow as follows: 20% (or $1,200) will flow to the NCI of Company B, and 80% (or $4,800) will flow to Company A, the controlling interest. 5. The 2% holding in Company P shares, owned by Company S, is treated as treasury stock. This approach views the subsidiary as the parent’s agent in purchasing parent company shares. As treasury stock, the 2,000 shares will not share in the distribution of income and will not create a separate excess of cost or book value. The treasury stock will be a subtraction from equity in the consolidated balance sheet.

8–3

Ch. 8—Exercises

EXERCISES EXERCISE 8-1 (1) Retained Earnings (3,000 × $40) ..................................................... Common Stock ............................................................................ Paid-In Capital in Excess of Par .................................................. To record stock dividend distributed on July 1, 2015.

120,000 30,000 90,000

Lego Company Stockholders’ Equity December 31, 2015 Common stock ($10 par)........................................................................ Paid-in capital in excess of par .............................................................. Retained earnings [$200,000 original balance + $108,000 income – $120,000 stock dividend – (33,000 share × $0.50 = $16,500 cash dividend)] ............................. Total stockholders’ equity.......................................................................

$330,000 240,000 171,500 $741,500

(2) Memo: Investment in Lego Company now includes 2,700 (30,000 × 90% × 10%) additional shares for a total of 29,700 shares. Cash ................................................................................................. Investment in Lego Company ...................................................... To record receipt of cash dividend (29,700 shares × $0.50).

14,850

Investment in Lego Company .......................................................... Subsidiary Income ....................................................................... To record 90% interest in Lego Company’s $108,000 net income for 2015. (3) Subsidiary Income............................................................................ Investment in Lego Company ...................................................... Dividends—Leego Company ....................................................... To eliminate current-year entries to investment account.

97,200

Goodwill ........................................................................................... Common Stock [($300,000 + $30,000) × 90%] ................................ Paid-In Capital in Excess of Par [($150,000 + $90,000) × 90%] ...... Retained Earnings [($200,000 – $120,000) × 90%] ......................... Investment in Lego Company (includes $225,000 from D&D)..... Retained Earnings—Leego Company (NCI adjustment) .............

14,850

97,200 108,000 93,150 14,850 250,000 297,000 216,000 72,000 810,000 25,000

Ch. 8—Exercises

8–4

Exercise 8-1, Concluded Determination and Distribution of Excess Schedule Company Implied Fair Value Fair value of subsidiary ........................ $900,000 Less book value of interest acquired: Common stock ($10 par)................ $300,000 Paid-in capital in excess of par ...... 150,000 Retained earnings .......................... 200,000 Total equity ............................... $650,000 Interest acquired ............................ Book value ........................................... Excess of fair value over book value ... $250,000

Parent Price (90%) $810,000

NCI Value (10%) $ 90,000

$650,000 90% $585,000 $225,000

$650,000 10% $ 65,000 $ 25,000

Adjustment of identifiable accounts: Adjustment Goodwill ............................................... $250,000

Worksheet Key debit D

Life

Amortization per Year

EXERCISE 8-2 Investment in Trailer .............................................................................. Subsidiary Income............................................................................

57,750 57,750

Calculation: 90% × first 6 months’ income of $35,000 ......................................... 75%* × second 6 months’ income of $35,000 .................................. Total ....................................................................................................... Investment in Trailer .............................................................................. Paid-In Capital in Excess of Par....................................................... Calculation: Interest after sale Trail, January 1, equity ................................................................ Income, first 6 months ................................................................. Sale of shares (2,000 × $75) ....................................................... Total stockholders’ equity ........................................................ Interest ......................................................................................... Interest prior to sale [($550,000 + $35,000) × 90%]......................... Increase in ownership interest .........................................................

$31,500 26,250 $57,750 24,750 24,750 $550,000 35,000 150,000 $735,000 × 75% $551,250 526,500 $ 24,750

*(10,000 shares × 90%)/(10,000 shares + 2,000 shares)

8–5

Ch. 8—Exercises

EXERCISE 8-3 Maintain Interest 8,000 24,000 30,000

Increase Interest 9,000 25,000 30,000

Decrease Interest 5,000 21,000 30,000

Subsidiary equity after sale ($450,000 + $60,000 income + $50,000 goodwill + $600,000 sale)....... $1,160,000

$1,160,000

Shares purchased by parent ...................................... Total shares owned by parent after purchase............ Total subsidiary shares outstanding after issue .........

Parent’s ownership percent after purchase ............... × 80% × 83.33% × 70% Parent’s new equity interest after purchase ............... $ 928,000 $ 966,667 $ 812,000 Subsidiary equity prior to sale (after fair value adjustment) ($450,000 + $60,000 income + $50,000 goodwill) ................................................. $ 560,000

$ 560,000

Parent’s ownership percent before purchase ............ Parent’s equity interest before purchase ................... Price paid ($60 per share) ......................................... Total investment ......................................................... Net adjustment ...........................................................

× 80% $ 448,000 480,000 $ 928,000 $ 0

× 80% $ 448,000 540,000 $ 988,000 $ 21,333

× 80% $ 448,000 300,000 $ 748,000 $ (64,000)

Maintain ownership percentage interest: Investment in Calco Company ...................................................... Cash .........................................................................................

480,000

Increase ownership percentage interest: Investment in Calco Company ($966,667 – $448,000) ................. Retained Earnings—Artic Company (assumes no paid-in capital in excess of par) ....................................................................... Cash ......................................................................................... Decrease ownership percentage interest: Investment in Calco Company ($812,000 – $448,000) ................. Cash ......................................................................................... Paid-In Capital in Excess of Par—Artic Company ....................

480,000 518,667 21,333 540,000 364,000 300,000 64,000

Ch. 8—Exercises

8–6

EXERCISE 8-4 Investment in Nolan ............................................................................ Retained Earnings—Tarman......................................................... To convert investment from cost to equity for income.

81,360 81,360

Income equity adjustment: Jan. 1, 2015 to Jan. 1, 2017 increase in retained earning ($42,000 × 60%) Jan. 1, 2017 to Jan. 1, 2019 increase in retained earnings ($78,000 × 72%*) Total ...........................................................................................................

$25,200 56,160 $81,360

*(60% × 30,000 shares)/(30,000 – 5,000 treasury stock shares) Retained Earnings—Tarman .............................................................. Investment in Nolan ......................................................................

5,760 5,760

Adjustment for treasury stock purchase: Equity after treasury stock purchase (72% × $327,000) .............................. Equity prior to treasury stock purchase (60% × $402,000) .......................... Increase (decrease) in investment ............................................................... Elimination: Common Stock—Nolan (72% × $300,000) ......................................... Paid-In Capital in Excess of Par—Nolan (72% × $60,000) ................. Retained Earnings—Nolan (72% × $120,000) .................................... Investment in Nolan ($216,000* + $81,360 – $5,760) .................. Treasury Stock (at cost, 72% × $75,000) ...................................... To eliminate the investments against the subsidiary’s equity.

$235,440 241,200 $ (5,760) 216,000 43,200 86,400 291,600 54,000

*60% × 30,000 shares × $12

8–7

Ch. 8—Exercises

EXERCISE 8-5 (1) Company A’s Books December 31, 2015

December 31, 2016

December 31, 2017

Cash ........................................ 4,000 Investment in B ........................ 12,000 Subsidiary Income—B .......... Cash ........................................ 4,000 Investment in B ........................ 32,000 Subsidiary Income—B .......... Income: 80% × ($30,000 + $15,000 from C). Cash ........................................ 4,000 Investment in B ........................ 42,400 Subsidiary Income—B .......... Income: 80% × ($40,000 + $18,000 from C).

Company B’s Books

16,000 3,000 12,000

36,000

Cash ........................................... Investment in C........................... Subsidiary Income—C ..........

3,000 15,000

46,400

Cash ........................................... Investment in C........................... Subsidiary Income—C ..........

15,000

18,000

(2) Company A’s Books

Company B’s Books

December 31, 2015 December 31, 2016

December 31, 2017

Cash ........................................ 4,500 Investment in B ........................ 50,400 Subsidiary Income—B .......... Income: 90% × ($40,000 + $21,000 from C).

54,900

Investment in C........................... Subsidiary Income—C..........

7,000

Cash ........................................... Investment in C........................... Subsidiary Income—C..........

3,500 14,000

Cash ........................................... Investment in C........................... Subsidiary Income—C ..........

3,500 17,500

part.

7,000

17,500

21,000

Ch. 8—Exercises

8–8

EXERCISE 8-6 (1) Determination and Distribution of Excess Schedule Company Implied Fair Value Fair value of subsidiary ........................ $4,500,000 Less book value of interest acquired: Common stock ............................... $ 400,000 Paid-in capital in excess of par ...... 1,100,000 Retained earnings .......................... 2,000,000 Total equity ............................... $3,500,000 Interest acquired ............................ Book value ........................................... Excess of fair value over book value ... $1,000,000

Parent Price (60%) $2,700,000

NCI Value (40%) $1,800,000

$3,500,000 $3,500,000 60% 40% $2,100,000 $1,400,000 $ 600,000 $ 400,000

Adjustment of identifiable accounts: Adjustment Cain Company equipment ................... $ 80,000 Baker Company building (80%) ........... 160,000* Goodwill ............................................... $ 760,000 Total ............................................... $1,000,000

Worksheet Key debit D1 debit D2 debit D3

Life

Amortization per Year

*NCI of Cain Company is also increased by $40,000. (2) Eliminations and Adjustments: Retained Earnings—Able ($12,000 × 80% × 60%) ....................... Retained Earnings—Baker ($12,000 × 80% × 40%)..................... Retained Earnings—Cain ($12,000 × 20%) for Cain’s NCI .......... Accumulated Depreciation ............................................................ Machine .................................................................................... To eliminate the remaining gain and restore machine value.

5,760 3,840 2,400 3,000

Accumulated Depreciation ............................................................ Depreciation Expense............................................................... To recognize gain for current year.

3,000

15,000

3,000

8–9

Ch. 8—Exercises

EXERCISE 8-7 Companies A, B, and C Consolidated Income Statement For Year Ended December 31, 2015 Sales [($300,000 + $400,000 + $100,000) – intercompany sales of $75,000] .............................................. Cost of goods sold [$200,000 + $300,000 + $60,000 – intercompany sales of $75,000 – realized profit in beginning inventory of $1,800 + unrealized profit in ending inventory of ($6,000 + $720)] .................................. Gross profit ................................................................................... Expenses ($60,000 + $30,000 + $10,000 – $4,000 depreciation adjustment for deferred gain on equipment)....... Consolidated net income .............................................................. To NCI—Company C .............................................................. To NCI—Company B .............................................................. To controlling interest....................................................................

$725,000

489,920 $235,080 96,000 $139,080 $ 9,600 17,680

27,280 $111,800

Subsidiary Company C Income Distribution Unrealized profit in ending inventory ..................................

$6,000

Internally generated net income .................................. $30,000 Adjusted net income ................... $24,000 NCI share ................................... × 40% NCI ............................................. $ 9,600

Subsidiary Company B Income Distribution* Internally generated net income . 60% × Company C adjusted income of $24,000 ................ Gain realized through depreciation ..........................

$70,000 14,400 4,000

Adjusted net income ................... $88,400 NCI share ................................... × 20% NCI ............................................. $17,680 *There is no impact shown for the ending inventory held by Company C since the gross profit was written down to zero under LCM.

Parent Company A Income Distribution Unrealized profit in ending inventory ..................................

$720

Internally generated net income .................................. $ 40,000 80% × Company B adjusted income of $88,400 ................ 70,720 Realized profit in beginning inventory ............................... 1,800 Controlling interest...................... $111,800

Ch. 8—Exercises

8–10

EXERCISE 8-8 Determination and Distribution of Excess Schedule, Ace Acquisition of Bell Company Implied Fair Value Fair value of subsidiary ........................ $700,000 Less book value of interest acquired: Common stock ($5 par).................. $200,000 Paid-in capital in excess of par ...... 100,000 Retained earnings .......................... 150,000 Remaining excess ($30,000 – $6,000 amortization) ................ 24,000 Total equity ............................... $474,000 Interest acquired ............................ Book value ........................................... Excess of fair value over book value ... $226,000

Parent Price (60%) $420,000

NCI Value (40%) $280,000

$474,000 60% $284,400 $135,600

$474,000 40% $189,600 $ 90,400

Adjustment of identifiable accounts:

Carter inventory (80% .......................... Bell equipment ..................................... Goodwill ............................................... Total ...............................................

Adjustment $ 16,000 30,000 180,000 $226,000

Worksheet Key debit D1 debit D2 debit D3

Life 1 5

Amortization per Year $16,000 6,000

*NCI of Carter is also increased by $4,000. EXERCISE 8-9 (1) Company N’s books: Cash ......................................................................................... Investment in Company O ........................................................ Subsidiary Income (40% × $40,000) .................................... Company M’s books: Cash ......................................................................................... Investment in Company N ........................................................ Subsidiary Income [90% × ($90,000 + $16,000)] ................. Cash ......................................................................................... Investment in Company O ........................................................ Subsidiary Income (20% × $40,000) ....................................

2,000 14,000 16,000 9,000 86,400 95,400 1,000 7,000 8,000

(2) Internally generated incomes ($200,000 + $90,000 + $40,000) ... Beginning inventory profit.............................................................. Ending inventory profit .................................................................. Consolidated net income............................................................... NCI—Company O ..................................................................... NCI—Company N ..................................................................... To controlling interest ...............................................................

$330,000 7,000 (9,000) $328,000 $ 15,400 10,490

25,890 $302,110

8–11

Ch. 8—Exercises

Exercise 8-9, Concluded Subsidiary O Company Income Distribution Unrealized gross profit in ending inventory ......................

Internally generated income ..... $6,000 Realized gross profit in beginning inventory............. Adjusted income ....................... NCI share ................................. NCI ...........................................

$40,000 4,500 $38,500 × 40% $15,400

Subsidiary N Company Income Distribution Unrealized gross profit in ending inventory ......................

Internally generated income ..... $3,000 Share of O income (40% × $38,500) ................. Realized gross profit in beginning inventory.............

$ 90,000 15,400 2,500

Adjusted income ....................... $104,900 NCI share ................................. × 10% NCI ........................................... $ 10,490

Parent Company M Income Distribution Internally generated net income ................................ 20% × O adjusted income of $38,500 ........................... 90% × N adjusted income of $104,900 ......................... Controlling interest....................

$200,000 7,700 94,410 $302,110

Ch. 8—Exercises

8–12

EXERCISE 8-10 (1) Determination and Distribution of Excess Schedule Company Implied Fair Value Fair value of subsidiary ........................ $580,000 Less book value of interest acquired: Common stock ($10 par)................ $500,000 Retained earnings .......................... 50,000 Total equity ............................... $550,000 Interest acquired ............................ Book value ........................................... Excess of fair value over book value ... $ 30,000

Parent Price (60%) $348,000

NCI Value (40%) $232,000

$550,000 60% $330,000 $ 18,000

$550,000 40% $220,000 $ 12,000

Adjustment of identifiable accounts: Adjustment Equipment ............................................ $ 30,000

(2)

Worksheet Key debit D

Life 20

Amortization per Year $1,500

Myles Corporation and Subsidiary Downer Corporation Consolidated Income Statement For Year Ended December 31, 2017 Sales ............................................................................................................ Less cost of goods sold................................................................................ Gross profit................................................................................................... Less expenses (including equipment depreciation of $1,500) ..................... Consolidated net income.............................................................................. To NCI .................................................................................................... To controlling interest .............................................................................

$1,150,000 840,000 $ 310,000 231,500 $ 78,500 $ 11,400 67,100

Subsidiary Downer Corporation Income Distribution Equipment depreciation ................

$1,500 Internally generated net income .. Adjusted net income ................... NCI share .................................... NCI ..............................................

$30,000 $28,500 × 40% $11,400

Parent Myles Corporation Income Distribution Internally generated net income .... 60% × Downer income of $28,500

$50,000 17,100

Controlling interest ........................

$67,100

8–13

Ch. 8—Problems

PROBLEMS PROBLEM 8-1 Wells Corporation booked entries for adjustments to investment in Towne Company: 2015 (1)*December 31 Investment in Towne (80% × $50,000) ............... Subsidiary Income ........................................ To record parent’s share of subsidiary income. (2)*Memo: All calculations are now based on 8,800 shares. 2016 July 1 Investment in Towne (80% × $25,000) ............... Subsidiary Income ........................................ To record parent’s share of subsidiary income for one-half year. 2016 (3)*July 1

Investment in Towne .......................................... Paid-In Capital in Excess of Par ................... To adjust investment for subsidiary sale of stock to noncontrolling interest.

2016 (4)*December 31 Investment in Towne .......................................... Subsidiary Income ........................................ To record 64% parent share of subsidiary income for one-half year.

40,000 40,000

20,000 20,000

14,400 14,400

16,000 16,000

*Calculations are on page 15.

Ch. 8—Problems

8–14

Problem 8-1, Continued Wells Corporation booked entries for adjustments to investment in Sara Company: 2015 (5)*July 1

2015 (6)*July 1

Investment in Sara.............................................. Subsidiary Income ........................................ To record 60% parent share of subsidiary income for one-half year.

12,000

Investment in Sara.............................................. Retained Earnings (decrease in equity) ............. Cash (3,700 × $25) ....................................... To record purchase of 3,700 additional subsidiary shares.

85,900 6,600

2015 (7)*December 31 Investment in Sara.............................................. Subsidiary Income ........................................ To record 62% parent share of subsidiary income for one-half year.

12,000

92,500

12,400 12,400

2016 (8)*January 1

Retained Earnings .............................................. Investment in Sara ........................................ To record decrease in equity due to treasury stock purchase.

13,950

(9)*December 31 Investment in Sara.............................................. Subsidiary Income ........................................ To record parent’s share of subsidiary income.

28,933

13,950

28,933

*Calculations are on page 15.

8–15

Ch. 8—Problems

Problem 8-1, Concluded Schedules to Determine Wells Corporation’s Adjustments to Its Investment Total Subsidiary Shares

Parent’s Shares

Parent’s Interest

Change in Subsidiary Equity

Total Subsidiary Equity

Controlling Share of Equity

Change in Controlling Investment

10,000 10,000

8,000 8,000

80% 80

........... $50,000

$220,000 270,000

$176,000 216,000

............ (1) $40,000

11,000 11,000 13,750 13,750

8,800 8,800 8,800 8,800

80 80 64 64

........... 25,000 96,250 25,000

270,000 295,000 391,250 416,250

216,000 236,000 250,400* 266,400

............ (2) 20,000 (3) 14,400 (4) 16,000

30,000 30,000 35,000 35,000

18,000 18,000 21,700 21,700

60 60 62 62

........... 20,000 125,000 20,000

400,000 420,000 545,000 565,000

240,000 252,000 337,900** 350,300

(5) (6) (7)

30,000 30,000

21,700 21,700

72.333 72.333

(100,000) 40,000

465,000 505,000

336,350*** 365,283

(8) (13,950) (9) 28,933

Towne January 1, 2015, Balances ......... 2015 Income ............................... December 31, 2015, Stock dividend ................................. January–June 2016, Income ....... July 1, 2016, Stock sale .............. July–December 2016, Income .... Sara January 1, 2015, Balances ......... January–June 2015, Income ....... July 1, 2015, Stock sale .............. July–December 2015, Income .... January 1, 2016, Purchase of treasury stock ........................ 2016 Income ...............................

*$391,250 × 64% = $250,400; balance after $250,400 – balance before $236,000 = $14,400 increase. **$545,000 × 62% = $337,900; balance after $337,900 – balance before $252,000 = $85,900 increase. $70,300 increase in investment – $74,000 paid for new shares = $3,700 decrease in Wells’s equity. ***$465,000 × 72.333% = $336,350; balance after $336,350 – balance before $350,300 = $13,950 decrease.

in part.

............ 12,000 85,900 12,400

Ch. 8—Problems

8–16

PROBLEM 8-2 Bear Corporation purchase of Kelly Company Shares: Determination and Distribution of Excess Schedule Company Implied Fair Value Fair value of subsidiary ........................ $375,000 Less book value of interest acquired: Common stock ($10 par)................ $200,000 Paid-in capital in excess of par ...... 50,000 Retained earnings .......................... 100,000 Total equity ............................... $350,000 Interest acquired ............................ Book value ........................................... Excess of fair value over book value ... $ 25,000

Parent Price (60%) $225,000

NCI Value (40%) $150,000

$350,000 60% $210,000 $ 15,000

$350,000 40% $140,000 $ 10,000

Adjustment of identifiable accounts:

Goodwill ...............................................

Adjustment $ 25,000

Worksheet Key debit D

Life

Amortization per Year

Bear Corporation purchase of Samco Company Shares: Determination and Distribution of Excess Schedule Company Implied Fair Value Fair value of subsidiary ........................ $312,500 Less book value of interest acquired: Common stock ($20 par)................ $200,000 Retained earnings .......................... 100,000 Total equity ............................... $300,000 Interest acquired ............................ Book value ........................................... Excess of fair value over book value ... $ 12,500

Parent Price (80%) $250,000

NCI Value (20%) $ 62,500

$300,000 80% $240,000 $ 10,000

$300,000 20% $ 60,000 $ 2,500

Adjustment of identifiable accounts: Adjustment Goodwill ............................................... $ 12,500

Worksheet Key debit D

Life

Amortization per Year

8–17

Ch. 8—Problems

Problem 8-2, Continued

*Entry to convert investment in Kelly Company to simple equity method as of December 31, 2017: Investment in Kelly ............................................................. Additional Paid-In Capital in Excess of Par—Bear Corporation .................................................................... Retained Earnings ......................................................

78,750 12,750 91,500

*Entry to convert investment in Samco Company to simple equity method as of December 31, 2017: Investment in Samco.......................................................... Additional Paid-In Capital in Excess of Par—Bear Corporation .................................................................... Retained Earnings ......................................................

78,500 9,000 87,500

*Calculations are from the following two schedules.

Ch. 8—Problems

8–18

Problem 8-2, Continued Schedules of Equity Adjustments for January 1, 2015–December 31, 2017 Adjustments Reflected an Increase to Controlling Additional Total Shares Increase in Total Share of Increase in Paid-In Capital Subsidiary Held by Parent’s Subsidiary Subsidiary Subsidiary Controlling Retained in Excess Kelly Common Stock Shares Parent Interest Equity Equity Equity Investment Earnings of Par January 1, 2015, Balances................... 20,000 12,000 60% .............. $375,000* $225,000 .............. ............ ............ January–June 2015, Income ................ 20,000 12,000 60 $ 25,000 400,000 240,000 $ 15,000 $ 15,000 ............ July 1, 2015, Sale of stock ................... 25,000 15,000 60 100,000 500,000 300,000 60,000** ............ ............ July 2015–December 2016, Income .... 25,000 15,000 60 85,000 585,000 351,000 51,000 51,000 ............ December 31, 2016, Cash dividend ..... 25,000 15,000 60 (25,000) 560,000 336,000 (15,000) (15,000) ............ January–July 2017, Income ................. 25,000 15,000 60 30,000 590,000 354,000 18,000 18,000 ............ ............ $(12,750) July 1, 2017, Treasury stock purchase 20,000 15,000 75 (135,000) 455,000 341,250*** (12,750) ............ July–December 2017, Income ............. 20,000 15,000 75 30,000 485,000 363,750 22,500 22,500 $(12,750) Total adjustments .................................................................................................................................................................. $ 91,500 *From D&D. **Required debit to investment account and credit to Cash for $60,000 to record additional purchase. ***After (75% × $455,000 = $341,250) – before $354,000 = $12,750 decrease in equity.

part.

8–19

Ch. 8—Problems

Problem 8-2, Concluded Schedules of Equity Adjustments for January 1, 2015–December 31, 2017

Total Subsidiary Shares 10,000 10,000

Shares Held by Parent 8,000 8,000

Controlling Increase in Total Share of Increase in Subsidiary Subsidiary Subsidiary Controlling Equity Equity Equity Investment ........... $312,500* $250,000 ........... 40,000 352,500 282,000 $32,000

Parent’s Samco Common Stock Interest January 1, 2015, Balances........... 80% Income, 2015 ............................... 80 December 31, 2015, Stock dividend ................................. 11,000 8,800 80 ........... 352,500 282,000 ........... January–September 2016, Income ................................... 11,000 8,800 80 22,500 375,000 300,000 18,000 October 1, 2016, Sale of stock ..... 15,000 9,000 60 120,000 495,000 297,000 (3,000)** October 2016–December 2017, Income ...................................... 15,000 9,000 60 62,500 557,500 334,500 37,500 Total adjustments ..................................................................................................................................................................

Adjustments Reflected an Increase to Paid-In Capital Retained in Excess Earnings of Par .......... ......... $32,000 ......... ..........

.........

18,000 ..........

......... $(9,000)**

37,500 $87,500

......... $(9,000)

*From D&D. **The investment has been increased by $6,000 (cost of the stock purchased by the parent), while the controlling share of equity has decreased by $3,000. The total decrease of $9,000 is deducted from additional paid-in capital in excess of par. The adjustment shown reduces the investment account (and additional paid-in capital in excess of par) to reconcile it with the parent’s share of the subsidiary equity.

part.

Ch. 8—Problems

8–20

PROBLEM 8-3 Determination and Distribution of Excess Schedule Company Implied Fair Value Fair value of subsidiary ........................ $875,000 Less book value of interest acquired: Common stock ($2 par).................. $200,000 Paid-in capital in excess of par ...... 400,000 Retained earnings .......................... 100,000 Total equity ............................... $700,000 Interest acquired ............................ Book value ........................................... Excess of fair value over book value ... $175,000

Parent Price (80%) $700,000

NCI Value (20%) $175,000

$700,000 80% $560,000 $140,000

$700,000 20% $140,000 $ 35,000

Adjustment of identifiable accounts: Adjustment Building ................................................ $ 80,000 Goodwill ............................................... 95,000 Total ............................................... $175,000

Worksheet Key debit D1 debit D2

Life 20

Amortization per Year $4,000

8–21

Ch. 8—Problems

Problem 8-3, Continued Palo Company and Subsidiary Sheila Company Worksheet for Consolidated Financial Statements For Year Ended December 31, 2018 Controlling Retained Earnings

Consolidated Balance Sheet

179,040 105,000 ................. ................. ................. ................. ................. 280,000 190,000 ................. ................. ................. ................. ................. 325,000 175,000 ................. (EI) 2,000 ................. ................. ................. 700,000 ................. (CVa) 64,000 (EL) 691,200 ................. ................. ................. ................. ................. (CVb) 40,480 (D) 112,000 ................. ................. ................. ................. ................ ................. (adj) 1,280 ................. ................. ................. Property, Plant, and Equipment ..................... 2,450,000 1,400,000 (D1) 80,000 ................. ................. ................. ................. Accumulated Depreciation ............................. (1,256,000) (536,000) ................. (A) 12,000 ................. ................. ................. Goodwill ......................................................... ................. ................. (D2) 95,000 ................. ................. ................. ................. Liabilities ........................................................ (750,000) (210,000) ................. ................. ................. ................. ................. Common Stock ($10 par)—Palo .................... (1,500,000) ................. ................. ................. ................. ................. ................. Paid-In Capital in Excess of Par—Palo .......... ................. ................. ................. (CVb) 40,480 ................. ................. ................. Retained Earnings—Palo ............................... (375,000) ................. (A) 5,120 (CVa) 64,000 ................. ................. (432,600) ....................................................................... ................. ................. (adj) 1,280 ................. ................. ................. ................. Common Stock ($2 par)—Sheila.................... ................. (250,000) (EL) 160,000 ................. ................. (90,000) ................. Paid-In Capital in Excess of Par—Sheila ....... ................. (650,000) (EL) 416,000 ................. ................. (234,000) ................. Retained Earnings—Sheila ............................ ................. (180,000) (EL) 115,200 (NCI) 63,000 ................. (124,920) ................. ................. ................. (A) 2,880 ................. ................. ................. ................. Sales .............................................................. (1,600,000) (750,000) (IS) 50,000 ................. (2,300,000) ................. ................. Subsidiary Dividend Income ........................... (23,040) ................. (CY) 23,040 ................. ................. ................. ................. Cost of Goods Sold ........................................ 1,120,000 450,000 (EI) 2,000 (IS) 50,000 1,522,000 ................. ................. Other Expenses ............................................. 405,000 220,000 (A) 4,000 ................. 629,000 ................. ................. Dividends Declared ........................................ 45,000 36,000 ................. (CY) 23,040 ................. 12,960 45,000 Totals .......................................................... 0 0 1,059,000 . 1,059,000 ................. ................. ................. Consolidated Net Income ........................................................................................................................................ (149,000) ................. To NCI (see distribution schedule) ...................................................................................................................... 26,640 (26,640) ................. To Controlling Interest (see distribution schedule)............................................................................................... 122,360 ................. (122,360) Total NCI ........................................................................................................................................................................................ (462,600) ................. Retained Earnings—Controlling Interest, December 31, 2018 .............................................................................................................................. (509,960) Totals .....................................................................................................................................................................................................................................

284,040 470,000 498,000 ................. ................. ................. 3,930,000 (1,804,000) 95,000 (960,000) (1,500,000) (40,480) ................. ................. ................. ................. ................. ................. ................. ................. ................. ................. ................. ................. ................. ................. ................. (462,600) (509,960) 0

Trial Balance Palo Sheila

Eliminations and Adjustments Dr. Cr.

Consolidated Income Statement

NCI

Cash............................................................... Accounts Receivable (net) ............................. Inventory ........................................................ Investment in Sheila Company.......................

part.

Ch. 8—Problems

8–22

Problem 8-3, Concluded Eliminations and Adjustments: (CVa) (CVb)

Convert the investment to the equity method for share of prior income [80% × ($180,000 – $100,000)]. Convert the investment to the equity method for the result of the subsidiary stock sale:

Controlling interest in subsidiary equity after sale (64% × {$780,000 + $300,000 sale + $95,000 goodwill + [$80,000 – ($4,000 × 2) = $72,000 building]}) ..................................... $798,080 Controlling interest in subsidiary equity before sale [80% × ($780,000 + $95,000 goodwill + $72,000 remaining building)] ... 757,600 Net increase in paid-in capital in excess of par—parent ............................. $ 40,480 (CY) Eliminate intercompany dividends. (EL) Eliminate parent’s share of subsidiary equity (80,000 ÷ 125,000 = 64%). (adj) Adjust for change in parent amortization for prior years ($4,000 × 2 years × 16% = $1,280). (D)/(NCI) Distribute $112,000 (64% × $175,000) excess and $63,000 (36% × $175,000) NCI adjustment according to the determination and distribution of excess schedule. (1) Building, $80,000 and (2) Goodwill, $95,000. (A) Amortize excess for current year and two prior years: Building = $4,000 per year. Distribute to retained earnings, 64% controlling, 36% NCI. (IS) Eliminate intercompany sale of $50,000. (EI) Eliminate profit in ending inventory ($10,000 × 20% = $2,000). Subsidiary Sheila Company Income Distribution Profit in ending inventory ............... Building amortization .....................

$2,000 Internally generated net 4,000 income ................................ Adjusted net income ................. NCI share ................................. NCI ...........................................

$80,000 $74,000 × 36% $26,640

Parent Palo Company Income Distribution Internally generated net income ................................ 64% × Sheila adjusted income of $74,000 ..............

$ 75,000 47,360

Controlling interest.................... $122,360

8–23

Ch. 8—Problems

PROBLEM 8-4 Determination and Distribution of Excess Schedule Company Implied Fair Value Fair value of subsidiary ........................ $260,000 Less book value of interest acquired: Common stock ($5 par).................. $100,000 Paid-in capital in excess of par ...... 50,000 Retained earnings .......................... 80,000 Total equity ............................... $230,000 Interest acquired ............................ Book value ........................................... Excess of fair value over book value ... $ 30,000

Parent Price (60%) $156,000

NCI Value (40%) $104,000

$230,000 60% $138,000 $ 18,000

$230,000 40% $ 92,000 $ 12,000

Adjustment of identifiable accounts: Adjustment Goodwill ............................................... $ 30,000

Worksheet Key debit D

Life

Amortization per Year

Ch. 8—Problems

8–24

Problem 8-4, Continued Mitta Corporation and Subsidiary Train Company Worksheet for Consolidated Financial Statements For Year Ended December 31, 2017 Trial Balance Mitta Train Cash............................................................... Accounts Receivable...................................... Inventory ........................................................ Investment in Train Company ........................

Property, Plant, and Equipment ..................... Accumulated Depreciation ............................. Goodwill ......................................................... Accounts Payable .......................................... Other Current Liabilities ................................. Bonds Payable ............................................... Common Stock ($10 par)—Mitta .................... Retained Earnings—Mitta .............................. Common Stock ($5 par)—Train ..................... Paid-In Capital in Excess of Par—Train ......... Retained Earnings—Train .............................. Sales .............................................................. Subsidiary Income.......................................... Cost of Goods Sold ........................................

Eliminations and Adjustments Dr. Cr.

106,200 63,500 ................. 113,600 60,000 ................. 350,000 80,000 ................. (EIa) ................. ................. ................. (EIb) 280,800 ................. ................. (CY1) ................. ................. ................. (CV) ................. ................. (CY2) 6,400 (EL) ................. ................. ................. (D) 1,800,000 360,000 ................. (600,000) (89,500) ................. ................. ................. (D) 30,000 ................. ................. ................. (180,000) (64,000) ................. (26,000) (8,000) ................. (500,000) ................. ................. (1,000,000) ................. ................. (212,600) ................. (CV) 4,320 ................. ................. (BIa) 1,500 ................. ................. (Blb) 1,152 ................. (125,000) (EL) 80,000 ................. (125,000) (EL) 80,000 ................. (112,000) (EL) 71,680 (NCI) ................. ................. (BIb) 648 (1,950,000) (600,000) (ISa) 30,000 ................. ................. (ISb) 20,000 (32,000) ................. (CY1) 32,000 1,170,000 420,000 (EIa) 2,000 (BIa) ................. ................. (EIb) 600 (ISa) ................. ................. ................. (BIb) ................. ................. ................. (ISb)

................. ................. 2,000 600 32,000 4,320 231,680 19,200 ................. ................. ................. ................. ................. ................. ................. ................. ................. ................. ................. ................. ................. 10,800 ................. ................. ................. ................. 1,500 30,000 1,800 20,000

Consolidated Income Statement ................. ................. ................. ................. ................. ................. ................. ................. ................. ................. ................. ................. ................. ................. ................. ................. ................. ................. ................. ................. ................. ................. ................. ................. (2,500,000) ................. ................. ................. ................. 1,539,300

NCI

Controlling Retained Earnings

Consolidated Balance Sheet

................. ................. ................. ................. ................. ................. ................. ................. ................. ................. ................. ................. ................. ................. ................. ................. ................. ................. ................. (45,000) (45,000) ................. (50,472) ................. ................. ................. ................. ................. ................. .................

................. ................. ................. ................. ................. ................. ................. ................. ................. ................. ................. ................. ................. ................. ................. ................. ................. (205,628) ................. ................. ................. ................. ................. ................. ................. ................. ................. ................. ................. .................

169,700 173,600 427,400 ................. ................. ................. ................. ................. 2,160,000 (689,500) ................. 30,000 (244,000) (34,000) (500,000) (1,000,000) ................. ................. ................. ................. ................. ................. ................. ................. ................. ................. ................. ................. ................. .................

part.

8–25

Ch. 8—Problems

Problem 8-4, Continued Mitta Corporation and Subsidiary Train Company Worksheet for Consolidated Financial Statements For Year Ended December 31, 2017 (Concluded) Controlling Retained Earnings

Consolidated Balance Sheet

Other Expenses ............................................. 630,000 130,000 ................. ................. 760,000 ................. ................. 10,000 ................. (CY2) 6,400 ................. 3,600 50,000 Dividends Declared ........................................ 50,000 Totals .......................................................... 0 0 360,300 360,300 ................. Consolidated Net Income ........................................................................................................................................ (200,700) ................. ................. To NCI (see distribution schedule) ...................................................................................................................... 18,432 (18,432) ................. To Controlling Interest (see distribution schedule)............................................................................................... 182,268 ................. (182,268) Total NCI ........................................................................................................................................................................................ (155,304) ................. Retained Earnings—Controlling Interest, December 31, 2017 .............................................................................................................................. (337,896) Totals .........................................................................................................................................................................................................................................

................. ................. ................. ................. ................. ................. (155,304) (337,896) 0

Trial Balance Mitta Train

Eliminations and Adjustments Dr. Cr.

Consolidated Income Statement

Eliminations and Adjustments: (CV) Conversion entry for stock sale: Interest after sale [64% × ($262,000 + $30,000 goodwill + $100,000 proceeds)] Interest prior to sale [60% × ($262,000 + $30,000 goodwill)] Increase/(Decrease) Price paid (4,000 × $20) Total decrease in equity and investment

NCI

$250,880 175,200 $ 75,680 (80,000) $ (4,320)

(CY1) Eliminate the current-year entries for income. Eliminate the current-year entries for dividends. (CY2) (EL) Eliminate parent’s 64% share of subsidiary equity. (D)/(NCI) Distribute original excess (64% × $30,000) and NCI adjustment (36% × $30,000). (BIa) Eliminate profit on Mitta’s goods in Train’s beginning inventory ($6,000 × 25% = $1,500). Distribute to retained earnings. (ISa) Eliminate 2017 sales of $30,000. (EIa) Eliminate profit on Mitta’s goods in Train’s ending inventory ($8,000 × 25% = $2,000). Sales from Train to Mitta: (BIb) Eliminate profit on Train’s goods in Mitta’s beginning inventory ($6,000 × 30% = $1,800), allocate 64% and 36%. (ISb) Eliminate 2017 sales of $20,000. (EIb) Eliminate profit on Train’s goods in Mitta’s ending inventory ($2,000 × 30% = $600).

part.

Ch. 8—Problems

8–26

Problem 8-4, Concluded Subsidiary Train Company Income Distribution Unrealized profit in ending inventory ......................

$600

Internally generated net income ................................ Realized profit in beginning inventory............. Adjusted net income ................. NCI share ................................. NCI ...........................................

$50,000 1,800 $51,200 × 36% $18,432

Parent Mitta Corporation Income Distribution Unrealized profit in ending inventory ......................

$2,000

Internally generated net income ................................ 64% × Train adjusted income of $51,200 .............. Realized profit in beginning inventory............. Controlling interest....................

$150,000 32,768 1,500 $182,268

8–27

Ch. 8—Problems

PROBLEM 8-5 Investment in Webo Company, January 1, 2015: Determination and Distribution of Excess Schedule Company Implied Fair Value Fair value of subsidiary ........................ $400,000 Less book value of interest acquired: Common stock ($10 par)................ $250,000 Retained earnings .......................... 150,000 Total equity ............................... $400,000 Interest acquired ............................ Book value ........................................... Excess of fair value over book value ... $ 0

Parent Price (80%) $320,000

NCI Value (20%) $ 80,000

$400,000 80% $320,000 $ 0

$400,000 20% $ 80,000 $ 0

Ch. 8—Problems

8–28

Problem 8-5, Continued Barns Company and Subsidiaries Webo Company and Elcam Company Worksheet for Consolidated Financial Statements For Year Ended December 31, 2016

Cash................................................ Accounts Receivable....................... Inventories ...................................... Investment in Webo Company Stock .......................................... Investment in Elcam Company Stock .......................................... Investment in Elcam Company Bonds ........................................ Property, Plant, and Equipment ...... Accumulated Depreciation .............. Accounts Payable ........................... Dividends Payable .......................... Bonds Payable ................................ Unamortized Bond Discount ........... Capital Stock—Barns ...................... Capital Stock—Webo ...................... Capital Stock—Elcam ..................... Paid-In Capital in Excess of Par—Barns ................................ Paid-In Capital in Excess of Par—Elcam................................ Retained Earnings—Barns .............. Retained Earnings—Webo .............. Retained Earnings—Elcam ............. Dividends Declared—Barns ............ Dividends Declared—Webo ............ Dividends Declared—Elcam ........... Treasury Stock (at cost) .................. Gain on Sale of Equipment ............. Sales ............................................... Interest Income on Bonds ............... Dividend Income ............................. Cost of Goods Sold .........................

Eliminations and Adjustments

ConsoliControlling dated Retained Balance Earnings Sheet

Barns

Trial Balance Webo

Elcam

Dr.

Cr.

Consolidated Income Statement

110,000 85,000 138,000

26,000 73,500 163,000

165,200 105,000 150,000

............... ............... ...............

(IA) (EI)

............... 52,000 15,000

................. ................. .................

............. ............. .............

301,200 211,500 436,000

320,000

.................

................. (CVW)

37,333

(ELW)

357,333

.................

.............

...............

600,000 .................

................. .................

................ ................

(CVE) (ELE)

44,000 556,000

................. .................

............. .............

............... ...............

................. 148,000 700,000 525,000 (402,000) (325,000) (202,000) (150,500) (12,000) ................. (400,000) ................. ................. ................. (600,000) ................. ................. (250,000) ................. ................. ................. .................

................. 834,000 (240,000) (F2) (86,900) (IA) ................. (200,000) (B) 800 ................. ................. (ELW) ................. (500,000) (ELE)

................ ................ 100 52,000 ............... 150,000 ............... ............... 222,222 ............... 400,000

(B) (F1)

148,000 2,000 ............... ............... ............... ............... 600 ................ ................ ................ ................

................. ................. ................. ................. ................. ................. ................. ................. ................. ................. .................

............. ............. ............. ............. ............. ............. ............. ............. ............. (27,778) (100,000)

............. ............. ............. ............. ............. ............. ............. ............. ............. ............. .............

............... 2,057,000 (966,900) (387,400) (12,000) (450,000) 200 (600,000) ............... ............... ...............

.................

...............

(CVE)

31,000

.................

.............

(31,000)

................. (302,200) ................. ................. ................. ................. 24,000 ................. ................. ................. (2,000) (2,950,000) ................. (28,000) 2,500,000

................. ................. ................. (200,000) ................. ................. ................. 22,500 ................. 48,000 ................. (1,550,000) (13,000) ................. 1,200,000

(70,000) (ELE) ................. (CVE) ................. (CVW) ................. (ELW) ................. (125,000) (ELE) ................. ................. 10,000 ................. ................. (F1) (1,750,000) (IS) ................. (B) ................. (CY2) 1,400,000 (EI)

56,000 75,000 (CVW) 2,667 177,778 ............... 100,000 ............... ............... (CY2) ............... (CY2) ............... (ELW) 2,000 385,000 13,000 28,000 15,000 (IS)

............... 40,000 ............... ............... ............... ............... ............... 20,000 8,000 42,667 ............... ............... ............... ............... 385,000

(14,000) ............. ............. ............. (22,222) (25,000) ............. 2,500 2,000 5,333 ............. ............. ............. ............. .............

............. ............. (264,533) ............. ............. ............. 24,000 ............. ............. ............. ............. ............. ............. ............. .............

(B)

NCI

part.

8–29

Ch. 8—Problems

Problem 8-5, Continued Barns Company and Subsidiaries Webo Company and Elcam Company Worksheet for Consolidated Financial Statements For Year Ended December 31, 2016 (Concluded)

Barns

Trial Balance Webo

Eliminations and Adjustments Elcam

Dr.

Cr.

Consolidated Income Statement

ConsoliNCI

Controlling dated Retained Balance Earnings Sheet

Operating Expenses ........................ 405,000 280,000 290,500 ............... (F2) 100 975,400 ............. ............. Interest Expense ............................. 16,200 2,500 16,400 ............... (B) 12,300 22,800 ............. ............. Gain on Bond Retirement ................ ................. ................. ................. ............... (B) 2,100 (2,100) ............. ............. 0 0 1,716,100 1,716,100 ............. ............. Totals ......................................... 0 Consolidated Net Income .................................................................................................................................................... (138,900) ............. ............. To NCI for both Webo and Elcam (see distribution schedule) ...................................................................................... 17,844 (17,844) ............. To Controlling Interest (see distribution schedule) ......................................................................................................... 121,056 ............. (121,056) Total NCI ................................................................................................................................................................................................... (197,011) ............. Retained Earnings—Controlling Interest, December 31, 2016 ..................................................................................................................................... (361,589) Totals ..........................................................................................................................................................................................................................................

Eliminations and Adjustments: (CVW) Convert investment in Webo to equity balance on January 1, 2016, 80% × ($50,000 retained earnings increase) .................. $ 40,000 Treasury stock purchase: Equity after sale [4,000/4,500 × ($450,000 – $48,000)] $357,333 Equity before sale (80% × $450,000) ......................... 360,000 Decrease in equity............................................................ (2,667) Net change in investment account ................................... $ 37,333 (CVE)

Convert investment in Elcam to equity balance on January 1, 2016: Change in retained earnings ............................................ $ (75,000) Change in paid-in capital in excess of par: Interest prior to sale..................................................... $525,000 Interest after sale {8/10 × [$525,000 + ($85 × 2,000 shares)]} 556,000 31,000 Net change to investment account ................................... $ (44,000)

part.

............... ............... ............... ............... ............... ............... ............... (197,011) (361,589) 0

Ch. 8—Problems

8–30

Problem 8-5, Continued (CY2) (ELW) (ELE) (B)

Eliminate intercompany dividends (4,000/4,500 × $22,500 = $20,000 for Webo dividends and 80% × $10,000 = $8,000 for Elcam dividends). Eliminate 4,000/4,500 interest in Webo equity accounts, including treasury stock against the investment account. Eliminate 80% of Elcam equity accounts against investment in Elcam account. Eliminate intercompany interest income and expense. Eliminate balance of investment in bonds against 75% of the bonds payable. The gain on retirement as of the beginning of the year is calculated as follows: Gain remaining at year-end: Carrying value of bonds at December 31, 2016 [($200,000 – $800) × 75%] ................................ Investment in bonds at December 31, 2016 ............ Gain amortized during the year: Interest revenue eliminated ...................................... Interest expense eliminated {[($200,000 × 8%) + ($1,200/3)] × 75%} ...................................... Gain at January 1, 2016 ...................................................

(F1) (F2) (IS) (EI) (IA)

$149,400 148,000

$1,400

$ 13,000 12,300

700 $2,100

Eliminate gain on sale of equipment as of June 30, 2016. Reduce depreciation on equipment [1/2 × ($2,000 ÷ 10) = $100]. Eliminate intercompany sales. Eliminate profit in ending inventory relating to sales made by Barns ($60,000 × 25% = $15,000). Eliminate intercompany debt.

Subsidiary Elcam Company Income Distribution Interest adjustment ($13,000 – $12,300) ................

$700

Internally generated net Income ................................ Gain on bonds retired ...............

$43,100 2,100

Adjusted net income ................. NCI share ................................. NCI ...........................................

$44,500 × 20% $ 8,900

8–31

Ch. 8—Problems

Problem 8-5, Concluded Subsidiary Webo Company Income Distribution Internally generated net Income ............................

$ 80,500

Adjusted net income ............. NCI share ............................. NCI .......................................

$ 80,500 × 11.11% $ 8,944

Parent Barns Company Income Distribution Unrealized profit in ending inventory ...................... Gain on equipment sale ................

Internally generated net $15,000 income ............................ 2,000 80% × Elcam adjusted income of $44,500 .......... 88.8888% × Webo adjusted income of $80,500 .......... Equipment gain realized ....... Controlling interest................

$ 30,800 35,600 71,556 100 $121,056

Ch. 8—Problems

8–32

PROBLEM 8-6 Mary’s investment in John on January 1, 2016 (9,000 shares): Determination and Distribution of Excess Schedule Company Implied Fair Value Fair value of subsidiary ........................ $340,000 Less book value of interest acquired: Common stock ($10 par)................ $150,000 Paid-in capital in excess of par ...... 75,000 Retained earnings .......................... 75,000 Total equity ............................... $300,000 Interest acquired ............................ Book value ........................................... Excess of fair value over book value ... $ 40,000

Parent Price (60%) $204,000

NCI Value (40%) $136,000

$300,000 60% $180,000 $ 24,000

$300,000 40% $120,000 $ 16,000

Adjustment of identifiable accounts: Adjustment Goodwill ............................................... $ 40,000

Worksheet Key debit D

Life

Amortization per Year

John’s investment in Joan on January 1, 2017 (5,000 shares): Determination and Distribution of Excess Schedule Company Implied Fair Value Fair value of subsidiary ........................ $150,000 Less book value of interest acquired: Common stock ($10 par)................ $100,000 Retained earnings .......................... 50,000 Total equity ............................... $150,000 Interest acquired ............................ Book value ........................................... Excess of fair value over book value ... $ 0

Parent Price (50%) $ 75,000

NCI Value (50%) $ 75,000

$150,000 50% $ 75,000 $ 0

8–33

Ch. 8—Problems

Problem 8-6, Continued

Mary’s investment in Joan on January 1, 2018 (4,000 shares plus effective control of 5,000 shares): Determination and Distribution of Excess Schedule Company Implied Fair Value Fair value of subsidiary ........................ $180,000 Less book value of interest acquired: Common stock ($10 par)................ $100,000 Retained earnings .......................... 80,000 Total equity ............................... $180,000 Interest acquired ............................ Book value ........................................... Excess of fair value over book value ... $ 0

Parent Price (90%) $162,000

NCI Value (10%) $ 18,000

$180,000 90% $162,000 $ 0

$180,000 10% $ 18,000 $ 0

January 1, 2018, market value per share of Joan’s stock: $72,000 paid by Mary/4,000 shares acquired = $18 per share Prior investment was adjusted as follows: Original cost (John’s investment in Joan) ................................ Equity income (50% × $30,000 increase in retained earnings) .............................................................. Total ......................................................................................... Fair value (5,000 shares × $18) ...............................................

$75,000 15,000 $90,000 $90,000

No further adjustment was required. *4,000 shares acquired by Mary + 5,000 shares owned by John and controlled by Mary = 9,000 total shares (90% of Joan’s controlling shares); 9,000 shares × $18 market value per share = $162,000.

Ch. 8—Problems

8–34

Problem 8-6, Continued Mary Company and Subsidiaries John Company and Joan Company Worksheet for Consolidated Financial Statements For Year Ended December 31, 2018

Cash................................................ Accounts Receivable....................... Inventory ......................................... Investment in John Company .......... Investment in Joan Company—Mary Investment in Joan Company—John Property, Plant, and Equipment ...... Accumulated Depreciation .............. Intangibles ....................................... Goodwill .......................................... Accounts Payable ........................... Accrued Expenses .......................... Bonds Payable ................................ Common Stock ($5 par)—Mary....... Paid-In Capital in Excess of Par—Mary.................................. Retained Earnings—Mary ............... Common Stock ($10 par)—John ..... Paid-In Capital in Excess of Par—John .................................. Retained Earnings—John ............... Common Stock ($10 par)—Joan ..... Retained Earnings—Joan ............... Sales ............................................... Gain on Sale of Equipment ............. Subsidiary Income—Mary ............... Subsidiary Income—John ...............

Eliminations and Adjustments

Mary

Trial Balance John

Joan

62,500 200,000 360,000 270,000 ................. ................. 86,000 ................. ................. ................. 2,250,000 (938,000) 15,000 ................. (215,500) (12,000) (500,000) (500,000)

60,000 55,000 80,000 ................. ................. ................. ................. ................. 107,500 ................. 850,000 (377,500) ................. ................. (61,000) (4,000) (300,000) .................

30,000 30,000 50,000 ................. ................. ................. ................. ................. ................. ................. 350,000 (121,800) ................. ................. (22,000) (1,200) (100,000) .................

Dr.

(F2) (D) (IA)

(700,000) ................. ................. (290,000) ................. ................. ................. (150,000) .................

(EL1)

............... ............... 90,000

................. ................. ................. ................. ................. ................. (1,800,000) ................. (58,000) ................. .................

(EL1) (EL1) (EL2) (EL3) (EL2) (EL3) (IS) (F1) (CY1) (CY2) (CY3)

45,000 78,000 40,000 50,000 32,000 40,000 20,000 10,000 42,000 16,000 20,000

(75,000) (130,000) ................. ................. ................. ................. (500,000) ................. ................. ................. (20,000)

................. ................. (100,000) ................. (80,000) ................. (300,000) (10,000) ................. ................. .................

(IA) (EI) (CY1) (EL1) (D) (CY2) (EL2) (CY3) (EL3) (F1)

(NCI)

ConsoliControlling dated Retained Balance Earnings Sheet

Cr.

Consolidated Income Statement

NCI

............... 3,000 1,500 33,000 213,000 24,000 14,000 72,000 17,500 90,000 10,000 ................ ................ ................ ................ ................ ................ ................

............. 152,500 ............. 282,000 ............. 488,500 ............. ............... ............. ............... ............. ............... ............. ............... ............. ............... ............. ............... ............. ............... ............. 3,440,000 ............. (1,435,300) ............. 15,000 ............. 40,000 ............. (295,500) ............. (17,200) ............. (900,000) ............. (500,000)

................ ................ ................

................. ................. .................

............. ............. (60,000)

............. (700,000) (290,000) ............... ............. ...............

................ 16,000 ................ ................ ................ ................ ................ ................ ................ ................ ................

................. ................. ................. ................. ................. ................. (2,580,000) ................. ................. ................. .................

(30,000) (68,000) ............. (10,000) ............. (8,000) ............. ............. ............. ............. .............

............. ............. ............. ............. ............. ............. ............. ............. ............. ............. .............

part.

............... ............... ............... ............... ............... ............... ............... ............... ............... ............... ...............

8–35

Ch. 8—Problems

Problem 8-6, Continued Mary Company and Subsidiaries John Company and Joan Company Worksheet for Consolidated Financial Statements For Year Ended December 31, 2018 (Concluded)

Mary

Trial Balance John

Joan

Dr.

Eliminations and Adjustments

Cr.

Consolidated Income Statement

NCI

ConsoliControlling dated Retained Balance Earnings Sheet

Cost of Goods Sold ......................... Other Expenses .............................. Dividends Declared .........................

1,170,000 350,000 180,000 (EI) 1,500 (IS) 20,000 1,681,500 ............. ............. 525,000 100,000 90,000 ................ (F2) 2,000 713,000 ............. ............. 75,000 ................. ................. ................ ............... ................. ............. 75,000 ................. 15,000 ................. ................ (CY1) 9,000 ................. ............. ............. ................. ................. 5,000 ................ (CY2) 2,000 ................. ............. ............. ................. ................. ................. ............... (CY3) 2,500 ................. 6,500 ............. Totals ......................................... 0 0 0 529,500 529,500 ................. ............. ............. Consolidated Net Income .................................................................................................................................................... (185,500) ............. ............. To NCI (John and Joan) (see distribution schedule) ...................................................................................................... 29,000 (29,000) ............. To Controlling Interest (see distribution schedule) ......................................................................................................... 156,500 ............. (156,500) Total NCI ................................................................................................................................................................................................... (198,500) ............. Retained Earnings—Controlling Interest, December 31, 2018 ..................................................................................................................................... (371,500) Totals ..........................................................................................................................................................................................................................................

Eliminations and Adjustments: (CY1) Eliminate current-year entries for Mary’s investment in John. Income: $70,000 × 60% = $42,000. (EL1) Eliminate Mary’s interest in John’s equity. (D)/(NCI) Distribute the excess and NCI adjustment according to the determination and distribution of excess schedule. (CY2) Eliminate current-year entries for Mary’s investment in Joan, $40,000 × 40% = $16,000. (EL2) Eliminate Mary’s interest in Joan’s equity. (CY3) Eliminate current-year entries for John’s investment in Joan, $40,000 × 50% = $20,000. (EL3) Eliminate John’s interest in Joan’s equity. (F1) Eliminate gain on sale of machine from Joan to Mary. (F2) Adjust depreciation on the machine for 2018. (IS) Eliminate intercompany sale of goods from John to Joan. (EI) Eliminate profit in ending inventory of goods sold by John to Joan, $5,000 × 30% = $1,500. (IA) Eliminate intercompany payable and receivable due to sale.

part.

............... ............... ............... ............... ............... ............... ............... ............... ............... ............... (198,500) (371,500) 0

Ch. 8—Problems

8–36

Problem 8-6, Concluded Subsidiary Joan Company Income Distribution Gain on sale of machine ...............

$10,000 Internally generated net income ................................ Gain on machine realized through use ......................... Adjusted income ....................... NCI share ................................. NCI ...........................................

$40,000 2,000 $32,000 × 10% $ 3,200

Subsidiary John Company Income Distribution Gross profit in ending inventory ..................................

$1,500

Internally generated net income ................................ 50% × Joan adjusted income of $32,000 .............. Adjusted income ....................... NCI share ................................. NCI ...........................................

$50,000 16,000 $64,500 × 40% $25,800

Parent Mary Company Income Distribution Internally generated net income ................................ 40% × Joan adjusted income of $32,000 .............. 60% × John adjusted income of $64,500 .............. Controlling interest....................

$105,000 12,800 38,700 $156,500

8–37

Ch. 8—Problems

PROBLEM 8-7 Shelby investment in Borner Company on January 1, 2015: Determination and Distribution of Excess Schedule Company Implied Fair Value Fair value of subsidiary ........................ $670,000 Less book value of interest acquired: Common stock ($10 par)................ $200,000 Paid-in capital in excess of par ...... 80,000 Retained earnings .......................... 300,000 Total equity ............................... $580,000 Interest acquired ............................ Book value ........................................... Excess of fair value over book value ... $ 90,000

Parent Price (90%) $603,000

NCI Value (10%) $ 67,000

$580,000 90% $522,000 $ 81,000

$580,000 10% $ 58,000 $ 9,000

Adjustment of identifiable accounts: Adjustment Plant assets ......................................... $ 50,000 Goodwill ............................................... 40,000 Total ............................................... $ 90,000

Worksheet Key debit D3 debit D4

Life 10

Amortization per Year $5,000

DeNoma Company investment in Shelby Corporation on January 1, 2017: Determination and Distribution of Excess Schedule Company Implied Fair Value Fair value of subsidiary ........................ $1,250,000 Less book value of interest acquired: Common stock ............................... $ 500,000 Paid-in capital in excess of par ...... 150,000 Retained earnings .......................... 500,000 Plant asset depreciation (2 years × $5,000 × 90%) .......................... (9,000) Total equity ............................... $1,141,000 Interest acquired ............................ Book value ........................................... Excess of fair value over book value ... $ 109,000

Parent Price (60%) $ 750,000

NCI Value (40%) $ 500,000

$1,141,000 $1,141,000 60% 40% $ 456,400 $ 684,600 $ 65,400 $ 43,600

Adjustment of identifiable accounts: Adjustment Plant assets ......................................... $ 50,000 Goodwill ............................................... 59,000 Total ............................................... $ 109,000

Worksheet Key debit D1 debit D2

Life 10

Amortization per Year $5,000

Ch. 8—Problems

8–38

Problem 8-7, Continued DeNoma Company and Subsidiaries Shelby Corporation and Borner Company Worksheet for Consolidated Financial Statements For Year Ended December 31, 2018

DeNoma Inventory ......................................... Other Current Assets ...................... Plant Assets .................................... Accumulated Depreciation ..............

Investment in Shelby Corporation ... Investment in Borner Company .......

Goodwill .......................................... Common Stock—DeNoma .............. Retained Earnings—DeNoma .........

Common Stock—Shelby ................. Paid-In Capital in Excess of Par—Shelby............................... Retained Earnings—Shelby ............

Common Stock—Borner ................. Paid-In Capital in Excess of Par—Borner ...............................

Trial Balance Shelby

Eliminations and Adjustments Borner

Dr.

NCI

............. 167,000 ............. 1,292,000 ............. 2,685,000 ............. ............... ............. ............... ............. (974,000) ............. ............... ............. ............... ............. ............... ............. ............... ............. ............... ............. ............... ............. ............... ............. ............... ............. ............... ............. ............... ............. 99,000 ............. ............... ............. (1,500,000) (908,560) ............... ............. ............... ............. ............... ............. ............... ............. ...............

................ 43,600 ................ ................ ................ ................ ................ ................

................. ................. ................. ................. ................. ................. ................. .................

(60,000) (274,540) ............. ............. ............. ............. ............. (20,000)

............. ............. ............. ............. ............. ............. ............. .............

............... ............... ............... ............... ............... ............... ............... ...............

................

.................

(8,000)

.............

...............

Cr.

75,000 60,000 900,000 2,000 1,200,000 800,000 ................. ................. ................. ................. (450,000) (300,000) ................. ................. ................. ................. ................. ................. 894,000 ................. ................. ................. ................. ................. ................. 828,000 ................. ................. ................. ................. ................. ................. ................. ................. ................. ................. (1,500,000) ................. (922,000) ................. ................. ................. ................. ................. ................. ................. ................. (500,000)

40,000 390,000 600,000 ................. (D1) ................. (D3) (200,000) (F1) ................. (F2) ................. ................. ................. ................. ................. ................. ................. ................. ................. ................. (D2) ................. (D4) ................. ................. (F1) ................. (A1) ................. ................. (BI) ................. (EL1)

................. ................. ................. ................. ................. ................. ................. .................

(150,000) (620,000) ................. ................. ................. ................. ................. .................

................. (EL1) ................. (Adj) ................. (EL1) ................. (A3) ................. (A1) ................. (BI) ................. (F1) (200,000) (EL2)

90,000 9,000 366,600 4,500 2,000 2,160 4,800 180,000

............... (EI) 8,000 ............... ................ ............... (F1) 15,000 50,000 ................ 50,000 ................ 3,000 ............... 3,000 (D3) 9,000 ................ (A3) 11,000 ................ (A1) 10,000 ................ (CY1) 72,000 ................ (EL1) 756,600 ................ (D1, D2) 65,400 ................ (Adj) 9,000 ................ (CY2) 45,000 ................ (EL2) 702,000 ................ (D3, D4) 72,000 59,000 ............... 40,000 ............... ............... ................ 7,200 ................ 3,000 ................ ............... ................ 3,240 ................ 300,000 ................

.................

(80,000) (EL2)

72,000

(NCI1)

Consoli-

Consolidated Income Statement

part.

Controlling dated Retained Balance Earnings Sheet

8–39

Ch. 8—Problems

Problem 8-7, Continued DeNoma Company and Subsidiaries Shelby Corporation and Borner Company Worksheet for Consolidated Financial Statements For Year Ended December 31, 2018 (Concluded)

DeNoma

Trial Balance Shelby

Eliminations and Adjustments Borner

Dr.

Cr.

Consolidated Income Statement

ConsoliNCI

Retained Earnings—Borner ............

Controlling dated Retained Balance Earnings Sheet

................. ................. (500,000) (EL2) 450,000 (NCI2) 9,000 ................. (56,900) ............. ............... ................. ................. ................. (A3) 1,500 ................ ................. ............. ............. ............... ................. ................. ................. (BI) 600 ................ ................. ............. ............. ............... Sales ............................................... (900,000) (700,000) (600,000) (IS) 125,000 ................ (2,075,000) ............. ............. ............... Cost of Goods Sold ......................... 570,000 425,000 400,000 (EI) 8,000 (IS) 125,000 1,272,000 ............. ............. ............... ................. ................. ................. ............... (BI) 6,000 ................. ............. ............. ............... Expenses ........................................ 205,000 200,000 150,000 (A1) 5,000 (F2) 3,000 562,000 ............. ............. ............... ................. ................. ................. (A3) 5,000 ................ ................. ............. ............. ............... Subsidiary Income........................... (72,000) ................. ................. (CY1) 72,000 ................ ................. ............. ............. ............... ................. (45,000) ................. (CY2) 45,000 ............... ................. ............. ............. ............... Totals ......................................... 0 ............... 0 .................0 1,961,600 1,961,600 ................. ............. ............. ............... Consolidated Net Income .................................................................................................................................................... (241,000) ............. ............. ............... To NCI—Borner (see distribution schedule) .................................................................................................................. 4,300 (4,300) ............. ............... To NCI—Shelby (see distribution schedule) .................................................................................................................. 44,680 (44,680) ............. ............... Consolidated Net Income .................................................................................................................................................... 192,020 ............. (192,020) ............... (668,420) Total NCI.............................................................................................................................................................................................. (668,420) ................ Retained Earnings—Controlling Interest, December 31, 2018 ..................................................................................................................................... (1,100,580) (1,100,580) Totals .......................................................................................................................................................................................................................................... 0

part.

Ch. 8—Problems

8–40

Problem 8-7, Continued Eliminations and Adjustments: (Adj)

Adjust Investment in Borner Company and Retained Earnings—Shelby for 2015 and 2016 amortizations of excess. (CY1) Eliminate the entry made by DeNoma to record its share of Shelby income. (EL1) Eliminate 60% of Shelby equity balances (after adjustment) against investment in Shelby. (D1, D2)/NCI1) Distribute the excess of cost over book value and NCI adjustment according to the determination and distribution of excess schedule for Investment in Shelby Corporation. (A1) Amortize the excess for the current and past years: Depreciation: Shelby: $50,000 ÷ 10 years ...........

Current $5,000

Prior $5,000

Total $10,000

(CY2) Eliminate the entry made by Shelby to record its share of Borner income. (EL2) Eliminate 90% of the Borner equity balances against investment in Borner. (D3, D4)/(NCI2) Distribute the remaining excesses and NCI adjustment [i.e., the original excess less the amount of the adjustment made in (Adj)]. (A3) Amortize excess as follows: Borner retained earnings, 3 years × 10% × $5,000 ..... $1,500 Shelby retained earnings, 1 year (2 years are in the adjustment), 90% × $5,000.................................... 4,500 Expense....................................................................... 5,000 (IS) Eliminate the current-year intercompany merchandise sale. (BI) Eliminate Borner’s gross profit contained in Shelby’s beginning inventory. The correction of retained earnings must be prorated between noncontrolling and controlling interests: $7,500 × 80% = $6,000 Borner: 10% × $6,000 ................................................. Shelby: 40% × 90% × $6,000 ...................................... DeNoma: 60% × 90% × $6,000 ................................... (EI) (F1)

(F2)

$ 600 2,160 3,240 $6,000

Eliminate the intercompany profit contained in Shelby’s ending inventory, $10,000 × 80% = $8,000. Adjust to remove gain on intercompany sale of assets, reduce accumulated depreciation by the prior-year amortization of the gain, and reduce Shelby’s (40%) and DeNoma’s (60%) retained earnings by the gain remaining at the beginning of the year. Recognize current-year gain through use of plant assets.

8–41

Ch. 8—Problems

Problem 8-7, Concluded Subsidiary Borner Company Income Distribution Ending inventory profit .................. Depreciation on excess .................

$8,000 Internally generated 5,000 income ................................ Beginning inventory profit ......... Adjusted income ....................... NCI share ................................. NCI ...........................................

$50,000 6,000 $43,000 × 10% $ 4,300

Subsidiary Shelby Corporation Income Distribution Depreciation on excess .................

$5,000 Internally generated income ................................ Share of Borner income (90% × $43,000) ................. Gain realized through plant asset use ............................ Adjusted income ....................... NCI share ................................. NCI ...........................................

$ 75,000 38,700 3,000 $111,700 × 40% $ 44,680

Parent DeNoma Company Income Distribution Internally generated income ................................ Share of Shelby income (60% × $111,700) ............... Controlling interest....................

$125,000 67,020 $192,020

Ch. 8—Problems

8–42

PROBLEM 8-8 Determination and Distribution of Excess Schedule Company Implied Fair Value Fair value of subsidiary ........................ $562,500 Less book value of interest acquired: Common stock ($10 par)................ $ 50,000 Paid-in capital in excess of par ...... 140,000 Retained earnings .......................... 220,000 Total equity ............................... $410,000 Interest acquired ............................ Book value ........................................... Excess of fair value over book value ... $152,500

Parent Price (80%) $450,000

NCI Value (20%) $112,500

$410,000 80% $328,000 $122,000

$410,000 20% $ 82,000 $ 30,500

Adjustment of identifiable accounts: Adjustment Goodwill ............................................... $152,500

Worksheet Key debit D

Life

Amortization per Year

8–43

Ch. 8—Problems

Problem 8-8, Continued Parson Company and Subsidiary Salary Company Worksheet for Consolidated Financial Statements For Year Ended December 31, 2016 Controlling Retained Earnings

Consolidated Balance Sheet

170,000 120,000 ................. (EI) 4,800 ................. ................. ................. 166,000 196,000 ................. ................. ................. ................. ................. 450,000 ................. (CV) 32,000 (EL) 360,000 ................. ................. ................. ................. ................. ................. (D) 122,000 ................. ................. ................. Investment in Parson Company ..................... ................. 100,000 ................. (TS) 100,000 ................. ................. ................. Land ............................................................... 80,000 70,000 ................. ................. ................. ................. ................. Buildings and Equipment ............................... 400,000 280,000 ................. ................. ................. ................. ................. Accumulated Depreciation ............................. (180,000) (90,000) ................. ................. ................. ................. ................. Goodwill ......................................................... ................. ................. (D) 152,500 ................. ................. ................. ................. Current Liabilities ........................................... (98,000) (74,000) ................. ................. ................. ................. ................. Long-Term Liabilities ...................................... (250,000) (100,000) ................. ................. ................. ................. ................. Common Stock ($10 par)—Parson ................ (100,000) ................. ................. ................. ................. ................. ................. Paid-In Capital in Excess of Par—Parson ...... (200,000) ................. ................. ................. ................. ................. ................. Retained Earnings—Parson ........................... (350,000) ................. ................. (CV) 32,000 ................. ................. (382,000) Common Stock ($10 par)—Salary ................. ................. (50,000) (EL) 40,000 ................. ................. (10,000) ................. Paid-In Capital in Excess of Par—Salary ....... ................. (140,000) (EL) 112,000 ................. ................. (28,000) ................. Retained Earnings—Salary ............................ ................. (260,000) (EL) 208,000 (NCI) 30,500 ................. (82,500) ................. Net Sales ....................................................... (640,000) (350,000) (IS) 48,000 ................. (942,000) ................. ................. Cost of Goods Sold ........................................ 360,000 200,000 (EI) 4,800 (IS) 48,000 516,800 ................. ................. Operating Expenses ....................................... 160,000 90,000 ................. ................. 250,000 ................. ................. Dividend Income ............................................ (8,000) (2,000) (CY1) 8,000 ................. ................. ................. ................. ................. ................. (CY2) 2,000 ................. ................. ................. ................. Dividends Declared—Parson ......................... 40,000 ................. ................. (CY2) 2,000 ................. ................. 38,000 Dividends Declared—Salary .......................... ................. 10,000 ................. (CY1) 8,000 ................. 2,000 ................. Treasury Stock ............................................... ................. ................. (TS) 100,000 ................. ................. ................. ................. Totals .......................................................... 0 0 707,300 .... 707,300 ................. ................. ................. Consolidated Net Income ........................................................................................................................................ (175,200) ................. To NCI (see distribution schedule) ...................................................................................................................... 12,000 (12,000) ................. To Controlling Interest (see distribution schedule)............................................................................................... 163,200 ................. (163,200) Total NCI ........................................................................................................................................................................................ (130,500) ................. Retained Earnings—Controlling Interest, December 31, 2016 .............................................................................................................................. (507,200) Totals .........................................................................................................................................................................................................................................

285,200 362,000 ................. ................. ................. 150,000 680,000 (270,000) 152,500 (172,000) (350,000) (100,000) (200,000) ................. ................. ................. ................. ................. ................. ................. ................. ................. ................. ................. 100,000 ................. ................. ................. ................. (130,500) (507,200) 0

Trial Balance Parson Salary

Eliminations and Adjustments Dr. Cr.

Consolidated Income Statement

NCI

Inventory ........................................................ Other Current Assets ..................................... Investment in Salary Company ......................

part.

Ch. 8—Problems

8–44

Problem 8-8, Concluded Eliminations and Adjustments: (CV) Convert to the simple equity method as of January 1, 2016. (CY1) Eliminate the current-year dividend income of Parson against dividends declared by Salary. (EL) Eliminate 80% of the Salary Company equity balances at the beginning of the year against the investment account. (D) Distribute the $122,000 excess of cost over book value and $30,500 NCI adjustment to goodwill. (IS) Eliminate the intercompany $48,000 sale and purchase. (EI) Eliminate the $4,800 intercompany gross profit in the ending inventory of Salary. (CY2) Eliminate the current-year dividend income of Salary against dividends declared by Parson. (TS) Transfer Investment in Parson Company to a treasury stock account. Subsidiary Salary Company Income Distribution Internally generated net income ................................ NCI share ................................. NCI ...........................................

$60,000 × 20% $12,000

Parent Parson Company Income Distribution Ending inventory profit ..................

$4,800 Internally generated net income ................................ 80% of Salary income ...............

$120,000 48,000

Controlling interest....................

$163,200

8–45

Ch. 8—Problems

PROBLEM 8-9 Determination and Distribution of Excess Schedule Company Implied Fair Value Fair value of subsidiary ........................ $148,000 Less book value of interest acquired: Common stock ($5 par).................. $ 20,000 Paid-in capital in excess of par ...... 10,000 Retained earnings .......................... 112,000 Total equity ............................... $142,000 Interest acquired ............................ Book value ........................................... Excess of fair value over book value ... $ 6,000

Parent Price (75%) $111,000*

NCI Value (25%) $ 37,000

$142,000 75% $106,500 $ 4,500

$142,000 25% $ 35,500 $ 1,500

Adjustment of identifiable accounts: Adjustment Goodwill ............................................... $ 6,000

Worksheet Key debit D

Life

Amortization per Year

*Last purchase at $51,800/1,400 shares = $37 per share. Fair value = 3,000 shares × $37 = $111,000 Adjustment to fair value: Fair value of prior purchase (1,600 shares × $37) ....... Cost.............................................................................. Gain .............................................................................

$59,200 48,000 $11,200

Ch. 8—Problems

8–46

Problem 8-9, Continued Heckert Company and Subsidiary Aker Company Worksheet for Consolidated Financial Statements For Year Ended December 31, 2017 Trial Balance Heckert Aker Cash............................................................... Marketable Securities ..................................... Trade Accounts Receivable ........................... Allowance for Doubtful Accounts.................... Intercompany Receivables ............................. Inventories ..................................................... Machinery and Equipment ............................. Accumulated Depreciation ............................. Investment in Aker Company (at cost) ........... Patents ........................................................... Goodwill ......................................................... Dividends Payable ......................................... Trade Accounts Payable ................................ Intercompany Payables .................................. Common Stock ($10 par)—Heckert ............... Common Stock ($5 par)—Aker ...................... Paid-In Capital in Excess of Par—Heckert ..... Paid-In Capital in Excess of Par—Aker .......... Retained Earnings—Heckert .......................... Retained Earnings—Aker ............................... Dividends Declared—Heckert ........................ Dividends Declared—Aker ............................. Sales and Services ........................................ Dividend Income ............................................ Other Income ................................................. Cost of Goods Sold ........................................ Depreciation Expense .................................... Administrative and Selling Expenses .............

Eliminations and Adjustments Dr. Cr.

38,100 29,050 ................. 33,000 18,000 ................. (TS) 210,000 88,000 ................. (IA) (6,800) (2,300) ................. 24,000 ................. ................. (IA) 275,000 135,000 ................. (EI) 514,000 279,000 ................. (F1) (298,200) (196,700) ................. 99,800 ................. (Adj) 11,200 (EL) ................. ................. ................. (D) 35,000 ................. ................. ................. ................. (D) 6,000 (7,500) ................. (CY2) 750 (195,500) (174,050) (IA) 24,000 (8,000) ................. (IA) 8,000 (150,000) ................. ................. ................. (22,000) (EL) 16,500 (36,000) ................. ................. ................. (14,000) (EL) 10,500 (378,000) ................. ................. ................. ................. ................. ................. (106,000) (EL) 79,500 (NCI) 7,500 ................. ................. (CY2) ................. 4,000 ................. (CY1) (850,000) (530,000) (IS) 182,000 (3,000) ................. (CY1) 3,000 (9,000) (3,700) (F1) 800 510,000 374,000 (EI) 5,400 (IS) 65,600 11,200 ................. 130,000 110,500 .................

................. 18,000 8,000 ................. 24,000 5,400 800 ................. 106,500 4,500 ................. ................. ................. ................. ................. ................. ................. ................. ................. ................. ................. 1,500 750 3,000 ................. ................. ................. 182,000 ................. .................

Consolidated Income Statement ................. ................. ................. ................. ................. ................. ................. ................. ................. ................. ................. ................. ................. ................. ................. ................. ................. ................. ................. ................. ................. ................. ................. ................. (1,198,000) ................. (11,900) 707,400 76,800 240,500

NCI

Controlling Retained Earnings

Consolidated Balance Sheet

................. ................. ................. ................. ................. ................. ................. ................. ................. ................. ................. ................. ................. ................. ................. ................. (5,500) ................. (3,500) ................. ................. (28,000) ................. 1,000 ................. ................. ................. ................. ................. .................

................. ................. ................. ................. ................. ................. ................. ................. ................. ................. ................. ................. ................. ................. ................. ................. ................. ................. ................. ................. (378,000) ................. 6,750 ................. ................. ................. ................. ................. ................. .................

67,150 33,000 290,000 (9,100) ................. 404,600 792,200 (494,900) ................. ................. 35,000 6,000 (6,750) (345,550) ................. (150,000) ................. (36,000) ................. ................. ................. ................. ................. ................. ................. ................. ................. ................. ................. .................

part.

8–47

Ch. 8—Problems

Problem 8-9, Continued Heckert Company and Subsidiary Aker Company Worksheet for Consolidated Financial Statements For Year Ended December 31, 2017 (Concluded) Controlling Retained Earnings

Consolidated Balance Sheet

Gain on investment ........................................ ................. ................. ................. (Adj) 11,200 (11,200) ................. ................. Treasury Stock (cost) ..................................... ................. ................. (TS) 18,000 ................. ................. ................. ................. 0 365,650 365,650 ................. ................. ................. Totals .......................................................... 0 Consolidated Net Income ........................................................................................................................................ (196,400) ................. ................. To NCI (see distribution schedule) ...................................................................................................................... 10,750 (10,750) ................. ................. (185,650) To Controlling Interest (see distribution schedule)............................................................................................... 185,650 Total NCI ........................................................................................................................................................................................ (46,750) ................. Retained Earnings—Controlling Interest, December 31, 2017 .............................................................................................................................. (556,900) Totals .........................................................................................................................................................................................................................................

................. 18,000 ................. ................. ................. ................. (46,750) (556,900) 0

Trial Balance Heckert Aker

Eliminations and Adjustments Dr. Cr.

Consolidated Income Statement

NCI

Eliminations and Adjustments: (Adj) Adjust investment account for gain on prior investment, $11,200. (CY1) Eliminate intercompany cash dividends. (CY2) Eliminate intercompany dividends on shares of Heckert owned by Aker, 1,500 × $0.50 = $750 against the dividends payable account. (EL) Eliminate 75% of subsidiary equity against the investment account. (D)/(NCI) Distribute excess and NCI adjustment to goodwill, according to the determination and distribution of excess schedule. (TS) Reclassify Aker’s investment in Heckert as treasury stock at cost. (F1) Eliminate gain on machinery sale by Aker. (IA) Eliminate intercompany receivables and payables. (IS) Eliminate intercompany merchandise sales of $182,000. (EI) Eliminate ending inventory profit on Aker sales to Heckert, 30% × $18,000 = $5,400.

part.

Ch. 8—Problems

8–48

Problem 8-9, Concluded

Subsidiary Aker Company Income Distribution Gain on sale of equipment ............ Unrealized profit in ending inventory ......................

$ 800 Internally generated net income ................................ 5,400 Gain on investment in Heckert . Adjusted net income ................. NCI share ................................. NCI ...........................................

$ 38,000 11,200 $ 43,000 × 25% $ 10,750

Parent Heckert Company Income Distribution Internally generated net income ................................ 75% × Aker adjusted income of $43,000 .............. Controlling interest....................

$153,400 32,250 $185,650

DERIVATIVES MODULE UNDERSTANDING THE ISSUES ue increases $700, then the time value has decreased by $200. This $200 change would be recognized in current income. Changes in the intrinsic value over time are initially recorded as a component of other comprehensive income and therefore do not currently impact operating income. However, these amounts will affect current operating income when the hedged item itself affects current operating income. For example, if the above option hedged a forecasted sale of inventory, changes in the intrinsic value would not be recognized currently until the hedged sale affected current income.

1. The intrinsic value of a forward contract to sell a commodity or currency is determined by comparing the spot rate/price at the date of inception of the forward to the spot rate/price at a later valuation date. At date of inception of the forward, the difference between the forward rate and spot represent the total time value of the contract. Both the intrinsic value and time value per item must be multiplied by the notional amount in order to calculate the respective total values. A put option has intrinsic value only if the strike price one can sell at is greater than the current spot price. The difference between these two values times the notional amount represents the total intrinsic value. The time value of an option is measured by subtracting the intrinsic value from the total value of the option.

4. Unlike a futures contract, an option contract represents a right, rather than an obligation. While the option contract requires the holder to make an initial nonrefundable cash outlay, the holder can allow the option to expire in unfavorable conditions. In the case of a futures contract, the contract must be exercised even if on unfavorable terms.

2. A firm commitment to sell inventory is fixed in terms of the quantity, price, and delivery terms. Therefore, if the price of the inventory changes prior to execution of the commitment, the commitment may become more or less valuable than anticipated. Keeping in mind that the price is fixed, a commitment to sell will become less valuable if prices increase prior to execution of the commitment. This exposure to loss may be effectively hedged against through the use of a derivative instrument such as a contract or option to buy inventory. In a highly effective hedge, the loss in value on the firm commitment should be offset by the gains in value on the derivative instrument.

5. An interest rate swap involves exchanging variable interest rates for fixed interest rates or fixed interest rates for variable interest rates. For example, assume that a company has borrowed $3 million at a variable interest rate of LIBOR plus 2% points. Concerned that interest rates will increase, the borrower could agree to pay a counterparty a fixed rate of interest in exchange for receiving a variable rate of interest which will be paid to the original lender. For example, assume the borrower agrees to pay 6.5% fixed in exchange for receipt of a variable rate of LIBOR plus 2%. If LIBOR is greater than 4.5%, the borrower will gain from the swap and effectively reduce their interest expense to a fixed rate of 6.5%. However, if LIBOR is less than 4.5%, the borrower will be paying more than the variable interest rate in that they have fixed their interest rate at 6.5%.

3. A cash flow hedge of a forecasted transaction affects both current and future operating income. The effect on current operating income is represented by the change in time value of the hedging instrument. This is measured as the change in total value over time less the change in intrinsic value over time. For example, if an option’s total value increases $500 and the intrinsic val-

Derivatives Module—Exercises

DM–2

EXERCISES EXERCISE 1 Because the option hedges a forecasted transaction, the only impact on earnings prior to the transaction actually taking place and then, in turn, affecting earnings itself will be changes in the time value of the option. The impact on earnings for the first and second 30-day period is a charge against earnings of $2,000 and $2,500, respectively, to be recognized as an unrealized loss on the hedge.

Notional amount in tons ............................. Strike price ................................................. Spot rate .................................................... Intrinsic value (if spot is > strike) ................ Time value ................................................. Total value .................................................

Beginning 500 $1,200 $1,201 $500 $4,500 $5,000

30 Days Later 500 $1,200 $1,214 $7,000 $2,500 $9,500

Expiration Date 500 $1,200 $1,216 $8,000 — $8,000

Regarding the hedge against a fixed rate loan, the impact on earnings would be the fixed interest expense as adjusted for the settlement of rate differences determined as follows:

Fixed interest ($3 million × 8% × 1/12 year) ..................... Settlement of rate differences: (8.1% vs. 8% on $3 million × 1/12 year) ..................... (7.8% vs. 8% on $3 million × 1/12 year) ..................... Net interest expense ......................................................... Gain on swap (increasing basis of swap asset) ................ Loss on swap (increasing the basis of the liability) ........... Total charge against earnings ...........................................

First 30 Days $20,000

Next 30 Days $20,000

250 $20,250 (3,000) 3,000 $20,250

(500) $19,500 (300) 300 $19,500

DM–3

Derivatives Module—Exercises

EXERCISE 2 Corn Futures June 30 150,000 $3.41 $3.53

July 31 150,000 $3.43 $3.54

$4,500

$3,000

4,500

(1,500)

Intrinsic value (change in spot rates) ...

1,500

(1,500)

Time value (spot-forward difference) or change in contract value less change in intrinsic value .................

3,000

—

Number of bushels ..................................... Spot price/bushel ....................................... Future price/bushel .................................... Fair value of contract: (original futures price vs. current futures price × notional amount) .......... Current-period gain (loss) in: Value of contract ..................................

June 1 150,000 $3.42 $3.56

(Note A)

Note A: Because the July 31 spot rate is greater than the June 30 spot rate, the contract has no intrinsic value. Therefore, the value of the contract must be traceable to time value. As a result of the above hedging activity, the following changes would occur: Increase (decrease) in value of inventory .... Gain (loss) on futures contract: Intrinsic value component ....................... Time value component ........................... Total .......................................................

June $ (1,500)

July $ 1,500

$ 1,500 3,000 $ 4,500

$ (1,500) — $ (1,500)

Derivatives Module—Exercises

DM–4

Exercise 2, Concluded Wheat Futures June 30 150,000 $6.19 $6.33

July 31 150,000 $6.175 $6.32

$3,000

$4,500

3,000

1,500

Intrinsic value (change in spot rates) ...

1,500

2,250

Time value (spot-forward difference) or change in contract value less change in intrinsic value .................

1,500

(750)

June 1 150,000 $6.20 $6.35

As a result of the above hedging activity, the following changes would occur: Increase (decrease) in value of inventory .... Gain (loss) on futures contract: Intrinsic value component ....................... Time value component ........................... Total .......................................................

June $(1,500)

July $(2,250)

$ 1,500 1,500 $ 3,000

$ 2,250 (750) $ 1,500

EXERCISE 3

(1) Net interest expense: Fixed interest (9% × $4,000,000 × ½ year) ............ Settlement of rate difference: (8.75% vs. 9% on $4,000,000 × ½ year) .......... (8.50% vs. 9% on $4,000,000 × ½ year) .......... Net interest expense ............................................... (2) Carrying value of note payable: Original face value .................................................. Change in value of debt .......................................... Carrying value of debt............................................. (3) Net unrealized gain (loss) on the swap ........................

June 30

December 31

$ 180,000

(5,000) $ 175,000

(10,000) $ 170,000

$4,000,000 14,000 $4,014,000 $ 0

$4,000,000 3,500 $4,003,500 $ 0

DM–5

Derivatives Module—Exercises

EXERCISE 4 (1) Critical criteria that must be satisfied in order to justify classification as a fair value hedge include the following: a. At inception, the hedging relationship is identified and documented. b. There is an expectation that the hedge will be highly effective. Effectiveness of the hedge must be assessed at inception and on an ongoing basis. c. The hedged item is a firm commitment that is exposed to changes in value as commodity prices change that could affect earnings. d. The hedge item (the commitment) is not being measured at fair value to reflect both positive and negative changes in value (commitments that are not hedged are generally only adjusted to reflect downward changes in value). (2) Several factors that could suggest that the hedge is highly effective include the following: a. The option is for the same notional amount (100,000 bushels) as is the commitment. b. The delivery location for the option is not significantly different than the location for the actual commitment. c. Changes in corn price for delivery in a different location than the commitment correlate highly with changes in prices at the actual delivery location. d. The term of the option corresponds with the term of the commitment. (3) An option may provide more flexibility than a futures contract because an option does not have to be exercised if it is out-of-the-money, unlike a future. Therefore, if corn prices increase above the strike price of $1.51 a bushel, the company is not obligated under the option to sell at the strike price. The only cost incurred by the company in that case is the initial cost of the option. (4) The value of an option consists of two components: intrinsic value and time value. The former represents the extent to which the current spot price compares favorably to the strike price. In the case of a put option, if the current price is less than the strike price, then the option has intrinsic value. The time value of an option reflects a variety of factors including the time until expiration and potential price volatility. Therefore, even if there is no intrinsic value currently, there may be time value in that things could change so that the option ultimately has intrinsic value. Obviously, at the expiration date, no time value is associated with an option. (5) Granted, with an option you are either in-the-money or you are not. Therefore, an option may not have a negative value. However, at inception, one must pay for the option, and this cost is incurred regardless of subsequent developments affecting the value of the option. One can certainly lose money on an option to the extent of this initial cost. (6) The initial time value component of an option’s value is allocated to earnings over the period of the term of the option. The amount of time value allocated to each period is determined by measuring changes over time in the time value of the option. The time value of the option at any point in time is determined by subtracting from the value of the option the intrinsic component of value leaving the time value component.

Derivatives Module—Exercises

DM–6

EXERCISE 5

Option A: Call Option Investment in option (equal to fair value of option) ........ Other comprehensive income Dr (Cr): Intrinsic value at inception out-of-the-money ........... Current intrinsic value out-of-the-money .................. Current intrinsic value [200 × ($1,510 – $1,500)] ..... Change in intrinsic value ....................................

30 Days Later

60 Days Later

700

$ 2,500

0 0

2,000 $(2,000)

Gain (loss) on option (change in time value): Current time value .................................................... Time value at inception ............................................ Change in time value..........................................

700 900 $ (200)

500 900 $ (400)

Option B: Put Option Investment in option (equal to fair value of option) ........

$ 3,300

$ 5,200

Other comprehensive income Dr (Cr): Intrinsic value at inception out-of-the-money ........... Current intrinsic value [100,000 × ($2.50 – $2.48)] .. Current intrinsic value [100,000 × ($2.50 – $2.45)] .. Change in intrinsic value ....................................

$(2,000)

$ 1,300 1,200 $ 100

0 2,000

5,000 $(5,000) $

200 1,200 $(1,000)

DM–7

Derivatives Module—Exercises

EXERCISE 6 (1) Analysis of changes in the value of the call option: Notional amount in pounds ........ Strike price ................................. Spot price................................... Intrinsic value (if strike is < spot)............................. Time value ................................. Total value. ................................ Feb. 20

Mar. 31

Apr. 20

February 20 300,000 $1.60 $1.61

February 28 300,000 $1.60 $1.59

March 31 300,000 $1.60 $1.62

April 20 300,000 $1.60 $1.64

3,000 800 3,800

1,200 1,200

6,000 800 6,800

12,000 500 12,500

Investment in Option ............................................................ Cash ................................................................................. To record payment of option premium.

3,800

Other Comprehensive Income.............................................. Investment in Option ........................................................ To record change in intrinsic value of option.

3,000

Investment in Option ............................................................ Unrealized Gain on Option ............................................... To record change in time value of option ($800 on February 20 vs. $1,200 on February 28).

400

Investment in Option ............................................................ Other Comprehensive Income ......................................... To record change in intrinsic value of option.

6,000

Unrealized Loss on Option ................................................... Investment in Option ........................................................ To record change in time value of option ($1,200 on February 28 vs. $800 on March 31).

400

Investment in Option ............................................................ Other Comprehensive Income ......................................... To record change in intrinsic value of option.

6,000

300

Cash ..................................................................................... Investment in Option ........................................................ To record net settlement of option.

12,500

3,800

3,000

400

6,000

400

6,000

300

12,500

Derivatives Module—Exercises

DM–8

Exercise 6, Concluded May

During May

June

Inventory of Soybean Meal ................................................... 489,000 Cash ................................................................................. To record purchase at $1.63 per pound.

489,000

Inventory of Food ................................................................. 489,000 Inventory of Soybean Meal .............................................. To record use of meal to make food.

489,000

Cost of Sales ........................................................................ 240,000 Other Comprehensive Income.............................................. 4,500 Inventory of Food ............................................................. To record sale of one-half of the food and the reclassification of other comprehensive income.

244,500

(2) The net effect on earnings with and without the cash flow hedge is as follows:

Assumed sales value ................................................................ Cost of sales ............................................................................. Assumed gross profit ................................................................ Gain (loss) excluded from effectiveness ................................... Net effect on earnings. .............................................................

Without the Hedge $ 300,000 (244,500) $ 55,500 $ 55,500

With the Hedge $ 300,000 (240,000) $ 60,000 (300) $ 59,700

If the forecasted purchase had not been hedged, there would have been a $4,200 decrease in earnings.

DM–9

Derivatives Module—Exercises

EXERCISE 7

Basis of 6% note payable: (a) Balance per Schedule A .................................... Current quarter change in value of swap: Value at end of quarter ................................ Value at beginning of quarter ..................... (b) Change in value .................................... (c)

Prior quarter(s) change in value of swap ..........

(a) + (b) + (c) Balance of note payable ........................ Interest expense: Amount per Schedule A .......................................... Settlement of rate difference: 5.8% vs. 6% on $10 million × ¼ year ................ 5.5% vs. 6% on $10 million × ¼ year ................ 5.6 % vs. 6% on $10 million × ¼ year ............... Net interest expense ...............................................

June 30

September 30

December 31

$6,089,100

$4,089,543

$2,059,993

14,954 0 14,954

6,037 $ 14,954 (8,917) $

3,049 6,037 (2,988)

14,954

6,037

$6,104,054

$4,095,580

$2,063,042

$ 120,887

61,343

(10,000) 51,343

91,337

(5,000) (12,500) $ 115,887

78,837

Schedule A: Amortization of Note Payable Without Swap Quarter

Payment

Interest

Principal

Mar. 31 June 30 Sept. 30 Dec. 31 Mar. 31 Total

$ 2,090,893 2,090,893 2,090,893 2,090,893 2,090,893 $ 10,454,466

$150,000 120,887 91,337 61,343 30,900 $454,466

$ 1,940,893 1,970,007 1,999,557 2,029,550 2,059,993 $ 10,000,000

Balance $ 10,000,000 8,059,107 6,089,100 4,089,543 2,059,993 0

Schedule B: Quarterly Variable versus Fixed Rate Differences

Quarter June 30 Sept. 30 Dec. 31 Mar. 31 Total

Variable Rate

Fixed Rate

5.80% 5.5 5.6 5.4

6.00% 6.0 6.0 6.0

Quarterly Interest at Variable Rate Fixed Rate $145,000 137,500 140,000 135,000

$150,000 150,000 150,000 150,000

Quarterly Difference $ (5,000) (12,500) (10,000) (15,000) $ (42,500)

Derivatives Module—Exercises

DM–10

Exercise 7, Concluded Summary of Entries Dr (Cr) over the Life of the Note Payable Cash

Note Payable

Interest

Gain (Loss) On Debt

Swap Asset

Gain (Loss) on Swap

14,954

(14,954)

(8,917)

8,917

(2,988)

2,988

(3,049)

3,049

Beginning Balance 10,000,000 (10,000,000) Mar. 31

(2,090,893)

1,940,893

150,000

June 30

(2,090,893)

1,970,007 (14,954)

120,887

5,000 Sept. 30

(2,090,893)

(5,000) 1,999,557 8,917

12,500 Dec. 31

(2,090,893) 10,000

Mar. 31

(2,090,893)

(12,500) 2,029,550 2,988 (10,000)

61,343

2,059,993 3,049

30,900 (15,000)

15,000 Ending Balance

(411,966)

91,337

411,966

DM–11

Derivatives Module—Problems

PROBLEMS PROBLEM M-1 (1)

Value of Option Intrinsic value ......................... Time value.............................. Total value.............................. Mar. 29

Apr.

March 29

March 31

April 30

May 18

$1,000 1,400 $2,400

$1,000 1,200 $2,200

$3,000 300 $3,300

$4,000 0 $4,000

Investment in Put Option ............................................ Cash ..................................................................... To record purchase of option.

2,400

Loss on Option (Time Value) ..................................... Gain on Option (Intrinsic Value) ........................... Investment in Put Option ...................................... To record change in value of option.

200

Investment in Put Option ............................................ Loss on Option (Time Value) ..................................... Gain on Option (Intrinsic Value) ........................... To record change in value of option.

1,100 900

Loss on Firm Commitment ......................................... Firm Commitment................................................. To record change in the value of commitment equal to the change in the intrinsic value of the option.

2,000

2,400

0 200

2,000

Derivatives Module—Problems

DM–12

PROBLEM M-1, Concluded May

June 16

Investment in Put Option ............................................ Loss on Option (Time Value) ..................................... Gain on Option (Intrinsic Value) ...........................

700 300

1,000

Inventory of Commodity A .......................................... Firm Commitment ...................................................... Cash ..................................................................... To record purchase of inventory.

115,000 3,000

Cash ........................................................................... Investment in Put Option ...................................... To record settlement of option.

4,000

Inventory of Commodity A .......................................... Cash ..................................................................... To record processing costs.

25,000

Cash ........................................................................... Sales Revenue ..................................................... To record sale of one-half of the inventory.

90,000

Cost of Sales .............................................................. Inventory of Commodity A .................................... To record to cost of inventory sold.

70,000

(2) Cost of commodity ................................. Cost of processing ................................. Loss on firm commitment ...................... Gain on option (intrinsic value) .............. Loss on option (time value) ................... Total cost of goods available for sale ....

1,000 1,000

118,000

4,000

25,000

90,000

70,000

Desired Position

Without the Option

With the Option

$115,000 25,000

$118,000 25,000

$140,000

$143,000

$115,000 25,000 3,000 (3,000) 1,400 $141,400

DM–13

Derivatives Module—Problems

PROBLEM M-2 (1)

Corn Futures Number of bushels. ........................ Spot price per bushel ...................... Futures price per bushel ................. Fair value of contract ................... (a) Change in above fair value .... (b) Change in spot rates: At beginning of period ....... At end of period ................ Change ..................................

September 1 September 30 1,000,000 $2.5000 $2.5100 $—

(a) – (b) = Change in spot-forward difference ............................... Wheat Futures Number of bushels. ........................ Spot price per bushel ...................... Futures price per bushel ................. Fair value of contract ................... (a) Change in above fair value .... (b) Change in spot rates: At beginning of period ....... At end of period ................ Change .................................. (a) – (b) = Change in spot-forward difference ...............................

Sept. 1

1,000,000 $2.5380 $2.5420 $ $

32,000 32,000

November 5

1,000,000 $2.5680 $2.5700

1,000,000 $2.5685 $2.5710

$ $

60,000 28,000

$ $

61,000 1,000

$2,500,000 2,538,000 $ 38,000

$2,538,000 2,568,000 $ 30,000

$2,568,000 2,568,500 $ 500

(6,000)

September 1 September 30

(2,000)

500

October 31

November 5

2,000,000 $3.5480 $3.5520

2,000,000 $3.5700 $3.5710

2,000,000 $3.5700 $3.5705

62,000 62,000

$ 100,000 $ 38,000

$ $

$7,030,000 7,096,000 $ 66,000

$7,096,000 7,140,000 $ 44,000

$7,140,000 7,140,000 $ —

2,000,000 $3.5150 $3.5210 $—

October 31

$ $

(4,000)

(6,000)

99,000 (1,000)

(1,000)

Memo entry to record the acquisition of the futures contract. Margin Account .................................................................... Cash ................................................................................. To record margin account deposit.

70,000

Futures Contract—Corn ....................................................... Futures Contract—Wheat ..................................................... Unrealized Hedging Loss ..................................................... Other Comprehensive Income ......................................... To record change in value of contract and include in earnings change in time value excluded from hedge effectiveness.

32,000 62,000 10,000

70,000

104,000

Derivatives Module—Problems

DM–14

Problem M-2, Concluded Oct. 31

Nov. 5

28,000 38,000 8,000

Futures Contract—Corn ....................................................... Unrealized Hedging Loss ..................................................... Futures Contract—Wheat ................................................ Other Comprehensive Income ......................................... To record change in value of contract and include in earnings change in time value excluded from hedge effectiveness.

1,000 500

Cash ............................................................................... Futures Contract—Corn ................................................... Futures Contract—Wheat ................................................ Margin Account ................................................................ To record settlement of futures and return of margin account.

230,000

74,000

1,000 500

Other Comprehensive Income.............................................. 178,500 Cost of Sales—Corn ........................................................ Cost of Sales—Wheat ...................................................... To adjust cost of sales for the recognition of gains on futures contracts.

61,000 99,000 70,000

68,500 110,000

(2) Factors that might cause the futures contracts to not be highly effective include the following: a. Changes in the price of wheat and corn may not correlate as highly with the change in the price of flour due to costs associated with producing flour. b. The CBT prices reflect delivery of commodities at a location that is different than the location of commodities used to make flour that is used by CBBI. c. The quality of the commodities traded on the CBT may be different than the quality of the commodities used to make the flour acquired by CBBI. d. The quantity of flour used by CBBI and therefore the equivalent amount of corn and wheat may be greater than the notional amount of the futures contracts. Therefore, some of the cash flows would not be hedged.

DM–15

Derivatives Module—Problems

PROBLEM M-3 Futures Contract To Sell Key Variables Number of units per contract................ Spot price per unit ................................ Futures price per unit ........................... Fair value of contract: 10,000 × ($3.50 – $3.44) ................ Current period change in: Fair value: $600 – $0 ................................... Intrinsic value: 10,000 × ($3.45 – $3.40) ........... Time value: $600 – $500 ...............................

January

February 10,000 $3.45 $3.50

March 10,000 $3.40 $3.44 $600 600 500 100

Effect on Earnings—Gain (Loss) Change in value of inventory ............... Change in intrinsic value ...................... Change in time value ........................... Net impact on earnings ........................

$ (500) 500 100 $ 100

Derivatives Module—Problems

DM–16

Problem M-3, Continued Forward Contract To Buy Key Variables Number of units per contract......................... Spot price per unit ......................................... Forward rate per unit..................................... Original forward rate per unit ........................ Fair value of forward in future $s: Original forward value: (5,000 × $92) ...................................... Current forward value: 5,000 × $91.50.................................... 5,000 × $91.20.................................... 5,000 × $90.60.................................... Change – Gain (loss) in forward value ............................................... Discount rate ................................................. Present value of the above fair value: FV = –$2,500, n = 1.5, I = 0.25% ............ FV = –$4,000, n = 0.5, I = 0.25% ............ FV = –$7,000, n = 0.0, I = 0.25% ............ Current present value ................................... Prior present value ........................................ Change in present value ...............................

January

February

March

5,000 $90.20 $91.50 $92.00

5,000 $90.50 $91.20 $92.00

5,000 $90.60 $90.60 $92.00

$460,000

$457,500 $456,000 $453,000 $ (2,500)

$ (4,000)

$ (7,000)

(2,491) 0 (2,491)

(3,995) (7,000) (3,995) (2,491) (1,504)

(7,000) (3,995) (3,005)

$2,491 (2,491)

$1,504 (1,504)

(2,491)

Effect on Earnings—Gain (Loss) Gain (loss) on firm commitment .................... Gain (loss) on forward contract ..................... Sales revenue [(5,000 × $90) – $7,000 gain on commitment] ................... Cost of sales ................................................. Net impact on earnings .................................

3,005 (3,005)

(443,000) 360,000 $ (83,000)

DM–17

Derivatives Module—Problems

Problem M-3, Concluded Call Option Key Variables Number of units per option................... Spot price per unit ................................ Strike price per unit .............................. Fair value of option .............................. Value of option: Intrinsic value: 100,000 × ($8.02 – $8.00) ......... Out-of-the-money....................... Time value...................................... Total value......................................

January

February

March

100,000 $8.05 $8.00 $2,400

100,000 $8.02 $8.00 $0

100,000 $7.95 $8.00 $0

$2,000 $ 400 $2,400

0 0 0

Effect on Earnings—Gain (Loss) Change in time value—gain (loss): Original value of $1,000 vs. $400. $ $400 vs. $0..................................... Change in intrinsic value—gain (loss): Original value of $5,000 vs. $2,000 $2,000 vs. $0.................................. Sales revenue (100,000 × $12)............ Cost of sales—processing (100,000 × $1.10)........................... Cost of sales—commodity A: 100,000 × $7.95 ............................. Change in intrinsic value previously in OCI ....................... Original intrinsic value of $5,000 vs. $0 ............................. Net impact on earnings ........................

(600) $ (400) In OCI In OCI $1,200,000 (110,000) (795,000)

$ (600)

$ (400)

(5,000) $ 290,000

Derivatives Module—Problems

DM–18

PROBLEM M-4 (1) Date December 31, 2017 ....... March 31, 2018 .............. June 30, 2018 ................ September 30, 2018 ...... December 31, 2018 ....... Totals ........................

Payment $1,136,408 1,136,408 1,136,408 1,136,408 $4,545,632

(2) Date June 30, 2018 ................ September 30, 2018 ...... December 31, 2018 ....... Totals ........................ (3) Date March 31, 2018 .............. June 30, 2018 ................ September 30, 2018 ...... December 31, 2018 ....... Totals ........................ (4) Date September 30, 2018 ...... December 31, 2018 ....... Totals ........................

Payment $115,000 108,750 $223,750

Interest Quarterly Rate Amount 1.25% 1.25 1.25 1.25

Principal

$157,383 145,145 132,754 120,208 $555,490

$ 979,025 991,263 1,003,654 1,016,200 $3,990,142

Interest Quarterly Rate Amount

Principal

1.1500% 1.0875

$115,000 108,750 $223,750

$ $

— — —

Balance $12,590,619 11,611,594 10,620,331 9,616,677 8,600,477

Balance $10,000,000 10,000,000 10,000,000

Balance at Beginning of Quarter $12,590,619 11,611,594 10,620,331 9,616,677

Pay Floating Rate 1.1875% 1.1625 1.1000 1.0375

Receive Fixed Rate 1.1875% 1.1875 1.1875 1.1875

Net Swap Interest $ — (2,903) (9,293) (14,425) $(26,621)

Stated Interest on Note $157,383 145,145 132,754 120,208 $555,490

Net Interest Expense $157,383 142,242 123,461 105,783 $528,869

Balance at Beginning of Quarter $10,000,000 10,000,000

Pay Floating Rate 1.1500% 1.0875

Receive Fixed Rate 1.1250% 1.1250

Net Swap Interest $(2,500) 3,750 $ 1,250

Stated Interest on Note* $122,500 116,250 $238,750

Net Interest Income $120,000 120,000 $240,000

*$10,000,000 × (2.90% + 2.0%)/4 = $122,500; $10,000,000 × (2.65% + 2.0%)/4 = $116,250.

part.

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DM–19

Derivatives Module—Problems

Problem M-4, Concluded (5) Pay floating rate interest per quarter ($10,000,000 × 1.0875%) .............. Receive fixed rate interest per quarter ($10,000,000 × 1.1250%) ........... Difference per quarter ..............................................................................

$108,750 112,500 $ 3,750

Number of quarters remaining .................................................................

Net present value of difference = 4 quarters, i = 1.0875% ......................

$ 14,601

(6) In addition to the risk that the interest income on the note would decline due to falling variable interest rates, there is now a concern due to changing currency exchange rates. If the interest income is to be received in euros and the euros are exchanged into dollars, it is possible that the number of dollars received could decline over time. This would be the case if the euro weakened relative to the dollar.

Derivatives Module—Problems

DM–20

PROBLEM M-5

Notional amount in troy ounces. .......... Strike price ........................................... Spot price ............................................. Intrinsic value (if strike is < spot) .......... Time value ........................................... Total value ........................................... July

Aug. 31

Sept. 10

Sept.

July 10 100,000 $5.00 $5.10 $10,000 $10,000 $20,000

July 31 100,000 $5.00 $5.14 $14,000 $9,000 $23,000

August 31 100,000 $5.00 $5.35 $35,000 $2,000 $37,000

Investment in Call Option .................................................. Cash ............................................................................ To record payment of option premium (100,000 × $0.20).

20,000

Investment in Call Option .................................................. Unrealized Loss on Hedge ($10,000 – $9,000) ................. Other Comprehensive Income ($10,000 – $14,000) ... To record change in value of the option. The change in time value is excluded from assessment of hedge effectiveness.

3,000 1,000

Investment in Call Option .................................................. Unrealized Loss on Hedge ................................................ Other Comprehensive Income..................................... To record change in value of option.

14,000 7,000

Unrealized Loss on Hedge ................................................ Other Comprehensive Income .......................................... Investment in Call Option ............................................ To record change in value of the option.

1,000 3,000

Cash .................................................................................. Investment in Call Option ............................................ To record net settlement of option.

33,000

Inventory of Silver .............................................................. Accounts Payable (or Cash) ........................................ To record purchase of inventory (100,000 × $5.33).

533,000

Accounts Receivable ......................................................... Plating Revenues ........................................................ To record sales.

225,000

Cost of Sales ..................................................................... Other Inventoriable Costs ............................................ Inventory of Silver (15,000 × $5.33) ............................ To recognize cost of sales.

184,950

September 10 100,000 $5.00 $5.32 $32,000 $1,000 $33,000 20,000

4,000

21,000

4,000

33,000

533,000

225,000

105,000 79,950

DM–21

Derivatives Module—Problems

Problem M-5, Concluded Sept.

Oct.

Other Comprehensive Income .......................................... Cost of Sales ............................................................... To adjust cost of sales [(15,000 divided by 100,000) × $22,000 of OCI].

3,300

Accounts Receivable ......................................................... Plating Revenues ........................................................ To record sales.

750,000

Cost of Sales ..................................................................... Other Inventoriable Costs ............................................ Inventory of Silver (50,000 × $5.33) ............................ To recognize cost of sales.

616,500

11,000

3,300

750,000

350,000 266,500

11,000

PROBLEM M-6 July a. Call Option A Unrealized gain (loss) on commitment: 10,000 × ($45 – $46) ................................................. 10,000 × ($45 – $44) ................................................. 10,000 × ($45 – $46.50) ............................................ Less previously recognized gain (loss) ..................... Net unrealized gain (loss).......................................... Unrealized gain (loss) on hedge ................................... Change in time value excluded from effectiveness: Time value of $2,000 at beg. vs. $2,400 at end ........ Time value of $2,400 at beg. vs. $1,000 at end ........ Time value of $1,000 at beg. vs. $1,000 at end ........ Net gain (loss)...................................................................

August

September

$(10,000) $ 10,000

$(10,000) 10,000

10,000 $ 20,000 (10,000)

$(15,000) (10,000) $(25,000) 15,000

Total

$(10,000) 10,000 (15,000) $(15,000) 15,000

400

400 (1,400)

(1,400) $

400

$ 8,600

b. Call Option B (hedge not effective—does not qualify for special hedge accounting) Unrealized gain (loss) on option: ($900 – $1,100) ......................................................... $ (200) ($600 – $900) ............................................................ $ (300) ($200 – $600) ............................................................ Net gain (loss) ............................................................... $ (200) $ (300)

$(10,000)

$ (1,000)

$ $ $

(400) (400)

(200) (300) (400) (900)

Derivatives Module—Problems

DM–22

Problem M-6, Concluded July c.

Put Option C Sales revenue ............................................................... Cost of sales ................................................................. Adjustment to cost of sales—Intrinsic value at July 1 of $0 versus intrinsic value at 9/10 of $12,500 [10,000 × ($30 – $28.75)] .......................................... Gross profit on sales ..................................................... Change in time value excluded from effectiveness: Time value of $500 at beg. vs. $600 at end .............. Time value of $600 at beg. vs. $200 at end .............. Time value of $200 at beg. vs. $100 at end .............. Net gain (loss) ...............................................................

d. Futures Contract D Change in time value excluded from effectiveness: [($9.94 – $9.95) vs. ($9.90 – $9.92) × 10,000].......... [($9.90 – $9.92) vs. ($9.87 – $9.89) × 10,000].......... [($9.87 – $9.89) vs. ($9.84 – $9.85) × 10,000].......... Net gain (loss) ............................................................... e. Interest Rate Swap Variable interest income: (6.8% × $10,000,000 × 1/12 year) ............................ (6.8% × $10,000,000 × 1/12 year) ............................ (6.7% × $10,000,000 × 1/12 year) ............................ Settlement of fixed variable difference: [(7% – 6.8%) × $10,000,000 × 1/12 year] ................. [(7% – 6.7%) × $10,000,000 × 1/12 year] ................. Net interest income .......................................................

August

September

Total

$ 287,500 $ 287,500 (200,000) (200,000)

12,500 12,500 $ 100,000 $ 100,000 $

100 $

100

100 (400) (400) (100) (100) (400) $ 99,900 $ 99,600

$ $ $

$ 56,667 $ 56,667

1,667 $ 56,667

$ 58,334

(100) (100)

100 (100)

$ 56,667 56,667 $ 55,833 55,833 1,667 2,500 2,500 $ 58,333 $ 173,334

DM–23

Derivatives Module—Problems

PROBLEM M-7 (1) 2016 Dec. 31

Interest Expense .................................................................. 800,000 Cash ................................................................................. To record interest expense [(7% + 1%) × $20,000,000 × ½ year]. Interest Rate Swap Asset ..................................................... Other Comprehensive Income ......................................... To record change in the value of the swap.

2017 June 30

Dec. 31

800,000

27,990 27,990

Interest Expense .................................................................. 810,000 Cash ................................................................................. To record interest expense [(7.1% + 1%) × $20,000,000 × ½ year]. Cash ..................................................................................... Other Comprehensive Income.............................................. Interest Rate Swap Asset ................................................ To record settlement of the swap [(7.1% – 7.0%) × $20,000,000 × ½ year] and the change in the value of the swap.

10,000 37,001

Other Comprehensive Income.............................................. Interest Expense .............................................................. To reclassify other comprehensive income to earnings.

10,000

810,000

47,001

10,000

Interest Expense .................................................................. 790,000 Cash ................................................................................. To record interest expense [(6.9% + 1%) × $20,000,000 × ½ year]. Other Comprehensive Income.............................................. Cash ................................................................................. Interest Rate Swap Asset ................................................ To record settlement of the swap [(6.9% – 7.0%) × $20,000,000 × ½ year] and the change in value of the swap.

10,331

Interest Expense .................................................................. Other Comprehensive Income ......................................... To reclassify other comprehensive income to earnings.

10,000

790,000

10,000 331

10,000

Derivatives Module—Problems

DM–24

Problem M-7, Concluded 2018 June 30

Interest Expense .................................................................. 780,000 Cash ................................................................................. To record interest expense [(6.8% + 1%) × $20,000,000 × ½ year]. Interest Rate Swap Asset ..................................................... Other Comprehensive Income.............................................. Cash .................................................................................

19,342 658

20,000

780,000

20,000 20,000

(2) Impact on Earnings of the Interest Rate Swap Dec. 31, 2016

6-Month Period Ending June 30, Dec. 31, 2017 2017

Effective interest rate: Without a hedge ........... With a hedge ................

8.0% 8.0

8.1% 8.0

7.9% 8.0

Interest expense: Without a hedge ........... With a hedge ................ Difference .....................

$800,000 800,000 $ 0

$810,000 800,000 $ 10,000

$790,000 800,000 $ (10,000)

June 30, 2018

Total

7.8% 8.0 $780,000 $3,180,000 800,000 3,200,000 $ (20,000) $ (20,000)

Unfortunately, in retrospect, the company would have been better off not to have engaged in an interest rate swap. The swap resulted in an additional decrease in earnings of $20,000. (3) The LIBOR rate on December 31, 2017, would have had to be 7%. This would have resulted in an 8% (7% + 1%) variable interest rate for the final 6-month period. If that were the case, then total interest expense would have been $3,200,000 whether or not there was a hedge.

CHAPTER 10 UNDERSTANDING THE ISSUES 1. If the U.S. dollar strengthens relative to a FC, this means that the dollar commands more FC. The direct exchange rate will change in that 1 FC will be worth fewer dollars. If a U.S. exporter of goods and services generates sales that are denominated in FC, they will be exposed to exchange rate risk. The dollar equivalent of the FC received from export customers will decrease as the dollar strengthens. If export sales are denominated in U.S. dollars, then foreign customers will have to give up more of their FC in order to acquire the necessary dollars. This means that U.S. goods and services would be more expensive and perhaps less attractive to foreign customers.

3. A commitment to purchase inventory payable in FC is characterized by a fixed number of FC. However, the exchange rate for the FC is subject to change; therefore, the commitment may cost the purchaser more or less equivalent dollars as rates change. The commitment to purchase would become less attractive if the number of dollars needed to acquire the fixed number of FC increases over time. This would be the case if the dollar weakened relative to the FC. As the dollar cost of the purchase increases, future gross profits decrease. This risk could be effectively hedged if the U.S. company secured the right to acquire the necessary FC at a fixed rate. Such a hedge could be accomplished through the use of a forward contract or option to buy FC at the future transaction date. The losses on the commitment could be offset by gains on the hedging instruments. Furthermore, the firm commitment account would then be used to adjust the basis of the acquired inventory at the date of the actual purchase transaction. The basis adjustment would reduce the cost of the inventory and allow for otherwise increased profit margins.

2. If the U.S. dollar is weakening against the FC, then more dollars will be required to settle FC purchases and exchange losses will be experienced. These losses could be hedged against through the use of a forward contract to buy FC. Given a fixed forward rate, the holder of the contract will know exactly how many dollars it will take to secure the necessary FC. As the value of the payable to the foreign vendor increases with resulting losses, the value of the forward contract will increase with resulting gains. Both the transaction losses and hedging gains will be recognized in current earnings. If the hedge is properly structured, it could be highly effective in offsetting the effects of a weakening U.S. dollar.

4. The time value of an option is measured as the value of the option less the intrinsic value. Therefore, changes in the time value of the option are determined by measuring changes in that value over time. In the case of a forecasted transaction, changes in the time value of an option are recorded as part of the change in the total value of the option with an offsetting debit or credit to current-period earnings.

Ch. 10—Exercises

10–2

EXERCISES EXERCISE 10-1 Balance sheet accounts—Debit (Credit): Inventory: Down payment (50,000 euros × $1.350) .................. Balance due (400,000 euros × $1.370) .................... Total ................................................................... Accounts payable: (400,000 euros × $1.381) ......................................... Investment in option ....................................................... Income statement accounts—Debit (Credit): Exchange loss: [400,000 × ($1.381 – $1.370)] .................................. [(400,000 × ($1.385 – $1.381)]................................. Gain on option: ($2,600 – $1,400) ..................................................... [($1.385 spot rate – $1.375 strike price) × 400,000] minus previous value of $2,600.......................... Note that the option has expired and, therefore, there is no time value.

June 30

July 31

$ 67,500 548,000 $615,500

(552,400) 2,600

— —

4,400 1,600 (1,200) (1,400)

EXERCISE 10-2 (1) January 1

(2) Value today (assumed amount) ............. Interest rate ........................................... 180 days of interest ............................... Value in 180 days ..................................

Direct Spot Rate 1 FC = $0.125

Indirect Spot Rate $1 = 8 FC

U.S. Dollars

Foreign Currency (FC)

$100 4% 1.97260 $101.97260

800 FC 5% 19.72603 819.72603 FC

180-day forward rate = $101.97260/819.72603 FC 1 FC = $0.1244 Alternatively, using the formula method: Forward rate = 0.125 ×

1 + 0.0197 = 0.1244 1 + 0.0246

10–3

Ch. 10—Exercises

Exercise 10-2, Concluded

(3) This suggests that the domestic (U.S.) interest rates are higher than those of the foreign country. Assume that one wants to buy foreign currency in the future; therefore, they retain and invest dollars until the future time arrives. The value of the invested dollars would be more than the value that would have been achieved if FC were originally acquired and invested at foreign rates. The value of the dollar relative to the FC has risen over time, and a higher forward rate, relative to the present spot rate, is thus called for. (4) When the U.S. dollar is weak relative to a FC, it takes more U.S. dollars to equal the FC. Alternatively, it takes fewer FC to acquire a U.S. dollar. Consequently, it takes fewer FC to purchase a given amount of U.S. goods priced in dollars after the U.S. dollar has weakened. This causes U.S. exports to be less expensive, and exports consequently increase. (5) If the dollar strengthened relative to the FC, the amount of FC would increase, and the forward rate would decrease. EXERCISE 10-3

(1) The intrinsic value of the option is represented by the difference between the strike price and the spot rate times the notional amount. The time value is equal to the value of the option less the intrinsic value. For the subject option, these values are as follows: Strike price ........................................ Spot rate ............................................ Notational amount ............................. Value of option .................................. Intrinsic value .................................... Time value .........................................

February 1 $ 2.05 $ 2.05 100,000 $ 1,000 — $ 1,000

April 30 $ 2.05 $ 2.08 100,000 $ 3,400 $ 3,000 $ 400

May 31 $ 2.05 $ 2.10 100,000 $ 5,000 $ 5,000 —

If the time value were included in the assessment of effectiveness, it would not be separately accounted for. Rather the time value would be combined with the intrinsic value and accounted for as one item. If the time value were excluded from the assessment of effectiveness, changes in the time value would be recognized currently in earnings. In the case of a forecasted transaction,, changes in intrinsic value over time would be recognized as a component of other comprehensive income and would not impact current earnings until the forecasted transaction occurred and affected earnings. If the option hedged a recognized liability, the hedge could be accounted for as either a fair value hedge or a cash flow hedge. If it were a fair value hedge, changes in the value of both intrinsic value and time value would be recognized currently in earnings. If it were a cash flow hedge, changes in intrinsic value would be initially recognized as a component of OCI and then recognized in earnings when changes in the value of the denominated liability were also recognized in earnings.

Ch. 10—Exercises

10–4

Exercise 10-3, Concluded

(2) Changes in the value of the forward contract are measured as the difference between the value at the original forward rate versus the current forward rate. This difference in value is then discounted back from the expiration date to the current date. For the subject forward contract, the values are as follows: February 1 April 30 May 31 Original forward value ............................ $207,000 $207,000 Current forward value ............................ $209,000 $210,000 Gain (loss) in value ................................ $ 2,000 $ 3,000 n = 1, I = 6%/12 ................................. $ 1,990 n = 0, I = 6%/12 ................................. $ 3,000 Change in value from prior period: Current present value ........................ $ 1,990 $ 3,000 Prior present value ............................ — $ 1,990 Change in present value ................... $ 1,990 $ 1,010 If the forward contract hedged an unrecognized firm commitment, the hedge could be recognized as either a fair value hedge or a cash flow hedge. If it were recognized as a fair value hedge, changes in the value of the contract would be recognized currently in earnings. If it were a cash flow hedge, changes in the time value, represented by the initial spot-forward difference, would be recognized currently in earnings if the time value were excluded from the assessment of hedge effectiveness.. However, changes in intrinsic value would be initially recognized as a component of OCI and then recognized in earnings when changes in the value of the commitment were also recognized in earnings. (3) Given the hedge of an unrecognized commitment, changes in the value of the hedging instrument would also be recognized as changes in the value of the commitment. When the commitment becomes an actual transaction, the recorded amount of the commitment would then be reversed as an adjustment to the basis of the acquired inventory. In the case of a hedge of a recognized FC-denominated liability, changes in the value of the hedging instrument would not impact the basis of the acquired inventory.

10–5

Ch. 10—Exercises

EXERCISE 10-4

(1) Apr. 15 May

No entry Inventory ............................................................................... 343,500 Accounts Payable ............................................................ To record the purchase of inventory when the spot rate was 1 FC = $0.687.

343,500

Memo: Company acquired a forward contract to buy FC at a forward rate 1 FC = $0.693. June 30

Aug. 1

Exchange Loss ..................................................................... Accounts Payable ............................................................ To accrue the exchange loss at year-end when the spot rate is 1 FC = $0.691. [500,000 × ($0.687 – $0.691)]

2,000

Forward Contract .................................................................. Gain on Forward Contract ................................................ To record change in value of forward contract when forward rate is 1 FC = $0.695. Change in value of forward contract is $1,000 [500,000 FC × ($0.695 – $0.693)]. (FV = 1,000; n = 1, i = 6%/12)

995

Forward Contract .................................................................. Gain on Forward Contract ................................................ To record change in value of forward contract when 1 FC = $0.696. Total change in forward value is $1,500 [500,000 FC × ($0.696 – $0.693)]. Total change of $1,500 less $995 previously recognized = $505.

505

2,000

995

Foreign Currency .................................................................. 348,000 Cash ................................................................................. Forward Contract ............................................................. To record settlement of forward contract when spot rate is 1 FC = $0.696. Accounts Payable ................................................................. 345,500 Exchange Loss ..................................................................... 2,500 Foreign Currency ............................................................. To settle the account payable when the spot rate is 1 FC = $0.696.

505

346,500 1,500

348,000

Ch. 10—Exercises

10–6

Exercise 10-4, Concluded

(2)

Stark, Inc. Partial Income Statement For the Year Ended June 30 Exchange gain (loss)......................................................................................... Gain on forward contract ................................................................................... Net income (loss) effect ....................................................................................

$(2,000) 995 $(1,005)

Stark, Inc. Partial Balance Sheet As of June 30 Inventory ............................... Forward contract ..................

$343,500 995

Accounts payable ................. $345,500 Net income (loss) effect ........ (1,005)

EXERCISE 10-5

(1) Gain (loss) on commitment through September 15: Number of FC in commitment: $549,600 ÷ $1.200 ....................................... $297,975 ÷ $0.685 ....................................... Change in spot rate from commitment date to transaction date: $1.200 vs. $1.160 ......................................... $0.685 vs. $0.692 ......................................... Gain (loss) on commitment: 458,000 FCA × $0.04 = $18,320. .................

FCA 458,000

435,000 $

0.04 $

Gross profit margin with the hedge: Selling price at committed rate................................. Firm commitment...................................................... Gain (loss) on commitment........................................ Gain (loss) on intrinsic value of option: 458,000 x ($1.200 vs. $1.160)................................ 435,000 x ($0.700 vs. $0.692)........... $3,480 435,000 x ($0.700 vs. $0.685)........... 6,525 .... Adjusted selling price................................................... Cost of sales.............................................................. Gross profit with the hedge........................................

0.007

$(18,320)

435,000 FCB × $0.007 = $3,045. ................. (2) Gross profit margin without the hedge: Selling price at spot rate on date of sale: 458,000 x $1.16..................................................... 435,000 x $0.692................................................... Cost of sales............................................................. Gross profit without the hedge...................................

FCB

$3,045

$531,280 440,000 $91,280

$301,020 235,000 $66,020

$531,280 18,320 (18,320)

$301,020 (3,045) 3,045

18,320 $549,600 440,000 $109,600

(3,045) $297,975 235,000 $62,975

10–7

Ch. 10—Exercises

EXERCISE 10-6

(1)

Hedge of a Commitment Using Forward Contract Option Prior to transaction date: Gain (loss) on commitment [100,000 FC × ($1.250 – $1.320)] ........ Gain (loss) on hedging instrument: Forward contract [100,000 FC × ($1.320 – $1.250)] .................. Option [100,000 FC × ($1.320 spot – $1.250 strike)] ................. Gain (loss) excluded from hedge effectiveness: Forward contract [100,000 FC × ($1.270 – $1.250)] .................. Option (premium paid is all time value) ...................................... Effect on earnings ............................................................................ Subsequent to transaction date: Sales revenue .................................................................................. Cost of sales—inventory cost (100,000 FC × $1.320) ..................... Cost of sales—adjustment of inventory basis .................................. Reclassification of other comprehensive income ............................. Effect on earnings ............................................................................ Total effect on earnings ........................................................................

$ (7,000)

Hedge of a Forecasted Transaction Forward Contract Option

$ (7,000)

7,000

— 7,000

(2,000)

$ (2,000)

(2,100) $ (2,100)

$ 160,000 (132,000) 7,000

$ 35,000 $ 33,000

—

$ 35,000 $ 32,900

$ (2,000)

$ (2,100) $ (2,100)

$ 160,000 (132,000)

7,000 $ 35,000 $ 33,000

7,000 $ 35,000 $ 32,900

(2) Based on the above analysis, it would appear that the decision to commit to the purchase or forecast the purchase would have the same net effect on earnings if a forward contract were used. Furthermore, this would be the case even if the rates moved in the opposite direction as that assumed. Therefore, if a forward contract were used, Jackson’s decision should focus on other factors. The legal form of a commitment is certainly much different from that of a forecasted transaction. Jackson would have much less flexibility with a commitment. Given the use of an option, it would appear that the decision to commit to the purchase or forecast the purchase would have the same net effect on earnings. The use of an option would have a slightly greater time value cost than that of a forward contract ($2,100 vs. $2,000). However, when compared to a forward contract, it is important to remember that an option represents a right rather than an obligation. Therefore, if spot rates declined, there would be a gain on the commitment and the option would lose value but only to the extent of the premium. If this occurred, the result would be a hedge that was not highly effective. In that case, the special accounting treatment for a fair value or cash flow hedge would not be available. This would result in the cost of the inventory being represented by the actual lower price paid and there would be no adjustment of basis or reclassification of other comprehensive income. The company would incur the premium cost on an option that was not used. Therefore, if spot rates declined, the option would allow for greater potential gross profits. .

part.

Ch. 10—Exercises

10–8

Exercise 10-6, Concluded

In conclusion, it would appear that the best alternative would be to forecast the transaction and hedge the forecast with an option. Note: If spot rates were to decline below the original rate of 1 FC = $1.250 and fall to 1 FC = $1.180, the alternatives would appear as follows: Hedge of a Hedge of a Forecasted Transaction Commitment Using Forward Forward Option Contract Option Contract Prior to transaction date: Gain (loss) on commitment [100,000 FC × ($1.250 – $1.180)] ........ $ 7,000 Gain (loss) on hedging instrument: Forward contract [100,000 FC × ($1.180 – $1.250)] .................. (7,000) Option (no intrinsic value – spot < strike) ................................... Gain (loss) excluded from hedge effectiveness: Forward contract [100,000 FC × ($1.270 – $1.250)] .................. (2,000) $ (2,000) $ (2,100) $ (2,100) Option (premium paid is all time value) ...................................... $ (2,100) $ (2,000) $ (2,100) Effect on earnings ............................................................................ $ (2,000) Subsequent to transaction date: Sales revenue .................................................................................. $ 160,000 $ 160,000 $ 160,000 $ 160,000 Cost of sales—inventory cost (100,000 FC × $1.180) ..................... (118,000) (118,000) (118,000) (118,000) Cost of sales—adjustment of inventory basis .................................. (7,000) (7,000) Reclassification of other comprehensive income ............................. $ 42,000 $ 35,000 $ 42,000 Effect on earnings ............................................................................ $ 35,000 $ 39,900 $ 33,000 $ 39,900 Total effect on earnings ........................................................................ $ 33,000

*As previously discussed, due to the asymmetric risk profile of an option, the hedge would not be highly effective and therefore not qualify for special accounting treatment.

part.

10–9

Ch. 10—Exercises

EXERCISE 10-7

Basis of Building Addition Event or activity: March 1 construction payment (200,000 FC × $1.50) ............................ Capitalized interest on 2-month note: 200,000 FC × 4.8% × 2/12 year × $1.48 .......................................... June 30 construction payment (300,000 FC × $1.55) ............................ Capitalized interest on 6-month note: 300,000 FC × 6.0% × 3/12 year × $1.58 .......................................... August 31 construction payment (400,000 FC × $1.60) ........................ Financing costs associated with the forward contract: 400,000 × ($1.53 – $1.52) ................................................................ September 30 construction payment (100,000 FC × $1.65) .................. Capitalized interest on 6-month note: 300,000 FC × 6.0% × 2/12 year × $1.65 .......................................... Total basis ..............................................................................................

$ 300,000 2,368 465,000 7,110 640,000 4,000 165,000 4,950 $1,588,428

Note that the change in value of the forward contract would be recorded as a component of other comprehensive income. The balance in OCI would impact earnings when depreciation expense on the addition is recognized in earnings.

Ch. 10—Exercises

10–10

EXERCISE 10-8

Event A: Transaction exchange gain (loss) [100,000 FC × ($1.100 – $1.150)] .............................................. Forward contract gain (loss) [100,000 FC × ($1.110 – $1.150)] .............................................. Net income (loss) effect ................................................................... Event B: Gain on commitment [(200,000 FC × ($1.172 – $1.150)] discounted 1 month ............ Sales (200,000 FC × $1.170) ........................................................... Adjustment to basis of sale .............................................................. Cost of inventory .............................................................................. Transaction exchange gain (loss) [200,000 FC × ($1.180 – $1.170)] .............................................. Forward contract gain (loss) [200,000 FC × ($1.180 – $1.150)] .............................................. Net income (loss) effect ................................................................... Event C: Sales ................................................................................................ Cost of inventory: (68,000 FC × $1.170) ................................................................. Adjustment for OCI [60,000 × ($1.150 – $1.170) – premium] .... Premium on forward [60,000 × ($1.150 – $1.160)] .......................... Net income (loss) effect ...................................................................

Without the Hedge

With the Hedge

$(5,000)

4,000 $(1,000)

Without the Hedge

With the Hedge $

(120,000)

4,378 234,000 (4,378) (120,000)

2,000

$ 116,000

(6,000) $ 110,000

Without the Hedge $100,000

With the Hedge $100,000

(79,560)

(79,560) 600 600 $ 21,640

$ 234,000

$ 20,440

10–11

Ch. 10—Problems

PROBLEMS PROBLEM 10-1

Transaction A: Gain (Loss) Exchange gain on exposed payable [100,000 FC × ($1.140 – $1.150)] ............................... Loss on forward contract................................................... Net effect on earnings .......................................................

$ 1,000 (796)* $ 204

*The total change in value of the contract is a loss of $796 [100,000 FC × ($1.138 – $1.146)] = $800. The NPV of $800 where n = 1 and i = 6%/12 = $796. Transaction B: Gain (Loss) Gain on commitment [100,000 FC × ($1.150 – $1.132)] ............................... Loss on forward contract [100,000 FC × ($1.150 – $1.132)] ............................... Adjustment to basis of sales revenue ...............................

$ 1,800 (1,800) (1,800) $(1,800)

Transaction C: Gain (Loss) Change in time value [100,000 FC × ($1.120 – $1.132)] ............................... Depreciation expense [(100,000 FC × $1.150) ÷ 60 months] ......................... Reclassification of other comprehensive income as current earnings. OCI balance of $3,000 credit (100,000 FC x ($1.150 - $1.20)) ÷ 60 months ....

$(1,200) (1,917) 50 $(3,067)

Transaction D: Change in time value* .......................................................

$ (200)

*On November 30, the intrinsic value is $500 and the time value is $700, versus December 31, when the intrinsic value is $1,500 and the time value is $500. Therefore, the change in time value is a loss of $200. The change in the intrinsic value is recognized as a component of OCI not of current earnings.

Ch. 10—Problems

10–12

PROBLEM 10-2

Balance sheet accounts—Debit (Credit): Inventory of medical equipment ..................................... Firm commitment ........................................................... Accounts receivable: (800,000 FC × $0.470) ............................................. Forward contract receivable............................................. Income statement accounts—Debit (Credit): (Gain) loss on firm commitment ..................................... (Gain) loss on forward contract (see Note A) ................. Sales revenue: (800,000 FC × $0.480) ............................................. Adjusted for firm commitment .................................. Adjusted sales revenue ............................................ Cost of sales .................................................................. Exchange (gain) loss on receivable: [800,000 FC × ($0.470 – $0.480)] ............................

2nd Quarter $ 325,000 (15,723)

3rd Quarter $ —

15,723

376,000 33,516

15,723 (15,723)

11,999 (17,793)* $(384,000) (27,722) $(411,722) $ 325,000 $

8,000

Note A:

Number of FC ......................................... Spot rate—1 FC ...................................... Forward rate remaining time—1 FC =..... Fair value of forward contract: Original forward rate.......................... Current forward rate .......................... Change—gain (loss)—in forward rate Present value of change: n = 3.5, i = 0.50% ........................ n = 2.0, i = 0.50% ........................ n = 0.5, i = 0.50% ........................ Change in value from prior period: Current present value .................. Prior present value ...................... Change in present value .............

June 1 800,000 $0.500 $0.510

June 30 800,000 $0.485 $0.490

August 15 800,000 $0.480 $0.475

September 30 800,000 $0.470 $0.468

$408,000 392,000 $ 16,000

$408,000 380,000 $ 28,000

$408,000 374,400 $ 33,600

$ 15,723 $ 27,722 $ 33,516 $ 15,723 — $ 15,723

$ 27,722 15,723 $ 11,999

$ 33,516 27,722 $ 5,794

*The third quarter gain on the forward contract consists of the August 15 gain of $11,999 and the September 30 gain of $5,794 for a total of $17,793.

10–13

Ch. 10—Problems

PROBLEM 10-3

(1) The foreign currency transaction: Sales (200,000 euros × $1.180) ............................................... Cost of goods sold .................................................................... Gross profit ............................................................................... Exchange gain (loss): 200,000 euros × ($1.179 – $1.180) ...................................... 200,000 euros × ($1.175 – $1.179) ...................................... Net income effect ......................................................................

March $236,000 160,000 $ 76,000

April $ — — $ —

(200) $ 75,800

(800) $(800)

March $597 $597

April $603 $603

March $(593) $(593)

April $(896) $(896)

Gain (loss) on forward contract (see Schedule B) .................... Net income effect ......................................................................

March $593 $593

April $896 $896

Schedule A for Part (2) March 1 Number of FC ................................................... 200,000 Forward rate remaining time—1 FC ................. $1.181

March 31 200,000 $1.178

April 30 200,000 $1.175

Fair value of original contract: Original forward rate ............................................................. Current forward rate ............................................................. Change—gain (loss) in forward rate ....................................

$236,200 235,600 $ 600

$236,200 235,000 $ 1,200

(2) The hedge on the foreign currency transaction: Gain (loss) on forward contract (see Schedule A) .................... Net income effect ...................................................................... (3) The foreign currency commitment: Gain (loss) on firm commitment (see Schedule B) ................... Net income effect ...................................................................... (4) The hedge on the foreign currency commitment:

Present value of change: n = 1, i = 0.50% .................................................................... n = 0, i = 0.50% .................................................................... Change in value from prior period: Current present value ........................................................... Prior present value ............................................................... (a) Change in present value .................................................

$ $ $

597 597 — 597

1,200

1,200 597 603

Ch. 10—Problems

10–14

Problem 10-3, Concluded Schedule B for Parts (3 and 4) March 15 Number of FC ................................................... 300,000 Forward rate remaining time—1 FC ................. $1.179

March 31 300,000 $1.177

April 30 300,000 $1.174

$353,700 353,100 $ 600

$353,700 352,200 $ 1,500

Present value of change: n = 2.5, i = 0.50% ................................................................. n = 1.5, i = 0.50% ................................................................. Change in value from prior period: Current present value ........................................................... Prior present value ............................................................... (a) Change in present value .................................................

$ $ $

593 593 — 593

1,489

1,489 593 896

PROBLEM 10-4

June

Inventory—Reconditioned Equipment ..................................... 158,400 Accounts Payable .............................................................. To record purchase of the equipment when 1 CA$ = $0.720. (220,000 × $0.720) Investment in Call Option ........................................................ Cash .................................................................................. To record purchase of option.

158,400

1,000

Accounts Receivable ............................................................... 216,000 Equipment Sales ............................................................... To record sale of equipment when 1 CA$ = $0.720. (300,000 × $0.720)

1,000

216,000

Memo: Company acquired a forward contract to sell 300,000 CA$ at a forward rate of 1 CA$ = $0.729.

10–15

Ch. 10—Problems

Problem 10-4, Continued

June 15

Memo: Committed to buy equipment Memo: Company acquired a forward contract to buy 400,000 CA$ at a forward rate of 1 CA$ = $0.731.

Inventory—Reconditioned Equipment ..................................... Cash .................................................................................. To record the cost to refurbish the equipment when 1 CA$ = $0.732. (30,000 × $0.732)

21,960 21,960

Accounts Receivable (310,000 x $0.732) ................................ 226,920 Sales.................................................................................. Cost of Goods Sold ($158,400 + $21,960) .............................. 180,360 Inventory—Reconditioned Equipment ............................... To record the sale of equipment when 1 CA$ = $0.732. (310,000 × $0.732) 30

Foreign Currency ..................................................................... 220,500 Accounts Receivable ......................................................... Exchange Gain .................................................................. To settle the accounts receivable when 1 CA$ = $0.735. (300,000 × $0.735) Loss on Contract ..................................................................... Forward Contract ............................................................... To record change in value of the June 1 contract [300,000 CA$ × ($0.735 – $0.729)].

180,360

216,000 4,500

1,800 1,800

Forward Contract..................................................................... 1,800 Cash ........................................................................................ 218,700 Foreign Currency ............................................................... To record the settlement of the June 1 contract. Investment in Call Option ($3,200 – $1,000) ........................... Gain on Option .................................................................. To record change in value of option acquired on June 1.

226,920

220,500

2,200 2,200

Ch. 10—Problems

10–16

Problem 10-4, Concluded

June 30

Loss on Firm Commitment ...................................................... Firm Commitment .............................................................. To record the loss on the commitment (see Schedule A).

2,388

Forward Contract..................................................................... Gain on Contract ............................................................... To record change in value of the June 15 contract (see Schedule A).

2,388

Schedule A

Number of FC ...................................................................... Forward rate remaining time—1 FC ..................................... Fair value of original contract: Original forward rate....................................................... Current forward rate ....................................................... Change—gain (loss) in forward rate .............................. Present value of change: n = 1, i = 0.50% .............................................................. Change in value from prior period: Current present value..................................................... Prior present value ......................................................... (a) Change in present value ...........................................

June 15 400,000 $0.731

June 30 400,000 $0.737 $292,400 294,800 $ 2,400 $

2,388

2,388 — 2,388

10–17

Ch. 10—Problems

PROBLEM 10-5

For each option Notational amount .................................................... Strike price ............................................................... Spot rate .................................................................. Value of option ......................................................... Intrinsic value ........................................................... Time value ...............................................................

March 1

March 31

May 31

200,000 $2.52 $2.50 $1,300 — $1,300

200,000 $2.52 $2.54 $5,000 $4,000 $1,000

200,000 $2.52 $2.57 $10,000 $10,000 —

1st Quarter 2nd Quarter 3rd Quarter Related to the commitment: Gain (loss) on commitment ............... Gain (loss on option transferred from OCI to offset gain or loss on commitment .................................. Gain (loss) in time value.................... Sales revenue (10,000 × $90) ........... Cost of Sales: Original cost (200,000 FC × $2.57) Adjustment for change in value of commitment .............................. Additional processing costs (10,000 × $12.50) ..................... Total impact on earnings ...................

Total

$(7,960)

$(6,040)

$ (14,000)

4,000 (300)

6,000 (1,000) $ 900,000

10,000 (1,300) 900,000

(514,000)

14,000

(125,000) $ 275,000

(125,000) $ 269,700

$(4,260)

Related to the purchase of equipment: Gain (loss) in time value.................... $ (300) Depreciation expense: Depreciable basis is 200,000 FC × $2.57 or $514,000 less the salvage value of $74,000 or $440,000. $440,000 depreciated over 10 years is $44,000 per year. $44,000 per year × 3/12 of a year Allocation of OCI equal to change in intrinsic value of $10,000 over depreciable life of asset. $10,000/10 years × 3/12 of a year Total impact on earnings ................... $ (300)

$(1,040) $(1,000)

$(1,000)

(1,300)

$ (11,000)

(11,000

250 $ (10,750)

250 $ (12,050)

Ch. 10—Problems

10–18

Problem 10-5, Concluded

Related to the note payable: Gain (loss) on note payable: 200,000 FC × ($2.54 – $2.50) ...... 200,000 FC × ($2.57 – $2.54) ...... Gain (loss) on option transferred from OCI to offset gain or loss on note payable ......................................... Gain (loss) in time value.................... Interest expense at 6%: 200,000 FC × 6% × 1/12 year = 1,000 FC × $2.54 .................. Gain (loss) on above accrued interest (1,000 FC × ($2.57 – $2.54)) ........ Interest expense at 6%: 200,000 FC × 6% × 2/12 year = 2,000 FC × $2.57 .................. Total impact on earnings ...................

1st Quarter 2nd Quarter 3rd Quarter

4th Quarter

$(8,000) $(6,000)

$ (8,000) (6,000)

6,000 (1,000)

10,000 (1,300)

4,000 (300) (2,540)

(2,540) (30)

$(6,840)

(5,140) $(6,170)

(30)

—

(5,140) $(13,010)

10–19

Ch. 10—Problems

PROBLEM 10-6

Dr (Cr) Without Hedging

Dr (Cr) With Hedging Option Forward

Hypothetical A: Balance sheet accounts: Inventory (100,000 FC × $1.50) ........................... $ 150,000 Accounts payable (100,000 FC × $1.55) ............. (155,000) (a) Derivative—option [100,000 FC × ($1.55 – $1.51)] (b) Derivative—forward contract [100,000 × ($1.55 – $1.52)] ............................................... Net assets excluding cash balances.................... $ (5,000) Income statement accounts: Exchange gain/loss on payable [100,000 × ($1.55 – $1.50)] ............................................... (a) Gain /loss on option ($4,000 – $800)................... (b) Gain/loss on forward contract .............................. Total impact on earnings—Debit (Credit) ............

$ 150,000 $ 150,000 (155,000) (155,000) 4,000 $

(1,000) $

5,000

5,000 $ (3,200)

5,000

1,800

3,000 (2,000)

5,000 (3,000) 2,000

Hypothetical B: Balance sheet accounts: Inventory .............................................................. Accounts payable ................................................ (a) Derivative—option ............................................... (a) Other comprehensive income—option ................ (a) Transfer of OCI to offset impact on earnings ....... (b) Derivative—forward contract ............................... (b) Other comprehensive income—forward .............. (b) Transfer of OCI to offset impact on earnings ....... Net assets excluding cash balances.................... Income statement accounts: Exchange gain/loss on payable ........................... (a) Gain/loss on option—time value .......................... (a) Gain (loss) on option—transferred from OCI ....... (b) Gain/loss on forward contract—time value .......... (b) Gain/loss on forward contract—transferred from OCI .......................................................... Total impact on earnings—Debit (Credit) ............

$ 150,000 (155,000)

(5,000)

$ 150,000 $ 150,000 (155,000) (155,000) 4,000 (4,000) 4,000 3,000 (5,000) 5,000 $ (1,000) $ (2,000)

5,000

5,000 $ 800 (4,000)

5,000 2,000

5,000

1,800

(5,000) 2,000

Ch. 10—Problems

10–20

Problem 10-6, Continued

Dr (Cr) Without Hedging

Dr (Cr) With Hedging Option Forward

Hypothetical C: Balance sheet accounts: FC firm commitment: Original balance [100,000 FC × ($1.50 – 1.40)] Adjusted to inventory ....................................... Inventory (basis given as $100,000) .................... 100,000 Transfer inventory to cost of sales ....................... (100,000) (a) Derivative—option [100,000 FC × ($1.50 – $1.40)] (a) Other comprehensive income—option ................ (a) Transfer of OCI to offset impact on earnings ....... (b) Derivative—forward contract [100,000 FC × ($1.48 – $1.40)] ............................................... (b) Other comprehensive income—forward .............. (b) Transfer of OCI to offset impact on earnings ....... Net assets excluding cash balances.................... $ — Income statement accounts: Gain/loss on commitment .................................... (a) Gain/loss on option—time value .......................... (a) Transfer of OCI to offset impact on earnings ....... (a) Gain/loss on forward contract—time value .......... (a) Gain/loss on forward contract—transferred from OCI .......................................................... Sales revenue (100,000 FC × $1.40): Original balance (100,000 FC × $1.40) ........... Adjusted by balance in firm commitment......... Cost of sales ........................................................ Total impact on earnings - Debit (Credit) .............

$ (10,000) $ (10,000) 10,000 10,000 100,000 100,000 (100,000) (100,000) 10,000 (10,000) 10,000

$ 10,000

8,000 (10,000) 10,000 $ 8,000

$ 10,000 $ 10,000 1,000 (10,000) 2,000 (10,000) (140,000) 100,000 $ (40,000)

(140,000) (140,000) (10,000) (10,000) 100,000 100,000 $ (49,000) $ (48,000)

10–21

Ch. 10—Problems

Problem 10-6, Concluded

Dr (Cr) Without Hedging

Dr (Cr) With Hedging Option Forward

Hypothetical D: Balance sheet accounts: Note receivable (100,000 FC × $1.40) ................ Collection of note ................................................. Derivative—option ............................................... Other comprehensive income—option ................ Transfer of OCI to offset impact on earnings ....... Net assets excluding cash balances.................... Income statement accounts: Exchange gain/loss on note receivable [100,000 FC × (1.40 – $1.50)] ......................... Interest income (100,000 FC × 6% × 3/12 year × $1.40) ........................................... Gain/loss on option—time value .......................... Gain/loss on option—transferred from OCI ......... Total impact on earnings—Debit (Credit) ............

$ 140,000 (140,000)

—

$ 140,000 (140,000) 10,000 (10,000) 10,000 $ 10,000

$ 10,000

(2,100)

(2,100) 1,000 (10,000) $ (1,100)

7,900

Hypothetical E: Balance sheet accounts: Inventory (basis given as $100,000) .................... Transfer inventory to cost of sales ....................... Derivative—forward contract ............................... Other comprehensive income—forward .............. Gain/loss on forward contract—transferred from OCI .......................................................... Net assets excluding cash balances.................... Income statement accounts: Sales revenue: Initial value (100,000 FC × $1.40) ................... Adjustment of OCI ........................................... Cost of sales ........................................................ Gain/loss on forward contract—time value .......... Total impact on earnings—Debit (Credit) ............

$ 110,000 (110,000)

$ 110,000 (110,000) 8,000 (10,000)

—

$(140,000) 110,000 $ (30,000)

10,000 8,000

$(140,000) (10,000) 110,000 2,000 $ (38,000)

Ch. 10—Problems

10–22

PROBLEM 10-7

(1) 1st 30 days

Next 30 days

Memo: Company acquired a forward contract to sell 600,000 FC at a forward rate of 1 FC = $1.89. Other Comprehensive Income............................... Forward Contract ............................................. To record gain on contract [600,000 FC × ($1.890 – $1.910) = 12,000]. NPV when n = 2 and i = 6%/12 = $11,881.

11,881

Discount Expense.................................................. Other Comprehensive Income .........................

2,004

Forward Contract ................................................... Other Comprehensive Income ......................... To record gain on contract [600,000 FC × ($1.890 – $1.900)] = 6,000. NPV when n = 1 and i = 6%/12 = $5,970 loss less the previously recognized loss of $11,881 equals a $5,911 gain.

5,911

Discount Expense.................................................. Other Comprehensive Income .........................

2,000

Accounts Receivable ............................................. Other Comprehensive Income ......................... Sales Revenue ................................................ To record sale of 1.2 million FC when the spot rate is $1.880 and to adjust sales revenue for the balance in OCI of $1,966.

2,256,000

11,881

2,004

5,911

2,000

1,966 2,254,034

10–23

Ch. 10—Problems

Problem 10-7, Continued

Last 30 days

Foreign Currency ................................................... Exchange Loss ...................................................... Accounts Receivable ....................................... To record collection of receivable when 1 FC = $1.850 and exchange loss of $36,000 [1,200,000 FC × ($1.850 – $1.880)].

2,220,000 36,000

Forward Contract ................................................... Gain on Forward Contract ............................... To record gain on contract [600,000 FC × ($1.890 – $1.850)] = $24,000 plus the previously recognized loss of $5,970.

29,970

Discount Expense.................................................. Gain on Forward Contract ...............................

1,996

Cash ...................................................................... Forward Contract ............................................. Foreign Currency .............................................

1,134,000

2,256,000

29,970

1,996 24,000 1,110,000

Ch. 10—Problems

10–24

Problem 10-7, Concluded

(2) Sales revenue (600,000 FC × $1.880) ............................... Adjustment to sales revenue .............................................. Adjusted sales revenue ...................................................... Cost of sales (1/2 of $1,800,000)........................................ Gross profit margin ............................................................. Exchange loss [600,000 × ($1.850 – $1.880)] .................... Gain on forward contract .................................................... Contract discount expense ................................................. Total impact on earnings ....................................................

Hedged $1,128,000 (1,970) $1,126,030 (900,000) $ 226,030 (18,000) 31,970 (6,000) $ 234,000

Not Hedged $1,128,000 — $1,128,000 (900,000) $ 228,000 (18,000) $ 210,000

The difference is traceable to the contract providing for the sale of 600,000 FC at a forward rate of $1.890 versus the spot rate at payment date of $1.850 for a difference of $24,000. The targeted position would have been to fix values as of the forecast date when the rate was $1.900 and not experience any exchange losses. The target compared to what was accomplished is as follows: Sales revenue (600,000 FC × $1.900) ............................... Adjustment to sales revenue .............................................. Adjusted sales revenue ...................................................... Cost of sales (1/2 of $1,800,000)........................................ Gross profit margin ............................................................. Exchange loss [600,000 × ($1.850 – $1.880)] .................... Gain on forward contract .................................................... Contract discount expense ................................................. Total impact on earnings ....................................................

Target $1,140,000 $1,140,000 (900,000) $ 240,000 — — — $ 240,000

Hedged $1,128,000 (1,970) $1,126,030 (900,000) $ 226,030 (18,000) 31,970 (6,000) $ 234,000

The target was not achieved because of the discount expense of $6,000 associated with the forward contract.

CHAPTER 11 UNDERSTANDING THE ISSUES to weaken against the dollar (a strengthening dollar). The remeasurement loss would be included in current-period earnings, and the U.S. parent would want to hedge against this loss in reporting earnings. The U.S. company could borrow foreign currency and designate the loan as a hedge of its net investment in the foreign subsidiary. As the foreign currency weakened, it would take fewer dollar equivalents to settle the FC-denominated loan. This would result in an exchange gain that could offset the remeasurement loss. Given a weakening FC, an FC-denominated loan receivable would not be an effective hedge of the net investment in the subsidiary.

1. If major cash inflows and/or outflows are not denominated in the entity’s domestic currency, this is a strong indicator that another currency is the functional currency. The company’s financing, sales, and expenditure activities should be evaluated in order to identify the primary currency in which the entity operates. For example, if a French company secures most of its financing from a U.S. bank with the debt to be serviced with dollars, this suggests that the functional currency is the U.S. dollar. 2. Because the French company’s functional currency is the euro, it is not exposed to risk associated with exchange rate changes between the euro and the U.S. dollar (the parent’s currency). Changes in the exchange rates will not have a current or known economic effect on either the parent’s or the French company’s cash flows or equity. Therefore, the translation adjustment should not be included as a component of net income. Including the adjustment in net income would suggest that exchange rate changes have an economic effect on the constituent companies when, in fact, they do not.

5. If a foreign entity’s functional currency is highly inflationary, there is an assumption that the currency has lost its utility as a measure of a store of value and lacks stability. Therefore, the currency would not serve as a useful functional currency. If the functional currency were translated, rather than remeasured, the results might be quite unusual and not very useful. The results will not represent reasonable dollarequivalent measures of the accounts. In order to overcome these unusual results, two possible approaches have been proposed. The first approach would adjust the foreign entity’s trial balance for inflationary changes over time and then translate the resulting balances. A second approach is to assume that the parent/investor (dollar) currency should serve as the foreign entity’s functional currency. This latter approach has been adopted by the FASB and therefore requires that the foreign entity’s statements be remeasured into the functional currency (dollars).

3. Because the euro is the subsidiary’s functional currency, its financial statements will be translated rather than remeasured. The translated balance of retained earnings consists of the following: a beginning balance represented by the translated balance at the end of the prior year plus net income translated at weighted-average exchange rates less dividends declared translated at the historical exchange rates existing at the date of declaration. 4. In order for there to be a remeasurement loss, the foreign currency (FC) would have

Ch. 11—Exercises

11–2

EXERCISES EXERCISE 11-1 (1)

Debit (Credit) December 31, 2015 Current Assets .............................................. Long-Lived Assets (net) ................................ Other Assets ................................................. Cost of Sales ................................................. Other Expenses ............................................ Current Liabilities .......................................... Other Liabilities ............................................. Net Sales....................................................... Dividends Declared ....................................... Common Stock.............................................. Retained Earnings (beginning)...................... Cumulative Translation Adjustment .............. Total ..............................................................

165,000 FC 420,000 170,000 525,000 205,000 (175,000) (125,000) (820,000) 25,000 (100,000) (290,000)

1 FC =

Debit (Credit) December 31, 2015

$1.92 1.92 1.92 1.96 1.96 1.92 1.92 1.96 2.02 1.62 Note A

$ 316,800 806,400 326,400 1,029,000 401,800 (336,000) (240,000) (1,607,200) 50,500 (162,000) (518,300) (67,400) $ 0

In FC

1 FC =

In U.S.$

140,000 180,000 (30,000) 290,000

Given $1.92 1.82

$227,300 345,600 (54,600) $518,300

Note A: Translation of Retained Earnings December 31, 2014 balance .......... 2015 income ................................... 2015 dividend ................................. December 31, 2015 balance ..........

(2) Cumulative Translation Adjustment Traceable to Years Prior to 2015 Debit (Credit) In U.S.$ Cumulative translation adjustment at December 31, 2015 ........ Year 2014 Translation Adjustment (see below) ......................... Cumulative translation adjustment at December 31, 2014 ........

$(67,400) 12,800 $(80,200)

11–3

Ch. 11—Exercises

Exercise 11-1, Concluded Year 2015 Translation Adjustment Debit (Credit) In U.S.$ Net assets at beginning of 2015 multiplied by change in exchange rates during the period: [390,000 FC × ($1.92 – $1.95)] ......................................................... Increase in net assets (excluding capital transactions) multiplied by the difference between the current rate and the average rate: [90,000 FC × ($1.92 – $1.96)] ........................................................... Increase in net assets due to capital transactions multiplied by the difference between the current rate and the rate at the time of the transactions: [25,000 FC × ($1.92 – $2.02)] ........................................................... (3)

Current Assets .............................................. Long-Lived Assets (net) ................................ Other Assets ................................................. Cost of Sales ................................................. Other Expenses ............................................ Current Liabilities .......................................... Other Liabilities ............................................. Net Sales....................................................... Dividends Declared ....................................... Common Stock.............................................. Retained Earnings (beginning)...................... Cumulative Translation Adjustment .............. Total ..............................................................

Debit (Credit) December 31, 2014 185,000 FC 400,000 165,000 425,000 260,000 (135,000) (225,000) (865,000) 30,000 (100,000) (140,000)

1 FC = $1.95 1.95 1.95 1.92 1.92 1.95 1.95 1.92 1.82 1.62 Given

$11,700 3,600

(2,500) $12,800 Debit (Credit) December 31, 2014 $ 360,750 780,000 321,750 816,000 499,200 (263,250) (438,750) (1,660,800) 54,600 (162,000) (227,300) (80,200) $ 0

(4) Reduction in 2015 Translation Adjustment Due to Hedge Value of loan payable at December 31, 2015 (100,000 FC × $1.92) ..... Value of loan payable at March 1, 2015 (100,000 FC × $2.02) ............. Change in value of loan payable ............................................................

$192,000 202,000 $ (10,000) Debit (Credit) In U.S.$

2015 translation adjustment before adjustments for accounting for excess upon acquisition of subsidiary............................................... Portion of adjustment allocated to noncontrolling interest (20%) ........... Portion of adjustment allocated to parent (80%) .................................... Gain in value of hedge on net investment .............................................. Net effect of translation on parent’s other comprehensive income ........

$ 12,800 (2,560) 10,240 (10,000) $ 240

Ch. 11—Exercises

11–4

EXERCISE 11-2 Remeasured no par common stock:

Common stock at January 1, 2014……………… Common stock issued in 2015…………………… Total common stock……………………………….

FC Value 200,000 140,000 340,000

Exchange Rate $1.61 $1.68

Remeasured Value $322,000 $235,200 $557,200

Remeasured retained earnings (Excluding Remeasurement Gain or Loss): FC Value Retained earnings at January 1, 2014 ............. 150,000 2014 net income: Net sales ................................................. 1,350,000 Cost of sales: Most recent purchase ......................... (500,000) Next most recent purchase ................ (400,000) Depreciation expense: July 1, 2013 equipment ...................... (20,000) September 30, 2014 equipment ......... (1,000) Other expenses ....................................... (210,000) Remeasurement gain (loss) Retained earnings at December 31, 2014 ....... 369,000 2015 net income: Net sales ................................................. 2,240,000 Cost of sales: Most recent purchase ......................... (500,000) Next most recent purchase ................ (300,000) Next most recent purchase ................ (600,000) Depreciation expense: July 1, 2013 equipment ...................... (20,000) September 30, 2014 equipment ......... (4,000) July 1, 2015 equipment ...................... (5,000) Other expenses ....................................... (320,000) Remeasurement gain (loss) 2015 dividend................................................... (20,000) Retained earnings at December 31, 2015 ....... 840,000

Exchange Rate $1.61

Remeasured Value $241,500

$1.63

2,200,500

$1.64 $1.62

(820,000) (648,000)

$1.61 $1.65 $1.63 Excluded

(32,200) (1,650) (342,300) $597,850

$1.70

$3,808,000

$1.68 $1.75 $1.73

(840,000) (525,000) (1,038,000)

$1.61 $1.65 $1.74 $1.70 Excluded $1.72

(32,200) (6,600) (8,700) (544,000) (34,400) $1,376,950

11–5

Ch. 11—Exercises

EXERCISE 11-3 June 30

Dec

Investment in Fabinet .................................................. Cash ...................................................................... To record purchase of 40% interest in Fabinet.

3,120,000

Cash ............................................................................ Investment to Fabinet ............................................ To record receipt of dividend (126,000 FC × $0.66 × 40%).

33,264

Investment in Fabinet .................................................. Subsidiary Income ................................................. Translation Adjustment .......................................... To record share of net income adjusted for the amortization of excess and share of translation (see Schedules A and B).

565,712

3,120,000

33,264

210,560 355,152

Schedule A—Calculation of Investor’s Share of Adjusted Equity Income Price paid ($3,120,000/$0.60) .......................................................... Equity purchased ..................................................... 10,500,000 FC 40% Interest acquired .............................................. × 40% Excess cost ...................................................................................... Allocation of excess cost: Equipment ($240,000/$0.60)...................................................... Goodwill ..................................................................................... Subsidiary net income (1,260,000 FC × $0.64) ............................... Investor’s interest ............................................................................. Investor’s interest in net income ...................................................... Depreciation of excess related to equipment: $240,000/10 years × ½ year ...................................................... Impairment loss on goodwill ............................................................. Investor’s adjusted income ..............................................................

5,200,000 FC 4,200,000 1,000,000 FC 400,000 FC 600,000 1,000,000 FC $ 806,400 × 40% $ 322,560 (12,000) (100,000) $ 210,560

Schedule B—Recomputation of Annual Translation Adjustment Net assets owned by the investee at the beginning of period multiplied by the change in the exchange rates during the period [10,500,000 FC × ($0.68 – $0.60)] ............................................................................................

$840,000

Increase in net assets (excluding capital transactions) multiplied by the difference between the current rate and the average rate used to translate income [1,260,000 FC × ($0.68 – $0.64)] .....................................

50,400

Increase/decrease in net assets due to capital transactions (including investments by the domestic investor) multiplied by the difference between the current rate and the rate at the time of the capital transaction [126,000 FC × ($0.68 – $0.66)] ................................................. Translation adjustment....................................................................................... Investor’s interest ............................................................................................... Investor’s interest in translation adjustment .......................................................

(2,520) $887,880 × 40% $355,152

Ch. 11—Exercises

11–6

EXERCISE 11-4 Translated net income: Debit (Credit) Sales Revenue .............................................. Cost of Inventory Sold ................................... Depreciation Expense ................................... Other Operating Expenses............................ Net Income .................................................... Note A Cost of inventory sold per FIFO: Second quarter 2016 ............................... Third quarter 2016 ................................... Fourth quarter 2016 ................................ Remeasurement gain (loss): Net assets at December 31, 2016: Monetary net assets ................................ Inventory ................................................. Depreciable assets (net) ......................... Land ........................................................ Total .................................................. Shareholders’ equity at December 31, 2016: Equity at July 1, 2016 .............................. Net income .............................................. Remeasurement gain (loss) .................... Total ..................................................

In FC (1,022,000) FC 480,000 80,000 60,000 (402,000) FC

Exchange Rate $1.19 Note A 1.15 1.19

In U.S.$ $(1,216,180) 564,100 92,000 71,400 $ (488,680)

In FC 150,000 FC 220,000 110,000 480,000 FC

Rate $1.15 1.18 1.20

In U.S.$ $172,500 259,600 132,000 $564,100

In FC

Rate

In U.S.$

732,000 FC 100,000 870,000 500,000 2,202,000 FC

$1.23 1.20 1.15 1.15

$ 900,360 120,000 1,000,500 575,000 $2,595,860

1,800,000 FC 402,000

1.15

$2,070,000 488,680 37,180 $2,595,860

2,202,000 FC

Net investment under the sophisticated equity method: Initial investment ............................................................................................... Share of subsidiary net income (30% × $488,680) ........................................... Share of remeasurement gain (30% × $37,180) ............................................... Amortization of excess of cost over book value (Note B).................................. Net investment as of December 31, 2016 ......................................................... Note B Cost ...................................................................................... Book value: (1,800,000 × $1.15) ................................ $2,070,000 Percentage interest acquired ................. × 30% Excess of cost over book value ............................................ Excess traceable to depreciable assets ............................... Depreciation of excess (over 9 years) .................................. Excess attributed to goodwill ................................................

$700,000 146,604 11,154 (6,000) $851,758

$700,000 621,000 $ 79,000 $ 54,000 $ 6,000 $ 25,000

11–7

Ch. 11—Exercises

EXERCISE 11-5 Calculation of cumulative translation as of yearend 2014:

Cash and cash equivalents ......................................... Accounts receivables .................................................. Inventory ..................................................................... Equipment ................................................................... Accumulated depreciation........................................... Patents ........................................................................ Accumulated amortization ........................................... Accounts payable........................................................ Notes payable ............................................................. Common stock ............................................................ Retained earnings - beginning .................................... Retained earnings - dividend ...................................... Net sales ..................................................................... Cost of sales ............................................................... Depreciation and amortization expense ...................... All other expenses ...................................................... Cumulative translation adjustment .............................. Totals ..........................................................................

December 31, 2014 Exchange In FC Rate In $ 71,000 $1.35 $ 95,850 148,000 $1.35 199,800 105,000 $1.35 141,750 300,000 $1.35 405,000 (50,000) $1.35 (67,500) 96,000 $1.35 129,600 (20,000) $1.35 (27,000) (80,000) $1.35 (108,000) (160,000) $1.35 (216,000) (106,000) $1.25 (132,500) (254,000) $1.25 (317,500) 50,000 $1.30 65,000 (620,000) $1.32 (818,400) 372,000 $1.32 491,040 28,000 $1.32 36,960 120,000 $1.32 158,400 (36,500) 0 $ 0

Net income ..................................................................

$100,000

$ 132,000

Ch. 11—Exercises

11–8

Calculation of cumulative translation as of yearend 2015:

December 31, 2015 Exchange In FC Rate In $ 52,000 $1.21 $ 62,920 120,000 $1.21 145,200 140,000 $1.21 169,400 360,000 $1.21 435,600 (73,000) $1.21 (88,330) 96,000 $1.21 116,160 (28,000) $1.21 (33,880) (74,000) $1.21 (89,540) (120,000) $1.21 (145,200) (106,000) $1.25 (132,500) (304,000) Note A (384,500) 40,000 $1.28 51,200 (700,000) $1.26 (882,000) 420,000 $1.26 529,200 31,000 $1.26 39,060 146,000 $1.26 183,960 23,250 0 $ 0

Net income ..................................................................

$103,000

$ 129,780

Note A: The beginning retained earnings balance is the translated value of beginning 2014 retained earnings, the 2014 net income, and the 2014 dividend. Analysis of Excess of cost over book value at acquisition expressed in FC:

Fair value of subsidiary ( 400,000 FC / 80%) ...... Less book value of interest acquired: Common stock .............................................. Retained earnings ......................................... Total equity.................................................... Excess acquired ............................................ Excess allocated to: Patents (42,000 / 80%) ................................. Goodwill ( to balance) .................................. Total excess ..................................................

Company Value 500,000

Parent 80% Value 400,000

NCI 20% Value 100,000

106,000 254,000 360,000 140,000

288,000 112,000

72,000 28,000

52,500 87,500 140,000

42,000 70,000 112,000

10,500 17,500 28,000

11–9

Ch. 11—Exercises

Allocation of income to NCI: 2014 Internally generated net income........................................................... $ 132,000 Amortization of patent portion of excess: 42,000 FC/ 80% = 52,500 FC x $1.32 allocated over 10years ...... (6,930) 42,000 FC/ 80% = 52,500 FC x $1.26 allocated over 10years ...... Impairment of goodwill (20% of 87,500 FC x $1.26) ........................... Adjusted net income ............................................................................ $ 125,070 Noncontrolling interest ......................................................................... 20% Noncontrolling interest in adjusted net income .................................... $ 25,014

2015 $129,780

(6,615) (22,050) $ 101,115 20% $ 20,223

EXERCISE 11-6 (1) Several factors that might explain why the U.S. dollar is the functional currency include: • The subsidiary’s equity capital has been provided in U.S. dollars. • The subsidiary’s debt capital has been provided in U.S. dollars. • Sales of the subsidiary’s products are settled in dollars. • Purchases of long-lived assets are paid for in dollars. • Payment for services rendered by the parent company such as insurance, legal fees, etc., are paid for in dollars. (2) (a)

Remeasurement of Cost of Sales for Product A: Time of Purchase Third quarter 2014 Fourth quarter 2014 First quarter 2015 Third quarter 2015 Fourth quarter 2015

(b)

Number of Units

FC Cost per Unit

Total FC Cost

Exchange Rate Balance ($/FC) in Dollars

400 900 1,200 3,000 700 6,200

53 55 58 59 57

21,200 49,500 69,600 177,000 39,900

$1.62 $1.65 $1.66 $1.71 $1.66

$ 34,344 81,675 115,536 302,670 66,234 $600,459

Remeasurement of Depreciation Expense: Time of Purchase March 1, 2013 November 1, 2013

FC Cost

Annual Depreciation

Exchange Rate ($/FC)

360,000 120,000

36,000 12,000

$1.50 $1.53

Balance in Dollars $54,000 18,360 $72,360

Ch. 11—Exercises

11–10

Exercise 11-6, Concluded (c)

Remeasurement of Patent Amortization Expense: Time of Purchase

$ Cost

Half-Year 20X6 Amortization

March 1, 2013

$108,000

$4,500

Remeasurement of Impairment Loss on Patent: Book value of patent at June 30, 2015: Original cost. .......................................... Less amortization: 2013 ....................................................... 2014. ...................................................... 20X6. ...................................................... Net book value ....................................... Impaired value at June 30, 2015: Value in FC ............................................. Rate of exchange.. ................................. Value in U.S.$.. ...................................... Impairment loss ($87,000 vs. $54,400) ........ (d)

$108,000 (7,500) (9,000) (4,500) $ 87,000 32,000 $1.70 $ 54,400 $ 32,600

Interest Expense and Transaction Exchange Gain/Loss on Borrowing: Interest expense (10,000 FCA × 6% × ½ year).. Exchange rate (1 FCA =) .............................. Interest expense in FC ................................. Exchange rate (1 FC =) ................................ Interest expense.. .........................................

300 FCA 1.24 372 FC $1.65 $613.80

Transaction Exchange Gain/Loss on Borrowing: Principal balance: At June 30, 2015 ............. At December 31, 2015 ..... Exchange loss .................

In FCA

1 FCA =

In FC

1 FC =

10,000 10,000

1.20 FC 1.24 FC

12,000 12,400 400

$1.65

$660

11–11

Ch. 11—Exercises

EXERCISE 11-7 Composition of Techno’s Account “Investment in Prefabco:”

March 31, 2013, initial investment ......... Last 9 months of 2013: Income × 70% ............................. Dividends × 70% ......................... 2014 Income × 70% ............................. Dividends × 70% ......................... 2015 Income × 70% ............................. Dividends × 70% ......................... December 31, 2015, balance ................

In FC

Exchange Rate (Dollars/FC) In U.S.$

In U.S.$

400,000

$2.08

$ 832,000

168,000 (50,400) 213,500 (64,050) 294,000 (88,200) 872,850

2.10 352,800 2.18 (109,872) 2.25 480,375 2.21 (141,550) 2.34 687,960 2.40 (211,680)

581,753 476,280 $1,890,033

Entries to eliminate the investment account: 1.

Subsidiary Income .............................................................. Dividends Declared (subsidiary account) ..................... Investment in Subsidiary............................................... To eliminate the subsidiary income and dividend declared against the investment in subsidiary.

687,960

Capital Stock (140,000 FC × $2.08 × 70%) ........................ Retained Earnings .............................................................. Investment in Subsidiary............................................... To eliminate beginning equity balances against investment in subsidiary.

203,840 909,353

Translated Balance of Retained Earnings:

In FC

March 31, 2013, pre-closing balance ..... 134,000 First quarter 2013 net income: Sales ................................................ 720,000 Cost of sales. ................................... (504,000) Other expenses ............................... (125,000) Balance at date of acquisition ................ 225,000 Parent’s interest. .................................... Parent’s 70% interest at March 31, 2013 70% of Income and dividends from last 9 months of 2013 through December 31, 2014 ......................... 2015 beginning balance.........................

211,680 476,280

1,113,193

(Dollars/FC) $2.08

In U.S.$ $

2.08 2.08 2.08

278,720

1,497,600 (1,048,320) (260,000) 468,000 × 70% 327,600

581,753 909,353

Ch. 11—Exercises

11–12

Exercise 11-7, Concluded 3.

Other Assets (206,429 × $2.40) ......................................... Retained Earnings ........................................................ Cumulative Translation Adjustment .............................. Investment in Subsidiary............................................... To distribute the excess of cost over book value—includes exchange rate adjustment. Cost to parent ..................................................................... Book value (including first quarter 2013 income) ............... Percentage acquired by parent .......................................... Excess of cost over book value ..........................................

495,429 128,811 66,057 300,560

400,000 365,000 70%

255,500 144,500

Allocation of Excess: Other assets .......................................... Exchange rate at acquisition date.......... Original dollar basis ...............................

To Parent

To NCI

Total in FC

144,500 $2.08 $300,560

61,929 $2.08 $128,811

206,429

Proof of Elimination of Investment Account: Balance before elimination entries.................................................. Elimination entry #1 ........................................................................ Elimination entry #2 ........................................................................ Elimination entry #3 ........................................................................ Eliminated balance .........................................................................

$1,890,033 (476,280) (1,113,193) (300,560) $ 0

11–13

Ch. 11—Problems

PROBLEMS PROBLEM 11-1 (1) Entries to record transactions—Debit (Credit): Cash .......................................... Common Stock ...................... Land ........................................... Inventory .................................... Cash ...................................... Receivable ................................. Sales ..................................... Cost of Sales ............................. Inventory ............................... Receivable ................................. Exchange Gain ......................

In FCA 1,250,000 1,250,000 625,000 625,000 1,250,000 320,000 320,000 312,500 312,500 80,000 80,000

In FCB 100,000 100,000 50,000 50,000 100,000 40,000 40,000 25,000 25,000

Trial balance: Trial Balance: Receivable................................... Inventory...................................... Land ............................................ Common Stock ............................ Sales ........................................... Cost of Sales ............................... Exchange Loss (Gain) ................. Remeasurment Loss (Gain) ........ Translation Adjustment................ Total ......................................

In FCA 400,000 FCA 312,500 625,000 (1,250,000) (320,000) 312,500 (80,000) — — 0 FCA

In FCB 40,000 FCB 25,000 50,000 (100,000) (40,000) 25,000 — — — 0 FCB

Net Income ..................................

(87,500) FCA

(15,000) FCB

Ch. 11—Problems

11–14

Problem 11-1, Concluded (2) Remeasurement and translation of trial balance: Rate In FCA Trial Balance: Receivable .................... 400,000 FCA Inventory ....................... 312,500 Land .............................. 625,000 Common Stock.............. (1,250,000) Sales ............................. (320,000) Cost of Sales ................. 312,500 Exchange Gain.............. (80,000) Remeasurement Loss ... — Translation Adjustment . — Total ........................ 0 FCA Net Income (Loss) ......... 87,500 FCA

FCB/FCA 0.10 0.08 0.08 0.08 0.125 0.08 0.10

Rate In FCB 40,000 FCB 25,000 50,000 (100,000) (40,000) 25,000 (8,000) 8,000

U.S.$/FCB

In U.S.$

$3.00 3.00 3.00 2.50 3.20 3.20 3.20 3.20

$ 120,000 75,000 150,000 (250,000) (128,000) 80,000 (25,600) 25,600 (47,000) 0 $ 48,000

0 FCB 15,000 FCB

(3) Translation adjustment traceable to the current year: Net assets at beginning of year multiplied by the change in exchange rates during the period: 100,000 FCB × ($3.00 – $2.50) .................................................................

$(50,000)

Increase in net assets (excluding capital transactions) multiplied by the difference between the current rate and the average rates used to translate income: 15,000 FC × ($3.00 – $3.20) .....................................................................

3,000

Increase in net assets due to capital transactions multiplied by the difference between the current rate and the rate at the time of the capital transaction: 0FC ............................................................................................................ Current-year translation adjustment ................................................................

— $(47,000)

(4) The remeasured FCB trial balance is the same as the trial balance that would have resulted had the transactions been originally recorded in FCB. FCB is the functional currency in which the company operates, and the remeasurement process should produce a trial balance that recognizes how the company would have appeared had the transactions been originally recorded in terms of its functional currency. Furthermore, the remeasurement process should result in a remeasurement gain or loss that reflects the fact that the company is exposed to exchange rate risk because it measures and denominates transactions in two different currencies. The remeasurement gain or loss should therefore be included as a component of net income. Financial statement relationships would also be the same after remeasurement as they were before remeasurement.

11–15

Ch. 11—Problems

PROBLEM 11-2 (1) Debit (Credit) Common Stock .............................................. Contributed Capital in Excess of Par Value .................................................. Retained Earnings as of December 31, 2016 ................................... Sales .............................................................. Cost of Inventory Sold ................................... Depreciation Expense ................................... Patent Amortization ....................................... Other Operating Expenses ............................ Loss on Disposal of Depreciable Assets ....... Note A Cost of inventory sold per FIFO: Fourth quarter 2016............................. First quarter 2017 ................................ Second quarter 2017 ........................... Third quarter 2017 ............................... Fourth quarter 2017............................. Note B Depreciation expense: January 1, 2015, acquisition: 900,000 ÷ 10 ................................. 160,000 ÷ 10 × 3/12 year .............. June 30, 2016, acquisition: 390,000 ÷ 10 ................................. 60,000 ÷ 10 × 3/12 year ................ March 31, 2017, acquisition: 600,000 ÷ 10 × 9/12 year .............. Note C Patent amortization: June 30, 2016, acquisition: 240,000 ÷ 12 .................................

Balance in FC (1,200,000) FC

Exchange Rate $1.41

Remeasured into U.S.$ $(1,692,000)

(1,800,000)

1.41

(2,538,000)

(1,000,000) (3,100,000) 2,200,000 179,500 20,000 294,500 1,500

given 1.35 Note A Note B Note C 1.35 Note D

(1,390,000) (4,185,000) 2,937,800 249,630 27,600 397,575 9,350

In FC 300,000 FC 400,000 620,000 700,000 180,000 2,200,000 FC

Rate $1.35 1.34 1.35 1.32 1.31

In U.S.$ $ 405,000 536,000 837,000 924,000 235,800 $2,937,800

In FC 90,000 FC 4,000

Rate $1.41 1.41

In U.S.$ $126,900 5,640

39,000 1,500

1.38 1.38

53,820 2,070

45,000 179,500 FC

1.36

61,200 $249,630

In FC 20,000 FC

Rate $1.38

In U.S.$ $27,600

Ch. 11—Problems

11–16

Problem 11-2, Concluded Note D Loss on disposal of asset: Disposition of January 1, 2015, acquisition: Original cost ........................................ Accumulated depreciation ................... Book value........................................... Sales proceeds.................................... Gain (loss) on disposal ........................

In FC 160,000 FC (36,000) 124,000 120,000 (4,000)

Rate $1.41 1.41

Disposition of June 30, 2016, acquisition: Original cost ........................................ Accumulated depreciation ................... Book value........................................... Sales proceeds.................................... Gain (loss) on disposal ........................

In FC 60,000 FC (4,500) 55,500 58,000 2,500

Rate $1.38 1.38

Total gain (loss) on disposal .....................

(1,500)

1.36

(2) Consolidated income traceable to noncontrolling interest: Income as remeasured .............................................................................. 2017 depreciation of excess (see Note E) ................................................. Adjusted income ........................................................................................ Noncontrolling interest ............................................................................... Noncontrolling interest in income............................................................... Note E Distribution of excess of cost over book value: Cost at date of acquisition ..................................................................... Book value at date of acquisition: Book value .................................................... 3,800,000 FC Interest acquired ........................................... × 80% Excess ................................................................................................... Excess allocated to: Equipment ....................................................................................... Goodwill ........................................................................................... Annual depreciation of above equipment: Allocated excess ................................................................................... Remaining useful life ............................................................................. Annual depreciation............................................................................... Exchange rate ....................................................................................... Remeasured depreciation .....................................................................

In U.S.$ $225,600 (50,760) 174,840 163,200 (11,640) In U.S.$ $82,800 (6,210) 76,590 78,880 2,290 (9,350) $556,835 (16,920) $539,915 × 20% $107,983

3,600,000 FC 3,040,000 560,000 FC 100,000 FC 460,000 560,000 FC 100,000 FC ÷ 8 1/3 years 12,000 FC × $1.41 $ 16,920

11–17

Ch. 11—Problems

PROBLEM 11-3 Sorenson Company Trial Balance Translation December 31, 2018

Account

Balance in FC

Cash...................................................................... 2,840,000 FC Accounts Receivable ............................................ 3,990,000 Inventory ............................................................... 5,800,000 Fixed Assets ......................................................... 15,000,000 Accumulated Depreciation .................................... (6,800,000) Accounts Payable ................................................. (1,580,000) Long-Term Debt .................................................... (5,000,000) Common Stock ..................................................... (3,000,000) Paid-In Capital in Excess of Par ........................... (2,000,000) Retained Earnings, January 1, 2018 ..................... (7,950,000) Sales ..................................................................... (10,000,000) Cost of Goods Sold ............................................... 7,500,000 Operating Expenses ............................................. 1,200,000 Cumulative Translation Adjustment ...................... Totals .............................................................. 0 FC Note A—The translated balance of retained earnings is as follows: Balance on January 1, 2016 (4,200,000 FC × $1.20) ....... 2016 Income (1,750,000 FC × $1.28) ............................... 2017 Income (2,000,000 FC × $1.30) ............................... Total ............................................................................

Relevant Exchange Rate $1.31 1.31 1.31 1.31 1.31 1.31 1.31 1.20 1.20 Note A 1.33 1.33 1.33

Balance in Dollars $ 3,720,400 5,226,900 7,598,000 19,650,000 (8,908,000) (2,069,800) (6,550,000) (3,600,000) (2,400,000) (9,880,000) (13,300,000) 9,975,000 1,596,000 (1,058,500) $ 0

$5,040,000 2,240,000 2,600,000 $9,880,000

Ch. 11—Problems

11–18

Problem 11-3, Continued Pueblo Corporation and Sorenson Company Worksheet for Consolidated Financial Statements (in dollars) For Year Ended December 31, 2018 Eliminations Trial Balance and Adjustments Pueblo Sorenson Dr Cr Cash...................................................................... 4,050,000 3,720,400 ................. ................. Accounts Receivable............................................. 5,270,000 5,226,900 ................. ................. Inventory ............................................................... 5,540,000 7,598,000 ................. ................. Investment in Sorenson ........................................ 20,969,000 ................... ................. (CY1) 1,729,000 .................. ................... ................. (EL) 15,880,000 .................. ................... ................. (D) 3,360,000 Fixed Assets ......................................................... 21,000,000 19,650,000 (D) 655,000 ................. Accumulated Depreciation .................................... (12,560,000) (8,908,000) ................. (A) 196,500 Additional Equipment ............................................ .................. ................... (D) 3,013,000 (A) 451,950 Accounts Payable ................................................. (3,450,000) (2,069,800) ................. ................. Long-Term Debt .................................................... (10,000,000) (6,550,000) ................. ................. Common Stock—Parent ....................................... (4,000,000) ................... ................. ................. Common Stock—Subsidiary ................................. .................. (3,600,000) (EL) 3,600,000 ................. Paid-In Capital in Excess of Par—Parent .............. (6,500,000) ................... ................. ................. Paid-In Capital in Excess of Par—Subsidiary ....... .................. (2,400,000) (EL) 2,400,000 ................. Retained Earnings, January 1, 2018—Parent ....... (12,180,000) ................... (A) 425,700 ................. Retained Earnings, January 1, 2018—Subsidiary . .................. (9,880,000) (EL) 9,880,000 ................. Sales ..................................................................... (26,000,000) (13,300,000) ................. ................. Cost of Goods Sold ............................................... 16,380,000 9,975,000 ................. ................. Operating Expenses .............................................. 3,210,000 1,596,000 (A) 219,450 ................. Subsidiary Income................................................. (1,729,000) ................... (CY1) 1,729,000 ................. (1,058,500) (A) 3,300 (D) 308,000 Cumulative Translation Adjustment....................... .................. 0 0 21,925,450 21,925,450 Combined Net Income .................................................................................................................................................................................

Consolidated Income Statement ................... ................... ................... ................... ................... ................... ................... ................... ................... ................... ................... ................... ................... ................... ................... ................... ................... (39,300,000) 26,355,000 5,025,450 ................... ................... ................... (7,919,550)

part.

Consolidated Balance Sheet 7,770,400 10,496,900 13,138,000 ................... ................... ................... 41,305,000 (21,664,500) 2,561,050 (5,519,800) (16,550,000) (4,000,000) ................... (6,500,000) ................... (11,754,300) ................... ................... ................... ................... ................... (1,363,200) ................... (7,919,550) 0

11–19

Ch. 11—Problems

Problem 11-3, Concluded Eliminations and Adjustments: (CY1) Eliminate the subsidiary income account ($1,729,000) against the investment account. (EL)

Eliminate the subsidiary’s January 1, 2018, equity balances against the investment account.

(D)

Distribute the excess of cost over book value. Cost to acquire subsidiary ................................................................ Book value of subsidiary .................................................................. Excess of cost over book value ........................................................ Less: Adjustment to equipment ........................................................ Additional equipment ........................................................................ Excess of cost over book value in dollars at: January 1, 2016 (2,800,000 FC × $1.20) ................................... December 31, 2018: Equipment (500,000 FC × $1.31) ......................................... Additional equipment (2,300,000 FC × $1.31)...................... Cumulative translation adjustment .......................................

(A)

12,000,000 FC 9,200,000 2,800,000 FC 500,000 2,300,000 FC $3,360,000 655,000 3,013,000 $ 308,000

Record appropriate depreciation of excess. Annual depreciation of excess: Equipment (500,000 FC ÷ 10) .................................................... Additional equipment (2,300,000 FC ÷ 20) ................................. Total .....................................................................................

50,000 FC 115,000 165,000 FC

Accumulated depreciation at December 31, 2018, in dollars: Equipment (50,000 × 3 years × $1.31) ....................................... Additional equipment (115,000 × 3 years × $1.31) .................... Total .....................................................................................

$196,500 451,950 $648,450

Current-year depreciation at December 31, 2018, in dollars (165,000 FC × $1.33) .................................................................

$219,450

Prior years’ depreciation expense in dollars: 2016 (165,000 FC × $1.28) ........................................................ 2017 (165,000 FC × $1.30) ........................................................ Total .....................................................................................

$211,200 214,500 $425,700

Cumulative translation adjustment ($648,450 – $219,450 – $425,700) ............................................

$3,300

Ch. 11—Problems

11–20

PROBLEM 11-4 Retained Earnings—Parent ................................................. Investment in Spruco ..................................................... To eliminate the entry in the subsidiary income account against the investment account (740,000 FC × 1.25 × 90%).

832,500

Capital Stock—Subsidiary (5,900,000 × 90%) ..................... Retained Earnings —Subsidiary (3,697,000 × 90%) .......... . Investment in Spruco ..................................................... To eliminate Kemper’s percentage interest in Spruco’s 2015 equity balances (excluding 2015 net income) calculated as follows:

5,310,000 3,327,300

Spruco’s equity balances:

832,500

8,637,300

In FC

Exchange Translated Rate Amount

Capital at September 1, 2013, excluding retained earnings (8,000,000 – 3,000,000) ......................

5,000,000

1.18

5,900,000

Retained earnings at September 1, 2013 ................ Remainder of 2013 income ...................................... Remainder of 2013 dividend .................................... 2014 net income ....................................................... 2014 dividend ........................................................... 2015 dividend ........................................................... Retained earnings balance at December 31, 2015 ..

3,000,000 350,000 (500,000) 920,000 (350,000) (300,000) 3,120,000

1.18 1.20 1.25 1.30 1.32 1.24

3,540,000 420,000 (625,000) 1,196,000 (462,000) (372,000) 3,697,000

Patents (439,200 + 48,800) ................................................. Goodwill (658,800 + 73,200) ................................................ Investment in Spruco ..................................................... Retained Earnings—Subsidiary ..................................... Cumulative Translation Adjustment —Subsidiary .......... To distribute the cost in excess of book value determined as follows: Cost to acquire subsidiary ........................................ 90% of Book value of subsidiary .............................. Excess of cost over book value ................................

488,000 732,000 1,062,000 118,000 40,000

8,100,000 7,200,000 900,000

40% to patent and 60% to goodwill

11–21

Ch. 11—Problems

Problem 11-4, Concluded Allocation of excess of cost over book value: Controlling interest ............................................. Noncontrolling interest (NCI) ..............................

Patent

In FC Goodwill

360,000 40,000 400,000

540,000 900,000 60,000 100,000 600,000 1,000,000

Total

Parent’s allocated excess at: ...................................

In U.S.$

October 1, 2013 (900,000 × $1.18) .......................... December 31, 2015 (900,000 × $1.22) ....................

$424,800 $637,200 $1,062,000 439,200 658,800 1,098,000

NCI’s allocated excess at: October 1, 2013 (100,000 × $1.18) .......................... December 31, 2015 (100,000 × $1.22) ....................

$47,200 48,800

Retained Earnings—Parent ................................................. Retained Earnings—Subsidiary. .......................................... Accumulated Amortization—Patents.............................. Cumulative Translation Adjustment —Subsidiary .......... To record amortization on excess determined as follows:

$70,800 73,200

102,600 11,400 109,800 4,200 In FC

Annual amortization of patent (400,000 FC over 10 years) .................................................... Accumulated amortization as of December 31, 2015 (2.25 years × 40,000) ......................................... Accumulated amortization as of December 31, 2015 (90,000 FC × $1.22) ........................................... Yearly amortization expense: Remainder of 2013 ............................................. 2014 ................................................................... 2015 ................................................................... Allocated to parent (90%) ............................. Allocated to NCI (10%) .................................

$118,000 122,000

In U.S.$

40,000 90,000 109,800 In FC 10,000 40,000 40,000 90,000

Exchange Translated Rate Amount 1.20 1.30 1.25

$ 12,000 52,000 50,000 $114,000 $102,600 $11,400

Ch. 11—Problems

11–22

PROBLEM 11-5 1.

Remeasurement of the 2015 trial balance: Balance in FC-A Inventory ....................................... 2,230,000 Depreciable assets ....................... 2,250,000 Accumulated depreciation ............ (387,500) Cash ............................................. 600,000 All other assets ............................. 1,088,000 Liabilities ....................................... (2,170,000) Common stock.............................. (2,200,000) Retained earnings ........................ (860,000) Net sales....................................... (6,057,500) Cost of sales ................................. 3,980,000 Depreciation expense ................... 150,000 All other expenses ........................ 1,377,000 Remeaurement loss (gain) .......... Totals ............................................ 0

Exchange Rate (FC-B/FC-A) See Note A See Note B See Note B 0.39 0.40 0.39 See Note C Given 0.43 See Note A See Note B 0.43 to balance

Balance In FC-B 919,400 1,140,000 (195,500) 234,000 435,200 (846,300) (1,094,000) (560,000) (2,604,725) 1,810,800 76,000 592,110 93,015 0

Note A – Remeasured cost of sales and ending inventory:

Goods available for sale: Beginning inventory........................ First quarter purchases .................. Second quarter purchases ............. Third quarter purchases ................. Fourth quarter purchases ............... Total goods available ..................... Ending inventory: Fourth quarter purchases ............... Third quarter purchases ................. Total ending inventory .................... Cost of sales ........................................

Balance in FC-A

Rate (FC-B/FC-A)

Balance In FC-B

940,000 1,470,000 1,200,000 1,740,000 860,000 6,210,000

0.48 0.46 0.44 0.42 0.40

451,200 676,200 528,000 730,800 344,000 2,730,200

860,000 1,370,000 2,230,000 3,980,000

0.40 0.42

344,000 575,400 919,400 1,810,800

11–23

Ch. 11—Problems

Note B –Remeasured depreciable assets, depreciation expense, and accumulated depreciation: Rate in FC-A (FC-B/FC-A) In FC-B Depreciable assets: Acquired on January 1, 2013 ......... 1,500,000 0.50 750,000 Acquired on March 31, 2014 .......... 750,000 0.52 390,000 Total ............................................... 2,250,000 1,140,000 Depreciation expense: Acquired at the beginning of 2013 . 100,000 0.50 50,000 Acquired on March 31, 2014 .......... 50,000 0.52 26,000 Total ............................................... 150,000 76,000 Accumulate depreciation: Acquired at the beginning of 2013: 100,000 FC-A per year x 3 years 300,000 0.50 150,000 Acquired on March 31, 2014: 50,000 FC-A per year x 1.75 years 87,500 0.52 45,500 Total ............................................... 387,500 195,500 Note C – Remeasured common stock:

Issued at beginning of 2013 ................. Issued on March 31, 2015 ...................

Balance Exchange Rate in FC-A (FC-B/FC-A) 2,000,000 0.50 200,000 0.47 2,200,000

Balance In FC-B 1,000,000 94,000 1,094,000

Translated trial balance for Gilmore Enterprises for the year 2015:

Inventory .............................................. Depreciable assets .............................. Accumulated depreciation.................... Cash..................................................... All other assets .................................... Liabilities .............................................. Common stock ..................................... Retained earnings ................................ Net sales .............................................. Cost of sales ........................................ Depreciation expense .......................... All other expenses ............................... Remeaurement loss (gain) .................. Cumulative translation adjustment ....... Totals ...................................................

Balance Exchange In FC-B Rate ($/FC-B) 919,400 $.30 1,140,000 $.30 (195,500) $.30 234,000 $.30 435,200 $.30 (846,300) $.30 (1,094,000) See Note D (560,000) Given (2,604,725) $.35 1,810,800 $.35 76,000 $.35 592,110 $.35 93,015 $.35 0

Balance In Dollars 275,820 342,000 (58,650) 70,200 130,560 (253,890) (442,300) (241,000) (911,654) 633,780 26,600 207,239 32,555 188,740 0

Ch. 11—Problems

11–24

Note D – Translated value for common stock:

Issued at beginning of 2013 ................. Issued on March 31, 2015 ...................

Balance Exchange in FC-B Rate ($/FC-B) 1,000,000 0.40 94,000 0.45 1,094,000

Balance in $ 400,000 42,300 442,300

Cumulative translation adjustment traceable to 2015: CR (DR) 2015

The change in exchange rates during the period multiplied by the amount of the net assets at the beginning of the period: 1,241,000 FC times $0.30 versus $0.47 ……………………. $(210,970) The difference between the weighted-average exchange rate used in translating income elements and the end-of-period exchange rate multiplied by the increase or decrease in net assets for the period traceable to net income: 358,000 FC times $0.30 versus $0.35 ……………………. (17,900) The increase (decrease) in net assets as a result of capital transactions multiplied by the difference between the end-of-period exchange rate and the exchange rate at the time of the transaction: 94,000 FC times $0.30 versus $0.45 ……………………. (14,100) Cumulative translation adjustment traceable to 2015 $(242,970) 4.

Amount of bank loan to serve as a hedge:

Remeasurement loss ............................... 2015 translation adjustment ..................... Net adverse impact .................................. Exchange rate at: 1 FC-B = Inception of loan …………………………………… $0.45 Year end 2015 ……………………………………... $0.30 Adverse impact divided by change in rate………………………………….. Value of loan at inception: 1,836,833 FC-B times $0.45 ……………………… Value of loan at year end 2015: 1,836,833 FC-B times $0.30 ……………………… Change in value of loan payable ..............

In Dollars $ 32,555 242,970 $ 275,525

0.15 1,836,833

$826,575.00

551,050 275,525

11–25

Ch. 11—Problems

PROBLEM 11-6 1.

Calculation of cumulative translation adjustment – Credit (Debit):

2014 The change in exchange rates during the period multiplied by the amount of the net assets at the beginning of the period: 600,000 FC times $ 1.38 versus $ 1.50 730,000 FC times $ 1.45 versus $ 1.38

………$ ………

The difference betweeen the weighted-average exchange rate used in translating income elements and the end-ofperiod exchange rate multiplied by the increase or decrease in net assets for the period traceable to net income: 180,000 FC times $ 1.38 versus $ 1.44 ……… 210,000 FC times $ 1.45 versus $ 1.43 ……… The increase (decrease) in net assets as a result of capital transactions multiplied by the difference between the end-ofperiod exchange rate and the exchange rate at the time of the transaction: (25,000) FC times $ 1.38 versus $ 1.52 ……… (25,000) FC times $ 1.38 versus $ 1.42 ……… (25,000) FC times $ 1.45 versus $ 1.40 ……… (25,000) FC times $ 1.45 versus $ 1.39 ……… 100,000 FC times $ 1.45 versus $ 1.42 ……… Cumulative translation adjustment……………………………………… $

2015

(72,000) $

51,100

(10,800) 4,200

3,500 1,000

(78,300) $

(1,250) (1,500) 3,000 55,550

Ch. 11—Problems

11–26

Problem 11-6, Continued 2.

Cumulative translation on consolidated balance sheet traceable to controlling and noncontrolling interests:

Calculation of excess of cost over book value at date of acquisition (in FC): Implied value of subsidiary (880,000 FC divided by 80%)…… 1,100,000 Book value at date of acquisition……………………………… 600,000 Excess of implied value over book value……………………… 500,000 Allocation of excess of cost over book value at date of acquisition (in FC): Interest

Undeveloped land……………………….… Equipment………………………………… Licensing agreements……………..……… Goodwill…………………………………… Total…………………………….……………

Total 112,500 150,000 100,000 137,500 500,000

80% 20% Controlling Noncontrolling 90,000 22,500 120,000 30,000 80,000 20,000 110,000 27,500 400,000 100,000

11–27

Ch. 11—Problems

Problem 11-6, Continued

Cumulative translation traceable to controlling and noncontrolling interests: Interest Year 2014 Translation adjustment per above - CR (DR)...……$ Distribution of asset markup: Equipment: Translated value (150,000 FC x $1.38)………… Value at acquisition (150,000 FX x $1.50)……… Cumulative translation adjustment……………… Licensing agreement: Translated value (100,000 FC x $1.38)………… Value at acquisition (100,000 FX x $1.50)……… Cumulative translation adjustment……………… Amortization of asset markups: Equipment amortized over 15 years: Value of depr. expense (10,000 FC x $1.44)… Value of accum. Depr. (10,000 FX x $1.38)…… Cumulative translation adjustment……………… Licensing agreement amortized over 5 years: Value of amortiz. expense (20,000 FC x $1.44) Value accum. Amortiz. (20,000 FX x $1.38)…… Cumulative translation adjustment……………… Total cumulative translation adjustment ………… $

80% 20% Total Controlling Noncontrolling (78,300) $ (62,640) $ (15,660)

207,000 (225,000) (18,000)

(14,400)

(3,600)

138,000 (150,000) (12,000)

(9,600)

(2,400)

14,400 (13,800) 600

480

120

28,800 (27,600) 1,200 (106,500) $

960 (85,200) $

240 (21,300)

Ch. 11—Problems

11–28

Problem 11-6, Concluded

Year 2015 Adjustment traceable to 2014- CR (DR)...…………$ Adjustment traceable to 2015- CR (DR)...………… Cumulative translation adjustment at y/e 2015…. Distribution of asset markup: Equipment: Translated value (150,000 FC x $1.45)………… Value at acquisition (150,000 FX x $1.50)……… Cumulative translation adjustment……………… Licensing agreement: Translated value (100,000 FC x $1.45)………… Value at acquisition (100,000 FC x $1.50)…… Cumulative translation adjustment……………… Amortization of asset markups: Equipment amortized over 15 years: Value of depr. expense (10,000 FC x $1.43)… Value of accum. Depr. (10,000 FX x $1.45) x 2 Cumulative translation adjustment……………… Licensing agreement amortized over 5 years: Value of amortiz. expense (20,000 FC x $1.43) Value accum. Amortiz. (20,000 FX x $1.45) x 2 Cumulative translation adjustment……………… Total cumulative translation adjustment ………… $

Interest 80% 20% Controlling Noncontrolling

Total (78,300) 55,550 (22,750) $

(18,200) $

(4,550)

217,500 (225,000) (7,500)

(6,000)

(1,500)

145,000 (150,000) (5,000)

(4,000)

(1,000)

14,300 (29,000) (14,700)

(11,760)

(2,940)

28,600 (58,000) (29,400) (79,350) $

(23,520) (63,480) $

(5,880) (15,870)

11–29

Ch. 11—Problems

PROBLEM 11-7 Translated Trial Balance December 31, 2015

Account

Balance in FC

Exchange Rate Dollars/FC

Balance in U.S.$

Cash.................................................................... Receivables (net) ................................................ Prepaids .............................................................. Inventory ............................................................. Depreciable Assets (net) ..................................... Other Assets ....................................................... Cost of Sales....................................................... Depreciation Expense ......................................... Other Expenses .................................................. Dividends declared ............................................. Totals ..................................................................

50,000 169,000 24,000 304,000 780,000 125,000 315,000 60,000 147,000 100,000 2,074,000

1.93 1.93 1.93 1.93 1.93 1.93 1.95 1.95 1.95 1.94

96,500 326,170 46,320 586,720 1,505,400 241,250 614,250 117,000 286,650 194,000 $4,014,260

Accounts Payable ............................................... Dividends Payable .............................................. Notes Payable..................................................... Bonds Payable .................................................... Capital Stock ....................................................... Paid-In Capital in Excess .................................... of Par Value ........................................................ Retained Earnings .............................................. Sales ................................................................... Cumulative Translation Adjustment .................... Totals ..................................................................

126,000 100,000 94,000 274,000 100,000

1.93 1.94 1.93 1.93 1.90

$ 243,180 194,000 181,420 528,820 190,000

210,000 530,000 640,000

1.90 Note A 1.93

399,000 1,029,750 1,235,200 12,890 $4,014,260

2,074,000

Note A—The translated dollar amount of retained earnings is as follows: Balance in FC Beginning balance .............................................. Last half of 2012 net income ............................... 2013 Net income ................................................. 2013 Dividend ..................................................... 2014 Net income ................................................. 2014 Dividend ..................................................... 2015 Year-end balance.......................................

300,000 75,000 135,000 (60,000) 160,000 (80,000) 530,000

Exchange Rate Dollars/FC 1.90 1.92 2.05 2.07 2.02 2.00

Balance in U.S.$ $ 570,000 144,000 276,750 (124,200) 323,200 (160,000) $1,029,750

Ch. 11—Problems

11–30

Problem 11-7, Continued Elimination and Adjusting Entries 1. Subsidiary Income...................................................................... Dividends Declared (sub account) ....................................... Investment in Subsidiary ...................................................... To eliminate the subsidiary income and dividend declared against the investment in subsidiary account.

173,840 155,200 18,640

Sales .............................................................................. Cost of sales................................................................... Depreciation expense..................................................... Other expenses .............................................................. Subsidiary income .......................................................... Parent’s interest .............................................................

$1,235,200 (614,250) (117,000) (286,650) $ 217,300 × 80% $ 173,840

Dividends declared: 100,000 FC × $1.94 × 80% = ....................

$ 155,200

2. Capital Stock .............................................................................. Paid-In Capital in Excess of Par Value ...................................... Retained Earnings...................................................................... Investment in Subsidiary.. .................................................... To eliminate 80% of beginning equity balances against investment in subsidiary.

152,000 319,200 823,800

3. Goodwill ..................................................................................... Depreciable Assets .................................................................... Retained Earnings ................................................................ Cumulative Translation Adjustment ..................................... Investment in Subsidiary ...................................................... To distribute the excess of cost over book value—includes exchange rate adjustment.

289,500 101,325

Cost to parent............................................................................. Book value ................................................................................. Percentage acquired by parent .................................................. Excess of cost over book value.................................................. Allocation of Excess: Goodwill ............................. Depreciable assets............. Exchange rate at acquisition date .................. Original dollar basis............

To Parent 120,000 42,000 162,000

To NCI 30,000 10,500 40,500

$1.90 $307,800

$1.90 $76,950

1,295,000

76,950 6,075 307,800

650,000 610,000 × 80%

488,000 162,000

Dec. 31, Total 2015 Total in in FC Dollars/FC U.S.$ 150,000 $1.93 $289,500 52,500 $1.93 101,325 202,500 $390,825

11–31

Ch. 11—Problems

Problem 11-7, Concluded 4. Depreciation Expense ................................................................ Retained Earnings...................................................................... Cumulative Translation Adjustment ..................................... Accumulated Depreciation ................................................... To depreciate excess—includes exchange rate adjustment. Depreciation expense:

In FC

5. Cumulative Translation Adjustment—DaLuca ........................... Cumulative Translation Adjustment—Parent ....................... Cumulative Translation Adjustment—NCI ............................ To allocate translation adjustment to parent and NCI.

Balance per translated trial balance ........ Above entry #3 ........................................ Above entry #4 ........................................ Total ........................................................

1,181 35,464

Average $/FC

2012 ...................................... 2,625 $1.92 2013 ...................................... 5,250 2014 ...................................... 5,250 2015 ...................................... 5,250 Accumulated depreciation = $101,325/10 years × 3.5 years

Cumulative translation balance:

10,237 26,408

2.05 2.02 1.95

In U.S. $ $ 5,040 10,763 10,605 10,237

20,146 16,117 4,029

Debit (Credit) in U.S.$

80% to Parent

20% to NCI

(12,890) (6,075) (1,181) (20,146)

(10,312) (4,860) (945) (16,117)

(2,578) (1,215) (236) (4,029)

Ch. 11—Problems

11–32

PROBLEM 11-8 Tobac, Inc. Trial Balance Translation December 31, 2017

Account

Balance in FC

Cash...................................................................... 3,087,385 FC Net Accounts Receivable ...................................... 12,000,000 Inventory ............................................................... 8,000,000 Depreciable Assets ............................................... 34,000,000 Accumulated Depreciation .................................... (12,300,000) Due to Balfour ....................................................... (2,087,385) Other Liabilities ..................................................... (3,700,000) Common Stock ..................................................... (19,000,000) Paid-In Capital in Excess of Par Value ................. (8,480,000) Retained Earnings, January 1, 2017 ..................... (7,520,000) Sales ..................................................................... (40,000,000) Cost of Sales......................................................... 27,600,000 Depreciation Expense ........................................... 3,300,000 Interest Expense on Balfour Loan (accrued at December 31) .............................. 118,154 Exchange Gain on Balfour Loan ........................... (30,769) Other Expenses .................................................... 5,012,615 Cumulative Translation Adjustment ...................... Totals .............................................................. 0 FC

Relevant Exchange Rate

Balance in Dollars

$0.65 0.65 0.65 0.65 0.65 0.65 0.65 0.55 0.55 Note A 0.67 0.67 0.67

$ 2,006,800 7,800,000 5,200,000 22,100,000 (7,995,000) (1,356,800) (2,405,000) (10,450,000) (4,664,000) (4,266,000) (26,800,000) 18,492,000 2,211,000

0.65 0.67 0.67

76,800 (20,615) 3,358,452 (3,287,637) $ 0

Note A—The translated balance in retained earnings is as follows: Balance on July 1, 2015 (2,520,000 FC × $0.55) ................................ Last 6 months, 2015 income (2,000,000 FC × $0.57) ......................... 2016 Income (3,000,000 FC × $0.58) ................................................. Retained earnings, December 31, 2016..............................................

$1,386,000 1,140,000 1,740,000 $4,266,000

11–33

Ch. 11—Problems

Problem 11-8, Continued Consolidating the Foreign Subsidiary Balfour Corporation and Tobac, Inc. Worksheet for Consolidated Financial Statements (in dollars) For Year Ended December 31, 2017 Eliminations Trial Balance and Adjustments Balfour Tobac Dr Cr Cash...................................................................... 4,463,200 2,006,800 ................. ................. Net Accounts Receivable ...................................... 15,350,000 7,800,000 ................. ................. Inventory ............................................................... 16,300,000 5,200,000 ................. ................. Due from Tobac .................................................... 1,356,800 ................... ................. (LN1) 1,356,800 Investment in Tobac .............................................. 23,712,363 ................... ................. (CY1) 2,682,363 .................. ................... ................. (EL) 19,380,000 .................. ................... ................. (D/A) 1,650,000 Depreciable Assets ............................................... 68,000,000 22,100,000 ................. ................. Equipment ............................................................. .................. ................... (D/A) 1,950,000 ................. Accumulated Depreciation .................................... (42,000,000) (7,995,000) ................. (D/A) 487,500 Due to Balfour ....................................................... .................. (1,356,800) (LN1) 1,356,800 ................. Other Liabilities ..................................................... (27,000,000) (2,405,000) ................. ................. Common Stock—Parent ....................................... (35,000,000) ................... ................. ................. Common Stock—Subsidiary ................................. .................. (10,450,000) (EL) 10,450,000 ................. Paid-In Capital in Excess of Par—Parent .............. (2,000,000) ................... ................. ................. Paid-In Capital in Excess of Par—Subsidiary ....... .................. (4,664,000) (EL) 4,664,000 ................. Retained Earnings, January 1, 2017—Parent ....... (4,500,000) ................... (D/A) 259,500 ................. Retained Earnings, January 1, 2017—Subsidiary . .................. (4,266,000) (EL) 4,266,000 ................. Sales ..................................................................... (98,000,000) (26,800,000) ................. ................. Cost of Sales ......................................................... 64,000,000 18,492,000 ................. ................. Depreciation Expense ........................................... 8,076,800 2,211,000 ................. ................. Interest Expense on Balfour Loan ......................... .................. 76,800 ................. (LN2) 76,800 Exchange Gain on Balfour Loan ........................... .................. (20,615) ................. ................. Other Expenses .................................................... 10,000,000 3,358,452 (D/A) 201,000 ................. Interest Income ..................................................... (76,800) ................... (LN2) 76,800 ................. Subsidiary Income................................................. (2,682,363) ................... (CY1) 2,682,363 ................. Cumulative Translation Adjustment....................... .................. (3,287,637) ................. (D/A) 273,000 0 0 25,906,463 25,906,463 Combined Net Income .................................................................................................................................................................................

Consolidated Income Statement ..................... ..................... ..................... ..................... ..................... ..................... ..................... ..................... ..................... ..................... ..................... ..................... ..................... ..................... ..................... ..................... ..................... ..................... (124,800,000) 82,492,000 10,287,800 ..................... (20,615) 13,559,452 ..................... ..................... ..................... ..................... (18,481,363)

part.

Consolidated Balance Sheet 6,470,000 23,150,000 21,500,000 ................... ................... ................... ................... 90,100,000 1,950,000 (50,482,500) ................... (29,405,000) (35,000,000) ................... (2,000,000) ................... (4,240,500) ................... ................... ................... ................... ................... ................... ................... ................... ................... (3,560,637) ................... (18,481,363) 0

Ch. 11—Problems

11–34

Problem 11-8, Concluded Eliminations and Adjustments: (CY1) Eliminate the subsidiary income account against the investment account. (EL)

Eliminate the subsidiary’s January 1, 2017, equity balances against the investment account.

(D/A) Distribute the excess of cost over book value and record appropriate amortization. Cost to acquire subsidiary ...................................................................... Book value of subsidiary ........................................................................ Excess of cost over book value ..............................................................

33,000,000 FC 30,000,000 3,000,000 FC

Annual depreciation of excess (3,000,000 FC ÷ 10) .............................. Accumulated depreciation of excess at December 31, 2016 (300,000 FC × 1.5 years) .................................................................

300,000 FC

Excess of cost over book value in dollars at: July 1, 2015 (3,000,000 FC × $0.55) ................................................ December 31, 2017 (3,000,000 FC × $0.65) ................................... Accumulated depreciation of excess at December 31, 2017, in dollars (750,000 FC × $0.65) ....................................................................... Depreciation expense in dollars: 2015 (150,000 FC × $0.57) .............................................................. 2016 (300,000 FC × $0.58) .............................................................. 2017 (300,000 FC × $0.67) ..............................................................

450,000 FC $1,650,000 $1,950,000 $487,500 $85,500 $174,000 $201,000

(LN1) Eliminate the intercompany loan balances. (LN2) Eliminate interest on intercompany loans.

11–35

Ch. 11—Problems

PROBLEM 11-9 Tobac, Inc. Trial Balance Translation December 31, 2017 Balance in Foreign Currency

Relevant Exchange Rate

Balance in Dollars

3,087,385 FC 12,000,000 8,000,000 34,000,000 (12,300,000) (2,087,385) (3,700,000) (19,000,000) (8,480,000) (7,520,000) (40,000,000) 27,600,000 3,300,000

$0.65 0.65 Note A Note B Note B 0.65 0.65 0.55 0.55 Note C 0.67 Note D Note B

$ 2,006,800 7,800,000 4,855,000 19,060,000 (6,792,000) (1,356,800) (2,405,000) (10,450,000) (4,664,000) (4,856,000) (26,800,000) 18,048,000 1,842,000

118,154 (30,769) 5,012,615

0.65 0.67 0.67

76,800 (20,615) 3,358,452 297,363 $ 0

Inventory acquired before July 1, 2015 (1,500,000 FC × $0.55) ............ Inventory acquired in the first quarter of 2017 (6,500,000 FC × $0.62) .

$ 825,000 4,030,000 $4,855,000

Account

Cash...................................................................... Net Accounts Receivable ...................................... Inventory ............................................................... Depreciable Assets ............................................... Accumulated Depreciation .................................... Due to Balfour ....................................................... Other Liabilities ..................................................... Common Stock ..................................................... Paid-In Capital in Excess of Par ........................... Retained Earnings, January 1, 2017 ..................... Sales ..................................................................... Cost of Sales......................................................... Depreciation Expense ........................................... Interest Expense on Balfour Loan (accrued at December 31, 2017) .................... Exchange Gain on Balfour Loan ........................... Other Expenses .................................................... Remeasurement Loss (Gain) ................................ Totals ..............................................................

0 FC

Note A—Ending inventory consists of:

Note B—Depreciable assets consists of the following: Assets acquired prior to July 1, 2015 (30,000,000 FC × $0.55) ............. Assets acquired on April 1, 2017 (4,000,000 FC × $0.64) .....................

$16,500,000 2,560,000 $19,060,000

Accumulated depreciation consists of: Assets acquired prior to July 1, 2015 (30,000,000 FC × 4*/10 × $0.55) ...................................................... Assets acquired on April 1, 2017 (4,000,000 FC × 1/10 × 9/12 year × $0.64) ......................................

$6,600,000

192,000 $6,792,000 *12,300,000 FC – (4,000,000 FC/10 × 9/12 for assets acquired on April 1, 2017) = 12,000,000 FC balance in accumulated depreciation related to assets acquired before July 1, 2015. 12,000,000 FC/(30,000,000 FC/10 years) = 4, the number of years those assets have been depreciated as of the end of 2017.

Ch. 11—Problems

11–36

Problem 11-9, Continued Depreciation expense consists of: Assets acquired prior to July 1, 2015 (30,000,000 FC × 1/10 × $0.55) ....................................................... Assets acquired on April 1, 2017 (4,000,000 FC × 1/10 × 9/12 year × $0.64) ......................................

$1,650,000 192,000 $1,842,000

Note C—The translated balance of retained earnings is as follows: Balance on July 1, 2015 (2,520,000 FC × $0.55) ................................... Last 6 months, 2015 income .................................................................. 2016 Income .......................................................................................... Retained earnings, December 31, 2016.................................................

$1,386,000 1,610,000 1,860,000 $4,856,000

Note D—Cost of sales consists of: Inventory purchases over past 9months of 2017 (23,400,000 FC × $0.66) .................................................................. Inventory purchased in the first quarter of 2017 (4,200,000 FC × $0.62) ....................................................................

$15,444,000 2,604,000 $18,048,000

11–37

Ch. 11—Problems

Problem 11-9, Continued Consolidating the Foreign Subsidiary Balfour Corporation and Tobac, Inc. Worksheet for Consolidated Financial Statements (in dollars) For Year Ended December 31, 2017 Eliminations Trial Balance and Adjustments Balfour Tobac Dr Cr Cash...................................................................... 4,463,200 2,006,800 ................. ................. Net Accounts Receivable ...................................... 15,350,000 7,800,000 ................. ................. Inventory ............................................................... 16,300,000 4,855,000 ................. ................. Due from Tobac .................................................... 1,356,800 ................... ................. (LN1) 1,356,800 Investment in Tobac .............................................. 25,115,363 ................... ................. (CY1) 3,495,363 .................. ................... ................. (EL) 19,970,000 .................. ................... ................. (D/A) 1,650,000 Depreciable Assets ............................................... 68,000,000 19,060,000 ................. ................. Equipment ............................................................. .................. ................... (D/A) 1,650,000 ................. Accumulated Depreciation .................................... (42,000,000) (6,792,000) ................. (D/A) 412,500 Due to Balfour ....................................................... .................. (1,356,800) (LN1) 1,356,800 ................. Other Liabilities ..................................................... (27,000,000) (2,405,000) ................. ................. Common Stock—Parent ....................................... (35,000,000) ................... ................. ................. Common Stock—Subsidiary ................................. .................. (10,450,000) (EL) 10,450,000 ................. Paid-In Capital in Excess of Par—Parent .............. (2,000,000) ................... ................. ................. Paid-In Capital in Excess of Par—Subsidiary ....... .................. (4,664,000) (EL) 4,664,000 ................. Retained Earnings, January 1, 2017—Parent ....... (5,090,000) ................... (D/A) 247,500 ................. Retained Earnings, January 1, 2017—Subsidiary . .................. (4,856,000) (EL) 4,856,000 ................. Sales ..................................................................... (98,000,000) (26,800,000) ................. ................. Cost of Sales ......................................................... 64,000,000 18,048,000 ................. ................. Depreciation Expense ........................................... 8,076,800 1,842,000 ................. ................. Interest Expense on Balfour Loan ......................... .................. 76,800 ................. (LN2) 76,800 Exchange Gain on Balfour Loan ........................... .................. (20,615) ................. ................. Other Expenses .................................................... 10,000,000 3,358,452 (D/A) 165,000 ................. Interest Income ..................................................... (76,800) ................... (LN2) 76,800 ................. Subsidiary Income................................................. (3,495,363) ................... (CY1) 3,495,363 ................. Remeasurement Loss ........................................... .................. 297,363 ................. ................. 0 0 26,961,463 26,961,463 Combined Net Income .................................................................................................................................................................................

Consolidated Income Statement ..................... ..................... ..................... ..................... ..................... ..................... ..................... ..................... ..................... ..................... ..................... ..................... ..................... ..................... ..................... ..................... ..................... ..................... (124,800,000) 82,048,000 9,918,800 ..................... (20,615) 13,523,452 ..................... ..................... 297,363 ..................... (19,033,000)

part.

Consolidated Balance Sheet 6,470,000 23,150,000 21,155,000 ................... ................... ................... ................... 87,060,000 1,650,000 (49,204,500) ................... (29,405,000) (35,000,000) ................... (2,000,000) ................... (4,842,500) ................... ................... ................... ................... ................... ................... ................... ................... ................... ................... ................... (19,033,000) 0

Ch. 11—Problems

11–38

Problem 11-9, Concluded Eliminations and Adjustments: (CY1) Eliminate the subsidiary income account against the investment account. (EL)

Eliminate the subsidiary’s January 1, 2017, equity balances against the investment account.

(D/A) Distribute the excess of cost over book value and record appropriate amortization. Cost to acquire subsidiary ..................................................................... Book value of subsidiary ........................................................................ Excess of cost over book value .............................................................

33,000,000 FC 30,000,000 3,000,000 FC

Annual depreciation of excess (3,000,000 FC ÷ 10) ............................. Accumulated depreciation of excess at December 31, 2016 (300,000 FC × 1.5 years) .................................................................

300,000 FC

Excess of cost over book value in dollars at: July 1, 2015 (3,000,000 FC × $0.55) ............................................... Accumulated depreciation of excess at December 31, 2017, in dollars (750,000 FC × $0.55) ...................................................................... Depreciation expense in dollars: 2015 (150,000 FC × $0.55) ............................................................. 2016 (300,000 FC × $0.55) ............................................................. 2017 (300,000 FC × $0.55) .............................................................

450,000 FC $1,650,000 $412,500 $82,500 $165,000 $165,000

(LN1) Eliminate the intercompany loan balances. (LN2) Eliminate the interest on intercompany loan.

CHAPTER 12 UNDERSTANDING THE ISSUES to the loss may not be recognized. However, if this were the case, one would consider any known pretax income in the carryback period and any “more likely than not” pretax income in the carryforward periods. If the pretax income in these periods were not sufficient to absorb the remaining pretax loss, then some of the third-quarter pretax loss would not recognize a benefit. In order to fully recognize the benefit associated with an interim period pretax loss, there must be some combination of the following: sufficient pretax income in other quarters of the current year, sufficient pretax income in the carryback period, and/or sufficient “more likely than not” pretax income in the carryforward period.

1. Viewing an interim period as an integral part of a larger annual period has several benefits. The allocation of expense under this viewpoint provides information that allows for more meaningful and insightful predictions of annual results. Furthermore, the effect of certain interim conditions that are not expected to exist at year-end may be given special accounting treatment. Examples of this include special accounting for temporary inventory liquidations and temporary unfavorable variances. If special accounting treatment were not available, projections of annual amounts would be distorted. 2. A number of factors are necessary in order to determine the estimated effective annual tax rate. First of all, the rate should reflect conditions to be experienced for the entire year. Therefore, in addition to year-to-date pretax income/loss, such amounts must be projected for the balance of the year. Statutory tax rates are applied to these annual amounts after considering the presence of possible annual permanent differences between book and tax income. The resulting taxes must also be reduced by possible tax credits. The applicability of the above factors becomes more complex in situations where there is an estimated annual pretax loss. This situation requires the consideration of possible tax loss and/or tax credit carrybacks and carryforwards.

4. There are a number of reasons why the total operating profit of the reportable segments does not normally equal the consolidated operating profit. First of all, not all operating segments are reportable and yet such amounts are included in consolidated amounts. Second, there are a number of intersegment transactions whose effect would be included in operating profits of reportable segments but eliminated from consolidated amounts. Third, not all elements of consolidated income are allocated to reportable segments. This is traceable to the fact that not all elements are used by the chief operating decision maker in evaluating segment performance and/or because allocation is not possible on a reasonable basis. Finally, the accounting employed from a management approach perspective may be different from the requirement to use GAAP in the measurement of consolidated amounts.

3. Several factors may explain this situation. If the third-quarter loss were greater than the pretax income in the first two quarters plus the forecasted pretax income for the fourth quarter, then some of the benefit traceable

Ch. 12—Exercises

12–2

EXERCISES EXERCISE 12-1 (1) Generally speaking, research and development (R&D) costs are expensed in the year in which they are incurred. Therefore, absent contrary evidence, all of the $360,000 of costs should be recognized in the current year rather than over a 24-month period. However, if all of the $360,000 of costs were to be recognized in the second quarter of the current year, the income of the quarter would be distorted. When a specific cost charged to expense for annual reporting purposes benefits more than one interim period of the current year, the cost may be allocated to those interim periods. This explains why the cost is allocated over the second through fourth quarters at the rate of $120,000 per quarter. (2) A likely explanation for an effective tax rate less than the statutory rate is that there are differences between how items of revenue and/or expense are recognized for tax purposes versus recognized for purposes of generally accepted accounting principles (GAAP). For example, in this specific case, it is possible that there are items of revenue per GAAP that are never taxable and/or there are items of expense per tax that are never recognized per GAAP. In addition to the previous items which are referred to as permanent differences, it is possible that there are tax credits that would result in an effective tax rate being less than the statutory tax rate. (3) If the tax benefit associated with the net operating loss in the prior year was not fully recognized in the year of loss, it is possible that an additional amount of benefit traceable to the loss could have been recognized in the current year. This could be the case because it has now become more likely than not that the tax benefit associated with the prior-year loss could be offset by current- or future-year income. If the tax benefit of a prior year’s loss becomes more likely than not in a subsequent year, the tax benefit is recognized currently rather than being recognized on a retroactive basis. (4) In order to estimate the annual effective tax rate applicable to an interim period, it is necessary to estimate the amount of annual taxable income. Therefore, the estimated amount of annual accounting and taxable income would have been determined at the end of both quarters. If at the end of the second quarter, the company had estimated an amount of annual taxable income that was less than the amount of taxable income estimated at the end of the first quarter, it is possible that the company could have moved down into a lower progressive tax bracket. This, in turn, would cause the second quarter’s effective tax rate to decrease. (5) The effective tax rate for the first quarter of the current year suggests several things. First, not all of the estimated current-year tax loss could be carried back against the prior two years. If this had been the case, the effective tax rate would have been at least 25%. Second, it does not appear that any portion of the current-year estimated annual tax loss could be carried forward against income in future years that was considered more likely than not. If this had been the case, the effective tax rate would have been more than 25% but less than 30%. The effective tax rate of 28% for the second quarter of the current year suggests that the present estimate of the current-year tax loss can be carried against all of the income in the prior two years and that an additional amount of loss can be carried forward against income of future years.

12–3

Ch. 12—Exercises

Exercise 12-1, Concluded (6) If the current year-to-date LIFO liquidation will not exist at year-end because it is estimated that current-year purchases will exceed current-year sales, then the interim cost of sales should be based on the replacement cost of temporarily liquidated inventory rather than its historical cost. Assuming that the replacement cost is higher than the cost of the liquidated inventory, then the cost per unit would not have decreased. EXERCISE 12-2 Strategy A Quarter 2 2015 YTD income (loss): Existing operations ......................................................... New strategy .................................................................. Subtotal .......................................................................... Projected for the balance of the year: Existing operations ......................................................... New strategy .................................................................. Annual income (loss) ...........................................................

$60,000 (85,000) (25,000) 30,000 (60,000) $ (55,000) 2015 DR (CR)

Annual entry: Taxes receivable (payable) ............................................ Deferred tax asset (15% x $40 K) .................................. Deferred tax asset .......................................................... Tax expense (benefit) ....................................................

2014 CR (DR) 6,000

4,000 (4,000)

(6,000)

Note: The deferred tax asset balance is $10,000 (15% × $50K + 25% × $10 K) Effective tax rate & YTD tax benefit: Annual expense (benefit) ............................................... Annual income (loss)...................................................... Effective rate .................................................................. YTD operating (loss) ...................................................... YTD tax (benefit) ............................................................

(4,000) (55,000) 7.27% (25,000) (1,818)

Ch. 12—Exercises

12–4

Strategy B Quarter 2 2015 YTD income (loss): Existing operations ......................................................... New strategy .................................................................. Subtotal .......................................................................... Projected for the balance of the year: Existing operations ......................................................... New strategy .................................................................. Annual income (loss) ........................................................... Prior year net operating loss carryforward ........................... Taxable income ....................................................................

$60,000 (40,000) 20,000 (30,000) 36,000 $ 26,000 (26,000) $ 0 2015 DR(CR)

2014 CR(DR) 6,000

3,500 (3,500)

(6,000)

Note: The deferred tax asset balance is $9,500 (15% × $50K + 25% × $8 K) represented by the remaining $58 K ($84 K - $26 K) of 2014 loss Effective tax rate & YTD tax benefit: Annual expense (benefit) ............................................... Annual income (loss)...................................................... Effective rate .................................................................. YTD operating (loss) ...................................................... YTD tax (benefit) ............................................................

(3,500) 26,000 -13.46% 20,000 (2,692)

Strategy C Quarter 2 2015 YTD income (loss): Existing operations ......................................................... New strategy .................................................................. Subtotal .......................................................................... Projected for the balance of the year: Existing operations ......................................................... New strategy .................................................................. Annual income (loss) ........................................................... Prior year net operating loss carryforward ........................... Taxable income ....................................................................

$60,000 60,000 30,000 50,000 $140,000 (84,000) $56,000

12–5

Ch. 12—Exercises

2015 DR(CR) Annual entry: Taxes receivable (payable) ............................................ (15% x $50 K + 25% x $6 - $5 tax credit) Deferred tax asset (15% x $40 K) .................................. Deferred tax asset .......................................................... Tax expense (benefit) ....................................................

2014 CR(DR)

(4,000) 6,000 (6,000) 10,000

(6,000)

Note: That there is no longer a deferred tax balance because all of the $84,000 prior year loss has been used against current year income. Effective tax rate & YTD tax benefit: Annual expense (benefit) ............................................... Annual income (loss)...................................................... Effective rate .................................................................. YTD operating (loss) ...................................................... YTD tax (benefit) ............................................................

10,000 140,000 7.14% 60,000 4,286

The estimated tax expense of $10,000 can also be calculated as follows: The tax expense on $140,000 after the tax credit would be: $50,000 at 15% .............................................................. $50,000 at 25% .............................................................. $40,000 at 30% .............................................................. Less tax credit ................................................................ The $84,000 prior year operating loss had additional benefit of: $40,000 at 30% .............................................................. $44,000 at 25% .............................................................. Less: 2014 recognized benefit .......................................

$7,500 12,500 12,000 (5,000) $27,000 12,500 11,000 (6,000) $17,000

The net expense is $10,000 ($27,000 expense less the additional benefit of $17,000).

Ch. 12—Exercises

12–6

EXERCISE 12-3 Granger Supply, Inc. Interim Income Statements For the Periods Ending Quarter 1 and 2 of the Current Year Net sales .............................................................................. Cost of sales (See Schedule A) ........................................... Gross profit .......................................................................... Selling, general, and administrative ..................................... Income (loss) before taxes................................................... Income tax expense (benefit) (See Schedule B) ................. Net income ...........................................................................

Quarter 1 $12,000,000 7,900,000 $ 4,100,000 2,100,000 $ 2,000,000 700,800 $ 1,299,200

Quarter 2 $9,000,000 7,805,000 $1,195,000 1,800,000 $ (605,000) (217,154) $ (387,846)

Quarter 1

Quarter 2

$4,300,000 3,000,000

$4,700,000 3,200,000

480,000 120,000 $7,900,000

(95,000) $7,805,000

Quarter 1 $2,000,000 5,100,000 $7,100,000 60,000 $7,160,000

Quarter 2 $1,395,000 4,000,000 $5,395,000 35,000 $5,430,000

Schedule A—Cost of Sales As stated: Cost of sales—industrial supplies .................................. Cost of sales—cleaning equipment................................ Adjustment for replacement cost: 400 units × ($2,700 – $1,500) ........................................ Adjustment for loss due to market decline ........................... New cost of sales ................................................................. Schedule B—Income Tax Schedule YTD income before tax ........................................................ Projected income ................................................................. Estimated annual income..................................................... Permanent differences ......................................................... Estimated adjusted taxable income ..................................... Statutory tax rate .................................................................. Tax on estimated adjusted taxable income .......................... Tax credits ........................................................................... Net tax.................................................................................. Effective tax rate .................................................................. Ordinary Pretax Income (Loss) Interim Current Effective Tax Period Period Year-to-Date Rate First $2,000,000 $2,000,000 35.04% Second (605,000) 1,395,000 34.67

35.00% $2,506,000 18,000 $2,488,000 35.04%

35.00% $1,900,500 30,000 $1,870,500 34.67%

Tax Expense (Benefit) Previously Current Year-to-Date Reported Period $700,800 $ — $ 700,800 483,646 700,800 (217,154)

12–7

Ch. 12—Exercises

EXERCISE 12-4 (1)

Before Change $100,000 110,000 $210,000 (5,000) $205,000

After Change $120,000 135,000 $255,000 (5,000) $250,000

Less tax credit................................................... Net tax .............................................................. Effective tax rate ...............................................

5,000 10,000 15,000 20,000 1,750 $ 51,750 (8,000) $ 43,750 20.83%

5,000 10,000 15,000 20,000 17,500 $ 67,500 (8,000) $ 59,500 23.33%

First six months’ tax expense (benefit): Pretax income (loss) .................................... Effective tax rate per above ......................... Tax expense (benefit) ..................................

$100,000 × 20.83% $ 20,833

$120,000 × 23.33% $ 27,996

YTD income (loss) ............................................ Projected income (loss) .................................... Total annual ...................................................... Less exempt income ......................................... Taxable income ................................................ Estimated tax: On first $50,000 @ 10% ............................... On next $50,000 @ 20% .............................. On next $50,000 @ 30% .............................. On next $50,000 @ 40% .............................. Remaining income @ 35%...........................

The change in accounting principle resulted in an increase in tax expense for the first six months of $7,163 ($27,996 vs. $20,833).

Ch. 12—Exercises

12–8

Exercise 12-4, Concluded (2)

First six months continuing ........... Third quarter continuing ................ Projected continuing ..................... Nonordinary loss ........................... Nonordinary gain .......................... Pretax income (loss) ..................... Tax expense (benefit) ...................

Ordinary Income $120,000 80,000 20,000 $220,000 $ 50,600

Total Income $120,000 80,000 20,000 (40,000) 60,000 $240,000 $ 57,600

Total Excluding Nonordinary Loss $120,000 80,000 20,000 60,000 $280,000

$180,000

$ 71,600

$ 35,400

Incremental tax expense (benefit) traceable to: All nonordinary items ($57,600 – $50,600) .......................... All nonordinary losses ($71,600 – $57,600) ......................... All nonordinary gains [$7,000 – ($14,000)] ..........................

$ 7,000 $ (14,000) $ 21,000

Taxable income: Pretax accounting income ........ Less exempt income ................ Taxable income ........................ Estimated tax: On first $50,000 @ 10% ........... On next $50,000 @ 20% .......... On next $50,000 @ 30% .......... On next $50,000 @ 40% .......... Remaining income @ 35%....... Less tax credit............................... Net tax ..........................................

Total Excluding Nonordinary Gain $120,000 80,000 20,000 (40,000)

$220,000 (4,000) $216,000

$240,000 (4,000) $236,000

$280,000 (4,000) $276,000

$180,000 (4,000) $176,000

5,000 10,000 15,000 20,000 5,600 $ 55,600 (5,000) $ 50,600

5,000 10,000 15,000 20,000 12,600 $ 62,600 (5,000) $ 57,600

5,000 10,000 15,000 20,000 26,600 $ 76,600 (5,000) $ 71,600

5,000 10,000 15,000 10,400 — $ 40,400 (5,000) $ 35,400

12–9

Ch. 12—Exercises

EXERCISE 12-5 Tax rates Case A YTD income (loss) ........................................................ Projected for the balance of the year ............................. Annual income (loss) .................................................... Prior year net operating loss carryforward ..................... Taxable income ..............................................................

30% 25% 2015 2014 $ (80,000) 120,000 40,000 $(30,000) (30,000) $10,000 $ (30,000)

15% 2013

Annual entry: Taxes receivable (payable) ........................................... Deferred tax asset (25% x $30 K) ................................. Tax expense (benefit) ................................................... Effective tax rate & YTD tax benefit: Annual expense (benefit) .............................................. Annual income (loss) .................................................... Effective rate .................................................................. YTD operating (loss) ..................................................... YTD tax (benefit) ...........................................................

DR (CR) DR (CR) (3,000) (7,500) 7,500 10,500 (7,500)

Case B YTD income (loss) ........................................................ Projected for the balance of the year ............................. Annual income (loss) .................................................... Loss carryback to prior 2 years ...................................... Taxable income ..............................................................

2015 $ (80,000)

2014

2013

(80,000) 30,000 $ (50,000)

$20,000

$10,000

$20,000

$10,000

Annual entry: Taxes receivable (payable) ........................................... Deferred tax asset.......................................................... Tax expense (benefit) ...................................................

DR (CR) 6,500

DR (CR) (5,000)

DR (CR) (1,500)

(6,500)

5,000

1,500

Effective tax rate & YTD tax benefit: Annual expense (benefit) .............................................. Annual income (loss) .................................................... Effective rate .................................................................. YTD operating (loss) ..................................................... YTD tax (benefit) ...........................................................

10,500 40,000 26.25% (80,000) (21,000)

(6,500) (80,000) 8.13% (80,000) (6,500)

Ch. 12—Exercises

Case C YTD income (loss) ........................................................ Projected for the balance of the year ............................. Annual income (loss) .................................................... Prior year net operating loss carryforward ..................... Loss carryback to prior 2 years ...................................... Taxable income ..............................................................

12–10

2015 $50,000 (80,000) (30,000)

$ (30,000)

2014

2013

$10,000 $ (20,000) (10,000) $

0 $(20,000)

Annual entry: Taxes receivable (payable) ........................................... Deferred tax asset (25% x $10 K) ................................. Deferred tax asset (30% x $20 K) ................................. Tax expense (benefit) ................................................... NOTE: The deferred tax asset at year-end 2015 is $6,000. Effective tax rate & YTD tax benefit: Annual expense (benefit) .............................................. Annual income (loss) .................................................... Effective rate .................................................................. YTD operating (loss) ..................................................... YTD tax (benefit) ...........................................................

DR (CR)

Case D YTD income (loss) ........................................................ Projected for the balance of the year ............................. Annual income (loss) .................................................... Prior year net operating loss carryforward ..................... Loss carryback to prior 2 years ...................................... Taxable income ..............................................................

2015 2014 $(20,000) (40,000) (60,000) $(40,000)

$30,000

30,000 $(60,000) $ (10,000)

$30,000

Annual entry: Taxes receivable (payable) ..................................... Deferred tax asset (25% x $5 K) ............................. Deferred tax asset (30% x $70 K) ........................... Tax expense (benefit) ............................................. NOTE: The deferred tax asset at year-end 2015 is $21,000. Effective tax rate & YTD tax benefit: Annual expense (benefit) ........................................ Annual income (loss) ............................................... Effective rate ............................................................ YTD operating (loss) ............................................... YTD tax (benefit) .....................................................

DR (CR)

2,500 3,500 (3,500)

(2,500)

(3,500) (30,000) 11.67% 50,000 5,833

19,750 (19,750)

2013

DR (CR) 4,500 1,250

DR (CR) (4,500)

(5,750)

4,500

(19,750) (60,000) 32.92% (20,000) (6,583)

12–11

Ch. 12—Exercises

EXERCISE 12-6 Quarter 1

Quarter 2

YTD pretax income (loss) ............................. Projected pretax income (loss) ..................... Estimated annual income .............................. Permanent differences .................................. Estimated adjusted income ...........................

Originally Stated $ 800,000 1,100,000 $1,900,000 — $1,900,000

Continuing $1,020,000 1,420,000 $2,440,000 — $2,440,000

Statutory tax: At 30% rate on first $1,500,000............... At 35% rate thereafter ............................. Total statutory tax.................................... Tax credits .................................................... Net tax...........................................................

$ 450,000 140,000 $ 590,000 29,500 $ 560,500

$ 450,000 329,000 $ 779,000 29,500 $ 749,500

$ 450,000 383,250 $ 833,250 15,000 $ 818,250

Effective tax rate ...........................................

29.50%

30.72%

31.53%

Type of Income Continuing Op. Continuing Op. Discontinued Continuing Op. Discontinued

Interim Quarter First First—Restated First—Restated Second Second

Pretax Income (Loss) Current Period Year-to-Date $ 800,000 $ 800,000 1,020,000 1,020,000 (220,000) (220,000) 525,000 1,545,000 (480,000) (700,000)

Discontinued $(220,000) (320,000) $(540,000) $(540,000)

Effective Tax Rate 29.50% 30.72% Note A 31.53% Note B

Continuing $1,545,000 1,050,000 $2,595,000 — $2,595,000

Discontinued $(700,000) — $(700,000) $(700,000)

Tax Expense (Benefit) Previously Current Year-to-Date Reported Period $ 236,000 $ — $ 236,000 313,344 — 313,344 (77,344) — (77,344) 487,139 173,795 313,344 (245,000) (77,344) (167,656)

Note A: The difference between the first and first restated continuing operations is the tax benefit attributed to the discontinued operations. Note B: Annual income (loss) ............................ Annual net tax expense (benefit)..........

Continuing Operations $2,595,000 818,250

All Sources $1,895,000 573,250

[(30% × $1,500,000) + (35% × $395,000) – $15,000]

The difference between $818,250 and $573,250 represents the tax benefit associated with the discontinued operation.

part.

Ch. 12—Exercises

12–12

EXERCISE 12-7

First-quarter income (loss) ................... Second-quarter income (loss) .............. YTD income (loss) ............................... Projected income (loss) ....................... Total annual ......................................... Estimated tax benefit: Carryback to 2015: On first $50,000 @ 15% ........... On next $25,000 @ 25% .......... On next $25,000 @ 34% .......... Carryback to 2016: On first $50,000 @ 15% ........... On next $25,000 @ 25% .......... Total tax benefit..............................

Quarter 1, 2017 Before After Change Change $ 40,000 $ 70,000 — — $ 40,000 $ 70,000 (155,000) (210,000) $(170,000) $ (85,000)

Quarter 2, 2017 Before After Change Change $ 40,000 $ 70,000 (30,000) (10,000) $ 10,000 $ 60,000 (150,000) (130,000) $(140,000) $ (70,000)

$ 7,500 6,250 8,500

$ 7,500 6,250 3,400

$ 7,500 6,250 8,500

$ 7,500 5,000 —

7,500 2,500 $32,250

— — $17,150

6,000 — $28,250

— — $12,500

Estimated rate of benefit ......................

18.97%

20.18%

17.86%

Quarter tax expense (benefit): YTD pretax income (loss)............... Effective tax rate per above ........... YTD tax expense (benefit) ............. Prior quarter expense (benefit) ...... Current quarter expense (benefit) ..

$ 40,000 × 18.97% $ 7,588 — $ 7,588

$ 70,000 × 20.18% $ 14,126 — $ 14,126

$ 10,000 × 20.18% $ 2,018 7,588 $ (5,570)

$ 60,000 × 17.86% $ 10,716 14,126 $ (3,410)

12–13

Ch. 12—Exercises

EXERCISE 12-8

Continuing income (loss) .................. Nonordinary item A ........................... Nonordinary item B ........................... Nonordinary item C ........................... Pretax income (loss) ......................... Tax expense (benefit) .......................

Ordinary Income $60,000 — — — $60,000 $10,000

Total Income $ 60,000 (30,000) 25,000 5,000 $ 60,000 $ 10,000

Total Excluding Nonordinary Loss (A) $60,000 — 25,000 5,000 $90,000 $18,850

Estimated tax: On first $50,000 @ 15% .............. On next $25,000 @ 25% ............. On next $25,000 @ 34% ............. Total estimated tax ......................

$ 7,500 2,500 — $10,000

$ 7,500 6,250 5,100 $18,850

Incremental tax expense (benefit) traceable to: All nonordinary items ($10,000 – $10,000) ................................ All nonordinary losses ($10,000 – $18,850)............................... All nonordinary gains [$0 – ($8,850)] .........................................

Total Excluding Nonordinary Gain (B & C) $ 60,000 (30,000) — — $ 30,000 $ 4,500 $4,500 — — $4,500

$ 0 (8,850) $ 8,850

Ordinary Income $60,000 — — — $60,000 $10,000

Total Income $ 60,000 (30,000) 25,000 5,000 $ 60,000 $ 10,000

Total Excluding Item B $ 60,000 (30,000) — 5,000 $ 35,000 $ 5,250

Total Excluding Item C $ 60,000 (30,000) 25,000 — $ 55,000 $ 8,750

Calculation of tax expense (benefit): On first $50,000 @ 15% .............. On next $25,000 @ 25% ............. Total estimated tax ......................

$ 7,500 2,500 $10,000

$5,250 — $5,250

$7,500 1,250 $8,750

$4,750 1,250 $6,000

Percent of Total 79.2% 20.8 100.0%

Incremental tax expense (benefit) traceable to: Item B ($10,000 – $5,250) ................................. Item C ($10,000 – $8,750) ................................. Total ...................................................................

Ratable allocation of $8,850 tax expense on nonordinary gains (items B and C): Item B .......................................... Item C..........................................

(79.2% × $8,850) (20.8% × $8,850)

$7,009 1,841 $8,850

Ch. 12—Exercises

12–14

EXERCISE 12-9 (1) It seems most likely that the area of oils and lubricants could be combined with the distribution of specialized tools. Both areas share a number of similarities including serving the same customer base for their products, size and growth of markets, economic and/or regulatory factors influencing the area, and nature of the products (used by repair centers). Certainly, there are some differences such as the type of distribution, wholesale or not, but the similarities seem to outweigh the dissimilarities. (2) Determination of whether segments are reportable:

Segment Oil and lubricants ........... Jet engine repair ............ Specialized tools ............ Truck leasing .................

Is Segment’s Absolute Value of Revenue Profit/Loss Assets 10% or More of 10% or More of 10% or More of $30,750,000? $4,514,200? $32,660,000? Yes Yes Yes No

Yes Yes Yes Yes

No Yes No Yes

Is Segment Reportable? Yes Yes Yes Yes

(3) Items that may comprise the reconciliation of segment totals to companywide totals may include the following: • Not all segments are reportable. • Corporate-level components of other income such as interest income, extraordinary gains, nonrecurring items of income. • Corporate-level components of other expense such as interest expense and gains on the disposal of assets. • Items that are not capable of being allocated to segments on a reasonable basis such as outside professional fees, liability insurance, and certain management salaries (HR, controllership, legal). • Items are not allocated to the reportable segments because they are not part of the information that is used by the chief operating decision maker as a basis for evaluating performance and allocating resources. • The accounting methods used to determine reportable segments may be different from those used to prepare consolidated totals. • The profits that are traceable to intersegment transactions that are included in segment totals but eliminated in the process of preparing consolidated corporate level financial statements.

12–15

Ch. 12—Exercises

EXERCISE 12-10 Determination of whether segments are reportable: Revenues Intersegment $ 0 3,400,000 0 2,700,000 $6,100,000

Total $ 82,000,000 15,400,000 45,000,000 24,700,000 $167,100,000

Total of all reported profits ........................................................................... Total of all reported losses ...........................................................................

$ 29,700,000 (13,600,000)

Segment Film Studios ............................................ Software Development ............................ Leisure Clothing ...................................... Office Design Group ............................... Total ........................................................

External $ 82,000,000 12,000,000 45,000,000 22,000,000 $161,000,000

Revenue 10% or More of $167,100,000? Yes No Yes Yes

Is Segment’s Absolute Value of Profit or Loss 10% or More of $29,700,000? Yes No Yes Yes

Reported Profit (Loss) $(11,000,000) (2,600,000) 23,000,000 6,700,000 $ 16,100,000

Assets 10% or More of $61,400,000? Yes No Yes No

Significance of reportable segments: Consolidated revenue ............................................................................................................... Percentage requirement............................................................................................................ Dollar requirement..................................................................................................................... External revenue of all reportable segments.............................................................................

Is Segment Reportable? Yes No Yes Yes

$177,000,000 × 75% $132,750,000 $149,000,000

Conclusion: The reportable segments represent a significant portion of the entity.

Assets $38,000,000 5,400,000 13,000,000 5,000,000 $61,400,000

part.

Ch. 12—Problems

12–16

PROBLEMS PROBLEM 12-1 Pretax Income (Loss)

Tax Expense (Benefit)

Quarter

Current Period

Year-toDate

Effective Tax Rate

Year-toDate

Previously Reported

Current Period

1 2 3

$(150,000) 120,000 97,000

$(150,000) (30,000) 67,000

16.00% 33.75% 31.55%

$(24,000) (10,125) 21,139

$ — (24,000) (10,125)

$(24,000) 13,875 31,264

Schedule of Estimated Effective Tax Rates Quarter 1 Quarter 2

YTD income (loss): First quarter ........................................... Second quarter ...................................... Third quarter .......................................... Total ....................................................... Projected income (loss) ................................ Total annual income (loss) ............................ Plus nondeductible expenses ....................... Less nontaxable income ............................... Taxable income (loss) ................................... Tax expense if taxable income: Tax at statutory rate ............................... Less tax credit ....................................... Tax expense .......................................... Estimated rate of tax expense ...............

Tax benefit if a taxable loss: Carryback to 2009 (See Note A) ........... Carryback to 2010: Amount of income to be carried back against .................................. Rate of tax ......................................... Amount of benefit .............................. Plus tax credit carryback: Carryback to 2009 ............................. Carryback to 2010 (Note B) .............. Tax benefit ............................................. Estimated rate of tax benefit ..................

$(150,000) $(150,000) (75,000) $(225,000) 22,000 — $(203,000)

$(150,000) 120,000 — $ (30,000) (50,000) $ (80,000) 15,000 (5,000) $ (70,000)

Not applicable

Quarter 3 $(150,000) 120,000 97,000 $ 67,000 33,000 $ 100,000 20,000 (7,000) $ 113,000 $ 39,550 (8,000) $ 31,550 31.55%

— $ 120,000 30.00% $ 36,000

$ 70,000 30.00% $ 21,000

— — $ 36,000 16.00%

— 6,000 $ 27,000 33.75%

Note A: The 2009 taxable loss of $75,000 would have been carried forward against the taxable income in 2010 of $195,000. Therefore, the only taxable income against which the 2011 projected taxable loss can be carried back against is the $120,000 of taxable income remaining available from 2010. If all of the 2010 remaining income available is not offset by the 2011 estimated annual loss, some of the 2011 tax credit may also be carried back against the net tax paid in 2010. Note B: Since the estimated annual taxable loss of $70,000 projected at the end of quarter 2 would only absorb part of the $120,000 of available income in 2010, there is still $50,000 of income available. That $50,000 of income would have been taxed at 30% for a tax of $15,000. The $6,000 of tax credit could clearly be carried back against that remaining tax of $15,000.

12–17

Ch. 12—Problems

PROBLEM 12-2

YTD income ........................................................ Projected income ................................................ Estimated annual income ....................................

Quarter 1 Original $(45,000) (25,000) $(70,000)

Quarter 1 Continuing $(30,000) 15,000 $(15,000)

Statutory tax rate .................................................

32%

Tax (benefit) of NOL carryback to prior two years Tax expense on estimated income ..................... Tax credits .......................................................... Net tax expense (benefit) ....................................

Effective tax rate .................................................

Interim Period (quarter) First First—Restated First—Restated Second Second Third Third

Type of Income Continuing Op. Continuing Op. Discontinued Continuing Op. Discontinued Continuing Op. Discontinued

Quarter 2 Continuing $28,000 62,000 $90,000

Quarter 3 Continuing $ 68,000 42,000 $110,000

32%

— $(6,400)

$(4,440) — (1,960)b $(6,400)

$28,800 (5,000) $23,800

$35,200 (8,000) $27,200

9.14%

42.67%

26.44%

24.73%

$(6,400)

Pretax Income (Loss) Current YearPeriod to-Date $(45,000) $(45,000) (30,000) (30,000) (15,000) (15,000) 58,000 28,000 c (57,000) (72,000) 40,000 68,000 (13,000)d (85,000)

Effective Tax Rate See a See b See b 26.44% Note A 24.73% Note B

Quarter 1 DISCO $(15,000) (40,000) $(55,000)

Tax Expense (Benefit) YearPreviously Current to-Date Reported Period $ (6,400) $ — $ (6,400) (6,400) — (6,400) — — — 7,403 13,803 (6,400) (23,040) — (23,040) 16,816 7,403 9,413 (27,200) (23,040) (4,160)

Because there is no future income that is “more likely than not” and there were carrybacks available, the tax benefit can only be found by adding the tax expense in the past two years [($12,000 × 30%) + ($10,000 × 28%)].

Because there is no future income that is “more likely than not” and there were carrybacks available, the tax benefit can only be found by carrying the $15,000 loss and tax credit back to the past two years [($12,000 × 30%) + ($3,000 × 28%) + $1,960 of tax credit].

($15,000) + ($42,000)

($30,000) + $25,000 + ($42,000 – $34,000) + ($16,000)

part.

Ch. 12—Problems

12–18

Problem 12-2, Concluded Note A:

Ordinary Income All Sources Annual income (loss) ....................... $90,000 $18,000 Annual net tax expense (benefit)..... 23,800 760 [(32% × $18,000) – $5,000] The difference between $23,800 and $760 represents the tax benefit associated with the discontinued operation.

Note B:

Ordinary Income All Sources Annual income (loss) ....................... $110,000 $25,000 Annual net tax expense (benefit)..... 27,200 — [(32% × $25,000) – $8,000] The difference between $27,200 and $0 represents the tax benefit associated with the discontinued operation.

12–19

Ch. 12—Problems

PROBLEM 12-3 Radix, Inc. Interim Income Statements

Net sales (see Schedule A) ................................................. Cost of sales (see Schedule B) ............................................ Gross profit .......................................................................... Selling, general, and administrative ..................................... Income before taxes ............................................................ Income taxes (see Schedule C) ........................................... Net income ...........................................................................

For the Second Quarter Ended June 30, 2011

For the Year-To-Date Ended June 30, 2011

$2,690,000 2,097,200 $ 592,800 210,000 $ 382,800 125,435 $ 257,365

$4,050,000 3,209,200 $ 840,800 322,000 $ 518,800 166,235 $ 352,565

Schedule A—Net Sales First quarter of 2011 ..................................................... Second quarter of 2011: Compressor components........................................ Oil and lubricants .................................................... Total ..............................................................................

$1,360,000 2,150,000 540,000 $4,050,000

Schedule B—Cost of Sales First quarter of 2011 ..................................................... Second quarter of 2011: Compressor business Current-year costs ........................................................ 2010 units: 2,100 units at $72/unit .................................................. Total .............................................................................. Oil and lubricant business Cost before market adjustments ................................... Reversal of first-quarter market adjustment.................. Total .............................................................................. Grand total ....................................................................

$1,112,000

$1,564,000 151,200 $1,715,200 $ 364,000 18,000 $ 382,000 $3,209,200

Ch. 12—Problems

12–20

Problem 12-3, Concluded Schedule C—Income Taxes YTD income: First quarter ............................................................ Second quarter ....................................................... Subtotal................................................................... Projected income .......................................................... Total annual income ..................................................... Plus nondeductible expenses ....................................... Taxable income ............................................................ Estimated tax: On first $50,000 @ 15% ......................................... On next $50,000 @ 25% ........................................ On the next $150,000 @ 30% ................................ On remaining amount @ 35% ................................

$136,000 382,800 $518,800 438,000 $956,800 32,000 $988,800 $

Less tax credit .............................................................. Net tax .......................................................................... Effective tax rate ...........................................................

7,500 12,500 45,000 258,580 $323,580 (17,000) $306,580 32.04%

YTD income .................................................................. Effective tax rate ........................................................... YTD tax expense .......................................................... Less first-quarter tax expense ...................................... Second-quarter tax expense ........................................

$518,800 32.04% $166,235 40,800 $125,435

12–21

Ch. 12—Problems

PROBLEM 12-4 Item A

The first quarter is being restated due to a decision to discontinue an operation in the second quarter. Therefore, the original pretax income (loss) reported for the first quarter must be allocated between continuing and discontinued operations. If the original pretax income was $70,000 and the discontinued operation accounts for a $30,000 loss, then the amount traceable to the restated continuing component must be $100,000 (the value of A). The two restated components, continuing and discontinued, now have pretax amounts that total the original amount [$100,000 + ($30,000) = $70,000].

Item B

Effective tax rate for quarter 1—restated income from continuing operations:

YTD income (loss)—see item A above .................................................... Projected income (loss) ($60,000 + $40,000) .......................................... Total annual income (loss) ....................................................................... Carryforward of 2013 loss ........................................................................ Estimated annual taxable income ............................................................

Quarter 1 Restated $100,000 100,000* $200,000 (80,000) $120,000

*The original amount included a $40,000 loss that is now part of discontinued operations. Estimated tax: On first $50,000 @ 15% ..................................................................... On next $50,000 @ 20% .................................................................... On next $50,000 @ 25% .................................................................... Remaining income @ 30% .................................................................

Item C

Less tax credit Net tax ......................................................................................................

7,500 10,000 5,000 — $ 22,500 (5,000) $ 17,500

Effective tax rate ($17,500/$200,000) ...................................................... Quarter 1—restated continuing income.................................................... Tax expense (the value of B) ...................................................................

8.75% $100,000 $ 8,750

The tax expense (benefit) traceable to the continuing and discontinued components of restated quarter 1 must total the tax expense originally reported for quarter 1 as follows: Tax expense (benefit) traceable to restated: Continuing operations ........................................................................ Discontinued operations (the value of C) ........................................... Tax expense originally reported for quarter 1...........................................

$ 8,750 (7,406) $ 1,344

Ch. 12—Problems

12–22

Problem 12-4, Continued Item D

Tax expense for quarter 2 income from continuing operations: Quarter 1—restated income (loss) ........................................................... Quarter 2 income (loss) ............................................................................ YTD income (loss) .................................................................................... Projected income (loss) ............................................................................ Total annual income (loss) ....................................................................... Carryforward of 2013 loss ........................................................................ Estimated annual taxable income ............................................................ Estimated tax: On first $50,000 @ 15% ..................................................................... On next $50,000 @ 20% .................................................................... On next $50,000 @ 25% .................................................................... Remaining income @ 30% .................................................................

Item E

Quarter 2 $100,000 50,000 $150,000 60,000 $210,000 (80,000) $130,000

Less tax credit .......................................................................................... Net tax ......................................................................................................

7,500 10,000 7,500 — $ 25,000 (5,000) $ 20,000

Effective tax rate ($20,000/$210,000) ...................................................... YTD income ............................................................................................. YTD tax expense (the value of D) ............................................................

9.52% $150,000 $ 14,280

YTD income (loss) from discontinued operations consists of: Quarter 1—restated.................................................................................. Quarter 2: Operating loss .................................................................................... Realized loss on disposal ................................................................... Impairment loss .................................................................................. The value of E ....................................................................................

$ (30,000) (60,000) (25,000) (30,000) $(145,000)

12–23

Ch. 12—Problems

Problem 12-4, Concluded Item F

Total Excluding Total Nonordinary Income Loss

Ordinary Income

Total Excluding Nonordinary Gain

Pretax income (loss): Continuing .......................... $210,000 Discontinued....................... — Extraordinary ...................... — Pretax income (loss) ........... $210,000 Tax expense (benefit)......... $ 20,000

$ 210,000 (145,000) 20,000 $ 85,000 $ —

$210,000 — 20,000 $230,000 $ 25,000

$ 210,000 (145,000) — $ 65,000

Taxable income: Pretax income (loss) ........... $210,000 2013 loss ............................ (80,000) Taxable income .................. $130,000

$ 85,000 (80,000) $ 5,000

$230,000 (80,000) $150,000

$ 65,000 (80,000) $ (15,000)

Estimated tax: On first $50,000 @ 15% ..... $ 7,500 On next $50,000 @ 20% .... 10,000 On next $50,000 @ 25% .... 7,500 Remaining income @ 30% . — $ 25,000 Less tax credit .......................... (5,000) Net tax ...................................... $ 20,000

750 — — — — (750) —

7,500 10,000 12,500 — $ 30,000 (5,000) $ 25,000

Incremental tax expense (benefit) traceable to: All nonordinary items ($0 – $20,000) .......................... All nonordinary losses ($0 – $25,000) .........................

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

$ $

The discontinued operation is the only nonordinary loss. Therefore, there is a $25,000 tax benefit (the value of F) traceable to the discontinued item.

Ch. 12—Problems

12–24

PROBLEM 12-5 Corrected Income Statement For the second Quarter of 2015 Sale revenue (see Schedule A) ........................................... Less: Sales returns & allowances ........................................ Net sales .............................................................................. Cost of sales (see Schedule B) ............................................ Gross profit .......................................................................... Selling, general & administrative (see Schedule C) ............. Net income before taxes ...................................................... Income taxes (see Schedule D) ........................................... Net income from continuing operations ...............................

$295,000 (14,000) $281,100 153,000 128,000 68,000 60,100 9,071 $ 50,929

Schedule A This represents the $280,000 plus the $15,000 that should have been recorded as a correction of error in the first quarter 2015 and 2014 income. Schedule B Cost of sales as reported ..................................................... Less: Annual inventory shrinkage ........................................ Subtotal ........................................................................... Error in reporting correction of error ..................................... Subtotal ........................................................................... LIFO liquidation adjustment: Number of units liquidated ............................................. Excess replacement cost ($9 vs $7) .............................. Subtotal ........................................................................... Allocated estimate of inventory shrinkage @ 2% ................. Adjusted balance ....................................................................

$145,000 (10,000) 135,000 9,000 144,000 3,000 2.0

6,000 150,000 3,000 $153,000

Schedule C Selling, general & administrative as reported....................... Health care insurance expense: Number of units liquidated ............................................. Correct expense included (allocate of two quarters) ...... Contract research costs: Incorrect expense included ............................................ Correct expense included (allocate of three quarters) ... Sales convention expense ................................................... Adjusted balance..................................................................

$41,000 12,600 (6,300) 21,000 (7,000)

6,300 14,000 6,700 $68,000

12–25

Ch. 12—Problems

Schedule D

2013

Quarter 1 2015

2014

Quarter 2 2015

Pretax income (loss) as previously reported .............. Corrections per schedule A through C ....................... Correction of sales ..................................................... Correction of cost of sales .........................................

$(50,000) $20,000 $(48,000)

Corrected pretax income (loss) .................................

$(44,000) $20,000 $(54,000)

$60,000

Tax expense (benefit) as previously Pretax income (loss) as previously reported ..............

$(7,500) $

$16,000

Corrected tax expense (benefit): 44,000 @ 15% ..................................................... 20,000 @15% ...................................................... - 54000 @ 15% .................................................... 6,000 YTD@ 16.19% less prior quarter YTD of $(8,100)

15,000 (9,000)

$70,000 (10,000)

(15,000) 9,000

0 $

$(6,600) $3,000 $ (8,100) $9,071

YTD income (loss) .................................................... Projected income (loss) ............................................ Total annual income (loss) ........................................

Quarter 1 2013 2014 2015 $(44,000) $20,000 $(54,000) 100,000 $(44,000) $ 20,000 46,000

Quarter 2 2015 $6,000 78,000 84,000

Less net operating loss carryforward from 2013 ........

(20,000)

(24,000)

Taxable income (Loss) ..............................................

$(44,000)

$22,000

$60,000

Annual entry: Taxes payable ...................................................... Deferred tax asset ................................................ Tax expense (benefit) .........................................

DR (CR) DR (CR) DR (CR) $ 0 $ 0 $ (3,300) $ 6,600 $(3,000) $ (3,600) $(6,600) $ 3,000 $ 6,900

DR (CR) $ (10,000) $ (3,600) $ 13,600

Estimated effective annual tax rate: 6,900 / 46,000 ............................................................ 13,600 / 84,000 ..........................................................

15.00%

The amounts impacting 2013 and 2014 will be recorded as a correction of an error.

16.19%

Ch. 12—Problems

12–26

PROBLEM 12-6 1.

The identification of a segment is based on a “management approach,” which focuses on how management organizes information about business components for purposes of making management decisions and assessing performance. In this particular case, the distribution of the products must be viewed as a single operating segment based on the management approach. This may be explained by a number of factors such as common distribution channels, marketing, retail sales stores (example: large grocery stores), and sales area.

Revenues traceable to segments generally do not agree with consolidated amounts for several reasons. First, segmental revenues include intersegment sales or revenues that are eliminated for the purpose of determining consolidated revenues. It is also possible that certain components of revenue are traceable to corporate-level activities (example: rental income) and are therefore not allocated to operating segments.

Public companies are required to disclose segmental data; therefore, such information is publicly available to a wide variety of parties including one’s competitors. Obviously, the more information that is publicly available allows competitors to have increased insight into how a company operates and its respective performance. Therefore, from a competitive standpoint, it would be better to have fewer segments that are broadly defined rather than many narrowly defined segments that disclose more information. For example, consider a company that manufactures automobile batteries and automobile interior seating. If these two products were combined into a single segment per the management approach, it would be harder for a competing manufacturer of automobile batteries to know how much of revenues, capital expenditures, and other required segmental disclosures are traceable to just the automobile battery component.

The determination as to whether or not a segment is considered reportable is based on several mutually exclusive criteria. In addition to considering reported revenues, reported profits or losses and/or asset totals may be used as a basis for determining whether or not a segment is reportable.

Interest expense on corporate bonds payable may be allocated to segments if such information is considered by the chief operating decision maker of an entity for purposes of decision making and performance evaluation related to a particular segment. However, it would typically seem more likely that such interest expense would not be allocated to a particular segment unless the capital provided by the bond proceeds could be directly allocated to a particular segment. It is highly likely that interest expense on corporate bonds would be considered as part of the corporate-level profit or loss.

Once again, it is important to remember that segmental net sales would include intersegment net sales that are eliminated for purposes of reporting consolidated company-wide net sales. Therefore, if there are intersegment sales, it is likely that the total of segmental net sales will exceed net sales for the entire company.

12–27

Ch. 12—Problems

Problem 12-6, Concluded 7.

The statement of cash flows reports cash flows from operations, investing, and financing. Certainly some, but not all, of the key information necessary to determine cash flows can be derived from segmental reports. For example, depreciation expense for a segment could be added back to the segment’s net profit or loss to give a rough measure of cash flows from operations. Obviously, changes in net working capital are not available to complete a measure of cash flows from operations. Information about a segment’s capital expenditures would provide important information regarding investing cash outflows. A complete measure of a segment’s cash flows cannot be derived from segmental reports; however, rough measures of certain areas of cash flow are possible. It would seem that the most difficult area to measure would be cash flows from financing in that the activities impacting these cash flows are not typically allocated to reportable segments.

Ch. 12—Problems

12–28

PROBLEM 12-7 (1) Determination of whether segments are reportable: Total $ 23,890,000 73,111,000

Reported Profit (Loss) $ 90,000 44,689,000

Assets $28,220,000 36,320,000

0 964,000 $16,345,000

5,360,000 4,264,000 $106,625,000

(107,000) (3,698,000) $40,974,000

6,750,000 6,015,000 $77,305,000

Total of all reported profits................................................................... Total of all reported losses ..................................................................

$44,779,000 (3,805,000)

Segment Semiconductors ............................... Control Devices ............................... Educational and Productivity Solutions .................................. Financing Activities .......................... Total .................................................

Revenues External Intersegment $19,920,000 $ 3,970,000 61,700,000 11,411,000 5,360,000 3,300,000 $90,280,000

Semiconductors ........................................... Control Devices ........................................... Educational and Productivity Solutions ....... Financing Activities ......................................

Revenue 10% or More of $106,625,000? Yes Yes No No

Is Segment’s Absolute Value of Profit or Loss 10% or More of $44,779,000? No Yes No No

Assets 10% or More of $77,305,000? Yes Yes No No

Consolidated revenue ................................................................................. Percentage requirement ............................................................................. Dollar requirement ......................................................................................

$98,568,000 × 75% $73,926,000

External revenue of all reportable segments ..............................................

$81,620,000

Is Segment Reportable? Yes Yes No No

Conclusion: The reportable segments represent a significant portion of the entity.

part.

12–29

Ch. 12—Problems

Problem 12-7, Continued (2) Presentation of segmental values: Reportable Segments Semiconductors Control Devices Revenues from: External customers .................................................. Intersegment sales ................................................... Total revenues....................................................

$19,920,000 3,970,000 $23,890,000

$61,700,000 11,411,000 $73,111,000

Segment profit (loss).....................................................

90,000

$44,689,000

Segment assets ............................................................

$28,220,000

$36,320,000

Reconciliation to Consolidated Revenue and Profit: Revenues Total revenues for reportable segments ......................................... Revenues for nonreportable segments........................................... Elimination of intersegment revenue .............................................. Corporate-level revenues ............................................................... Total consolidated revenues ........................................................... Profit or loss Total profit or loss for reportable segments .................................... Profit or loss of nonreportable segments ........................................ Elimination of intercompany profit................................................... Corporate-level: Revenues ................................................................................ Expenses................................................................................. Total consolidated pretax income ................................................... Assets Total assets for reportable segments ............................................. Assets of nonreportable segments ................................................. Elimination of intersegment assets related to intersegment sales .. Corporate-level assets .................................................................... Total consolidated assets ...............................................................

$ 97,001,000 9,624,000 (16,345,000) 8,288,000 $ 98,568,000 $ 44,779,000 (3,805,000) (700,000)* 8,288,000 (7,020,000) $ 41,542,000 $ 64,540,000 12,765,000 (700,000)* 23,000,000 $ 99,605,000

*This represents the intercompany profit on the inventory sold by the Control Devices segment.

Ch. 12—Problems

12–30

Problem 12-7, Continued Business Segment and Geographical Area Data The company presented manufactures, develops, and sells a diverse range of electronic equipment and parts. Its primary targets are consumer and industrial markets. The company’s control device manufacturing is the company’s strongest line and together with its semiconductor technology is rapidly expanding into the global market. The company presented has four predominate businesses: Semiconductors, Control Devices, Educational and Productivity Solutions, and Financing Activities. They are all business segments and are presented in this report. The Semiconductors segment uses innovative technology to produce semiconductor chips. The chips are sold mainly to equipment engineers and manufacturers. The Semiconductors segment will also customize semiconductor chips to suit customer specifications. The Control Devices segment consists mainly of electrical control devices. The control device customer base is primarily equipment engineers and manufacturers. Control devices are also custom-ordered to suit a manufacturer’s or engineer’s specific needs. Educational and Productivity Solutions produce educational and time-efficient devices. The products are sold primarily through retailers and over the Internet. The company’s Financing Activities segment holds a diversified portfolio of investments. It also holds several royalty and licensing agreements with operating segments in several different countries. Business Segment Revenues (Including Intersegment)**

Semiconductors ............................................................ Control Devices ............................................................ Educational and Productivity Solutions......................... Financing Activities ....................................................... Total ..............................................................................

Revenues External Intersegment $19,920,000 $ 3,970,000 61,700,000 11,411,000 5,360,000 0 964,000 3,300,000 $90,280,000 $16,345,000

Business Segment Profit (Loss)**

Reported Profit (Loss) $ 90,000 44,689,000 (107,000) (3,698,000) $40,974,000

12–31

Ch. 12—Problems

Problem 12-7, Continued Business Segment Assets** Semiconductors ............................................................ Control Devices ............................................................ Educational and Productivity Solutions......................... Financing Activities ....................................................... Total ..............................................................................

Assets $28,220,000 36,320,000 6,750,000 6,015,000 $77,305,000

Based on the answer in part (1), students may appropriately combine the Educational and Productivity Solutions and the Financing Activities segments in a category labeled “other segments.” Geographic Area Revenues (Excluding Intersegment)** United States ................................................................ Japan ............................................................................ Germany ....................................................................... Other International ........................................................ Total ..............................................................................

Revenues $40,950,000 36,157,300 8,083,200 13,377,500 $98,568,000

Geographic Area Long-Lived Assets** United States ................................................................ Japan ............................................................................ Germany ....................................................................... Other International ........................................................ Total ..............................................................................

Assets $33,377,000 20,332,900 5,566,000 7,688,100 $66,964,000

**If available, comparison data for prior years would be included in the presentations.

Ch. 12—Problems

12–32

Problem 12-7, Concluded (3) Several ratios that may be helpful in analyzing segmental information are as follows: Educational and Control Productivity Semiconductors Devices Solutions $90,000 $44,689,000 ($107,000) Return on assets* $28,220,000 $36,320,000 $6,750,000

Operating profit margin

Total asset turnover*

Fixed asset turnover*

Financing Activities

Total

($3,698,000) $6,015,000

$40,974,000 $77,305,000

0.32%

123.04%

–1.59%

–61.48%

53.00%

$90,000 $23,890,000

$44,689,000 $73,111,000

($107,000) $5,360,000

($3,698,000) $4,264,000

$40,974,000 $106,625,000

0.38%

61.12%

–2.00%

–86.73%

38.43%

$23,890,000 $28,220,000

$73,111,000 $36,320,000

$5,360,000 $6,750,000

$4,264,000 $6,015,000

$106,625,000 $77,305,000

0.85

2.01

0.79

0.71

1.38

$23,890,000 $18,230,000

$73,111,000 $24,000,000

$5,360,000 $5,540,000

$4,264,000 $3,760,000

$106,625,000 $51,530,000

1.31

3.05

0.97

1.13

2.07

*If available, average assets/fixed assets would be used as the denominator. The geographical area disclosures could provide information regarding fixed asset turnover. Furthermore, one can develop a strong sense for market concentrations regarding geographical areas.

part.

12–33

Ch. 12—Problems

PROBLEM 12-8

(1) Presentation of segmental values: All Other Segments

Reportable Segments B

D $ 5,566,725 618,525 60,000

$ 1,374,500

48,000

$ 2,556,570 192,430 10,000

12,000

$13,521,295 810,955 130,000

100,000a $ 4,171,500

$ 2,759,000

$ 6,245,250

$ 1,386,500

100,000 $14,562,250

Segment profit (loss): Total revenues from above ... Cost of goods sold ................ General and administrativeb .. Profit (loss) ......................

$ 4,171,500 (2,154,000) (371,252) $ 1,646,248

$ 2,759,000 (2,082,200) (245,543) $ 431,257

$ 6,245,250 (1,723,200) (555,810) $ 3,966,240

$ 1,386,500 (1,220,600) (123,395) $ 42,505

$14,562,250 (7,180,000) (1,296,000) $ 6,086,250

Segment assets .........................

$ 8,048,000

$ 5,324,000

$ 4,490,000

$ 3,717,000

$21,579,000

A Revenues from: External customers ............... Intersegment sales ................ Interest revenue ......................... Gain on intersegment sale of fixed assets ........................... Total revenues.................

$ 4,023,500

Total

(2) Reconciliation of Significant Items to Consolidated Amounts Revenues Total revenues for reportable segments .......................................................... Revenues of nonreportable segments ($574,500 + $800,000 + $12,000) ...... Elimination of intersegment revenues and gain on sale of fixed assets .......... Corporate-level revenues ................................................................................ Total consolidated revenues ............................................................................

$13,175,750 1,386,500 (910,955) 0 $13,651,295

part.

Ch. 12—Problems

12–34

Problem 12-8, Concluded

Profit or Loss Total profit or loss for reportable segments ..................................................... Profit or loss on nonreportable segments ($1,386,500 – $1,220,600 – $123,395) ..................................................... Elimination of intersegment profits: Intersegment sales and gain on sale of fixed assets ....................................... Cost of goods sold ........................................................................................... General and administrative .............................................................................. Corporate-level: Revenues ($32,000 + $315,000) ............................................................... General and administrative (20% × $1,620,000) ....................................... Total consolidated pretax income from continuing operations.........................

347,000 (324,000) $ 6,007,143

Assets Total assets for reportable segments .............................................................. Assets of nonreportable segments .................................................................. Elimination of intersegment assets related to intersegment sales ................... Corporate-level assets ($115,000 + $1,737,000) ............................................ Total consolidated assets ................................................................................

$17,862,000 3,717,000 (102,107)d 1,852,000 $23,328,893

$ 6,043,745 42,505 (910,955) 798,848c 10,000a

Segment B should depreciate the original net book value of $200,000 over 10 years rather than the new selling price of $300,000 over 10 years. Therefore, depreciation expense should be $20,000 per year versus $30,000. The gain on the sale of $100,000 ($300,000 – $200,000) is included in Segment A’s total revenue.

The total revenue for all the segments is $14,562,250 (sales + interest revenue + gain on sale of fixed assets for all segments). The allocation of general and administrative expenses of $1,296,000 (80% × $1,620,000) is as follows: Segment A: ($4,171,500 ÷ $14,562,250) × $1,296,000 = $371,252 Segment B: ($2,759,000 ÷ $14,562,250) × $1,296,000 = $245,543 Segment D: ($6,245,250 ÷ $14,562,250) × $1,296,000 = $555,810 Other segments: ($1,386,500 ÷ $14,562,250) × $1,296,000 = $123,395

Segment B recorded a cost of $144,000 on the sale to Segment C. Segment C in turn recorded 75% of B’s selling price, or $144,323 (75% × $192,430), as cost of sales. The total cost recorded was $288,323 ($144,000 + $144,323). However, the actual cost of goods sold was 75% of B’s cost of $144,000, or $108,000. Therefore, $180,323 ($288,323 – $108,000) of cost should be eliminated along with the $618,525 cost of the goods purchased by Segment A from Segment D.

This represents the excessive net book value of $90,000 ($100,000 gain on sale – $10,000 excessive depreciation) on the equipment sold to B and the intercompany profit of $12,107 [($192,430 × 25% = $48,107) – $36,000] on the inventory purchased from B.

12–35

Ch. 12—Problems

PROBLEM 12-9

Date To:

Bank Lending Officer

From: Student Accountant Re:

Raymack Manufacturing - Questions related to segmental reporting

In regards to the above referenced item, please accept the following responses to your questions. 1.

The decision to report these areas as two segments may be due to a number of factors. Although both segments earn revenues and generate expenses, their operating results may be reviewed by separate chief operating decision makers for organizational purposes. Furthermore, the segaments appear to have distinctly different products and services, differ in terms of manufacturing process, and may have distinctly different ways of marketing their products and services. The real key to this question is how management organizes the information regarding the areas for the purpose of making operating decisions and assessing performance. If management views them separately for those purposes, then they best be viewed as separate segments.

Often the total of segmental net sales exceed consolidated net sales because segmental sales include intersegment sales that are eliminated in the reporting of consolidated sales.

A likely explanation as to why consolidated pretax income is greater than segmental pretax income is due to the fact that there are certain corporate sources of income that are not allocated to segments. For example, corporate level gains and losses on cash equivalents or investments and extraordinary gains may be examples of such items. It is also possible that some items of income are not allocated to segments because they are not part of the information that is evaluated by the chief operating decision maker or that allocated items are measured differently for segmental reporting purposes versus consolidated reporting. It is important to note that not all items of income can be allocated to segments on a reasonable basis.

Tax expense or benefit is normally viewed as a consolidated component of income and is not allocated to segments. However, the effective tax rate reported in consolidated statements could be applied to a segment's pretax operating results to get some sense of a measure of after tax performance. This is just an estimate and it is important to note that the effective consolidated tax rate may reflect activities that occur in a number of different tax jurisdictions and not the tax jurisdiction in which the particular segment operates.

On an entity wide basis, the total of all long-lived assets must be reported by geographical location whether or not they have been allocated to segments. The assets that must be reported by segments include all assets that can be reasonably allocated to the operation of the segment. Therefore, the identifiable assets include items in addition to long-lived assets such as cash, cash equivalents, receivables, inventory, and prepaid assets.

Ch. 12—Problems

12–36

In addition to reporting pretax operating income (loss), segments are required to report segmental assets. This allows for a calculation of return on assets. However, segments are not required to allocated shareholders' equity to segments thereby preventing the calculation of return on equity. Furthermore, U.S. GAAP does not require the reporting of liabilities allocated to segments which when subtracted from assets could be used to estimate equity. Generally speaking equity capital is raised to finance all operations of an entity and it may be difficult to allocate this capital to segments on a reasonable basis.

Both Germany and Spain are considered to be "European Countries". The allocation of sales to geographic segments is generally based on where the customer is or where the goods are shipped to and not based on where the sales is made (e.g., Michigan). In this case both of the customers are in Europe and both should be included in the European segment.

Obviously a number of variables can be measured in terms of growth. It would seem that growth in revenues, operating profit (loss), and identifiable assets would all be important variables for purposes of measuring growth. Perhaps even as important would be to relate these variable to each other. For example, growth in revenues relative to growth in assets or growth in profit relative to growth in revenues. It is also important to note that not all measures of growth would be applicable to all segments. For example, it is possible to have a segment that is very capital intensive such as manufacturing where investment in assets is a critical factor as compared to an segment that does human resource consulting and is less capital intensive.

CHAPTER 13 UNDERSTANDING THE ISSUES 1. Partnerships are generally less formal than other types of organizations and yet it is important to consider a number of factors in a partnership agreement. Individual partners have more legal exposure in a partnership because, unlike a corporation, partnerships are characterized by unlimited liability. However, limited partners, limited liability corporations, and limited liability partnerships provide for a significant reduction in such liability. Partnerships offer significant tax advantages over a corporation in that they are not taxed as a separate entity and, therefore, avoid double taxation issues. However, other types of tax option organizations are also available that avoid double taxation.

3. Unless the profit-sharing agreement states otherwise, all provisions of the agreement should be satisfied except the final allocation of any remaining profits. Rather than finally allocating any remaining profits, the profit/loss percentages would be used to allocate the resulting deficiency. In contemplation of such a condition, it is possible that a profit-sharing agreement would call for satisfying each provision, in order of priority, to whatever extent possible. In the case of a loss, the only provision that could be satisfied would be that which allocates the loss between the partners per their profit/loss percentages. 4. Generally speaking, a partner’s capital account would be debited for the following: their share of any partnership losses, the closing of the drawing account to capital, and any withdrawals whose amount is deemed to be excessive per the partnership agreement and therefore to be considered as a direct reduction of capital.

2. The use of a salary or bonus as a means of allocating profits would be appropriate when there is a desire to reward partners for personal services or significant personal time commitments to the partnership. The use of interest on capital as a means of allocating profits would be appropriate when the business is capital intensive versus labor intensive or if the partners are not significantly involved in the day-to-day operations.

Ch. 13—Exercises

13–2

EXERCISES EXERCISE 13-1 1.

Investors in a partnership are not issued stock and have a capital balance rather than a capital stock at par value account. Regarding the question of legal liability, a partnership is characterized by unlimited liability in that claims against the partnership can proceed against individual partners’ net assets if necessary. Therefore, unlike in the case of a corporation, there is no level of minimum liability. It is possible, however, to structure a partnership as a limited partnership in which case a limited partner’s liability may not extend to their personal net assets.

A partnership is not a separate distinct taxable entity for income tax purposes; therefore, the balance sheet would have no income tax accruals and the income statement would not include a related tax expense account. The pretax income of a partnership is allocated to the individual partners, and the respective income tax is assessed at the individual partner level.

Salaries in a partnership are considered to be an allocation component for the purpose of allocating profits rather than an expense of the partnership. The absence of a salary expense does not mean that partners did not receive consideration equal to the salary amount. However, the consideration received is recorded as a draw or direct reduction of capital rather than an expense. Obviously, if one were comparing a partnership’s net income to that of a corporation in which employed shareholders’ salaries are shown as an expense, the partnership income statement should be adjusted to reflect some level of salaries in order to improve comparability.

As is the case with salaries, interest on capital balances is a component for the purpose of allocating profits rather than an actual expense of the partnership. If consideration is conveyed to a partner in an amount equal to their interest on invested capital, the consideration conveyed would be classified as a draw or direct reduction of capital rather than an expense. The purpose of allocating some portion of profits as interest on invested capital is to recognize that in certain cases a partner’s contribution to the profits of an entity is highly dependent on the level of their capital contribution. If significant capital were not retained in a partnership, the partner could invest such capital in alternative ways and receive a return on investment. However, if the capital is retained in the partnership, the partner should be rewarded for their investment as they would be in any other set of circumstances.

13–3

Ch. 13—Exercises

EXERCISE 13-2 The students should employ the typical elements of a memo and be in good form. The content should reflect a number of concerns. The agreement appears to be reasonably clear in language and content. However, certain aspects do not seem to be equitable, including the following: a.

The partnership has the first right to acquire the withdrawing partner's interest which is normal. However, the consideration paid may be significantly less than what an individual might pay. A more appropriate approach might be a right of first refusal to match the consideration to be received from another party.

Basing the consideration paid in terms of the capital balance at the end of the fiscal quarter preceding notification fails to recognize the withdrawing partner's interest in profits and losses subsequent to the end of the prior quarter.

Using 60% of the capital balance is clearly designed to discourage a partner from withdrawing in that at least 100% would be more appropriate assuming that capital balances reflect current values.

Using capital balances prepared in conformity with GAAP certainly does not mean that the net assets of the partnership will be measured at their fair market value. Furthermore, there may be unrecorded assets that should be considered, such as the value of special arrangements, client files, and goodwill.

The financing of the consideration paid over 24 months fails to include an interest factor.

The anticipated major withdrawals of capital after year-end present a special problem. If a partner withdraws before that time, they will receive 60% of their capital balance. However, if they wait until the special withdrawal time, they will receive 100% of that withdrawal amount and then 60% of any remaining capital balance.

EXERCISE 13-3 (1) Allocation of $220,000 of Partnership Income

Profit and loss percentage ................ Salary ................................................ Bonus (see Note A) ........................... Interest on capital .............................. Balance ....................................... Total ............................................

Johnson

Larson

1/3 $50,000 — 4,000 23,000 $77,000

1/3 $60,000 — 2,500 23,000 $85,500

Kragen 1/3 — 20,000 14,500 23,000 $57,500

Cumulative Total $110,000 130,000 151,000 220,000

Ch. 13—Exercises

13–4

Exercise 13-3, Concluded (2) Allocation of $34,000 of Partnership Loss

Profit and loss percentage ................ Salary ................................................ Bonus (see Note A) ........................... Interest on capital .............................. Balance ............................................. Total ..................................................

Johnson

Larson

1/3 $ 50,000 — 4,000 (55,000) $ (1,000)

1/3 $ 60,000 — 2,500 (55,000) $ 7,500

Johnson

Larson

Kragen

1/3 $50,000 — 1,905 — $51,905

1/3 $60,000 — 1,190 — $61,190

1/3 $ — 12,000 6,905 — $18,905

Johnson

Larson

Kragen

$4,000 19.05%

$2,500 11.90%

$14,500 69.05%

Kragen 1/3 — — 14,500 (55,000) $(40,500)

Cumulative Total $110,000 110,000 131,000 (34,000)

(3) Allocation of $132,000 of Partnership Income

Profit and loss percentage ................ Salary ................................................ Bonus (see Note A) ........................... Interest on capital (see Note B) ......... Balance ............................................. Total ..................................................

Cumulative Total $110,000 122,000 132,000 132,000

Note A: Calculation of Annual Bonus Bonus when Income Is $220,000 Bonus = 10% (Net Income – Bonus) 110% Bonus = 10% ($220,000) 110% Bonus = $22,000 Bonus = $20,000 Bonus when Loss Is $34,000 No bonus is due since there is a loss versus income. Bonus when Income Is $132,000 Bonus = 10% (Net Income – Bonus) 110% Bonus = 10% ($132,000) 110% Bonus = $13,200 Bonus = $12,000 Note B: Stated Interest on Capital

Dollar ................................................. Percent of total ..................................

Cumulative Total $21,000 100.00%

Therefore, the remaining profit of $10,000 should be allocated as interest per the above percentages as follows: $1,905 $1,190 $6,905 $10,000

13–5

Ch. 13—Exercises

EXERCISE 13-4 1.

The best way to measure invested capital is to use a weighted average. This will result in proper consideration of varying levels of capital over time. In this particular case, it is anticipated that significant capital contributions will be made over the first 18 months of operation. Therefore, the level of invested capital will vary significantly over time, and the use of a simple average or measure of capital at a point in time would not be appropriate. Once the level of invested capital stabilizes, a simple average or measure of capital at a point in time may be acceptable. Consideration should also be given to whether or not drawing balances are to be netted out against capital balances in order to measure invested capital. A net measure of capital is the truest measure of the capital invested by the partners.

The interest rate on invested capital should reflect the risk associated with the investment in the partnership. Obviously, the higher the risk the higher the interest rate. However, a proper assessment of the risk/return relationship may not be easy, and other alternative returns on investment may be a good proxy for the interest rate. For example, the rate a bank might charge to lend money to the partnership may be a good place to start. However, it is important to remember that a bank loan would likely have a higher priority of repayment and/or collateral as compared to an investment by a partner. Therefore, the bank interest rate would reflect a lower level of risk. Rates of return associated with venture capital investors may also provide some insight. If it is anticipated that a partner who primarily provides capital may also receive an allocation of remaining profit based on a profit and loss ratio, the interest rate on capital may be adjusted downward in order to reflect this as an additional return on invested capital. It might also be appropriate to provide for adjustments in the rate of interest as conditions and underlying risk factors change.

Capital balances reflect book values, not fair market values; therefore, the proposed buyout provision seems inadequate. Given the nature of the proposed partnership business, metal fabricating, there will be many assets whose book value does not equate to their fair market value. Furthermore, there may be unrecorded assets such as goodwill that are not reflected in capital balances on an ongoing basis. Ideally, the buyout provision should be based on the fair market value of the partnership adjusted for the fact that a partner’s interest may be a minority interest and/or that such an interest may lack marketability. This is an excellent opportunity to introduce the valuation concepts that deal with minority versus controlling interests and a discount for a lack of marketability.

Salaries are a component of a profit- or loss-sharing agreement and are not the same as drawings. It is the drawings that are paid out over some period of time. Therefore, it is possible that a partner will be paid an amount that is different than the salary. If a partnership agreement were to state that a salary was to be paid in some particular manner, it would be more correct to state that draws are to be made in some particular manner.

Clearly, calculating a bonus as a percentage of income is the easiest method. However, it is not the fairest way. If a bonus is based on income, then part of the bonus is a bonus on the bonus. Only by basing the bonus on income after the bonus is this problem avoided.

Ch. 13—Exercises

13–6

Exercise 13-4, Concluded 6.

Individual partners contribute to a partnership in a variety of ways, and a profit- or losssharing agreement hopefully recognizes this by virtue of using a variety of provisions such as interest on invested capital, salaries, bonuses, etc. Satisfying each provision to the extent possible requires that the various provisions be put in an order of priority, which suggests that some partners’ contributions to the partnership may be more important than others. Satisfying all provisions of the agreement and then absorbing any deficiency with the profit and loss ratios seems to be more fair in that it recognizes that all partners hopefully contribute in a variety of unique, yet important ways. For example, providing capital to the proposed partnership may be just as important as engineering products. There would be no products to engineer if the necessary infrastructure could not be acquired. Satisfying all provisions of the agreement seems to be most fair.

EXERCISE 13-5 Allocation of third year income based on original profit allocation:

Salaries ................................................... Bonuses .................................................. Remaining profits .................................... Total ........................................................

Walker $ 90,000 11,000 (10,000) $ 91,000

Hayes $ 90,000 11,000 (10,000) $ 91,000

Leaky $ 70,000 11,000 (10,000) $ 71,000

Cumulative Total $250,000 283,000 253,000

*Bonus = 15% (Net Income – Bonus) 115% Bonus = 15% (Net Income) 115% Bonus = $37,950 Bonus = $33,000 Allocation of third year income based on revised profit allocation and combined income of $353,000:

Salaries ................................................... Interest on capital (see Note A) .............. Special allocation to Leaky (see Note B) Remaining profits to Walker and Hayes .. Total ........................................................

Walker $ 90,000 4,750 — (5,613) $ 89,138

Hayes $ 90,000 3,750 — (5,613) $ 88,138

Leaky $ 90,000 16,125 69,600 — $175,725

Cumulative Total $270,000 294,625 364,225 353,000

13–7

Ch. 13—Exercises

Exercise 13-5, Continued Allocation of third year income based on revised profit allocation and combined income of $403,000: Cumulative Hayes Leaky Total Walker Salaries ................................................... $ 90,000 $ 90,000 $ 90,000 $270,000 Interest on capital (see Note A) .............. 4,750 3,750 16,125 294,625 Special allocation to Leaky (see Note B) — — 101,600 396,225 3,388 — 403,000 Remaining profits to Walker and Hayes .. 3,388 $ 97,138 $207,725 Total ........................................................ $ 98,138 Note A: Interest on Weighted-Average Capital, Walker Number Amount of Months Invested Invested $40,000 6 6 55,000 12 Weighted-average .............. Interest @ 10% ..................

Weighted Dollars $240,000 330,000 $570,000 $ 47,500 4,750

Interest on Weighted-Average Capital, Hayes Number of Months Invested 6 6 12 Weighted-average .............. Interest @ 10% .................. Amount Invested $30,000 45,000

Weighted Dollars $180,000 270,000 $450,000 $ 37,500 3,750

Interest on Weighted-Average Capital, Leaky Number Amount of Months Weighted Invested Invested Dollars $ 60,000 3 $ 180,000 185,000 3 555,000 200,000 6 1,200,000 12 $1,935,000 Weighted-average .............. $161,250 Interest @ 10% .................. 16,125

Ch. 13—Exercises

13–8

Exercise 13-5, Concluded Note B: Special Allocation to Leaky If Leaky had joined with the outside investor and the net income was a minimum of $100,000, the allocation of profits would have been as follows:

Salaries ................................................... Interest on capital .................................... Remaining profits .................................... Total ........................................................ 80% of above allocation ..........................

Leaky $ 60,000 — 27,000 $ 87,000 $ 69,600

Outside Investor $ — 6,250 6,750 $ 13,000

Cumulative Total $ 60,000 66,250 100,000

If Leaky had joined with the outside investor and the net income was a minimum of $150,000, the allocation of profits would have been as follows:

Leaky $ 60,000 — 67,000 $127,000 $101,600

Outside Investor $ — 6,250 16,750 $ 23,000

Cumulative Total $ 60,000 66,250 150,000

Author's Note: In addition to the above quantitative analysis there are other factors to consider such as the following: •

Relative to the original partnership agreement, Hayes is not gaining significantly from the proposed new arrangement.

•

Hayes is being allocated interest on their capital including the required investment of $15,000. What other alternatives might Hayes have for this capital? Could they earn more than what is being offered in the revised agreement?

•

Doesn’t the new agreement give Hayes interest on capital that they could possibly get anyway? Especially with respect to the $15,000 investment. Where will Hayes get the $15,000? Is the prohibition against withdrawals too restrictive?

•

Will keeping Leaky’s new products in the original partnership increase sales of existing product lines or allow for expanded sales not directly traceable to Leaky?

•

If the growth in net income is primarily traceable to Leaky’s products, it seems that Leaky will always be the one gaining from this. When can some of that growth be shared with the remaining partners who may directly or indirectly promote the sale of such products?

13–9

Ch. 13—Exercises

EXERCISE 13-6 Year 1—Allocation of $250,000 of Partnership Income Banyan

Schultz

Witkowski Proposal Profit and loss percentage ................ Salary ................................................ Bonus (see Note A) ........................... Interest on capital .............................. Balance ............................................. Total ..................................................

1/3 $120,000 — 5,000 (2,500) $122,500

1/3 $80,000 — 5,000 (2,500) $82,500

1/3 $40,000 2,500 5,000 (2,500) $45,000

Original Partner Proposal Profit and loss percentage ................ Balance .............................................

45% $112,500

30% $75,000

25% $62,500

Witkowski

Cumulative Total $240,000 242,500 257,500 250,000

$250,000

Year 2—Allocation of $300,000 of Partnership Income Banyan

Schultz

1/3 $120,000 — 5,000 12,667 $137,667

1/3 $80,000 — 5,000 12,667 $97,667

1/3 $40,000 7,000 5,000 12,667 $64,667

Original Partner Proposal Profit and loss percentage ................ Balance .............................................

45% $135,000

30% $90,000

25% $75,000

Witkowski

Cumulative Total $240,000 247,000 262,000 300,000

$300,000

Ch. 13—Exercises

13–10

Exercise 13-6, Concluded Year 3—Allocation of $360,000 of Partnership Income Banyan

Schultz

1/3 $120,000 — 5,000 30,667 $155,667

1/3 $ 80,000 — 5,000 30,667 $115,667

1/3 $40,000 13,000 5,000 30,667 $88,667

Original Partner Proposal Profit and loss percentage ................ Balance .............................................

45% $162,000

30% $108,000

25% $90,000

Bonus when Income Is $250,000 Bonus percent ................................... Based on income of .......................... Amount of bonus ...............................

5% $ 50,000 $ 2,500

$ $

Bonus when Income Is $300,000 Bonus percent ................................... Based on income of .......................... Amount of bonus ...............................

5% $ 60,000 $ 3,000

10% $ 40,000 $ 4,000

Bonus when Income Is $360,000 Bonus percent ................................... Based on income of .......................... Amount of bonus ...............................

5% $ 60,000 $ 3,000

10% $100,000 $ 10,000

Witkowski

Cumulative Total $240,000 253,000 268,000 360,000

$360,000

Note A: Calculation of Annual Bonus 10% — —

It appears that Witkowski would be well advised to accept the original partners’ proposal during the initial 3-year term. If income can continue to grow at a 20% rate, only then may Witkowski’s proposal prove to be the most advantageous. Certainly, the assumption of an annual growth rate of 20% should be viewed with skepticism.

13–11

Ch. 13—Exercises

EXERCISE 13-7 Allocation of $168,000 of Partnership Income

Profit and loss percentage ................ Interest on capital (see Note A) ........ Salary ................................................ Bonus (see Note B) ........................... Balance ............................................. Total ..................................................

Moore

Probst

Tanski

20% $23,125 20,000 — (9,225) $33,900

40% 1,500 75,000 14,000 (18,450) $ 72,050

40% 1,500 65,000 14,000 (18,450) $ 62,050

Cumulative Total $ 26,125 186,125 214,125 168,000

Note A: Interest on Weighted-Average Capital, Moore Number of Months Weighted Invested Dollars 3 $ 750,000 9 2,025,000 12 $2,775,000 Weighted-average .............. $231,250 Interest @ 10% .................. 23,125 Amount Invested $250,000 225,000

Interest on Weighted-Average Capital, Probst Number of Months Invested 3 3 3 3 12 Weighted-average .............. Interest @ 10% .................. Amount Invested $60,000 20,000 — (20,000)

Weighted Dollars $180,000 60,000 — (60,000) $180,000 $15,000 1,500

Interest on Weighted-Average Capital, Tanski Number of Months Invested 3 3 3 3 12 Weighted-average .............. Interest @ 10% .................. Amount Invested $40,000 20,000 — —

Weighted Dollars $120,000 60,000 — — $180,000 $15,000 1,500

Ch. 13—Exercises

13–12

Exercise 13-7, Concluded Note B: Calculation of Annual Bonus Bonus When Income Is $168,000 Bonus (B) = 20% × (Net Income – Bonus) 1.20% B = 20% × $168,000 1.20% B = $33,600 B = $28,000 EXERCISE 13-8 1.

Interest on capital is intended to reward those partners who have significant capital investments in the partnership. In a capital intensive business, such as the proposed company, capital is an important driver of income. To the extent that the capital invested by various partners varies significantly, it would be most fair to recognize the differing levels of investment when allocating profits. If capital balances remain relatively constant over a particular reporting period then a simple average of invested capital may be acceptable. However, if capital balances vary over time through additional investments and/or withdrawals of capital, a more representative measure of capital is most appropriate. A weighted average of capital would be the most appropriate way to measure changing levels of capital over time. Rather than measuring capital on a daily basis, a practical approach might be to measure capital on a monthly or quarterly basis that is based on the average capital during that period.

Although mathematically more rigorous, the purpose of calculating a bonus on net income after the bonus is to insure that a bonus is not being accrued on the bonus itself. If the bonus is based on net income before the bonus, this value includes the bonus and then applying a percentage bonus would mean that there was a bonus on the bonus. For example, if net income before the bonus is $11,000 (this $11,000 by definition includes the bonus) then applying a 10% bonus to this $11,000 results in a bonus of $1,100 of which $1,000 is a bonus and $100 is a 10% bonus on the bonus.

Drawing and capital is not the same thing although in combination, they represent total capital. Generally a drawing account is used to record withdrawals of capital not contributions of capital and/or the allocation of profits or losses. The use of a drawing account is a convenient way to easily determine how much a partner has withdrawn from a partnership over a reporting period. This is easier that commingling such withdrawals with other capital items that may occur over a period of time. At the end of an accounting period the drawing account is closed out to the respective partner’s capital account. An important point is that if a profit allocation calls for interest on invested capital, it should be clearly stated as to whether the measure of capital does or does not take into consideration the balance in a partner’s drawing account at a particular point in time.

In its purest sense, a salary to a partner is considered as a component of the profit and loss agreement. Obviously salaries reported as W-2 wages represent that portion of the partner’s salary that has been distributed. If such salaries are intended to be a component of the profit and loss agreement, the income to be allocated should be measured before consideration of the W-2 salaries.

13–13

Ch. 13—Exercises

Although this is possible to do, normally the percentage allocation for profits and losses are the same. Practically speaking, it would be unusual to think of a situation where a partner’s efforts and initiatives should be considered different if in the end the result is an operating loss versus a profit. However, conceptually one could make the argument that if a loss is traceable to the actions or conduct of a partner that are different than their actions or conduct when profits are present, the resulting losses should be allocated differently.

A partnership is characterized by unlimited liability and the partners are personally liable, jointly and severally. This would be the case if the erection component of the business were included in the partnership. However, if the erection component were in a separate LLC the individual members of the LLC would not have personal liability for the actions undertaken by the entity that are not traceable to their own wrongdoings. It is not uncommon for certain activities of an entity to be established as a separate business entity. For example, this is a common practice with respect to real estate placed in a separate LLC and then leased back to the company.

If the attorney were a limited partner in a limited partnership, their obligation for partnership obligations would be restricted to a stated amount that is generally equal to their invested capital. However, if the attorney were a limited partner, they would not participate in the management of the company.

Being a partner would expose the attorney to more potential risk than an outside lender of capital. As a partner they could be held personally liable for the obligations of the partnership. Whereas this would not be the case if they were an outside lender. Furthermore, an outside lender would have a prior claim to partnership assets over that of a partner given a partnership liquidation. However, being a partner would allow them to participate in management and possibly share in profits (or losses) beyond the amount allocated as interest on invested capital.

EXERCISE 13-9 (1) Allocation of Profits Based on Alternative A Assumed income level ........................... $500,000 $560,000

$600,000

Salary .................................................... Interest (Note A) .................................... Bonus .................................................... Share of net income (10%) .................... Total ....................................................... Probability of occurrence ....................... Weighted outcome .................................

$120,000 5,500 — 50,000 $175,500 × 30% $ 52,650

$120,000 5,500 — 60,000 $185,500 × 20% $ 37,100

Combined most likely profit ...................

$180,500

$120,000 5,500 — 56,000 $181,500 × 50% $ 90,750

Ch. 13—Exercises

13–14

Exercise 13-9, Continued Cash Distributions Date—End of Quarter 1 ............................................... Quarter 2 ............................................... Quarter 3 ............................................... Quarter 4 ............................................... Quarter 1 next year ................................ Total .......................................................

Amount $ 30,000 30,000 30,000 30,000 30,000 $150,000

Present value @ 6% ..............................

$143,479

Note A:

Amount Invested $100,000 70,000 40,000 10,000

Number of Months Invested 3 3 3 3 12

Weighted-average ......................... Interest @ 10% ..............................

Weighted Dollars $300,000 210,000 120,000 30,000 $660,000 $55,000 5,500

Allocation of Profits Based on Alternative B Assumed income level ........................... $500,000 $560,000

$600,000

Salary .................................................... Interest (Note B) .................................... Bonus .................................................... Total ....................................................... Probability of occurrence ....................... Weighted outcome .................................

$ 96,000 10,000 50,000 $156,000 × 30% $ 46,800

$ 96,000 10,000 60,000 $166,000 × 20% $ 33,200

Combined most likely profit ...................

$161,000

$ 96,000 10,000 56,000 $162,000 × 50% $ 81,000

Cash Distributions Date—End of Quarter 1 ............................................... Quarter 2 ............................................... Quarter 3 ............................................... Quarter 4 ............................................... Quarter 1 next year ................................ Total .......................................................

Amount $ — 24,000 24,000 24,000 60,000 $132,000

Present value @ 6% ..............................

$124,556

13–15

Ch. 13—Exercises

Exercise 13-9, Concluded Note B:

Amount Invested $100,000

Number of Months Invested 12

Weighted-average ......................... Interest @ 10% ..............................

Weighted Dollars $1,200,000 $100,000 10,000

Allocation of Profits Based on Alternative C $560,000 Assumed income level ........................... $500,000

$600,000

Salary .................................................... Share of net income (20%) .................... Total ....................................................... Probability of occurrence ....................... Weighted outcome .................................

$ 80,000 100,000 $180,000 × 30% $ 54,000

$ 80,000 120,000 $200,000 × 20% $ 40,000

Combined most likely profit ...................

$190,000

$ 80,000 112,000 $192,000 × 50% $ 96,000

Amount $ 20,000 20,000 20,000 80,000 20,000 $160,000

Present value @ 6% ..............................

$152,184

(2) Summary of above calculations: Combined most likely profit ................... Net present value ..................................

Alternative A $180,500 143,479

Alternative B $161,000 124,556

Alternative C $190,000 152,184

An initial investment of $100,000 is required, regardless of which alternative is selected. Therefore, this investment is ignored for purposes of selecting an alternative. Also, all present value calculations include the cash flow in the first quarter of the next year. This was considered necessary in order to fully evaluate the irregular cash flow patterns of certain alternatives. Based on the above summary, it would appear that Alternative C is preferred. Not only does this generate the highest values, but it also allows the partner to retain similar amounts of capital in the partnership as do other alternatives. Therefore, potential growth of the partnership through retention of capital does not appear to be harmed by this alternative.

Ch. 13—Problems

13–16

PROBLEMS PROBLEM 13-1 Allocation of $280,000 of Partnership Income

Profit and loss percentage ................ Salary ................................................ Bonus based on sales ....................... Bonus (see Note A) ........................... Interest on capital (see Note B) ........ Allocation of equipment gain ............. Balance ............................................. Total ..................................................

Rockford

Skeeba

Tapinski

35% $50,000

25% $40,000 15,000 20,000 6,750 — 7,542 $89,292

40% $55,000

20,000 3,083 10,000 10,559 $93,642

20,000 — 10,000 12,067 $97,067

Cumulative Total $145,000 160,000 220,000 229,833 249,833 280,000

Note A: Calculation of Annual Bonus Bonus When Income Is $280,000 Bonus = 30% (Net Income – Gain on Equipment Sale – Bonus) Bonus = 30% ($280,000 – $20,000 – Bonus) 130% Bonus = $78,000 Bonus = $60,000 Note B: Interest on Weighted-Average Capital, Rockford Number of Months Invested 5 7 12 Weighted-average .......................... Amount in excess of $50,000 ......... Interest @ 10% .............................. Amount Invested $75,000 85,000

Weighted Dollars $375,000 595,000 $970,000 $80,833 30,833 3,083

Interest on Weighted-Average Capital, Skeeba Number of Months Invested 6 6 12 Weighted-average .......................... Amount in excess of $50,000 ........ . Interest @ 10% .............................. Amount Invested $125,000 110,000

Weighted Dollars $ 750,000 660,000 $1,410,000 $117,500 67,500 6,750

13–17

Ch. 13—Problems

Problem 13-1, Concluded Interest on Weighted-Average Capital, Tapinski Number Amount of Months Invested Invested $40,000 3 50,000 9 12 Weighted average .......................... Amount in excess of $50,000 ......... Interest @ 10% ..............................

Weighted Dollars $120,000 450,000 $570,000 $47,500 — —

PROBLEM 13-2 Analysis of Sandburg’s capital account: January 1, 2015, balance as of date of divorce .......... Distributions to Sandburg: June 30 ................................................................. September 30........................................................ Distributions to Sandburg’s spouse: February 28 (see Schedule B) .............................. August 31 .............................................................. Allocation of partnership net income (see Schedule A) December 31, 2015, balance ...................................... Distributions to Sandburg: June 30 ................................................................. September 30........................................................ Distributions to Sandburg’s spouse: February 28 (see Schedule B) .............................. August 31 .............................................................. Allocation of partnership net income (see Schedule A) December 31, 2016, balance ......................................

$ 180,000 $ (60,000) (65,000)

(125,000) (40,000) 397,414 $ 412,414

$(125,000) — $ (85,500) (50,000)

(125,000) (135,500) 370,803 $ 522,717

Calculation of total distributions due Sandburg’s spouse as of February 28, 2017: February payment traceable to 2016 (see Schedule B) .......................................................................... $ 62,500 50% of December 31, 2016, capital balance [see above schedule ($522,717 – $62,500) × 50%]............. 230,108 Total distribution ......................................................................... $ 292,608 Note: The December 31, 2016, balance is reduced by the claim against it by the partner’s spouse.

Ch. 13—Problems

13–18

Problem 13-2, Continued Schedule A—Allocation of Partnership Profit 2015 Profits: Salaries .............................................................. Bonus (see Note A) ............................................ Interest on capital (see Note B).......................... Subtotal .............................................................. Remaining profit ................................................. Total profit ..........................................................

Sandburg $100,000 68,182 6,021 $174,203 223,211 $397,414

2016 Profits: Salaries .............................................................. Bonus (see Note A) ............................................ Interest on capital (see Note B).......................... Subtotal .............................................................. Remaining profit ................................................. Total profit ..........................................................

$100,000 63,636 13,100 $176,736 194,067 $370,803

Note A:

Calculation of 2015 Bonus Bonus = 10% ($750,000 – Bonus) 110% Bonus = 10% ($750,000) 110% Bonus = $75,000 Bonus = $68,182

Williams $125,000 4,375 $129,375 223,211 $352,586 $125,000 10,129 $135,129 194,068 $329,197

Total $225,000 68,182 10,396 $303,578 446,422 $750,000 $225,000 63,636 23,229 $311,865 388,135 $700,000

Calculation of 2016 Bonus Bonus = 10% ($700,000 – Bonus) 110% Bonus = 10% ($700,000) 110% Bonus = $70,000 Bonus = $63,636

Note B: Calculation of interest on capital 2015 Weighted-Average Capital, Sandburg Number of Amount Months Weighted Invested Invested Dollars $180,000 6 $1,080,000 120,000 2 240,000 80,000 1 80,000 15,000 3 45,000 12 $1,445,000 Weighted-average ........... Interest @ 5% .................

$120,417 6,021

2015 Weighted-Average Capital, Williams Number of Amount Months Weighted Invested Invested Dollars $125,000 6 $ 750,000 95,000 3 285,000 5,000 3 15,000 0 12 $1,050,000 Weighted-average ......... Interest @ 5% ................

$87,500 4,375

13–19

Ch. 13—Problems

Problem 13-2, Concluded 2016 Weighted-Average Capital, Sandburg Number of Amount Months Weighted Invested Invested Dollars $412,414 2 $ 824,828 326,914 4 1,307,656 201,914 2 403,828 151,914 4 607,656 $3,143,968 12 Weighted-average ........... Interest @ 5% .................

$261,997 13,100

2016 Weighted-Average Capital, Williams Number of Amount Months Weighted Invested Invested Dollars $357,586 6 $2,145,516 57,586 3 172,758 37,586 3 112,758 12

$2,431,032

Weighted-average .... Interest @ 5% ...........

$202,586 10,129

Schedule B—Distributions to Sandburg’s Spouse In 2015, the first year of divorce, there was no February distribution. In 2016, there is a February distribution, traceable to the prior year as follows: Base earnings traceable to 2015: Net income ............................................................... $ 750,000 Excluded salaries ..................................................... (200,000) Excluded bonus (limited to $50,000) ........................ (50,000) Total ......................................................................... $ 500,000 Percent traceable to spouse .................................... × 25% Subtotal .................................................................... $ 125,000 Interest on previous August distribution deficiency: ($50,000 – $40,000) × 10% × 1/2 year............... 500 Prior payment ........................................................... (40,000) Amount due to spouse ............................................. $ 85,500 In 2017, there is a February distribution, traceable to the prior year as follows: Base earnings traceable to 2016: Net income ............................................................... $ 700,000 Excluded salaries ..................................................... (200,000) Excluded bonus (limited to $50,000) ........................ (50,000) Total ......................................................................... $ 450,000 Percent traceable to spouse .................................... × 25% Subtotal .................................................................... $ 112,500 Interest on previous August distribution deficiency: $0 × 10% × 1/2 year ........................................... — Prior payment ........................................................... (50,000) Amount due to spouse ............................................. $ 62,500

Ch. 13—Problems

13–20

PROBLEM 13-3 Analysis of First Alternative Cash flow components:

March 31 2017

2016 Distribution of prior years’ income (see Note A)........................................ Distribution of capital investment ............ 8% Return on proceeds (see Note B) ..... Total ........................................................ Present value index................................. Net present value .................................... Note A:

2018

$ 205,000 1,500,000 136,400 $136,400 0.8573 $116,941

$1,705,000 0.9259 $1,578,704

147,312 $147,312 0.7938 $116,941

Total $ 205,000 1,500,000 283,712 $1,988,712 $1,812,586

Year 2015—Allocation of $550,000 of Partnership Income

Profit and loss percentage ........ Salary ....................................... Bonus (see below) .................... Balance .................................... Total .........................................

Raymond

Other Partners

Cumulative Total

40% $125,000 50,000 30,000 $205,000

60% $300,000 — 45,000 $345,000

$425,000 475,000 550,000

Bonus = 10% (Net Income – Bonus) 110% Bonus = 10% × $550,000 110% Bonus = $55,000 Bonus = $50,000 Note B: Year

Rate

Interest Invested

2016 2017

8.0% 8.0 8.0

$1,705,000 1,705,000 136,400

Amount Return $136,400 $136,400 10,912 $147,312

Analysis of Second Alternative Cash flow components: Distribution of prior years’ income (see Note A)....................................... Distribution of capital investment ............ 8% Return on proceeds (see Note B) ..... Total ........................................................ Present value index................................. Net present value ....................................

March 31 2016

2017

2018

Total

$205,000 —

$104,000

$ 118,000 1,700,000 26,032 $1,844,032 0.7938 $1,463,852

$ 427,000 1,700,000 42,432 $2,169,432

$205,000 0.9259 $189,815

16,400 $120,400 0.8573 $103,224

$1,756,891

13–21

Ch. 13—Problems

Problem 13-3, Concluded Note A:

Year 2016—Allocation of $605,000 of Partnership Income

Raymond

Other Partners

Cumulative Total

20% $ 80,000 — 24,000 $104,000

80% $350,000 55,000 96,000 $501,000

$430,000 485,000 605,000

Bonus = 10% (Net Income – Bonus) 110% Bonus = 10% × $605,000 110% Bonus = $60,500 Bonus = $55,000 Year 2017—Allocation of $682,000 of Partnership Income

Raymond

Other Partners

Cumulative Total

20% $ 80,000 — 38,000 $118,000

80% $350,000 62,000 152,000 $564,000

$430,000 492,000 682,000

Bonus = 10% (Net Income – Bonus) 110% Bonus = 10% × $682,000 110% Bonus = $68,200 Bonus = $62,000 Note B: Year 2016 2017

Interest Rate

Amount Invested

8.0% 8.0 8.0

$205,000 205,000 120,400

Return $16,400 $16,400 9,632 $26,032

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Ch. 13—Problems

13–22

PROBLEM 13-4 Allocation of profits for years 2 through 4 Year 2 Salaries ........................................ Bonus based on sales .................. Other bonuses (see Note A) ........ Interest on capital (see Note B) ... Remaining profits or losses .......... Total .............................................

Jacobs $80,000 — 10,000 9,250 (3,250) $96,000

Levine $110,000 — 10,000 7,250 (3,250) $124,000

Year 3 Salaries ........................................ Bonus based on sales .................. Other bonuses (see Note A) ........ Interest on capital (see Note B) ... Remaining profits or losses .......... Total .............................................

Jacobs $80,000 5,000 12,500 12,100 15,000 $124,600

Levine $110,000 — 12,500 12,900 15,000 $150,000

Year 4 Salaries ........................................ Bonus based on sales .................. Other bonuses (see Note A) ........ Interest on capital (see Note B) ... Remaining profits or losses .......... Total .............................................

Jacobs $80,000 10,000 15,000 11,060 37,255 $153,315

Levine $110,000 — 15,000 14,430 37,255 $176,685

Cumulative Total $190,000 190,000 210,000 226,500 220,000

Cumulative Total $190,000 195,000 220,000 245,000 275,000 Cumulative Total $190,000 200,000 230,000 255,490 330,000

Note A: Calculation of Bonus Year 2 Bonus = 10% (Net Income – Bonus) 110% Bonus = 10% (Net Income) 110% Bonus = $22,000 Bonus = $20,000

Year 3 Bonus = 10% (Net Income – Bonus) 110% Bonus = 10% (Net Income) 110% Bonus = $27,500 Bonus = $25,000

Year 4 Bonus = 10% (Net Income – Bonus) 110% Bonus = 10% (Net Income) 110% Bonus = $33,000 Bonus = $30,000

13–23

Ch. 13—Problems

Problem 13-4, Continued Note A: Interest on Weighted-Average Capital Year 2

Jacobs Number of Amount Months Weighted Invested Invested Dollars $100,000 3 $ 300,000 85,000 3 255,000 100,000 3 300,000 255,000 85,000 3 $1,110,000 12 Weighted-average ........... Interest @ 10% ...............

Year 3

Jacobs Number of Amount Months Weighted Invested Invested Dollars $166,000 3 $ 498,000 136,000 3 408,000 106,000 3 318,000 76,000 3 228,000 $1,452,000 12 Weighted-average ........... Interest @ 10% ...............

Year 4

$92,500 9,250

$121,000 12,100

Jacobs Number of Amount Months Weighted Invested Invested Dollars $170,600 3 $ 511,800 130,600 3 391,800 90,600 3 271,800 50,600 3 151,800 $1,327,200 12 Weighted-average ........... Interest @ 10% ...............

$110,600 11,060

Amount Invested $80,000 65,000 80,000 65,000

Levine Number of Months Weighted Invested Dollars 3 $240,000 3 195,000 3 240,000 3 195,000 12 $870,000

Weighted-average ......... Interest @ 10% ..............

Amount Invested $174,000 144,000 114,000 84,000

Levine Number of Months Weighted Invested Dollars 3 $ 522,000 3 432,000 3 342,000 3 252,000 12 $1,548,000

Weighted-average ......... Interest @ 10% ..............

Amount Invested $204,400 164,400 124,400 84,000

$72,500 7,250

$129,500 12,900

Levine Number of Months Weighted Invested Dollars 3 $ 613,200 3 493,200 3 373,200 3 252,000 12 $1,731,600

Weighted-average ......... Interest @ 10% ..............

$144,300 14,430

Ch. 13—Problems

13–24

Problem 13-4, Concluded Payments to Jacob’s ex spouse for years 3 through 5 Monthly payment of $2,500 .................. 40% of the prior year salary ................. Less monthly payments ....................... 30% of excess distribution ................... Total due to ex spouse .........................

Year 3 $30,000 32,000 (30,000) — $32,000

Year 4 $ 30,000 32,000 (30,000) 786 $ 32,786

Year 5 $ 30,000 32,000 (30,000) 10,202 $ 42,202

Distributions paid in the prior year........ Prior year salary ................................... Distribution in excess of salary............. Less effective tax on share of income .. Excess distribution ............................... 30% of excess distribution ...................

$60,000 80,000 — n/a $ — $ —

$120,000 80,000 40,000 37,380 $ 2,620 $ 786

$160,000 80,000 80,000 45,995 $ 34,006 $ 10,202

Partnership income .............................. Effective tax rate on income ................. Tax on income......................................

$96,000 30% $28,800

$124,600 30% $ 37,380

$153,315 30% $ 45,995

PROBLEM 13-5 Allocation of current year profit Meyers $ 2,490 120,000 10,000

Interest on capital (see Note A)............ Salaries ................................................ Other bonuses (see Note B) ................ Bonus to Kopinski (10% × ($420,000 – $306,165) ................... Loss on disposition of assets ............... (5,000) Remaining profits or losses .................. 35,750 Total ..................................................... $163,240

Lincoln $ 1,200 96,000 —

Kopinski $ (300) 72,000 5,000

— 35,750 $132,950

11,361 — 35,750 $123,811

Cumulative Total $ 3,390 291,390 306,390 317,751 312,751 420,000

13–25

Ch. 13—Problems

Problem 13-5, Concluded Note A: Interest on Weighted-Average Capital Meyers Number of Amount Months Invested Invested $59,000 3 44,000 3 44,000 3 19,000 3 12 Weighted-average ........... Interest @ 6% ................. Kopinski Number of Amount Months Invested Invested $25,000 6 (35,000) 6

Weighted Dollars $177,000 132,000 132,000 57,000 $498,000 $ 41,500 2,490

Weighted Dollars $150,000 (210,000) — — $(60,000)

Weighted-average ........... Interest @ 6% .................

$ (5,000) (300)

Amount Invested $30,000 10,000

Lincoln Number of Months Weighted Invested Dollars 6 $180,000 6 60,000 — — 12 $240,000

Weighted-average ......... Interest @ 6% ................

$20,000 1,200

Note B: Bonus on excess gross billings

Gross billings........................................ Threshold billings ................................. Excess billings...................................... Bonus % ............................................... Bonus ...................................................

Meyers $500,000 400,000 100,000 10% $ 10,000

Lincoln $380,000 400,000 — 10% $ —

Kopinski $450,000 400,000 50,000 10% $ 5,000

Meyers $ 59,000 (120,000) (25,000) (15,000) 163,240 $ 62,240

Lincoln $ 30,000 (96,000) (20,000)

Kopinski $ 25,000 (72,000) (60,000)

132,950 $ 46,950

123,811 $ 16,811

Determination of year end capital balances

Beginning capital balance .................... Withdrawal of salaries .......................... Drawings in excess of salaries ............. Disposition of assets ............................ Allocation of profits ............................... Ending capital balance .........................

Ch. 13—Problems

13–26

PROBLEM 13-6 Allocation of $330,000 of Partnership Income Sampson

30% $80,000 —

30% 40% $80,000 $100,000 $260,000 — 30,000 290,000

1,250 1,000 1,500 1,500 5,288 $90,538

1,250 625 750 750 5,287 $88,662

3,750 3,000 3,500 3,500 7,050 $150,800

296,250 300,875 306,625 312,375 330,000

Rivera

Sampson

Elliott

Net capital beginning balance ....... Draws ............................................ Profit allocation .............................. Capital investment ......................... Total ............................................... Weighted total (3/12 of a year) ......

$ 40,000 (30,000) 40,000

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

$ 50,000 $ 12,500

$ 70,000 — 40,000 40,000 $150,000 $ 37,500

Beginning balance ......................... Draws ............................................ Total ............................................... Weighted total (3/12 of a year) ......

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

$ 50,000 (25,000) $ 25,000 $ 6,250

$150,000 (30,000) $120,000 $ 30,000

Beginning balance ......................... Draws ............................................ Profit allocation .............................. Loan conversion ............................ Total ............................................... Weighted total (3/12 of a year) ......

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

$120,000 (20,000) 40,000

$ 60,000 $ 15,000

$ 25,000 (50,000) 40,000 15,000 $ 30,000 $ 7,500

$140,000 $ 35,000

Beginning balance ......................... Draws ............................................ Profit allocation .............................. Total ............................................... Weighted total (3/12 of a year) ......

$ 60,000 — — $ 60,000 $ 15,000

$ 30,000 — — $ 30,000 $ 7,500

$140,000 — — $140,000 $ 35,000

Profit and loss percentage ............................ Salary ............................................................ Bonus (see Note A) ....................................... Interest on capital (see Note B): 10% interest on quarter 1 average ....... 10% interest on quarter 2 average ....... 10% interest on quarter 3 average ....... 10% interest on quarter 4 average ....... Balance ......................................................... Total .............................................................. Note A:

Elliot

Cumulative Total

Rivera

Calculation of Annual Bonus Bonus When Income Is $330,000 Bonus = 10% (Net Income – Bonus) 110% Bonus = 10% × $330,000 110% Bonus = $33,000 Bonus = $30,000

Note B:

Determination of Interest on Capital Quarter 1

Component

13–27

Ch. 13—Problems

PROBLEM 13-7 Amount to Be Paid to the Estate of Franklin Average of last three years of allocated profit: 2013 allocated profit (as given) .............................................................. 2014 allocated profit (see Schedule A) .................................................. 2015 allocated profit (see Schedule A) .................................................. Total allocated profit ............................................................................... Average allocated profit .........................................................................

$190,000 134,150 118,195 $442,345 $147,448

5 times average ...................................................................................... 50% of 2015 capital balance (see Schedule B) ..................................... Total to be paid to estate ........................................................................

$737,242 86,172 $823,414

Schedule A—Restatement and Allocation of Profits Profit as reported by Franklin ......................................... Adjustments: 1. Adjust for fictitious sales ...................................... 2. Adjust for inventory pricing errors: Misstatement of beginning inventory ............... Misstatement of ending inventory .................... 3. Adjust casualty insurance expense ..................... 4. Adjust prepaid insurance balance: $15,000 versus 3 mo. @ $3,000 ..................... $19,200 versus 3 mo. @ $3,300 ..................... 5. Remove depreciation on equipment: $20,000/5yrs. times 1/2 year ........................... $20,000/5yrs. times 1/4 year ........................... 6. Remove cash sale ............................................... Adjusted profit ................................................................ 2014 Allocation Profit and loss percentage ............................ Salaries ......................................................... Interest on capital (see Note A) .................... Bonus [10% of ($150,000 excess less fictitious sales of $25,000)] .............. Balance ......................................................... Total ..............................................................

Wilson

2014

2015

$500,000

$480,000

(25,000)

(75,000)

— (35,000) —

35,000 (75,000) 60,000

(6,000) (9,300)

$434,000 Watts

Franklin

2,000 1,000 (42,000) $376,700 Cumulative Total

30% 35% 35% $150,000 $150,000 $150,000 $450,000 22,500 17,500 12,500 502,500 12,500 (24,300) $160,700

(28,350) $139,150

(28,350) $134,150

515,000 434,000

Ch. 13—Problems

13–28

Problem 13-7, Continued

2015 Allocation

Wilson

Profit and loss percentage ............................ Salaries ......................................................... Interest on capital (see Note A) .................... Bonus ($80,000 excess less the fictitious sales of $117,000 = no bonus) ................ Balance ......................................................... Total ..............................................................

Watts

Franklin

Cumulative Total

30% 35% 35% $150,000 $150,000 $150,000 $450,000 8,500 3,500 (3,000) 459,000 — (24,690) $133,810

459,000 376,700

(28,805) $124,695

(28,805) $118,195

Weighted Dollars

Amount Invested

2015 Number of Months Weighted Invested Dollars

3 3 3 3 12

$ 900,000 750,000 600,000 450,000 $2,700,000

$100,000 90,000 80,000 70,000

Weighted-average ........... Interest @ 10% ...............

$225,000 22,500

Note A: Interest on Weighted-Average Capital, Wilson

Amount Invested $300,000 250,000 200,000 150,000

2014 Number of Months Invested

3 3 3 3 12

Weighted-average .......... Interest @ 10% ...............

$ 300,000 270,000 240,000 210,000 $1,020,000 $85,000 8,500

Interest on Weighted-Average Capital, Watts

Amount Invested

2014 Number of Months Invested

Weighted Dollars

Amount Invested

3 3 3 3 12

$ 750,000 600,000 450,000 300,000 $2,100,000

$50,000 40,000 30,000 20,000

Weighted-average ........... Interest @ 10% ...............

$175,000 17,500

$250,000 200,000 150,000 100,000

2015 Number of Months Weighted Invested Dollars 3 3 3 3 12

Weighted-average ............ Interest @ 10% .................

$150,000 120,000 90,000 60,000 $420,000 $35,000 3,500

13–29

Ch. 13—Problems

Problem 13-7, Concluded Interest on Weighted-Average Capital, Franklin

Amount Invested

2014 Number of Months Invested

Weighted Dollars

Amount Invested

3 3 3 3 12

$ 600,000 450,000 300,000 150,000 $1,500,000

$ — (10,000) (40,000) (70,000)

Weighted-average ........... Interest @ 10% ...............

$125,000 12,500

$200,000 150,000 100,000 50,000

2015 Number of Months Weighted Invested Dollars 3 3 3 3 12

Weighted-average ......... Interest @ 10% ..............

— (30,000) (120,000) (210,000) $(360,000) $(30,000) (3,000)

Schedule B—Franklin's Corrected Capital Balance Balance at year-end 2013 ......................... 2014 Profit allocation. ................................ 2014 Drawings ($50,000/quarter).............. 2015 Profit allocation ................................. 2015 Drawings ($10,000/quarter).............. 2015 Extra drawings ($20,000 × 2) ........... Balance at year-end 2015 ......................... Balance times 50%....................................

$200,000 134,150 (200,000) 118,195 (40,000) (40,000) $172,345 $ 86,172

CHAPTER 14 UNDERSTANDING THE ISSUES partnership and that of the original partnership ($500,000 versus $400,000).

1. A major concern is that the value used as a basis for establishing the price an incoming partner should pay is the fair value of the existing partnership’s net assets. Existing capital balances most often do not reflect fair value. The fair value should include both tangible and intangible assets such as goodwill. All assets and liabilities should be considered in order to determine their fair value. Another concern is that acquiring a 30% interest by paying 30% of the existing partnership’s capital will not result in the incoming partner having a 30% interest in the starting capital of the new partnership. For example, if the existing capital of a partnership is $100,000 and an incoming partner pays $30,000, then the new partnership will have a starting capital balance of $130,000. However, the incoming partner’s capital balance of $30,000 will only represent a 23% ($30,000 as a percentage of $130,000) interest in the capital of new partnership. It is important to remember that the capital balance of the original partnership, even after adjusting to fair value, will represent 70% of the new partnership’s value; therefore, it should be used as a basis to suggest the value of a 30% interest.

3. Several guidelines govern the process of liquidating a partnership. First, all assets and liabilities of the partnership should be identified, and the assets should be converted into a distributable form. Second, as assets become available for distribution, the order of priority as established by RUPA should be followed. A practical exception to this priority involves the doctrine of right of offset. Third, every attempt should be made to secure net personal assets from those partners that have deficit capital balances. Finally, of critical importance is the guideline that distributions to parties should not be premature. That is to say, all distributions should be based on the conservative assumptions that remaining assets are worthless and that all partners are personally insolvent. This overly conservative position will ensure that no partner receives a payment before he/she is entitled to it. The use of schedules of safe payments is a practical way to calculate appropriate and safe payments to partners. 4. If a fellow partner has a deficit capital balance, it is possible that other partners will have to absorb that deficit partner’s balance. Although the absorbing partners may have a personal claim against the deficit partner for the amount absorbed, the collectibility of the claim may be a concern. If a partner has a deficit capital balance during the liquidation process, it is hoped that the deficit will be eliminated. If the subsequent liquidation of partnership net assets results in sufficient gains, it is possible that a deficit capital balance may be eliminated or reduced. It is also possible that deficit capital balances in total means that there will be unsatisfied partnership creditors and that those creditors will attach to the personal assets of individual partners. Those creditors may move against any partner's assets; therefore, a partner

2. The first step would be to determine the fair value of the net assets of the original partnership. This would include a valuation of existing net assets as well as the recognition that there may be other net values that are not captured on the financial statements. For example, there may be a contingent liability or goodwill that has not been recognized. Once the fair value of the net assets (e.g., $400,000) has been determined, this amount would represent the percentage interest in the new partnership to be retained by the original partners (e.g., 80%). Dividing the fair value by the percentage interest retained results in a suggested value of the new partnership entity ($400,000 ÷ 80% = $500,000). The suggested value of the acquired interest is the difference between the value of the new

14–2 with personal wealth could end up having to contribute additional assets to the partnership. If other partners are not able to make similar contributions, their deficit capital balances may have to be absorbed by the partners with credit (surplus) capital balances. Whether the deficits absorbed can ultimately be collected from the deficit partners presents another concern.

14–3

Ch. 14—Exercises

EXERCISES EXERCISE 14-1 (1) Inventory ................................................................................... Accounts Receivable .......................................................... Warranty Obligations .......................................................... Pearson, Capital ................................................................. Murphy, Capital................................................................... To adjust book values to market values.

58,000

Cash ......................................................................................... Goodwill .................................................................................... Pearson, Capital ................................................................. Murphy, Capital................................................................... Warner, Capital ................................................................... To record admission of Warner and recognition of goodwill. If Warner contributes $84,000 for a 30% interest in capital, this suggests a total new partnership value of $280,000.

84,000 56,000

18,000 10,000 18,000 12,000

33,600 22,400 84,000

(2) If the $56,000 of goodwill proved to be worthless, Warner would be charged 35% of $56,000, or $19,600. However, the real harm to Warner would be that of having paid more to enter the partnership than he/she should have. If the goodwill did not exist, then the adjusted assets of the previous partners would have been $140,000 ($45,000 + $65,000 + $30,000), which represents 70% of a total partnership value of $200,000. In that case, Warner would have only paid $60,000 for a 30% interest in capital. Therefore, Warner would have paid an extra $24,000 ($84,000 versus $60,000) for the goodwill that proved to be worthless.

EXERCISE 14-2 Date:

To:

My client

From: Student, CPA Re:

Issues involving goodwill and the liquidation of a partnership

With respect to the questions you had regarding the above referenced matter, please consider the following responses which correspond to your questions (1) through (7). (1) It is correct that a corporation cannot record goodwill unless it has been purchased through the acquisition of another company. However, in the case of a partnership, when a new partner invests in the partnership or the partnership acquires the interest of an existing partner the transaction may be recorded under either the bonus method or the goodwill method. Under the goodwill method, goodwill is recognized on the partnership financial statements in order to reflect the economic goodwill suggested by the consideration conveyed in the transaction.

Ch. 14—Exercises

14–4

Exercise 14-2, Concluded (2) The goodwill method involves recording goodwill and/or the appreciation on net assets and results in measuring net assets at amounts that are more in line with economic market value. However, this typically results in an increase in assets as compared to the bonus method, which does not adjust to market values. Therefore, the bonus method would be most appropriate in that it understates the asset values and results in a higher return on assets and partnership capital. Furthermore, income would typically be lower under the goodwill method in that the depreciation and amortization associated with revised asset values would be charged against income. (3) The capital of a partner is the last claim against assets to be satisfied given the liquidation of a partnership. Technically, the claims are satisfied in the following order: amounts owed to creditors (including partners who are creditors) and amounts owed to partners as capital (after all closing entries). Generally speaking, amounts owed to partners as creditors are combined with capital accounts under the concept of right of offset. (4) Unsatisfied partnership liabilities could attach to any one or more partners that had personal assets. Obviously, the unsatisfied creditors would seek out those partners that have the greatest and most liquid net personal assets. Which partner unsatisfied creditors will seek out is in no way controlled by which partner has the greatest positive capital balance in the partnership. Once the unsatisfied partnership liabilities move against an individual partner, it is important to note the partnership creditors share on a pro rata basis with the partner's personal creditors in the distribution of the partner's assets. (5) Given the above response, it would be better to have a corporation own the office building and thereby shelter it from being directly included in your personal assets. This does not mean that the stock you hold in the corporation is not ultimately a personal asset, but the value of that stock would first be reduced by any liabilities of the corporation as well as other factors that may influence its value such as real estate values. (6) Per the response to item (3) above, a loan to the partnership would have a higher priority in liquidation than a capital investment. However, loans typically have a rate of return that is below the rate of return that may be experienced on a capital investment. The answer to this question lies in the expected rate of return on capital versus the rate of interest on the debt. Debt generally is less risky and therefore offers a lower return on investment. One should be cautioned against thinking that invested capital always experiences a higher return than debt capital. (7) In theory, the sales price should not differ between what is offered by the partnership and that offered by an individual partner. In that case, the key factor would be which party has the greatest ability to pay the sales price. If any portion of the sales price is to be paid over time, the partnership as an entity may have a greater ability to pay over that of an individual partner. Receiving a lower sales price in the form of cash up front may be more advisable than a price paid over time which is subject to default risk. After you have had an opportunity to review this memo, I would be happy to discuss these issues with you at your convenience. Please feel free to contact me.

14–5

Ch. 14—Exercises

EXERCISE 14-3 (1) A sale by Freeman to another individual, as compared to a sale to the partnership, would not affect Pape’s capital balance. Freeman's capital balance would merely be transferred at book value to the other party's capital account. (2) The $125,000 paid to Freeman relative to their capital balance of $80,000 represents a bonus of $45,000 that is allocated between the remaining partners according to their proportionate capital balances. Given that the remaining partners have equal proportionate average capital balances, Pape’s capital balance would be reduced by $22,500 to a balance of $17,500. (3) The $45,000 over excess over Freeman’s capital balance represents two things: 1) Freeman’s share of the appreciation in value of the recorded net assets and 2) Freeman’s share of the total entity goodwill. The strict allocation and recognition of these two elements to only Freeman would have no impact on Pape’s capital balance. (4) Once again, the $45,000 over excess over Freeman’s capital balance represents two things: 1) Freeman’s share of the appreciation in value of the recorded net assets and 2) Freeman’s share of the total entity goodwill. If the partnership is going to recognize goodwill traceable to the entire entity, then it would seem appropriate to recognize other net asset appreciation that is traceable to the entire entity. The $45,000 represents Freeman’s 50% interest in both of these elements and therefore, a total of $90,000 is traceable to the entire partnership’s interest in both of these elements. Accordingly, Pape should recognize as an increase in capital their 25% interest in the $90,000 of appreciation or $22,500 resulting in an adjusted capital balance of $62,500 ($40,000 plus $22,500). The $22,500 would be allocated as $10,000 (25% × ($200,000 value of net assets less $160,000 book value of assets) traceable to previously recognized net assets and $12,500 traceable to goodwill. (5) Given the movement toward recognizing net assets at fair value, the method set forth in (4) above would be preferable. It results in a more meaningful value of all of the assets, tangible and intangible, held by the partnership. This in turn will result in more meaningful metrics such as return on assets, return on equity, etc. (6) If the current method were to be retained, it is imperative that the method for determining "average capital" be clearly set forth. Is it a simple or a weighted average? What impact do draws and loans have on the calculation, etc. Using just capital as a basis for allocation seems rather narrow. Although a commercial construction may be capital intensive (investment in equipment, etc.), a number of other factors might be more relevant to the allocation of profits. Time spent by the partners and their varying functions might suggest that salaries and bonuses might be more primary means of allocation with interest on capital being used rather than proportionate capital balances. If these methods were adopted, some percentages would have to be adopted to allocate remaining unallocated amounts.

Ch. 14—Exercises

14–6

EXERCISE 14-4 (1) The note payable has a market value greater than the book value that will reduce the net asset value of the partnership by $15,000. However, the assets whose market values differ from their book values will result in a $24,000 increase in the net asset value of the partnership. The total net increase in the value is $9,000 ($24,000 less $15,000). Petersen’s interest in this net increase is $4,500 (50% × $9,000), resulting in a suggested value for his interest in the partnership of $104,500. (2) If the value of Petersen’s interest before consideration of goodwill is $104,500 as set forth above, then the difference between $130,000 and $104,500, or $25,500, represents Petersen’s 50% interest in the value of goodwill. Therefore, the suggested value of goodwill is $51,000. (3) Both Jacobsen and Olsen would be acquiring equal interests in the net asset values associated with Petersen’s interest; therefore, one would expect them to value these assets at equal amounts. The critical factor relates to the voting interests acquired by each of the remaining partners. If Jacobsen were to acquire half of Petersen’s interest along with half of his voting rights, then Jacobsen would have a controlling voting interest in the partnership. This may result in Jacobsen being motivated to pay more for her one-half than Olsen would be willing to pay. All things being equal, having a controlling interest represents a “control premium,” which is typically reflected in transaction prices. (4) Based on the $104,500 value in item (1) above, a half interest in that would be $52,250. Therefore, selling a half interest for $60,000 suggests that $7,750 represents Petersen’s 25% (one-half of a total 50% interest) interest in goodwill with an imputed total goodwill value of $31,000. Prior to sale, Petersen’s capital balance would be increased by $4,500 per item (1) above plus the $7,750 goodwill traceable to the partial sale resulting in a total of $112,250. After the sale for $60,000, Petersen’s capital balance would be reduced to $52,250 ($112,250 less $60,000). (5) In either case, Petersen should sell his interest for the same price. However, the ability for him to collect the sales price may be a factor. The partnership itself may have a greater ability to pay the sales price. The partnership may have a greater ability to borrow the necessary funds for the purchase price due to its collateral position and operating cash flows. Obviously, Petersen would be most interested in maximizing the value of his interest and receiving a cash payment in the most timely and secure manner. The ability of a buyer to pay, whether it is the partnership or an individual, is a critical factor to be considered. If the partnership were to acquire Petersen’s interest, then Jacobsen could achieve a controlling interest in the remaining partnership without using her personal funds.

14–7

Ch. 14—Exercises

EXERCISE 14-5 (1)

Partnership

Fair market value of original partnership: Assets at book value ......................... Liabilities at book value and fair market value ................................... (a) Book value of original partnership ..... Asset appreciation (depreciation) ...... (b) Net assets ......................................... Percent of new partnership represented by the: (c) Investment of new partner ................. (d) Fair value of the original partnership . (e) Fair value of new partnership suggested by the fair value of the original partnership [(b) ÷ (d)] ... (f) Fair value of original partnership ....... (g) Fair value of consideration that should be conveyed by the new partner [(e) – (f)]......................

$ 500,000

$ 600,000

$ 800,000

(369,500) $ 130,500 (50,000) $ 80,500

(410,000) $ 190,000 125,000 $ 315,000

(558,000) $ 242,000 50,000 $ 292,000

30% 70%

25% 75%

20% 80%

$ 115,000 80,500

$ 420,000 315,000

$ 365,000 292,000

$ 34,500

$ 105,000

$ 73,000

(2)

(h) (i) (b) (h) (j)

Partnership Amount of consideration to be conveyed: Value of land ..................................... Value of cash .................................... Total consideration ............................ Fair value of new partnership suggested by the fair value of the new partner’s investment [(h) ÷ (c)] Fair value of the original partnership ..................................... Investment of new partner ................. Adjusted value of new partnership excluding goodwill [(d) + (h)] .......... If (i) exceeds (j), goodwill is traceable to .................................... In the amount of [(i) – (j)] ................... If (j) exceeds (i), goodwill is traceable to .................................... In the amount of [(e) – (j)] ..................

$ 50,000 4,000 $ 54,000

$ 50,000 60,000 $ 110,000

$ 50,000 15,000 $ 65,000

$ 180,000

$ 440,000

$ 325,000

$ 80,500 54,000

$ 315,000 110,000

$ 292,000 65,000

$ 134,500

$ 425,000

$ 357,000

Original Partners $ 45,500

Original Partners $ 15,000 New Partner $ 8,000

Ch. 14—Exercises

14–8

Exercise 14-5, Concluded

Proof: Book value of original partnership ..... Asset appreciation (depreciation) ...... Goodwill traceable to original partnership ..................................... Goodwill traceable to new partner ..... (h) Investment of new partner ................. Total capital of new partnership ........ (c) New partner’s interest in capital ........ New partner’s capital balance ........... (a)

$130,500 (50,000)

$190,000 125,000

45,500

15,000

54,000 $180,000 × 30% $ 54,000

110,000 $440,000 × 25% $110,000

$242,000 50,000 8,000 65,000 $365,000 × 20% $ 73,000

EXERCISE 14-6 1. Cash

Noncash Assets

Liabilities

Combined Capital and Loan Balances A (50%) B (30%) C (20%)

Beginning balance ................ $ 20,000 $ 358,000 $ 92,000 $116,000 $ 90,000 $ 80,000 Liquidation of receivables and inventory................... 140,000 (158,000) (9,000) (5,400) (3,600) Pay liabilities ......................... (92,000) (92,000) Assume maximum loss on remaining noncash assets .............................. (200,000) (100,000) (60,000) (40,000) Retain cash of $10,000 ......... (10,000) (5,000) (3,000) (2,000) Balances ............................... $ 58,000 $ — $ — $ 2,000 $ 21,600 $ 34,400 Distribution to B is ................. $ 21,600 2. Cash

Noncash Assets

Liabilities

Combined Capital and Loan Balances A (50%) B (30%) C (20%)

Beginning balance ................ $ 20,000 $ 358,000 $ 92,000 $116,000 $ 90,000 $ 80,000 Sale of noncash assets ......... 53,000 (213,000) (80,000) (48,000) (32,000) Pay liabilities ......................... (92,000) (92,000) Assume maximum loss on remaining noncash assets .............................. (145,000) (72,500) (43,500) (29,000) Retain cash of $10,000 ......... (10,000) (5,000) (3,000) (2,000) Balances ............................... $ (29,000) $ — $ — $ (41,500) $ (4,500) $ 17,000 Distribution to B is ................. Zero—There is not enough cash to even cover the liabilities.

14–9

Ch. 14—Exercises

Exercise 14-6, Concluded 3. Noncash Assets

Cash

Liabilities

Combined Capital and Loan Balances A (50%) B (30%) C (20%)

Beginning balance ................ $ 20,000 $ 358,000 $ 92,000 $116,000 $ 90,000 $ 80,000 Sale of noncash assets ......... 250,000 (300,000) (25,000) (15,000) (10,000) Pay liabilities ......................... (92,000) (92,000) Pay loan payable to A ........... (70,000) (70,000) Assume maximum loss on remaining noncash assets .............................. (58,000) (29,000) (17,400) (11,600) Retain cash of $10,000 ......... (10,000) (5,000) (3,000) (2,000) Balances ............................... $ 98,000 $ — $ — $ (13,000) $ 54,600 $ 56,400 Absorb A's deficit balance ..... 13,000 (7,800) (5,200) Balances ............................... $ 98,000 $ — $ — $ — $ 46,800 $ 51,200 Distribution to B is ................. $ 46,800

EXERCISE 14-7 1. None of the available cash would be available to Boyd.

Beginning balances ............... Sales of assets...................... Balances ............................... Payment of liabilities ............. Distributions (Schedule A) .... Balances ...............................

Noncash Combined Capital and Loans Assets Liabilities Adams Boyd Chambers Cash $ 12,000 $ 255,000 $ 170,000 $ 25,000 $(5,000) $ 47,000 200,000 (180,000) (8,000) 4,000 8,000 $ 212,000 $ 45,000 $ 170,000 $ (33,000) $ (1,000) $ 55,000 (170,000) (170,000) (37,000) (7,500) (29,500) 0 $ 25,500 $ (1,000) $ 25,500 $ 5,000 $ 45,000 $ Schedule A Schedule of Safe Payments Adams 40%

Boyd 20%

Combined capital and loan balances $ 33,000 Estimated liquidation expenses and/or adjustment to minimum cash balance ............ (2,000) Balances ...................................... $ 31,000 Maximum loss possible ................ (18,000) Balances ...................................... $ 13,000 Allocation of debit capital balances (5,500) Safe payment ............................... $ 7,500

$ (1,000)

$55,000

$ 87,000

(1,000) $ (2,000) (9,000) $ (11,000) 11,000 $ 0

(2,000) $ 53,000 (18,000) $ 35,000 (5,500) $ 29,500

(5,000) $ 82,000 (45,000) $ 37,000 — $ 37,000

Profit and loss percentages .........

Chambers 40%

Total 100%

Ch. 14—Exercises

14–10

Exercise 14-7, Concluded 2. $6,000 of the available cash would be available to Boyd. Noncash Assets Liabilities Cash Beginning balances ............... $ 12,000 $ 255,000 $ 170,000 Sales of assets...................... 280,000 (255,000) 0 $ 170,000 Balances ............................... $ 292,000 $

Combined Capital and Loans Adams Boyd Chambers $ 25,000 $ (5,000) $ 47,000 22,000 11,000 22,000 $ 47,000 $ 6,000 $ 69,000

3. Boyd would be liable to Adams for $10,000. Noncash Combined Capital and Loans Cash Assets Liabilities Adams Boyd Chambers $ 12,000 $ 255,000 $ 170,000 $ 25,000 $(5,000) $ 47,000 150,000 (255,000) (30,000) (15,000) (30,000) $ 162,000 $ 0 $ 170,000 $ (5,000) $ (20,000) $ 17,000 (162,000) (162,000) 8,000 8,000 (8,000) (8,000) $ — $ — $ — $ 3,000 $ (20,000) $ 17,000

Beginning balances ............... Sales of assets...................... Balances ............................... Payment of liabilities ............. Contribution of capital ........... Payment of liabilities ............. Balances ............................... Allocation of Boyd capital balance ................. Balance ................................. $

0 $

(10,000) $ 20,000 $ (7,000) $ 0

$ (10,000) $ 7,000

4. Boyd would need a final capital balance of $16,000 represented by their personal deficit of $16,000. Therefore, their share of the gain on the sale of assets would have to be $21,000 so that after offsetting their $5,000 deficit capital balance, they would have a final balance of $16,000. Therefore the assets would have to be sold for $330,000 ($225,000 + ($21,000 divided by 20%). Noncash Combined Capital and Loans Cash Assets Liabilities Adams Boyd Chambers Beginning balances ............... $ 12,000 $ 225,000 $ 170,000 $ 25,000 $ (5,000) $ 47,000 Sales of assets...................... 330,000 (225,000) 42,000 21,000 42,000 Balances ............................... $ 342,000 $ 0 $ 170,000 $ 67,000 $ 16,000 $ 89,000

14–11

Ch. 14—Exercises

EXERCISE 14-8 (1) Allocation of typical profits under the original partnership’s agreement:

Salaries ................................. Bonus to A* ........................... Remaining profits .................. Total ......................................

A $30,000 12,000 10,000 $52,000

B $30,000

C $40,000

4,000 $34,000

6,000 $46,000

Cumulative Total $100,000 112,000 132,000

*Bonus = 10% (Net Income – Bonus) 110% Bonus = 10% (Net Income) 110% Bonus = $13,200 Bonus = $12,000 Allocation of new partnership profits necessary to satisfy Bower:

Salaries ....................................... Remaining profits* ...................... Bonus to Dawson** ..................... Total ............................................

A $30,000 42,000

B $30,000 14,000

C $40,000 42,000

$72,000

$44,000

$82,000

D $30,000 42,000 20,000 $92,000

Cumulative Total $130,000 270,000 290,000

*In order for Bower to increase his allocation by $10,000, he would need to receive a $14,000 allocation based on the profit percentage. Therefore, the total amount of profit subject to this allocation would be $140,000 ($14,000 divided by 10%). **If the cumulative total of income allocated before the bonus to Dawson is $270,000, then Dawson would be entitled to the $20,000 bonus under the revised partnership agreement. (2) The fair value of the net assets of the original partnership is $56,000 ($530,000 – $474,000). If Dawson acquires a 30% interest in the capital of the partnership, this would mean that the fair value traceable to the original partnership would represent 70% of the new partnership’s total capital. Therefore, the total capital of the new partnership would be $80,000 ($56,000 ÷ 70%), and Dawson would have to pay $24,000 ($80,000 – $56,000) for a 30% interest in the new partnership.

Ch. 14—Exercises

14–12

Exercise 14-8, Concluded (3) If the partnership were liquidated as described, Bower would receive additional cash of $88,200, determined as follows: Noncash Offset Capital Balances Assets Liabilities Arnold Bower Chambers $ 0 $ 680,000 $ 430,000 $ 50,000 $140,000 $ 60,000 4,000 (2,000) (800) (1,200) (20,000) (2,500) (16,000)* (1,500) 515,000 (660,000) (72,500) (29,000) (43,500) (434,000) (434,000) $ 81,000 $ 0 $ 0 $ (27,000) $ 94,200 $ 13,800 12,000 12,000 15,000 (6,000) (9,000) 0 $ 0 $ 0 $ 88,200 $ 4,800 $ 93,000 $ Cash

Beginning balances ....... Recognition of liability .... Vehicle transfer .............. Sales of assets .............. Payment of liabilities ...... Balances ........................ Contribution of assets .... Allocation of deficit ......... Balances ........................

*$15,000 fair value + (20% × $5,000 book value vs. fair value) = $16,000 EXERCISE 14-9 1. Partner B could contribute $12,000 determined as follows:

Beginning balances ............... Sales of assets...................... Payment of liabilities ............. Balances ...............................

Other Cash Assets Liabilities Partner A Partner B Partner C $ — $ 180,000 $ 150,000 $ 34,000 $(15,000) $ 11,000 165,000 (180,000) (5,000) (5,000) (5,000) (150,000) (150,000) 0 $ 0 $ 29,000 $ (20,000) $ 6,000 $ 15,000 $

Partner B Amount Partnership deficit ................. $ 20,000 Personal liabilities ................. 80,000 $ 100,000

% of Total 20.00% 80.00% 100.00%

Allocation of Personal Assets $ 12,000 48,000 $ 60,000

2. After Partner A contributes $22,500 toward the $24,000 of remaining partnership liabilities, Partner C would contribute the remaining $1,500 since they have net personal assets of $8,000. Determined as follows: Other Assets Liabilities Partner A Partner B Partner C $ — $ 180,000 $ 150,000 $ 34,000 $(15,000) $ 11,000 126,000 (180,000) (18,000) (18,000) (18,000) (126,000) (126,000) $ 0 $ 0 $ 24,000 $ 16,000 $ (33,000) $ (7,000) Cash

Beginning balances ............... Sales of assets...................... Payment of liabilities ............. Balances ...............................

14–13

Ch. 14—Exercises

Exercise 14-9, Concluded Partner A Amount Partnership creditors ............. $ 24,000 Personal liabilities ................. 40,000 $ 64,000

% of Total 37.50% 62.50% 100.00%

Allocation of Personal Assets $ 22,500 37,500 $ 60,000

3. The amounts contributed by Partners B and C are adequate to satisfy the remaining partnership creditors. Therefore, Partner A would not need to contribute any additional funds to the partnership. Other Assets Liabilities Partner A Partner B Partner C Cash $ — $ 180,000 $ 150,000 $ 34,000 $(15,000) $ 11,000 135,000 (180,000) (15,000) (15,000) (15,000) (135,000) (135,000) $ 0 $ 0 $ 15,000 $ 19,000 $ (30,000) $ (4,000)

Beginning balances ............... Sales of assets...................... Payment of liabilities ............. Balances ............................... Contributions by Partners B and C ............. 18,200 Payment of liabilities ............. (15,000) Balances ............................... $ 3,200 $

(15,000) 0 $ 0 $ 19,000

15,000

3,200

$ (15,000) $

(800)

Partner B Amount Partnership deficit ................. $ 30,000 Personal liabilities ................. 60,000 $ 90,000

% of Total 33.33% 66.67% 100.00%

Allocation of Personal Assets $ 15,000 30,000 $ 45,000

% of Total 10.00% 90.00% 100.00%

Allocation of Personal Assets $ 3,200 28,800 $ 32,000

Partner C Amount Partnership deficit ................. $ 4,000 Personal liabilities ................. 36,000 $ 40,000

4. Partner A would first have to absorb the remaining deficit balances of Partners B and C leaving Partner A with a final capital balance of $3,200. This $3,200 is all that the personal creditors could recover against Partner A’s interest in the partnership.

Ch. 14—Problems

14–14

PROBLEMS PROBLEM 14-1 Carlton $ 120,000

Balances as of December 31, 2014 ........ Withdrawal of Stansbury ............................ Allocation of 2015 income (see Schedule A).......................................... 100,000 Quarterly withdrawals in 2015 .................... (120,000) Balances as of December 31, 2015 ........... $ 100,000 Withdrawal of bonus amount ..................... Allocation of first six months of 2016 income (see Schedule A) ..................... 40,000 Quarterly withdrawals through June 30 ..... (60,000) Balances as of June 30, 2016 .................... $ 80,000 Acquisition of Laidlaw’s interest ................. (8,000) Allocation of second six months of 2016 income (see Schedule A) ............ 36,500 Quarterly withdrawals through December 31 (20,000) Balances as of December 31, 2016 ........... $ 88,500 Admit Wilson to partnership ($144,000/60% = $240,000) ................ Allocation of 2017 income (see Schedule A).......................................... 140,000 (120,000) Quarterly withdrawals in 2017 .................... Balances as of December 31, 2017 ........... $ 108,500 Allocation of first six months of 2018 income (see Schedule A) ..................... 85,000 Quarterly withdrawals through June 30 ..... (60,000) Balances as of June 30, 2018 .................... $ 133,500 Withdrawal of Carlton: Recognition of goodwill ........................ 26,500 Payment of $160,000 ........................... (160,000) Balances as of July 1, 2018 ....................... $ 0

Weber $ 70,000

Capital Balances Stansbury Laidlaw $ 80,000 (80,000) $ 80,000

87,500 (90,000) $ 67,500 (12,500)

112,500 (90,000) $102,500 (37,500)

35,000 (45,000) $ 45,000 (6,000) 36,500 (20,000) $ 55,500

Wilson

270,000

45,000 (45,000) $ 65,000 (65,000)

Total $270,000

190,000

144,000 $ 96,000

140,000 (120,000) $ 75,500 85,000 (60,000) $ 100,500

140,000 (120,000) $ 116,000

300,000

85,000 (60,000) $ 141,000

375,000

26,500 $ 127,000

26,500 $

$ 167,500

part.

294,500

14–15

Ch. 14—Problems

Problem 14-1, Concluded Schedule A—Allocation of Net Income 2015

Salary ..................................... Bonus (Note A) ....................... Subtotal .................................. Remaining profit (loss) ........... Total .......................................

Carlton $120,000 $120,000 (20,000) $100,000

Weber $ 90,000 12,500 $102,500 (15,000) $ 87,500

Laidlaw $ 90,000 37,500 $127,500 (15,000) $112,500 $ 45,000 15,000 $ 60,000 (15,000) $ 45,000

Wilson

Total $300,000 50,000 $350,000 (50,000) $300,000

1st 6 mos. 2016 Salary ..................................... Bonus (Note B) ....................... Subtotal .................................. Remaining profit (loss) ........... Total .......................................

$ 60,000 (20,000) $ 40,000

$ 45,000 5,000 $ 50,000 (15,000) $ 35,000

2nd 6 mos. 2016 Per profit and loss percentages......................

$ 36,500

Per profit and loss percentages......................

140,000

$140,000

420,000

1st 6 mos. 2018 Per profit and loss percentages......................

85,000

255,000

2017

$ 60,000

Note A:

Bonus = 20% (Net Income – Bonus) Bonus = 20% ($300,000 – Bonus) 120% Bonus = $60,000 Bonus = $50,000

Note B:

Bonus = 20% (Net Income – Bonus) Bonus = 20% ($120,000 – Bonus) 120% Bonus = $24,000 Bonus = $20,000

$150,000 20,000 $170,000 (50,000) $120,000

$ 73,000

PROBLEM 14-2 (1) Partner B’s capital balance will now be 80% of $30,000 or $24,000. (2) The understatement of $25,000 is traceable to the original partnership and the total partners’ capital would increase $25,000 to a revised total of $140,000. The $140,000 would represent 70% of a new suggested value of $200,000 ($140,000 divided by 70%). Therefore, Partner D would be expected to contribute $60,000 of consideration ($200,000 less $140,000). (3) The overstatement of $25,000 is traceable to the original partnership and the total partners’ capital would decrease $25,000 to a revised total of $90,000. The $90,000 would represent 75% of a new suggested value of $120,000 ($90,000 divided by 70%). Therefore, Partner D would be expected to contribute $30,000 of consideration ($120,000 less $90,000).

Ch. 14—Problems

14–16

Problem 14-2, Concluded (4) The capital of the original partnership plus the contribution of the new partner would total $181,000 of which Partner D would have a 30% interest or $54,300. Therefore, a bonus of $11,700 ($66,000 less $54,300) would be allocated to the original partners. Partner B’s interest in the bonus would be 30% or $3,510 resulting in a new capital balance of $33,510. (5) The contribution of $66,000 represents a 30% interest in a partnership with a total value of $220,000. Therefore, the value traceable to the original partnership must be $154,000 ($220,000 less $66,000) of which $115,000 was previously recognized. This suggests goodwill traceable to the original partnership of $39,000 ($154,000 – $115,000) of which 30% is allocable to Partner B. Partner B’s revised capital balance would be $41,700 ($30,000 plus 30% of $39,000). (6) After the contribution of $70,000 the total capital of the new partnership would be $185,000 of which the new partner would have a 30% interest or $55,500 (30% times $185,000). This suggests that a bonus of $14,500 ($70,000 – $55,500) is traceable to the original partners. Partner A’s interest in the bonus is $7,250 resulting in a revised capital balance of $77,250. (7) The $25,000 understatement in value of the recognized assets is traceable to the original partners and total partnership capital would increase to $140,000 ($115,000 plus $25,000). Dividing the $140,000 by 70% (the original partners’ interest in the new partnership) would suggest a value of $200,000. This would suggest that the new partner should pay $60,000 for a 30% interest in the partnership. However, the fact that the new partner is paying more than that suggests that there is good will traceable to the original partnership and that the new partner’s investment of $70,000 represents 30% of a total value of $233,333 ($70,000 divided by 30%). Comparing this total value of $233,333 against the revised original book value of $140,000 and the investment of $70,000 results in goodwill of $23,333 ($233,333 – $140,000 – $70,000). (8) The $25,000 understatement in value of the recognized assets is traceable to the original partners and total partnership capital would increase to $140,000 ($115,000 plus $25,000). Dividing the $140,000 by 70% (the original partners’ interest in the new partnership) would suggest a value of $200,000. This would suggest that the new partner should pay $60,000 for a 30% interest in the partnership. However, the fact that the new partner is paying less than $60,000 suggests that the new partner is also contributing goodwill in the amount of $35,000 ($60,000 – $25,000). (9) Adjusting the partnership for the $30,000 understatement in value would increase B’s capital to $39,000 ($30,000 + 30% times $30,000). If B is paid $51,000 for their interest, this suggests that $12,000 ($51,000 – $39,00) represents B’s 30% interest in total entity goodwill of $40,000 ($12,000 divided by 30%). After recording this information, A’s capital balance would be $105,000 ($70,000 +50% times the $30,000 asset appreciation + 50% of the $40,000 of goodwill).($145,000 ($115,000 + $30,000).

14–17

Ch. 14—Problems

PROBLEM 14-3 (1) Pre-sale capital balance ........................ Sale to Grossman .................................. Post-sale capital balance ....................... (2) Pre-sale capital balance ........................ Recognize only decreases in the value of existing assets ..................... Sale to Grossman .................................. Post-sale capital balance ....................... (3) Pre-sale capital balance ........................ Recognize only decreases in the value of existing assets ..................... Sale to partnership ................................ Post-sale capital balance ....................... (4) Pre-sale capital balance ........................ Recognize only decreases in the value of existing assets ..................... Recognition of Zeigler's goodwill ........... Sale to partnership ................................ Post-sale capital balance ....................... (5) Pre-sale capital balance ........................ Recognize only decreases in the value of existing assets ..................... Recognition of all suggested goodwill ... Sale to partnership ................................ Post-sale capital balance ....................... (6) Pre-sale capital balance ........................ Recognize all changes in the value of existing assets ..................... Recognition of all suggested goodwill ... Sale to partnership ................................ Post-sale capital balance .......................

Grossman

Casper

$125,000 150,000 $275,000

$200,000 $200,000

Grossman

Casper

Ziegler

Total

$125,000

$200,000

$ 150,000

$ 475,000

(12,250) 143,000 $255,750

(15,750) $184,250

Grossman

Casper

Ziegler

Total

$125,000

$200,000

$ 150,000

$ 475,000

(14,000) (8,500) $102,500

(14,000) (7,000) (35,000) (8,500) (143,000) (160,000) $177,500 $ 0 $ 280,000

Grossman

Casper

Ziegler

Total

$125,000

$200,000

$ 150,000

$ 475,000

(14,000)

$111,000

$186,000

Grossman

Casper

Ziegler

Total

$125,000

$200,000

$ 150,000

$ 475,000

(14,000) 34,000

$145,000

$220,000

Grossman

Casper

Ziegler

Total

$125,000

$200,000

$ 150,000

$ 475,000

8,000 12,000

$145,000

$220,000

Ziegler

Total

$ 150,000 $ 475,000 (150,000) — $ 0 $ 475,000

(7,000) (35,000) (143,000) — $ 0 $ 440,000

(7,000) (35,000) 17,000 17,000 (160,000) (160,000) $ 0 $ 297,000

(7,000) (35,000) 17,000 85,000 (160,000) (160,000) $ 0 $ 365,000

4,000 20,000 6,000 30,000 (160,000) (160,000) $ 0 $ 365,000

Note: This problem provides an opportunity to discuss which of the above alternatives, if any, is most appropriate. Consideration should be given to what is currently allowed by generally accepted accounting principles.

Ch. 14—Problems

14–18

PROBLEM 14-4 (1)

Capital Balances Murray Clay Rayburn

Davis Balances as of December 31, 2013 ................ Distribution of Clay’s 2013 bonus (see Schedule A) .................... Distribution of 2013 other income (see Schedule A; 80% × $144,000) ............................... Allocation of 2014 income* (see Schedule A) ............................ Quarterly distributions .................. Balances as of December 31, 2014 ................ Admission of Rayburn (see Schedule B) ............................ Distribution of Clay’s 2014 bonus (see Schedule A) .................... Distribution of 2014 other income (see Schedule A; 80% × $24,000) ................................. Allocation of 2015 income* (see Schedule A) ............................ Subtotal ........................................ Withdrawal of Davis**................... Balances as of December 31, 2015 ................ Distribution of Clay’s 2015 bonus (see Schedule A) .................... Distribution of 2015 other income (see Schedule A) .................... Allocation of 2016 income* (see Schedule A) ............................ Balances as of June 30, 2016 ......

$ 50,000

$ 80,000

Total

$ 70,000 (36,000)

(38,400)

108,000 (100,000)

84,000 (70,000)

$ 19,600

$ 49,600

$ 9,600

(3,300)

$ 78,800 $ 68,900

(6,000) (6,400)

(6,400)

50,000 50,000 $ 59,900 $ 89,900 4,500 (59,900)

36,100 $ 30,000 4,500

5,900 $ 74,800 1,500

$ 34,500

$ 76,300

$ 94,400

205,200

(1,100)

0 0

40,948 $ 135,348

40,948 $ 74,348

28,104 $104,404

314,100

*Not yet distributed **Davis balance of $59,900 – cash paid to Davis $49,400 = $10,500, which is allocated to the remaining partners (Murray and Clay each get 3/7 and Rayburn gets 1/7)

14–19

Ch. 14—Problems

Problem 14-4, Continued Schedule A Allocation of Profits and Losses 2013 Income Profit and loss percentages... Salaries ................................. Bonus (see Note A) ............... Remaining profits .................. Total ...................................... 2014 Income Salaries ................................. Bonus (see Note B) ............... Remaining profits .................. Total ...................................... 2015 Income Salaries ................................. Interest .................................. Bonus (see Note C)............... Remaining profits .................. Total ...................................... 2016 Income Salaries ................................. Interest (10% × $76,300) ...... Remaining profits .................. Total ......................................

Davis 33.3%

Murray 33.3%

$100,000

48,000 $148,000

$100,000

8,000 $108,000

Clay 33.3%

Rayburn

Cumulative Total

$ 70,000 36,000 48,000 $154,000

$270,000 306,000 450,000

8,000 $108,000

$70,000 6,000 8,000 $84,000

270,000 276,000 300,000

$50,000

$35,000

0 $50,000

1,100 0 $36,100

$ 5,900

0 0

40,948 $40,948

Note A:

Bonus = 20% (Net Income – Salaries) Bonus = 20% ($450,000 – $270,000) Bonus = 20% ($180,000) Bonus = $36,000

Note B:

Bonus = 20% (Net Income – Salaries) Bonus = 20% ($300,000 – $270,000) Bonus = 20% ($30,000) Bonus = $6,000

Note C:

Bonus = 20% (Net Income – Salaries) Bonus = 20% ($142,000 – $135,000) Bonus = 20% ($7,000) Bonus = $1,400 but limited to available net income

40,948 $40,948

0 5,900

0 7,630 20,474 $28,104

135,000 140,900 142,000 142,000

0 7,630 110,000

Ch. 14—Problems

14–20

Problem 14-4, Concluded Schedule B Changes in Partnership Interests Admission of Rayburn: Total capital of previous partners ........................................................... Investment of Rayburn ........................................................................... Total capital of new partnership ............................................................. 50% interest allocated to Rayburn ......................................................... Balance allocated to previous partners .................................................. Investment of Rayburn ........................................................................... Balance of negative bonus to previous partners ....................................

$ 78,800 59,000 $137,800 68,900 $ 68,900 59,000 $ 9,900

(2) Distribution of Available Cash on September 15, 2016 Available cash (see Schedule C) ...... Payment of liabilities ......................... Payment to partners (see Note D) .... Total ..................................................

Cash $ 277,000 (84,000) (183,000) $ 10,000

Liabilities

Murray

Clay

Rayburn

$112,908 $112,908

$1,908 $1,908

$68,184 $68,184

$84,000 $84,000

Schedule C Partial Liquidation Schedule

Balances at June 30, 2016 ..... August 1 sale of assets .......... September 1 sale of assets .... Balances .................................

Note D:

Noncash Loan from Capital Balances Cash Assets Liabilities Murray Murray Clay Rayburn $ 15,000 $433,100 $84,000 $50,000 $135,348 $74,348 $104,404 180,000 (220,000) (16,000) (16,000) (8,000) 82,000 (70,000) 4,800 4,800 2,400 $277,000 $143,100 $84,000 $50,000 $124,148 $63,148 $ 98,804

Schedule of Safe Payments

Profit and loss percentages...........................

Murray 40%

Combined capital and loan balances ............ Estimated cash reserve................................. Maximum loss possible ................................. Safe payment ................................................

$174,148 (4,000) (57,240) $112,908

Clay Rayburn 40% 20% $ 63,148 (4,000) (57,240) $ 1,908

Total 100%

$ 98,804 $ 336,100 (2,000) (10,000) (28,620) (143,100) $ 68,184 $ 183,000

14–21

Ch. 14—Problems

PROBLEM 14-5 If the partnership is liquidated, Jacobs’ capital balance and resulting distribution will be as follows: Cash Profit and loss percentages .................... Beginning balances ................................. Discovery of liabilities.............................. Sale of assets ......................................... Payment of liabilities ............................... Liquidation expenses .............................. Payment of Williams’ loan ....................... Balances ................................................. Contribution by Harrington ...................... Absorb Harrington's deficit ...................... Payment of Williams’ loan .......................

Noncash Assets

$ (15,000)

$ 322,000

232,000 (172,000) (18,000) (25,000) $ 2,000 13,000

(322,000)

$ 15,000

Liabilities $ 160,000 12,000

Combined Loan and Capital Balances Jacobs Williams Harrington 30% $ 52,000 (3,600) (27,000)

30% $ 65,000 (3,600) (27,000)

40% $ 30,000 (4,800) (36,000)

(5,400)

(7,200)

(172,000) $

—

$ 16,000

(5,400) (25,000) $ 4,000

—

(2,500) $ 13,500

(2,500) 1,500

$ (18,000) 13,000 5,000 $ —

If the partnership is liquidated, Jacobs will receive $13,500 of cash and a claim against Harrington for $2,500. The claim against Harrington will appear to be of questionable collectibility. If the offer by Williams is accepted, the amount received by Jacobs will be determined as follows: Cash Profit and loss percentages .................... Beginning balances ................................. Adjustment for uncertainties ................... Balances .................................................

$ (15,000) $ (15,000)

Noncash Assets $ 322,000 (70,000) $ 252,000

Liabilities $ 160,000 $ 160,000

Combined Loan and Capital Balances Jacobs Williams Harrington 30% $ 52,000 (21,000) $ 31,000

30% $ 65,000 (21,000) $ 44,000

part.

40% $ 30,000 (28,000) $ 2,000

Ch. 14—Problems

14–22

Problem 14-5, Concluded Payment due Jacobs: Capital balance .................................................. Percent to be paid .............................................. Total payment .................................................... Less down payment ........................................... Remaining balance ............................................ Number of installments ...................................... Installment payment ........................................... Net present value of installments when: Payment is ................................................... Number of months is .................................... Monthly interest rate is ................................. Net present value ......................................... Total payment .................................................... Less imputed interest: Stated payments .......................................... NPV of payments ......................................... Net consideration received ...........................

31,000 50% 15,500 (3,100) 12,400

24 516.67

516.67 24 0.50% $11,657.48 $15,500.00 $ 12,400 11,657.48

742.52 $14,757.48

Even after imputing interest on the installment receivable, it will appear that Jacobs is better off to accept the offer from Williams. Not only does Jacobs avoid the uncertainty associated with the claim against Harrington, but she is also able to avoid the uncertainties associated with questionable liquidation assumptions. Having said this, Jacobs should also evaluate the collectibility of the installment payments from Williams.

14–23

Ch. 14—Problems

PROBLEM 14-6 Capital Balances Reinartz Hepburn

Murphy 2016

2017

2018

2019

Balance as of December 31, 2015 ........... Allocation of profits (see Note A) ....................... Distributions ........................... Year-end balance ...................

$ 54,000

$ 76,000

127,600 102,400 (100,000) (100,000) $ 81,600 $ 78,400

Pioso

—

Total

—

$ 130,000

230,000 (200,000) $ 160,000

Beginning balance .................. Admission of Hepburn (see Note C) ...................... Allocation of profits (see Note A) ....................... Distributions ........................... Year-end balance ...................

$ 81,600

$ 78,400

30,000

20,000

$ 70,000

120,000

145,250 98,875 (80,000) (80,000) $ 176,850 $ 117,275

85,875 (80,000) $ 75,875

330,000 (240,000) $ 370,000

Beginning balance .................. Sale of interest to Reinartz ..... Allocation of profits (see Note A) ....................... Distributions ........................... Year-end balance ...................

$ 176,850 $ 117,275 (176,850) 176,850

$ 75,875

—

Beginning balance .................. Adjustment of net assets ........ Recognition of Reinartz goodwill (see Note C) ........ Sale of interest by Reinartz .... Subtotal .................................. Admission of Pioso (see Note C) ...................... Ending balance ......................

—

$ 160,000

$ 370,000 —

100,000 (60,000) $ 334,125

100,000 (80,000) $ 95,875

$ 334,125 (5,000)

$ 95,875 (5,000) — $ 90,875

—

20,875 (350,000) $ 90,875

— 0

21,625 $112,500

75,000 $ 75,000

96,625 $ 187,500

—

20,875 (350,000) $ —

—

200,000 (140,000) $ 430,000 $ 430,000 (10,000)

Note A: 2016 Allocation Profit Profit and loss percentages ............................. Salary .............................................................. Bonus (see Note B) ......................................... Balance ............................................................ Totals ...............................................................

Murphy 40% $ 80,000 46,000 1,600 $127,600

Reinartz 60% $100,000 2,400 $102,400

Cumulative Total $180,000 226,000 230,000

Ch. 14—Problems

14–24

Problem 14-6, Concluded

2017 Allocation Profit and loss percentages .. Salary ................................... Bonus (see Note B) .............. Balance ................................. Totals .................................... 2018 Allocation Profit and loss percentages .. Balance ................................. Totals .................................... Note B: Partner Murphy

Murphy 30% $ 80,000 66,000 (750) $145,250 Murphy

—

Reinartz 45% $100,000 (1,125) $ 98,875 Reinartz 50% $100,000 $100,000

Hepburn 25% $70,000 16,500 (625) $85,875 Hepburn 50% $100,000 $100,000

Cumulative Total $250,000 332,500 330,000 Cumulative Total $200,000

2016 Bonus Percent of Income 20%

Income $230,000

Bonus $46,000

2017 Bonus Partner Murphy Hepburn Note C:

Percent of Income 20% 5%

Income $330,000 330,000

Bonus $66,000 16,500 $82,500

Admission of Hepburn: If Hepburn paid $70,000 for a 25% interest in capital, this would suggest that the new partnership had a value of $280,000. This value exceeds the capital of the old partnership ($160,000) plus the investment of the new partner ($70,000). Therefore, goodwill of $50,000 [$280,000 – ($160,000 + $70,000)] is traceable to the original partnership. The goodwill is allocated to the original partners per their profit percentages. Sale of Reinartz Interest: If Reinartz's capital balance has a book value of $329,125 after the adjustment of net assets, a sale to the partnership for $350,000 suggests goodwill of $20,875 as being traceable to Reinartz. Admission of Pioso: If Pioso paid $75,000 for a 40% interest in capital, this would suggest that the new partnership had a value of $187,500. This value exceeds the capital of the old partnership ($90,875) plus the investment of the new partner ($75,000). Therefore, goodwill of $21,625 [$187,500 – ($90,875 + $75,000)] is traceable to the original partnership. The goodwill is allocated to the original partners per their profit percentages (in this case, Hepburn gets 100%).

14–25

Ch. 14—Problems

PROBLEM 14-7 If the partnership were liquidated on March 31, 2016, Klaproth would receive $48,750, determined as follows:

Event/Circumstance

Cash

Noncash Assets

Liabilities

Profit and loss percentages ....... Beginning balances ................... $ 120,000 $1,500,000 $1,400,000 Liquidation of assets .................. 1,380,000 (1,500,000) .. Settlement of liabilities ............... (1,350,000) (1,400,000) Unrecorded contingent liabilities ................................ (60,000) Payment of liquidation expenses............................... (25,000) Subtotal...................................... $ 65,000 $ — $ — Contribution of personal assets . 12,500 Absorption of deficit ................... — Subtotal...................................... $ 77,500 $ — $ — Final payment to partners .......... (77,500) — — Final balances............................ $ — $ — $ —

Partner’s Capital Balances Klaproth Stone Jackson 35%

30%

35%

$110,000 (42,000) 17,500

$ 20,000 (36,000) 15,000

$ 90,000 (42,000) 17,500

(21,000)

(18,000)

(21,000)

(8,750) $ 55,750

(7,500) $ (26,500) 12,500 14,000 $ — — $ —

(8,750) $ 35,750

(7,000) $ 48,750 (48,750) $ —

(7,000) $ 28,750 (28,750) $ —

If Klaproth continued in the partnership until March 31, 2018, he would receive draws of $20,000 and a final payment of $117,040 (110% of final capital balance of $106,400) less an investment of $50,000, determined as follows:

Event/Circumstance

Cash

Noncash Assets

Liabilities

Profit and loss percentages ....... Beginning balances ................... Allocation of 2016 net income (see Note A) .......................... Partnership draws ...................... Investment of capital .................. Allocation of 2017 net income (see Note B) .......................... Partnership draws ...................... Subtotal...................................... Adjustment of receivables and Inventory to market value ..... Final balances............................

Partner’s Capital Balances Klaproth Stone Jackson 35%

$120,000 $1,500,000 $1,400,000 $ 110,000

30%

35%

$ 20,000

$ 90,000

32,000 (20,000) 50,000

46,000 (40,000) 30,000

42,000 (20,000)

— 200,000 56,900 (60,000) — $ 60,000 $1,820,000 $1,400,000 $ 228,900

62,200 (40,000) $ 78,200

80,900 (20,000) $ 172,900

— (350,000) (122,500) $ 60,000 $1,470,000 $1,400,000 $ 106,400

(105,000) $ (26,800)

(122,500) $ 50,400

— (80,000) 80,000

120,000

—

Ch. 14—Problems

14–26

Problem 14-7, Concluded Note A: Allocation of 2016 income:

Klaproth

Stone

Jackson

Profit and loss percentages ....... Salary ......................................... Bonus as a percent of sales....... Balance ...................................... Totals .........................................

35% $100,000 30,000 (98,000) $ 32,000

30% $130,000 — (84,000) $ 46,000

35% $ 90,000 50,000 (98,000) $ 42,000

Allocation of 2017 income:

Klaproth

Stone

Jackson

35% $100,000 36,000 (79,100) $ 56,900

30% $130,000 — (67,800) $ 62,200

35% $ 90,000 70,000 (79,100) $ 80,900

Cumulative Total $320,000 400,000 120,000

Note B: Cumulative Total $320,000 426,000 200,000

It appears that Klaproth would be well advised to continue in the partnership if forecasted results are realized. Even if the cash flows from the two alternatives were expressed as present values, continuing in the partnership appears to be the best alternative.

14–27

Ch. 14—Problems

PROBLEM 14-8 Combined Capital and Loans

Noncash Beginning balances ............................... Month 1 Collection of receivables ....................... Allowance for uncollectible accounts .... Return of inventory ................................ Balances................................................ Payment of liabilities ............................. Balances................................................ Monthly safe payment (Schedule A) .... Balances................................................ Month 2 Sale of division net assets..................... Satisfaction of Partner B note payable.. Customer sale ....................................... Payment of liquidation expenses .......... Balances................................................ Monthly safe payment (Schedule A) .... Balances................................................ Month 3 Sale of inventory ................................... Balances................................................ Contribution of assets by Partner C (see Schedule B) ........................................ Partner B's assumption of deficit........... Balances................................................ Monthly safe payment (Schedule A) .... Balances................................................ Month 4 Sale of remaining assets ....................... Payment of liquidation expenses .......... Balances................................................ Partner B's assumption of deficit........... Balances................................................ Final distribution .................................... Balances................................................

Cash Assets Liabilities Partner A Partner B Partner C $ 12,000 $210,000 $100,000 $ 75,000 $ 67,000 $(20,000) 35,000

(43,000) (4,000) (2,400) (1,600) (12,000) (6,000) (3,600) (2,400) (70,000) $(62,000) (4,000) 2,400) (1,600) $ 47,000 $ 85,000 $ 38,000 $ 61,000 $ 58,600 $(25,600) (38,000) (38,000) $ 9,000 $ 85,000 $ 0 $ 61,000 $ 58,600 $(25,600) (4,000) — — (4,000) — $ 5,000 $ 85,000 $ 0 $ 61,000 $ 54,600 $(25,600) 34,000

(28,000) (15,000) (14,000)

16,000 (6,000) $ 49,000 $ 28,000 (45,000) $ 4,000 $ 28,000

10,000 (15,000) $ 14,000 $ 13,000

3,000 1,800 1,200 5,000 (22,000) 2,000 1,000 600 400 (3,000) (1,800) (1,200) 0 $ 67,000 $ 33,200 $(23,200) (32,500) (12,500) — 0 $ 34,500 $ 20,700 $(23,200)

$ (2,500) (1,500) (1,000) 0 $ 32,000 $ 19,200 $(24,200)

17,000 $ 31,000 $ 13,000 (27,000) $ 4,000 $ 13,000

$ $

7,000 (13,000) (4,500) $ 6,500 $ 0

6,500 $ (6,500) $ 0 $

(7,200) 0 $ 32,000 $ 12,000 $21,375) (5,625) 0 $ 10,625 $ 6,375 $

17,000 7,200 — — —

(3,000) $ (1,800) (1,200) (2,250) $ (1,350) $(900) 0 $ 5,375 $ 3,225 $ (2,100) (2,100) 2,100 0 $ 5,375 $ 1,125 — (5,375) (1,125) 0 $ 0 $ 0 $ 0

Ch. 14—Problems

14–28

Problem 14-8, Concluded Schedule A Schedule of Safe Payments Profit and loss percentages................................ Month 1 Combined capital and loan balances ................. Estimated liquidation expenses and/or adjustment to minimum cash balance ............ Balances............................................................. Maximum loss possible ...................................... Balances............................................................. Allocation of debit capital balances .................... Balances............................................................. Allocation of debit capital balances .................... Safe payment ..................................................... Month 2 Combined capital and loan balances ................. Estimated liquidation expenses and/or adjustment to minimum cash balance ............ Balances............................................................. Maximum loss possible ...................................... Balances............................................................. Allocation of debit capital balances .................... Safe payment ..................................................... Month 3 Combined capital and loan balances ................. Estimated liquidation expenses and/or ............. adjustment to minimum cash balance ............ Balances............................................................. Maximum loss possible ...................................... Balances............................................................. Allocation of debit capital balances .................... Safe payment .....................................................

Partner A 50%

Partner B 30%

Partner C 20%

Total 100%

$ 61,000

$ 58,600

$(25,600)

$ 94,000

(2,500) $ 58,500 (42,500) $ 16,000 (27,250) (11,250) 11,250 $ 0

(1,500) $ 57,100 (25,500) $ 31,600 (16,350) 15,250 (11,250) $ 4,000

(1,000) $(26,600) (17,000) $(43,600) 43,600 0

(5,000) $ 89,000 (85,000) $ 4,000 — 4,000

$ 4,000

$ 67,000

$ 33,200

$(23,200)

$ 77,000

(2,000) $ 65,000 (14,000) $ 51,000 (18,500) $ 32,500

(1,200) $ 32,000 (8,400) $ 23,600 (11,100) $ 12,500

(800) $(24,000) (5,600) $(29,600) 29,600 $ 0

(4,000) $ 73,000 (28,000) $ 45,000 — $ 45,000

$ 32,000

$ 12,000

$ 44,000

(2,000) $ 30,000 (6,500) $ 23,500 (2,125) $ 21,375

(1,200) $ 10,800 (3,900) $ 6,900 (1,275) $ 5,625

(800) $(800) (2,600) $ (3,400) 3,400 $ 0

(4,000) $ 40,000 (13,000) $ 27,000 — $ 27,000

Schedule B Contribution by Partner C

Amount Partnership deficit ................. $ 24,200 Personal liabilities ................. 96,800 $ 121,000

% of Total 20.00% 80.00% 100.00%

Allocation of Personal Assets $ 17,000 68,000 $ 85,000

14–29

Ch. 14—Problems

PROBLEM 14-9 Other Assets

Cash Profit and loss percentages .................... Beginning balances ................................. June 30 sale of assets ............................ Balances ................................................. Contribution of assets ............................. Payment of liabilities ............................... Balances ................................................. July 28 sale of assets.............................. Balances ................................................. Contribution of assets ............................. Payment of liabilities ............................... Balances ................................................. Adams contribution ................................. Payment of liabilities ............................... Balances ................................................. Chenery contribution ............................... Payment of liabilities ............................... Balances ................................................. Allocation of Beyer deficit (3:4) ............... Balances ................................................. Allocation of Chenery deficit ................... Balances .................................................

$ 25,000 120,000 $ 145,000 6,000 (131,000) $ 20,000 10,000 $ 30,000 24,000 (54,000) $ — 12,000 (12,000) $ — 3,000 (3,000) $ — — $ — — $ —

$ 240,000 (160,000) $ 80,000 $ 80,000 (80,000) $ —

Liabilities $ 200,000 $ 200,000 (131,000) $ 69,000 $ 69,000

—

(54,000) $ 15,000

—

(12,000) 3,000

—

(3,000) —

—

Partner’s Capital Balance Adams Beyer Chenery 30% $ 50,000 (12,000) $ 38,000

30% $ (10,000) (12,000) $ (22,000) 6,000

40% $ 25,000 (16,000) $ 9,000

$ 38,000 (21,000) $ 17,000

$ (16,000) (21,000) $ (37,000) 5,000

$ 17,000 12,000

$ (32,000)

—

$ 29,000

$ (32,000)

— 3,000

$ 29,000 (13,714) $ 15,286 (15,286) $ —

$ (32,000) 32,000 $ —

—

part.

9,000 (28,000) $ (19,000) 19,000

3,000 (18,286) $ (15,286) 15,286 $ —

Ch. 14—Problems

14–30

Problem 14-9, Concluded Allocation of Adams' personal assets: Personal liabilities ..................................................................... Unsatisfied partnership creditors .............................................. Total claims against personal assets ........................................

$22,500 15,000 $37,500

Assets to be contributed to partnership (40% × $30,000) ........

$12,000

Allocation of Chenery's personal assets: Personal liabilities ..................................................................... Unsatisfied partnership creditors .............................................. Total claims against personal assets ........................................

$27,000 3,000 $30,000

Assets to be contributed to partnership (10% × $30,000) ........

$3,000

60% 40 100%

90% 10 100%

(Note: The $30,000 of assets is $49,000 less the $19,000 previously contributed to the partnership.)

CHAPTER 15 UNDERSTANDING THE ISSUES 3. Budgets are the legal authorization to raise revenue, incur long-term debt, and appropriate resources. Authorized expenditures are termed appropriations. Budgetary totals, including appropriations, are recorded in the general ledger as control accounts to allow for budgetary comparisons in the ledgers as well as to facilitate financial reporting of a budgetary comparison statement.

1. GASB Statement No. 34 stipulates a new reporting model that includes two separate, but related sets of financial statements. The first set, the fund financial statements, focuses on reporting activity as a collection of separate funds with a current working capital focus that uses a modified accrual basis of accounting. The second set contains government-wide statements that concentrate on the government as a whole with an economic long-term focus using full accrual-basis accounting. The value of both perspectives is the retention of a near cash or working capital focus on funding government with a longer-term focus that measures whether such services can continue without attention to condition of all capital assets and recognition of and planning for increased expenditures in future periods. Capital assets and long-term liabilities are not accounted for in the governmental funds but will be accounted for and reported in the government-wide financial statements. Thus, the “working capital” fund balance will be replaced with a long-term notion of net assets—broken into unrestricted, restricted, and capital, net of related debt.

4. The advantage of reporting designations of the fund balance is improved communications of decisions made by the common council or town/village board that will impact the availability of resources for other purposes. Categorizing the fund balance first into nonspendable allows users of the financial statements to assess the government’s ability to cover financial obligations and invest in future assets. Further classifying the fund balance by restriced, committed, assigned, and unassigned allows the user to assess the extent to which the spendable fund balance may be appropriate for future uses of the government. 5. The encumbrance system is designed as an early indicator or an “expected expenditure” to prevent overspending and to plan for payment of an “expected liability.” It is an estimate of an expenditure that may or may not be realized by year-end but will require the use of existing or future financial resources.

2. Separating activity into governmental, proprietary, and fiduciary funds allows for detailed reporting of resources and spending. Separating of activities also allows for a different measurement focus and basis of accounting depending on whether activities are general government or business-type activities. In addition, since the governmental activities are accounted for using a modified accrual basis of accounting in order to capture financial resource information, the account groups have served to record (i.e., list) the long-term capital assets and liabilities. Proponents of this model argue that information generated best serves the budget-planning process and answers questions relating to how much resources are needed to pay for the current level of services.

6. The governmental funds are designed to capture financial resources information. Therefore, when a capital asset is acquired or sold, the resources (financial resources used or acquired) are recorded in the funds. The account groups are designed to provide information on the number and condition of these capital assets. The same is true for long-term liabilities. When debt is incurred, the cash is recorded in the fund to capture the inflow of financial resources. But the debt is recorded in the account group. When debt is repaid, the outflow of

15–2 cash is recorded in the fund, and the debt is removed from the account group. Since the fund and account groups capture different information, making a journal entry only in the fund would adequately record flows of financial resources but not record the balances of long-term liabilities and/or capital assets.

7. (Appendix) The 13 basic principles of government accounting are found in GASB Statement No. 1 and in Codification of Governmental Accounting and Financial Reporting Standards. They form a model of fund accounting theory and help anchor the subsequent work of the GASB as detailed in Chapters 15–17 of this text.

15–3

Ch. 15—Exercises

EXERCISES EXERCISE 15-1 (1) c

Items (a) and (b) are Other Financing Sources, while (d) is a reduction of Expenditures.

(2) d

(a), (b), and (c) represent outflows of financial resources to acquire goods and services. The consumption, not the purchase of inventory, is an expenditure.

(3) b

Representing potential inflow of assets, Estimated Revenues is debited.

(4) d

Revenues are credited when the taxpayers are billed.

(5) a

Donated fixed assets are recorded in the general fixed asset account group at their estimated fair value when received.

(6) c

Governmental organization reporting is designed to demonstrate the accountability for the stewardship of the resources in their care. Both operational and fiscal accountability are important to the financial reporting.

(7) a

Acquisition of a new police car in a city's general fund would be displayed as an expenditure in its governmental fund statement of revenues, expenditures, and changes in fund balances.

(8) b

Expenditures are closed along with the other nominal accounts to determine an increase or a decrease in the fund balance from the current-period operations.

(9) d

When a purchase order is approved, Encumbrances is debited to reflect the expected expenditure. A reserve is also established by a credit to Fund Balance—Reserved for Encumbrances.

(10) a

The lease obligation is long-term debt and should be recorded in the account group.

EXERCISE 15-2 (1) a

Grants without restriction are recorded as revenue when received.

(2) e

These pension expenditures will be recorded in the internal service fund.

(3) b

This is an expenditure by the general fund.

(4) c

This is recorded as a transfer to the swimming pool fund.

(5) e

A loan only affects the balance sheet accounts.

(6) c

This is a general fund contribution to establish an internal service fund and not an expenditure for services.

(7) b

Payments on an operating lease are expenditures for the general fund.

Ch. 15—Exercises

15–4

EXERCISE 15-3 Estimated Revenues ($205,000 + $7,000 + $90,000 + $50,000) .... Estimated Other Financing Sources ($100,000 + $15,000) ............. Budgetary Fund Balance ................................................................. Appropriations ............................................................................ Estimated Other Financing Uses ($20,000 + $10,000) ..............

352,000 115,000 63,000 500,000 30,000

(Note to Instructor: Property taxes paid by a proprietary fund are considered revenue.)

EXERCISE 15-4 Jan.

Feb.

Apr.

July

Cash ..................................................................................... Tax Anticipation Notes Payable ..................................... To record borrowing.

275,000

Cash ..................................................................................... Tax Liens Receivable ..................................................... Revenues ....................................................................... To record collection of tax liens.

12,000

Cash ..................................................................................... Tax Liens Receivable ..................................................... To record collection of tax liens, sale of property.

13,000

Allowance for Uncollectible Tax Liens .................................. Tax Liens Receivable ..................................................... Revenues ....................................................................... To close allowance.

23,000

Cash ..................................................................................... Delinquent Property Taxes Receivable .......................... Revenues ....................................................................... To record collection of delinquent property taxes.

104,500

Tax Liens Receivable ........................................................... Delinquent Property Taxes Receivable .......................... To transfer delinquent property taxes to tax liens.

5,000

Allowance for Uncollectible Delinquent Taxes ..................... Revenues ................................................................. To close allowance for uncollectible delinquent taxes.

30,000

Property Taxes Receivable .................................................. Allowance for Property Taxes Receivable...................... Revenues ....................................................................... To record current property tax levy.

422,000

275,000

10,000 2,000

13,000

17,000 6,000

100,000 4,500

5,000

30,000

21,100 400,900

15–5

Ch. 15—Exercises

Exercise 15-4, Concluded Sept. Cash ..................................................................................... Property Taxes Receivable ............................................ To collect current property taxes.

345,000

Tax Anticipation Notes Payable ........................................... Expenditures ........................................................................ Cash ............................................................................... To pay off tax anticipation notes.

275,000 18,000

345,000

293,000

EXERCISE 15-5 (1) Cash ......................................................................................... Other Financing Sources .................................................... To transfer from municipal trust fund.

45,000 45,000

(2) No entry in the general fund for land. Record in the general fixed assets account group: Land .......................................................................................... Investment in General Fixed Assets—Donations ............... To record donation of park.

75,000

(3) Due from State ......................................................................... Revenues............................................................................ To record state grant.

30,000

(4) Cash ......................................................................................... Other Financing Sources .................................................... To record sale of fire truck.

9,000

75,000

30,000

9,000

Additional entry in General Fixed Assets Group: Investment in General Fixed Assets—General Fund Revenues Equipment...........................................................................

36,000

(5) Cash ......................................................................................... Revenues............................................................................ Deferred Inflow of Resources ............................................. To record sale of park stickers.

5,000

36,000 2,500 2,500

Ch. 15—Exercises

15–6

EXERCISE 15-6 (1) Expenditures ($100,000 + $50,000 + $125,000 + $13,000) ..... Tax Anticipation Notes Payable ................................................ Inventory of Supplies ................................................................ Vouchers Payable............................................................... To record payment of vouchers.

288,000 200,000 45,000

(2) Other Financing Uses ............................................................... Cash ................................................................................... To transfer to debt service fund.

50,000

(3) Expenditures ............................................................................. Inventory of Supplies .......................................................... To record consumption of inventory.

43,000

Fund Balance—Unassigned ..................................................... Fund Balance—Nonspendable ........................................... To adjust fund balance to match inventory balance.

2,000

533,000

50,000

43,000

2,000

EXERCISE 15-7 (1) Encumbrances .......................................................................... Fund Balance—Unassigned ............................................... To restore previous year’s encumbrances.

18,000

(2) Encumbrances .......................................................................... Fund Balance—Assigned or Committed............................. To record current encumbrances.

70,000

(3) Fund Balance—Assigned or Committed .................................. Encumbrances .................................................................... To reverse encumbrances for orders received.

88,000

Inventory of Supplies ................................................................ Vouchers Payable............................................................... To record purchase of inventory.

82,000

(4) Expenditures ($25,000 + $82,000 – $30,000) .......................... Inventory of Supplies .......................................................... To record use of inventory.

77,000

18,000

70,000

88,000

82,000

77,000 5,000 5,000

15–7

Ch. 15—Exercises

EXERCISE 15-8 Date

Item

January 1 January 15 February 1 February 15 June 3 December 31

Budget Encumbrances Vouchers Vouchers Vouchers Inventory

Encumbrances Debit Credit Balance — 16,000 — — — —

— — — 12,000 4,000 —

— 16,000 — 4,000 — —

Expenditures

Unobligated Balance

— — 5,000 12,300 6,300 (2,000)

25,000 9,000 4,000 3,700 1,400 3,400

EXERCISE 15-9 (a) Estimated Revenues ................................................................ Appropriations..................................................................... Budgetary Fund Balance—Unassigned.............................. To record budget for the year.

520,000

(b) Taxes Receivable—Current ..................................................... Allowance for Uncollectible Current Taxes ......................... Revenues............................................................................ To record tax levy.

378,788

(c) Encumbrances .......................................................................... Fund Balance—Assigned or Committed............................. To record purchase orders authorized.

240,000

280,000

(e) Fund Balance—Assigned or Committed .................................. Encumbrances .................................................................... To reverse encumbrance entry for items invoiced.

223,000

Expenditures ............................................................................. Vouchers Payable............................................................... To record invoices vouchered.

225,000

135,000

(g) Cash ......................................................................................... Revenues............................................................................ To record receipt of a grant-in-aid.

100,000

(f)

515,000 5,000

3,788 375,000

240,000

280,000

223,000

225,000

135,000

100,000

Ch. 15—Exercises

15–8

Exercise 15-9, Concluded (h) Cash ......................................................................................... Revenues............................................................................ To record receipt of miscellaneous revenues.

10,000

(i)

120,000

(j)

Expenditures ............................................................................. Cash ................................................................................... To record purchase of property. (The property would also be entered in the general fixed assets account group.)

10,000

120,000

No entry. Recorded only in general fixed assets account group.

(k) Other Financing Uses ............................................................... Due to Other Funds ............................................................ To record amount due other funds and approved for payment.

12,000

(l)

Due from State ......................................................................... Revenues............................................................................ To record share of state sales taxes receivable.

30,000

(m) Vouchers Payable .................................................................... Cash ................................................................................... To record vouchers paid.

175,000

(n) Budgetary Fund Balance—Unassigned ................................... Appropriations .......................................................................... Estimated Revenues........................................................... To reverse budgetary entry.

5,000 515,000

Revenues ................................................................................. Expenditures ....................................................................... Other Financing Uses ......................................................... Fund Balance—Unassigned ...............................................

515,000

Fund Balance—Unassigned ..................................................... Encumbrances .................................................................... To close nominal accounts.

17,000

12,000

30,000

175,000

520,000

480,000 12,000 23,000 17,000

15–9

Ch. 15—Exercises

EXERCISE 15-10 (1) Closing entries:

(2)

Appropriations ............................................................................ Estimated Other Financing Uses ............................................... Budgetary Fund Balance............................................................ Estimated Revenues........................................................... Estimated Other Financing Sources ...................................

650,000 50,000 50,000

Other Financing Sources ........................................................... Revenues ................................................................................... Expenditures ....................................................................... Other Financing Uses ......................................................... Fund Balance—Unassigned ...............................................

166,500 595,000

Fund Balance—Unassigned ...................................................... Encumbrances ....................................................................

60,000

600,000 150,000

588,000 46,500 127,000 60,000

Shorewood Village General Fund Budgetary Comparison Schedule For Fiscal Year Ended June 30, 2019

Revenues .................................................................... Expenditures ............................................................... Excess (shortage) of revenues over expenditures .......................................................... Other financing sources .............................................. Other financing uses ................................................... Total other financing sources (uses) ..................... Fund balances, July 1, 2018 ....................................... Fund balances, June 30, 2019 ....................................

Budget $ 600,000 650,000

Actual $ 595,000 588,000

Variance— Favorable (Unfavorable) $ (5,000) 62,000

$ (50,000) $ 150,000 50,000 $ 100,000 $ 92,000 $ 142,000

$ 7,000 $ 166,500 46,500 $ 120,000 $ 92,000 $ 219,000

$ 57,000 $ 16,500 3,500 $ 20,000 $ 0 $ 77,000

Ch. 15—Exercises

15–10

Exercise 15-10, Concluded (3)

Shorewood Village General Fund Balance Sheet June 30, 2019 Assets

Liabilities and Fund Equity

Cash ...................................... Receivables (net) ..................

$190,000 120,000

Total assets ........................

$310,000

Liabilities: Vouchers payable ........... $ 91,000 Fund balances: Assigned or committed................ $ 60,000 Unassigned ................................. 159,000* Total fund equity .............................. $219,000 Total liabilities and fund equity .... $310,000

*$92,000 balance plus $761,500 inflows minus $634,500 outflows minus $60,000 encumbrances

EXERCISE 15-11 Event

Fund or Group

Purchase

General Fund

Sale (10 years later)

Entry Expenditures ........................................ Cash ................................................

65,000

Fund Balance—Assigned or Committed Encumbrances .................................

70,000

General Fixed Assets Account Group

Land ..................................................... Investment in General Fixed Assets— General Fund Revenues .............

65,000

General Fund

Cash ..................................................... Other Financing Sources .................

105,000

General Fixed Assets Account Group

Investment in General Fixed Assets— General Fund Revenues.................. Land ............................................

65,000 70,000

65,000 105,000 65,000 65,000

15–11

Ch. 15—Exercises

EXERCISE 15-12 (a) Land ................................................................................................ Buildings ......................................................................................... Investment in General Fixed Assets—General Funds .............. To record property purchase.

325,000 975,000

(b) Land ................................................................................................ Buildings ......................................................................................... Investment in General Fixed Assets—Donations ..................... To record donated property at its fair value.

330,000 220,000

(c) Construction in Progress ................................................................ Investment in General Fixed Assets—Capital Projects Funds (General Obligation Bonds) ................................................ To record cost of work to date.

800,000

(d) Machinery and Equipment .............................................................. Investment in General Fixed Assets—General Fund Revenues ............................................................................ To record fire engine purchase at full value.

190,000

Investment in General Fixed Assets—General Fund Revenues .... Machinery and Equipment ........................................................ To record trade-in.

100,000

(e) Infrastructure .................................................................................. Investment in General Fixed Assets—Capital Projects Funds ..... To record cost of new street.

250,000

(f)

70,000

Computer Software ......................................................................... Investment in General Fixed Assets—General Fund Revenues ..

1,300,000

550,000

800,000

190,000

100,000

250,000

70,000

EXERCISE 15-13 (1) Amount to Be Provided for Compensated Absences ..................... Unfunded Compensated Absences .......................................... To record the noncurrent portion of the obligation for vacations.

2,200,000

(2) Unfunded Compensated Absences ................................................ Amount to Be Provided for Compensated Absences ............... To reduce the long-term obligation for vacations.

400,000

2,200,000

400,000

(3) Amount to Be Provided for Claims and Judgments ........................ 11,000,000 Claims and Judgments Payable ............................................... 11,000,000 To record the noncurrent portion of the judgment against the city.

Ch. 15—Exercises

15–12

Exercise 15-13, Concluded (4) Amount to Be Provided for Payment of Bonds ............................ 100,000,000 General Obligation Bonds Payable........................................ 100,000,000 To record the issuance of general obligation bonds at maturity value. (5) Amount Available in the Debt Service Fund ................................ Amount to Be Provided for Payment of Bonds ...................... To record accumulation of resources in the debt service fund for bond principal.

1,000,000

(6) Amount Available in the Debt Service Fund ................................ Amount to Be Provided for Payment of Bonds ...................... To record interest earned and appreciation in fair value of investments in the debt service fund.

4,800,000

1,000,000

4,800,000

EXERCISE 15-14 (a) Amount to Be Provided for Payment of Term Bonds ................... Term Bonds Payable ............................................................. To record issuance of general obligation bonds at maturity value to finance construction of an art center.

13,000,000

(b) Amount Available in Debt Service Funds—Term Bonds ............. Amount to Be Provided for Payment of Term Bonds ............. To record allocation to debt service fund.

1,300,000

(c) Amount to Be Provided for Payment of Serial Bonds .................. Serial Bonds Payable ............................................................ To record serial bonds issued to finance construction of a health center.

6,000,000

Amount Available in Debt Service Funds—Serial Bonds ............ Amount to Be Provided for Payment of Serial Bonds ............ To record allocation to debt service fund ($6,000,000/10).

600,000

(d) Serial Bonds Payable .................................................................. Amount Available in Debt Service Funds—Serial Bonds ...... To record retirement of serial bond issue.

600,000

13,000,000

1,300,000

6,000,000

600,000

EXERCISE 15-15 (Note to Instructor: The GASB Web site lists all of the pronouncements of the board. Individual standards can be purchased, but current exposure drafts and discussion memoranda can be obtained for no fee. In addition, the GASB mission, board membership, and meeting schedules are found on the site.)

15–13

Ch. 15—Problems

PROBLEMS PROBLEM 15-1 (1) b

Funds are used to separate reporting of the diverse variety of governmental activities and to meet legal provisions stipulating use of resources imposed on the governmental unit.

(2) a

The Governmental Accounting Standards Board is the authoritative body for financial reporting standards used by state and local governments.

(3) b

The GASB stipulated that the measurement focus for governmental funds is the flow of financial resources.

(4) c

Interperiod equity seeks to determine whether current-year revenues are sufficient to pay for current-year services or whether future taxpayers will be required to assume burdens for services previously provided. The flow of financial resources measurement focus measures the extent to which financial resources obtained during a period are sufficient to cover claims incurred during that period against financial resources of a governmental fund. The GASB recognized that because budgetary and fund accounting practices cause costs of government activities to be spread among a number of funds, general purpose financial reporting must also include the measurement of the cost of services provided during a period.

(5) a

Long-term debt used to purchase fixed assets is recorded in the general fund as an other financial resource, but the debt itself is recorded in the general long-term debt account group.

(6) d

Current standards specify that neither interest nor principal on long-term debt should be accrued in advance of the year in which it is due. Governments may, however, opt to accrue principal if resources are available in the debt service fund by year-end.

(7) b

Reporting outstanding encumbrances as a fund balance reserve indicates that not all of the resources in the fund are available for new expenditures.

PROBLEM 15-2 a

Encumbrance control is increased when an order is placed and decreased when the voucher is recorded. When encumbrances are closed at year-end, they are decreased.

(2) a

Grants from outside units are revenues unless they require the prior recording of an expenditure that is then reimbursed.

(3) c

The appropriation still available for use is the original appropriation less expenditures and encumbrances.

(4) c

These notes are short-term operating debt that will be repaid out of current revenues.

(5) d

When supplies are received, the original entry to encumber the estimated cost is reversed.

(6) b

A hypothetical entry to record the tax levy is:

(1)

Taxes Receivable—Current................................................ Allowance for Uncollectible Current Taxes ................... Revenues ......................................................................

100,000 4,000 96,000

Ch. 15—Problems

15–14

Problem 15-2, Concluded Because revenues are estimated and recorded net of the uncollectible, a decrease in the allowance is a revision (in this case an increase) of revenues. This is true even if the revenues were recorded in a prior period. (7) a

Revenues are recognized when measurable and available to meet current-period expenditures. This is interpreted to include collections of the current period or shortly after year-end (usually within 60 days of year-end).

(8) a

The general fixed assets account group records the fixed assets of governmental funds but not proprietary funds or trust funds.

(9) b

Expenditures are recorded when the liability is incurred. Under the modified accrual basis of accounting, the noncurrent liability is recorded in the general long-term debt account group.

(10) d

The fixed asset is recorded in the account group at its fair value with a credit to Investment in General Fixed Assets identifying the original funding source.

PROBLEM 15-3 (1) At inception of the lease: General Fund

Expenditures ................................................. 800,000 Other Financing Sources ........................ To record the acquisition of the equipment under capital lease.

General Fixed Assets Account Group

Leased Equipment ....................................... 800,000 Investment in General Fixed Assets—Capital Leases ..................... To record the equipment.

General Long-Term Debt Account Group

Amount to Be Provided ................................. 800,000 Capital Lease Obligation ......................... To record the capital lease obligation.

800,000

(2) First interest payment: General Fund

General Fixed Assets Account Group

Expenditures (interest) ($800,000 × 6%) ...... Expenditures (principal) ................................ Cash ........................................................ To record the first lease payment of principal and interest. Investment in General Fixed Assets—Capital Leases .......... Leased Equipment ............................ To record the depreciation on the leased equipment (optional entry under current standards).

48,000 60,694 108,694

80,000 80,000

15–15

Ch. 15—Problems

Problem 15-3, Concluded General Long-Term Debt Account Group

Capital Lease Obligation ............................... 60,694 Amount to Be Provided ........................... To record the reduction of the lease principal. Note: Each lease payment reduces the principal balance of the obligation., Therefore each subsequent payment will allocate a smaller portion to interest and a larger portion to principal.

60,694

PROBLEM 15-4 (1) (a) Estimated Revenues................................................................. Appropriations ................................................................... Budgetary Fund Balance—Unassigned ............................ To record budget.

400,000

Encumbrances .......................................................................... Fund Balance—Unassigned .............................................. To reinstate encumbrance.

16,000

(b) Fund Balance—Assigned ......................................................... Encumbrances .................................................................. To reverse encumbrance entry.

16,000

Expenditures ............................................................................. Vouchers Payable ............................................................. To record voucher.

16,400

(c) Taxes Receivable—Current...................................................... Allowance for Uncollectible Current Taxes (4%) ............... Revenues .......................................................................... To record tax levy.

300,000

(d) Cash ......................................................................................... Taxes Receivable—Current .............................................. Taxes Receivable—Delinquent ......................................... Interest and Penalties Receivable on Taxes ..................... Due from Other Funds ....................................................... To record receipts.

355,600

Allowance for Uncollectible Delinquent Taxes .......................... Allowance for Uncollectible Interest and Penalties ................... Revenues.................................................................................. Taxes Receivable—Delinquent ......................................... Interest and Penalties Receivable on Taxes .....................

12,000 800 3,600

362,000 38,000

16,000

16,400

12,000 288,000

250,000 84,000 7,600 14,000

16,000 400

Ch. 15—Problems

15–16

Problem 15-4, Concluded (e) Encumbrances .......................................................................... Fund Balance—Assigned .................................................. To record encumbrances.

276,000

Supplies Inventory .................................................................... Expenditures ............................................................................. Vouchers Payable ............................................................. To record vouchers.

16,000 244,000

Fund Balance—Assigned ......................................................... Encumbrances .................................................................. To record encumbrance entry.

254,000

50,000 280,000

(g) Expenditures ............................................................................. Vouchers Payable ............................................................. To record voucher for automobile.

16,000

(h) Expenditures ............................................................................. Inventory of Supplies ......................................................... To record use of inventory.

10,000

Fund Balance—Unassigned ..................................................... Fund Balance—Nonspendable ......................................... To establish desired fund balance designation.

6,000

(2) Appropriations .................................................................................. Budgetary Fund Balance—Unassigned ........................................... Estimated Revenues.................................................................

362,000 38,000

Fund Balance—Unassigned ............................................................ Revenues ......................................................................................... Expenditures .............................................................................

52,000 284,400

Fund Balance—Unassigned ............................................................ Encumbrances ..........................................................................

22,000

(f)

276,000

260,000

254,000

330,000

16,000

10,000

6,000

400,000

336,400 22,000

(3) Statement of Revenues, Expenditures, and Changes in Fund Balance: Revenues ..................................................................................................... Expenditures ................................................................................................ Excess of Revenues over Expenditures* .....................................................

$284,400 336,400 $ (52,000)

Fund Balances, July 1, 2018 ........................................................................ Fund Balances, June 30, 2019 ....................................................................

76,000 $ 24,000

*In practice, this title remains as shown even though the result is negative (a deficit). However, alternate wording, such as Excess of Expenditures over Revenues, could be used.

15–17

Ch. 15—Problems

PROBLEM 15-5 (a) Estimated Revenues .................................................................. Estimated Other Financing Sources .......................................... Appropriations ...................................................................... Estimated Other Financing Uses ......................................... Budgetary Fund Balance—Unassigned ...............................

400,000 200,000

Encumbrances ........................................................................... Fund Balance—Unassigned ................................................

12,000

(b) Taxes Receivable—Current ($220,800/96%) ............................ Allowance for Uncollectible Current Taxes .......................... Revenues .............................................................................

230,000

(c) Encumbrances ........................................................................... Fund Balance—Assigned .....................................................

316,000

(d) Fund Balance—Unassigned ...................................................... Fund Balance—Designated for Capital Outlays ...................

20,000

(e) Cash ........................................................................................... Allowance for Uncollectible Delinquent Taxes ........................... Taxes Receivable—Delinquent ............................................ Taxes Receivable—Current ................................................. Expenditures ........................................................................ Revenues ............................................................................. Other Financing Sources ..................................................... Other Financing Sources .....................................................

664,000 8,000

(f) Fund Balance—Assigned........................................................... Encumbrances .....................................................................

302,000

Expenditures .............................................................................. Vouchers Payable ................................................................

308,000

(g) Inventory .................................................................................... Expenditures .............................................................................. Other Financing Uses ................................................................ Vouchers Payable ................................................................ Due to Debt Service Fund ....................................................

40,000 204,000 20,000

(h) Revenues ................................................................................... Deferred Revenues ..............................................................

2,000

Allowance for Uncollectible Current Taxes ................................ Revenues ($226,000 – $220,800) ........................................

5,200

560,000 20,000 20,000 12,000 9,200 220,800 316,000 20,000

46,000 226,000 4,000 178,000 200,000 18,000 302,000 308,000

244,000 20,000 2,000 5,200

Ch. 15—Problems

15–18

Problem 15-5, Concluded (i) Vouchers Payable ...................................................................... Cash .....................................................................................

580,000

(j) Expenditures .............................................................................. Inventory ..............................................................................

46,000

Fund Balance—Nonspendable .................................................. Fund Balance—Unassigned ................................................

6,000

580,000 46,000 6,000

PROBLEM 15-6 (1) (a) Estimated Revenues........................................................... Estimated Other Financing Sources ................................... Appropriations ............................................................. Estimated Other Financing Uses ................................. Budgetary Fund Balance—Unassigned ...................... To record the approved budget.

900,000 27,000

(b) Encumbrances .................................................................... Fund Balance—Unassigned ........................................ To return encumbered amount to fund balance.

15,000

(c) Taxes Receivable—Current................................................ Allowance for Uncollectible Current Taxes .................. Revenues .................................................................... To record tax levy.

650,000

(d) Fund Balance—Reserved for Encumbrances .................... Encumbrances ............................................................ To return reserve to unassigned balance.

25,000

Expenditures ....................................................................... Vouchers Payable ....................................................... To voucher invoices received.

24,000

(e) Cash ................................................................................... Taxes Receivable—Current ........................................ Taxes Receivable—Delinquent ................................... To record receipt of property tax payments.

644,000

Taxes Receivable—Delinquent .......................................... Allowance for Uncollectible Current Taxes ......................... Taxes Receivable—Current ........................................ Allowance for Uncollectible Delinquent Taxes ............ To record delinquent taxes and reclassify related estimated uncollectibles.

26,000 6,500

875,000 20,000 32,000

15,000

6,500 643,500

25,000

24,000

624,000 20,000

26,000 6,500

15–19

Ch. 15—Problems

Problem 15-6, Continued Tax Liens Receivable ......................................................... Allowance for Uncollectible Delinquent Taxes .................... Taxes Receivable—Delinquent ................................... Allowance for Uncollectible Tax Liens ......................... To record tax liens and reclassify related uncollectibles.

8,000 3,000

Encumbrances .................................................................... Fund Balance—Assigned ............................................ To record issuance of purchase orders.

700,000

Fund Balance—Assigned ................................................... Encumbrances ............................................................ To reverse encumbrance entry for items invoiced.

680,000

Expenditures ....................................................................... Supplies Inventory .............................................................. Vouchers Payable ....................................................... To voucher invoices received.

675,000 10,000

(g) Expenditures ....................................................................... Supplies Inventory ....................................................... To record consumption of inventory.

8,000

Fund Balance—Unassigned ............................................... Fund Balance—Nonspendable ................................... To establish supplies reserve.

2,000

(h) Expenditures ....................................................................... Cash ............................................................................ To record purchase of land. (Also requires entry in general fixed assets account group.)

250,000

(i)

Cash ................................................................................... Due from State Government ............................................... Revenues .................................................................... To record federal and state revenues.

300,000 60,000

Other Financing Uses ......................................................... Cash ............................................................................ To record transfers made to other funds. (Requires entries in other funds.)

20,000

(k) Expenditures ....................................................................... Cash ............................................................................ To record mortgage payment. (Requires entry in general long-term debt account group.)

50,000

(f)

(j)

8,000 3,000

700,000

680,000

685,000

8,000

2,000

250,000

360,000

20,000

50,000

Ch. 15—Problems

15–20

Problem 15-6, Continued (l)

Cash ................................................................................... Notes Receivable................................................................ Other Financing Sources ............................................. Revenues .................................................................... To record sale of land. Only the $130,000 gain is new revenue. (Requires entry in general fixed assets account group.)

100,000 280,000

(m) Cash ................................................................................... Other Financing Sources ............................................. To record cash received from other funds. (Requires entries in other funds.)

23,000

(n) Cash ................................................................................... Notes Receivable ........................................................ Revenues ($280,000 × 8% × 1/4 year) ...................... To record cash received from developer.

285,600

(2) Appropriations ............................................................................ Estimated Other Financing Uses ............................................... Budgetary Fund Balance—Unassigned ..................................... Estimated Revenues........................................................... Estimated Other Financing Sources ................................... To reverse entry recording budget.

875,000 20,000 32,000

Revenues ................................................................................... Other Financing Sources ........................................................... Expenditures ....................................................................... Other Financing Uses ......................................................... Fund Balance—Unassigned ...............................................

1,139,100 273,000

Fund Balance—Unassigned ...................................................... Encumbrances .................................................................... To close nominal accounts.

20,000

250,000 130,000

23,000

280,000 5,600

900,000 27,000

1,007,000 20,000 385,100 20,000

15–21

Ch. 15—Problems

Problem 15-6, Concluded (3)

City of Toma General Fund Budgetary Comparison Schedule For Year Ended December 31, 2019

Revenues .................................................................... Expenditures ............................................................... Excess of revenues over expenditures ....................... Other financing sources .............................................. Other financing uses ................................................... Excess of revenues and other sources over expenditures and other uses ................................. *Fund balances, January 1, 2019 ................................. *Fund balances, December 31, 2019 ...........................

Budget $ 900,000 875,000 $ 25,000 27,000 (20,000)

Variance— Favorable Actual (Unfavorable) $1,139,100 $ 239,100 1,007,000 (132,000) $ 132,100 $ 107,100 273,000 246,000 (20,000) 0

$ 32,000 (165,000) $(133,000)

$ 385,100 (165,000) $ 220,100

$ 353,100 0 $ 353,100

January 1

December 31

*The total of the fund balances consists of: Fund balance—nonspendable ................................................... Fund balance—assigned ........................................................... Fund balance—unassigned ....................................................... Total fund balances ............................................................

0 15,000 (180,000) $(165,000)

2,000 20,000 198,100 $220,100

PROBLEM 15-7 (1) Year 1: General Fund

General Long-Term Debt Account Group

Expenditures ................................................. Cash ....................................................... To record the pension benefits financed by current-year resources.

15,000,000

Amount to Be Provided ................................. Unfunded Pension Obligation ................. To record the portion of the Net pension liability not financed in the current period.

17,000,000

15,000,000

17,000,000

Ch. 15—Problems

15–22

Problem 15-7, Concluded (2) Year 2: General Fund

General Long-Term Debt Account Group

Expenditures ................................................. 20,000,000 Cash ....................................................... To record the pension contribution paid in year 2. Unfunded Pension Obligation ....................... 2,000,000 Amount to Be Provided ........................... To record the payment of $2,000,000 over the increase in net pension liability in year 2.

20,000,000

2,000,000

PROBLEM 15-8 (1) Expenditures (2) Investment in General Fixed Assets—Capital Leases (3) Amount to Be Provided for Lease Payments ............................. Capital Lease Payable .........................................................

120,000 120,000

15–23

Ch. 15—Problems

PROBLEM 15-9 Entry in General Fixed Assets Account Group

Entry in General Fund (a) Expenditures .......................... Voucher Payable ............... To record voucher.

80,000 80,000

Fund Balances Assigned or Committed Encumbrances .................. 75,000 Encumbrances ............. To reverse encumbrance. (b) Cash ....................................... Other Financing Sources.... To record proceeds from equipment sale.

Machinery and Equipment ................. Investment in General Fixed Assets—General Fund Revenues ................................ To record purchase.

80,000

75,000

6,000 6,000

Investment in General Fixed Assets— General Fund Revenues .............. Machinery and Equipment ....... To remove equipment sold.

15,000

Land ................................................... 100,000 Investment in General Fixed Assets—Donations .................. To record donated land. Construction in Progress ................... 300,000 Investment in General Fixed Assets—Donations .................. To record partially finished donated building.

(d) Expenditures .......................... Cash .................................. To record payment for snow plow.

92,000 92,000

Investment in General Fixed Assets— Special Revenue Funds ............... 66,000 Machinery and Equipment ....... To remove traded snow plow. Machinery and Equipment ................. 110,000 Investment in General Fixed Assets—General Fund Revenues ................................ To record new snow plow acquired.

15,000

100,000

300,000

66,000

110,000

Ch. 15—Problems

15–24

PROBLEM 15-10 Transaction

Fund or Group

(a)

GLTDAG

(b)

(c)

(d)

Entry Amount to Be Provided for Payment of Term Bonds ........................................... Term Bonds Payable ...........................

General Fund

Other Financing Uses ...................................... Cash ..........................................................

GLTDAG

Amount Available in Debt Service Funds— Term Bonds ............................................... Amount to Be Provided for Payment of Term Bonds ...............................

General Fund

Other Financing Uses ...................................... Cash ..........................................................

GLTDAG

Amount Available in Debt Service Funds— Serial Bonds .............................................. Amount to Be Provided for Payment of Serial Bonds ...............................

(f)

2,700,000 200,000 200,000 200,000 200,000 135,000 135,000 135,000 135,000

General Fund

Expenditures .................................................... Cash ..........................................................

22,000

GFAAG

Equipment........................................................ Investment in General Fixed Assets— General Fund Revenues ......................

25,000

Investment in General Fixed Assets— General Fund Revenues ............................ Equipment ............................................ (e)

2,700,000

GLTDAG

GFAAG

22,000

25,000 15,000 15,000

Serial Bonds Payable ...................................... Amount Available in Debt Service Funds— Serial Bonds.........................................

135,000

Construction in Progress ................................. Investment in General Fixed Assets— Capital Projects Fund...........................

450,000

135,000

450,000

15–25

Ch. 15—Problems

PROBLEM 15-11 (1) (a) Buildings ................................................................................... Construction in Progress ................................................... Investment in General Fixed Assets— Capital Projects Funds ............................................... To record completion of new school.

850,000

(b) Land .......................................................................................... Investment in General Fixed Assets—Donations .............. To record donation of land.

140,000

250,000 600,000

140,000

(c) Proprietary funds maintain their own record of fixed assets as will be illustrated in the next chapter. These business-type activities will not be recorded in the general fixed assets account group, but will be shown on the capital assets schedule. (d) Machinery and Equipment ........................................................ Investment in General Fixed Assets— General Fund Revenues ............................................ To record purchase of new engine. Investment in General Fixed Assets—General Fund Revenues ................................................................. Machinery and Equipment ......................................... To record trade-in of old engine.

120,000 120,000

65,000 65,000

(e) Buildings ................................................................................... Investment in General Fixed Assets— General Fund Revenues ............................................ To record capital improvements on city hall.

40,000

(f)

Infrastructure Assets ................................................................. Investment in General Fixed Assets— Special Revenue Funds ............................................. To record improvements other than buildings.

20,000

(g) Investment in General Fixed Assets ......................................... Accumulated Depreciation—Buildings .............................. Accumulated Depreciation—Machinery and Equipment ... Accumulated Depreciation—Infrastructure ........................

175,000

40,000

20,000

100,000 50,000 25,000

Ch. 15—Problems

15–26

Problem 15-11, Concluded (2)

City of Elmcreek Schedule of Capital Assets December 31, 2019 Governmental activities: Land .................................................. Buildings ............................................ Construction in progress ................... Machinery and equipment ................. Infrastructure assets .......................... Total general fixed assets ........... Less accumulated depreciation: Buildings ............................................ Machinery and equipment ................. Infrastructure ..................................... Total depreciation ........................ Governmental capital assets ...................

Beg. Balance

Additions

$1,000,000 2,150,000 250,000 800,000 1,400,000 $5,600,000

$ 140,000 890,000 120,000 20,000 $1,170,000

$ 400,000 300,000 500,000 $1,200,000 $4,400,000

$ 100,000 50,000 25,000 $ 175,000 $ 995,000

Retirements

End. Balance

$ 250,000 65,000 $ 315,000

$1,140,000 3,040,000 0 855,000 1,420,000 $6,455,000

$ 0 $ 315,000

$ 500,000 350,000 525,000 $1,375,000 $5,080,000

PROBLEM 15-12 (1) (a) 2014 July 1 Amount to Be Provided for Payment of Term Bonds............ 1,500,000 Term Bonds Payable ...................................................... To record issuance of term bonds for school project. (b) 2016 Jan. 1 Amount to Be Provided for Payment of Serial Bonds ........... 1,000,000 Serial Bonds Payable ..................................................... To record issuance of serial bonds to finance city hall and center. 2 Amount Available in Debt Service Funds—Serial Bonds ..... Amount to Be Provided for Payment of Serial Bonds ..... To record January 2, 2016, deposit in debt service fund. The same entry would be repeated at the beginning of each year until maturity.

1,500,000

1,000,000

70,000

15–27

Ch. 15—Problems

Problem 15-12, Continued Dec. 31 Amount Available in Debt Service Funds—Serial Bonds ..... Amount to Be Provided for Payment of Serial Bonds ..... To record 2016 earnings of sinking fund ($70,000 × 8%). This same entry would be repeated at the end of each year, using the following annual earnings:

Year 2016 2017 2018 2019

Serial Redemption January 1 — — — $100,000

Annual Deposit January 2 $70,000 70,000 70,000 70,000

Cumulative Balance January 2 $ 70,000 145,600 227,248 215,428

5,600 5,600

Annual Amount Available Earnings for Serial Bond at 8% Redemption December 31 $ 5,600 $ 75,600 11,648 157,248 18,180 245,428 17,234 232,662

2019 Jan. 1 Serial Bonds Payable ........................................................ Amount Available in Debt Service Funds— Serial Bonds .......................................................... To record retirement of serial bonds maturing January 1, 2019.

100,000 100,000

(c) No entry in general long-term debt account group, because proprietary funds maintain their own records of long-term debt. (d) 2017 Jan. 1 Amount to Be Provided for Payment of Term Bonds......... Term Bonds Payable ................................................... To record issuance of term bonds.

400,000 400,000

Note: The following entry would be made annually to record the contribution to the sinking fund: Amount Available in Debt Service Funds—Term Bonds ... Amount to Be Provided for Payment of Term Bonds ...

40,000 40,000

Note: The general long-term debt account group would not record the earnings of the sinking fund because they are to be applied to the semiannual interest payments.

Ch. 15—Problems

15–28

Problem 15-12, Concluded (2)

City of Clinton Schedule of General Long-Term Liabilities December 31, 2019 General Long-Term Liabilities

Term bonds payable .......................... Serial bonds payable.......................... Total general long-term liabilities payable .........................................

Beginning Balance $1,900,000 1,000,000

Additions $ 0 0

Deductions $100,000

Ending Balance $1,900,000 900,000

$2,900,000

$100,000

$2,800,000

PROBLEM 15-13 (1) Purchases Method—When the purchases method is used, the purchase of inventory is initially recorded as an expenditure. Since the Fund Balance does not contain a nonspendable amount for the ending inventory, the purchases method must have been used. (2) $811,000 = $825,000 less $14,000 net balance in receivables. (3) $89,000—Vouchers payable is the amount due suppliers. (4) $100,000—The capital outlay expenditures amount is capitalized in the general fixed assets account group. (5) $52,000—The debt service principal is calculated as $74,000 debt service expenditures less $22,000 interest amount. (6) $1,349,000 expenditures.

15–29

Ch. 15—Problems

PROBLEM 15-14 (1)

Oneida Township General Fund Worksheet For Six Months Ended June 30, 2018

Cash................................................................................ Taxes Receivable—Delinquent ....................................... Allowance for Uncollectible Delinquent Taxes ................ Tax Liens Receivable ...................................................... Allowance for Uncollectible Tax Liens ............................. Due from Parks Fund ...................................................... Inventory of Supplies....................................................... Vouchers Payable ........................................................... Due to Utility Fund........................................................... Fund Balance—Nonspendable ....................................... Fund Balance—Unassigned ........................................... Tax Anticipation Notes Payable ...................................... Estimated Revenues ....................................................... Estimated Other Financing Uses..................................... Appropriations ................................................................. Budgetary Fund Balance—Unassigned .......................... Taxes Receivable—Current ............................................ Allowance for Uncollectible Current Taxes ...................... Revenues ........................................................................

Expenditures ................................................................... Encumbrances ................................................................ Fund Balance—Assigned or Committed ......................... Excess of Revenues over Expenditures..........................

Trial Balance Cr. Dr. 45,000 .......... .......... .......... .......... .......... 20,000 .......... .......... 2,000 4,000 .......... .......... 1,000 12,000 .......... 5,000 .......... .......... 43,000 .......... 4,000 .......... 5,000 .......... 31,000 86,000 86,000 .......... .......... .......... .......... .......... .......... .......... .......... .......... .......... .......... .......... .......... .......... .......... .......... .......... .......... .......... .......... .......... .......... .......... .......... .......... .......... .......... .......... .......... .......... .......... .......... .......... .......... .......... ..........

(b) (d) (f) (f) (d) (g) (h) (h) (i) (a)

(c)

(i) (g) (h) (e) (g)

Operating Entries Dr. Cr. 120,000 (h) 204,000 4,000 ............... 344,000 ............... ............... (f) 20,000 2,000 ............... ............... (d) 4,000 1,000 ............... ............... (f) 11,000 26,000 (i) 10,000 151,000 (g) 186,000 4,000 ............... ............... (i) 16,000 16,000 ............... ............... ............... ............... (b) 120,000 655,000 ............... ............... (a) 27,000 ............... (a) 620,000 ............... (a) 8,000 430,000 (f) 290,000 ............... (c) 8,600 ............... (c) 421,400 ............... (d) 1,000 ............... (f) 2,000 ............... (f) 23,000 10,000 ............... 160,000 ............... 49,000 ............... 250,000 (g) 183,000 183,000 (e) 250,000 ............... ............... 2,405,000 2,405,000

Revenues and Expenditures Dr. Cr. ............ ............ ............ ............ ............ ............ ............ ............ ............ ............ ............ ............ ............ ............ ............ ............ ............ ............ ............ ............ ............ ............ ............ ............ ............ ............ ............ ............ ............ ............ ............ ............ ............ ............ ............ ............ ............ ............ ............ ............ ............ ............ ............ ............ ............ ............ ............ ............ ............ 447,400 ............ ............ ............ ............ 219,000 ............ ............ ............ ............ ............ 228,400 ............ 447,400 447,400

part.

Balance Sheet Dr. Cr. ............... ............... ............... ............... 309,000 ............... ............... ............... ............... ............... ............... ............... ............... ............... 1,000 ............... 21,000 ............... ............... 78,000 ............... ............... ............... 21,000 ............... 15,000 ............... ............... ............... 120,000 655,000 ............... ............... 27,000 ............... 620,000 ............... 8,000 140,000 ............... ............... 8,600 ............... ............... ............... ............... ............... ............... ............... ............... ............... ............... ............... ............... ............... ............... 67,000 ............... ............... 67,000 ............... 228,400 1,193,000 1,193,000

Ch. 15—Problems

15–30

Problem 15-14, Concluded (2)

Oneida Township General Fund Balance Sheet June 30, 2018 Assets and Resources

Current Assets: Cash ........................................................................................... Taxes receivable—current ......................................................... Less: Allowance for uncollectible current taxes ................... Due from Parks Fund ................................................................. Inventory and supplies ............................................................... Total current assets ..............................................................

$309,000 $140,000 8,600

131,400 1,000 21,000 $462,400

Liabilities and Fund Equity Liabilities: Tax anticipation notes payable................................................... Vouchers payable ...................................................................... Total liabilities ....................................................................... Fund Balances: Nonspendable ............................................................................ Assigned .................................................................................... Unassigned ................................................................................ Total fund balance ................................................................ Total liabilities and fund equity .............................................

$120,000 78,000 $198,000 $ 21,000 67,000 176,400 264,400 $462,400

Ch. 16—Problems

16–1

CHAPTER 16 UNDERSTANDING THE ISSUES 6. Both funds account for public-purpose trusts. If the resources and any earnings on investments can be used to finance government programs, then a special revenue fund is used. If only the earnings can be spent, a permanent fund is used.

1. Capital projects funds are used to account for the inflows and outflows of financial resources raised and expended to acquire major capital assets used by the general government. This accounting is in accordance with the flows of financial resources measurement focus adopted for governmental funds. Fixed assets acquired with proceeds from general obligation bonds are accounted for in the general fixed assets account group subsequent to acquisition.

7. Two major types of interfund transfers are operating transfers and equity transfers. Operating transfers are of a frequent and recurring nature and record billings for goods or services provided, or transfers between funds for such items as debt servicing, financing of specific programs, or funding of major construction projects. Equity transfers are infrequent and often nonrecurring. These transfers are often in conjunction with the initiating or closing of a fund. Operating or equity transfers between governmental funds use “other financing sources” and “other financing uses” accounts. Operating transfers between proprietary funds and governmental funds or between two proprietary funds are recorded as revenues and expenditures/expenses. Equity transfers between governmental funds and proprietary funds are recorded as interfund transfers (in proprietary funds) and other financing sources or uses (in governmental funds).

2. Closing of a capital projects fund at the end of a period is desirable to adjust and balance the fund accounts for the annual preparation of the financial statements. As part of this process, the fund balance designations are determined. Also, the total amount of expenditures on a project is determined, which is recorded in the general fixed assets account group as the cost of a completed asset or as Construction in Progress. 3. Capital special assessments are levied in installments to provide more time over which to spread collections. Only the portion available in the current period is recognized as revenue. Recognition of revenue must be deferred for those installments to be collected in future periods.

8. Both an agency fund and a trust fund are fiduciary funds. An agency fund is adopted when the fiduciary responsibility is short term and all funds received are expendable. A trust fund is used when the fiduciary responsibility is of a longer duration.

4. The due date and amounts of principal and interest payments are known. No useful data would be produced by using budgetary accounts. 5. Revenues would be credited if resources were received from a source outside of the governmental unit that need not be repaid. An example is a property tax levy. If repayment is required, as in the case of a bond issue, the credit is to Other Financing Sources. The latter account is also used for amounts received from other funds of the same governmental unit if that unit had previously recorded the resources as revenue. The procedure prevents recognizing the same resources twice as revenue.

9. Both are proprietary funds. An enterprise fund is used to account for activities of a government that provides goods or services to the public. An internal service fund is used to account for activities providing goods or services to other departments within the same governmental unit. 10. Expenses are the expiration of economic resources. Expenditures are the expiration of financial resources. Proprietary funds record expenses using accrual accounting.

16–2 Governmental funds record expenditures using modified accrual accounting. 11. The accounting emphasis for governmental funds emphasizes the funds available, spendable resources, and their expenditures. Modified accrual accounting is required. The accounting for proprietary funds, however, emphasizes expenses rather than expenditures and is similar to that for a private enterprise. Proprietary funds measure net income, focusing on the total cost of services and the amounts of cost recovered by revenue. Proprietary funds are accounted for with a capital maintenance measurement focus, using the accrual basis of accounting. They account for their own assets (including fixed assets and depreciation) and liabilities (including long-term debt). Proprietary funds also differentiate between contributed and earned equity, just as a corporation would.

12. Private-purpose trust funds are used to account for assets held by the government on behalf of an individual, a group, or an organization. Permanent funds record assets held, income from which will benefit the government activities.

16–3

Ch. 16—Exercises

EXERCISES EXERCISE 16-1 (1)

The cash flow statement for governmental proprietary funds and nonexpendable trust funds has four parts. Cash from operations, cash from capital financing activities, cash from non-capital financing activities, and cash from investing activities. Business Enterprises only have one part for financing activities.

(2)

The general fund uses modified accrual. Enterprise funds recognize revenue when earned under full accrual accounts.

(3)

Accounting procedures of internal service funds resemble commercial accounting. Thus, all costs for operating the fund as well as asset replacement and expansion should be covered.

(4)

Payments for services provided by an internal service fund within the same governmental entity are considered quasi-external transactions. Therefore, they are recognized as operating revenues.

(5)

As an interest adjustment factor, the premium should be transferred to the debt service fund that pays the interest.

(6)

Item A is debt service, B is in the trust fund, and D is within the proprietary fund.

(7)

The police car is not a current financial resource and is not reported on the balance sheet.

(8)

The reclassification entry is a follows: Deferred Inflow of Resources ............................................ Revenues ....................................................................

XXX XXX

(9)

Governmental funds do not report cash flows since the amounts reported using modified accrual are near cost.

(10)

The revenue is recorded by the general fund, but the debt service fund makes the payment of principal and interest.

EXERCISE 16-2 (1)

The debt service fund follows general fund procedures except for the usual practice of not using budgetary entries.

(2)

Permanent funds are used to account for public-purpose trusts, for which earnings are expendable for a specific purpose. Permanent funds are classified as governmental funds.

(3)

Permanent funds are classified as governmental and follow accounting rules similar to general funds.

Ch. 16—Exercises

16–4

Exercise 16-2, Concluded (4)

Capital projects funds are used to account for major construction activity financed by general tax revenues or special assessments.

(5)

An investment trust fund is used to account for assets, liabilities, net position, and changes in net position of external participants in an investment pool managed by the government.

(6)

Debt service funds are used to account for the payment of interest and principal on general government long-term debt, not short-term debt or the debt of proprietary funds.

(7)

The agency fund internally distributes monies to recipient funds.

(8)

With no commitment by the governmental unit, the liability is solely that of the assessed property owners. However, the amount of the bond liability may be shown in the notes to the financial statements.

(9)

Expenses are not reported in governmental funds. In addition, governmental funds only report pension expenditure for amounts to be paid out of available financial resources.

(10)

The amount to be provided is reduced with the receipt of available funds in the debt service fund.

EXERCISE 16-3 (1)

Interest is recorded only in the period that interest is due.

(2)

The capital projects fund receives the proceeds and records the applicable expenditures.

(3)

All long-term debt that is the responsibility of the city (except debt of proprietary funds) is recorded here.

(4)

Expenditures are closed at year-end in the capital projects fund. The amount spent to date is recorded in an “in-progress” account in the general fixed assets account group.

16–5

Ch. 16—Exercises

EXERCISE 16-4 Fund or Account Group (a)

Entries

Debit

Credit

Capital Projects Fund

Estimated Other Financing Sources ......................... 36,000,000 Appropriations ...................................................... 14,000,000 Budgetary Fund Balance...................................... 22,000,000 To record budgeted amounts for city hall construction project.

General Fund

The general fund budgetary entry would include $6,000,000 in Estimated Other Financing Uses.

General Fund

Other Financing Uses ............................................... Cash ..................................................................... To record contribution to capital projects fund.

6,000,000

Capital Projects Fund

Cash ......................................................................... Other Financing Sources ..................................... To record contribution from the general fund.

6,000,000

Capital Projects Fund

Cash ......................................................................... 29,650,000 Expenditures............................................................. 50,000 Other Financing Uses ............................................... 300,000 Other Financing Sources ..................................... 30,000,000 To record proceeds from the sale of bonds.

General Long-Term Debt

Amount to Be Provided for Payment of Serial Bonds 30,000,000 Serial Bonds Payable ........................................... 30,000,000 To record liability for the serial bonds.

(d)

Capital Projects Fund

Encumbrances.......................................................... 32,000,000 Fund Balance—Assigned..................................... 32,000,000 To record signing of construction contract.

(e)

Capital Projects Fund

Fund Balance—Assigned ......................................... Encumbrances ..................................................... To record liquidation of encumbrances.

7,000,000

Expenditures............................................................. Cash ..................................................................... To record expenditures for partial completion.

7,000,000

Construction in Progress .......................................... Investment in General Fixed Assets— Capital Projects Fund(s) .................................. To record partial completion of city hall project.

7,000,000

(b)

(c)

General Fixed Assets Account Group

6,000,000

7,000,000

Ch. 16—Exercises

16–6

EXERCISE 16-5 Cash................................................................................................. Other Financing Sources ........................................................... To record cash receipt from the general fund.

20,000

Cash................................................................................................. Other Financing Sources ........................................................... To record bonds issued.

380,000

Encumbrances ................................................................................. Fund Balance—Committed ........................................................ Fund Balance—Assigned........................................................... To record purchase orders placed and signing of contract.

400,000

Fund Balance—Committed .............................................................. Fund Balance—Assigned ................................................................ Encumbrances ........................................................................... To reverse encumbrances.

320,000 80,000

Expenditures .................................................................................... Contracts Payable ...................................................................... Vouchers Payable*..................................................................... To record actual liabilities of project.

449,000

Contracts Payable............................................................................ Vouchers Payable* .......................................................................... Contracts Payable—Retained Percentage ................................ Cash ........................................................................................... To record payments and retained percentage.

375,000 74,000

20,000

380,000

320,000 80,000

400,000

375,000 74,000

30,000 419,000

*Vouchers payable could be used for the entire $449,000. EXERCISE 16-6 Fund or Account Group Date Entries Debt Jan. 1 Special Assessments Receivable (current) ....... Service Special Assessments Receivable (noncurrent) . Revenues ...................................................... Deferred Inflow of Resources ....................... To record receivables from special assessments.

Debit 95,000 285,000

Credit

95,000 285,000

June 30 Cash .................................................................. Special Assessments Receivable (current) .. Revenues (5% × $380,000) .......................... To record receipt of payment by owners.

66,500

Expenditures ..................................................... Cash.............................................................. To record payment of principal and interest.

66,500

47,500 19,000

66,500

16–7

Ch. 16—Exercises

Exercise 16-6, Concluded Fund or Entries Account Group Date Debt Dec. 31 Cash .................................................................. Service Special Assessments Receivable (current) .. Revenues (5% × $332,500) .......................... To record receipt of payment by owners. Expenditures ..................................................... Cash.............................................................. To record payment of principal and interest. General Jan. Long-Term Debt

1 Amount to Be Provided by Special Assessments................................................. Special Assessment Serial Bonds Payable ................................................

June 30 Special Assessment Serial Bonds Payable....... and Amount to Be Provided by Special Dec. 31 Assessments ............................................

Debit 64,125

Credit 47,500 16,625

64,125 64,125

380,000 380,000 47,500 47,500

EXERCISE 16-7 (a) No entry is made in the debt service fund. (b) Expenditures ......................................................................................... Matured Bonds Payable ................................................................. Matured Interest Payable (6% × $5,000,000) ................................. To record matured items.

800,000

(c) Cash ..................................................................................................... Other Financing Sources ................................................................ To record receipt of cash from the general fund.

800,000

(d) Cash with Fiscal Agent ......................................................................... Cash ............................................................................................... To record transfer to First Bank.

800,000

(e) Matured Bonds Payable ....................................................................... Matured Interest Payable ..................................................................... Cash with Fiscal Agent ................................................................... To record payments by bank.

500,000 291,000

500,000 300,000

800,000

791,000

Ch. 16—Exercises

16–8

EXERCISE 16-8 (a) Restricted Assets—Cash for Construction ..................................... Interfund Transfer from General Fund ...................................... To record restricted amount received from the general fund.

300,000

(b) Accounts Receivable ...................................................................... Due from Other Funds .................................................................... Operating Revenues (or Billings for Services) .......................... To record billings.

220,000 67,000

(c) Cash ............................................................................................... Due from Other Funds .............................................................. Accounts Receivable ................................................................ To record collections.

232,000

(d) Restricted Assets—Revenue Bond Development Cash ................. Revenue Bonds Payable .......................................................... To record bond issuance with restriction on proceeds.

700,000

300,000

287,000

42,000 190,000

700,000

(e) No entry. Enterprise funds do not use budgetary accounts for encumbrances. (f)

Construction in Progress ................................................................ Contracts Payable from Restricted Assets ............................... To record liability for work to date.

360,000

(g) Contracts Payable from Restricted Assets ..................................... Restricted Assets—Revenue Bond Development Cash ........... To record issuance of check from restricted cash.

300,000

360,000

300,000

EXERCISE 16-9 Permanent Fund Cash....................................................................................................... Revenues ......................................................................................... To record gift to the city.

200,000

Investment in Bonds .............................................................................. Cash ................................................................................................. To record the investment in bonds.

200,000

Cash....................................................................................................... Revenues ......................................................................................... To record the interest on bonds.

15,000

200,000

15,000

16–9

Ch. 16—Exercises

Exercise 16-9, Concluded Unrealized Loss ..................................................................................... Investment in Bonds......................................................................... To record fair value adjustment.

600

Other Financing Uses ............................................................................ Cash ................................................................................................. To record transfer to special revenue fund.

12,000

Revenues ............................................................................................... Other Financing Uses ...................................................................... Unrealized Loss ............................................................................... Fund Balance Restricted .................................................................. To record closing entry.

215,000

600

12,000

12,000 600 202,400

City of Alexander Water Quality Improvement Permanent Funds Balance Sheet December 31, 2018 Assets Cash................................................................................................................... Investments........................................................................................................ Total assets ..................................................................................................

Total $ 3,000 199,400 $202,400

Fund Balance Restricted for endowments ................................................................................

$202,400

EXERCISE 16-10 (1)

(6)

(2)

(7)

(3)

(8)

(4)

(9)

(5)

(10)

Ch. 16—Exercises

16–10

EXERCISE 16-11 (1)

(6)

(2)

(7)

(3)

(8)

(4)

(9)

(5)

(10)

EXERCISE 16-12 (a) GF, GFAAG (b) DSF, CPF, GLTDAG (c) GF, DSF, GLTDAG (d) DSF, GLTDAG (e) CPF, GFAAG (f) PF, SRF (g) ENT, INT, GFAAG, PPT (h) ENT (i) CPF, DSF, GLTDAG, GFAAG

16–11

Ch. 16—Problems

PROBLEMS PROBLEM 16-1 (1) b

The agency fund distributes the collections to the recipient funds.

(2) c

The grant is for the construction of a fixed asset.

(3) b

The capital projects fund records other financing sources and uses. The debt service fund records other financing sources. The general long-term debt account group records the amount available in the debt service fund for principal only. Because the premium is an adjustment to the interest, no entry is made in the general long-term debt account group.

(4) b

Enterprise funds record their own debt as a liability, so only the $500,000 in bonds for general operating expenses would be recorded as an other financing source.

(5) d

All self-sustaining activities are recorded in proprietary funds; in this case, both are enterprise funds.

(6) a

Services to other governmental units by an internal service fund are recorded as either revenues or billings.

(7) d

The general fund records only its transfer; the debt proceeds are recorded as other financing sources in the capital projects fund.

(8) c

The change in the fund balance is equal to (revenues plus other sources) minus (expenditures and other uses).

PROBLEM 16-2 (1) d

Only the property taxes are revenue of a governmental fund.

(2) c

Expenditures for a debt service fund equal the amount of matured principal ($2,000,000) plus matured interest ($900,000). Unpaid accrued interest is recognized as an expenditure only if the payment date for such interest has passed.

(3) a

Because transfers received from other funds are not revenue but are other financing sources, only the interest of $600,000 qualifies as revenue.

(4) c

The grant from the state is revenue to the capital projects fund. Bond proceeds and transfers from other funds are other financing sources.

(5) a

Under modified accrual, issue costs and debt insurance are recorded as expenditures.

(6) b

The general fund would record an interfund transfer-out (other financing use).

Ch. 16—Problems

16–12

Problem 16-2, Concluded (7) d

“City streets and sidewalks” are infrastructure fixed assets. A governmental unit must include such assets in its financial statements. The city hall ($800,000) and the three fire stations ($1,000,000) must also be included in the general fixed assets account group.

(8) a

Special revenue funds are established to account for restricted resources used for operating activities such as repair of streets and educational and economic development programs. If resources are for a major construction project, the proceeds will be accounted for in a capital projects fund.

PROBLEM 16-3 (1)

Palmer Township Administration Center Capital Projects Fund Journal Entries For Period July 1, 2018, to June 30, 2019 2018 July 1

Dec. 1

Cash ............................................................................... Transfer-In—Other Financing Source ........................ To record transfer of funds from general fund.

250,000

Expenditures .................................................................. Cash ........................................................................... To record unencumbered expenditures.

200,000

Cash ............................................................................... Other Financing Sources ........................................... Other Financing Sources—Premium ......................... To record sale of bonds.

6,060,000

Other Financing Uses ..................................................... Cash ........................................................................... To transfer premium to debt service fund.

60,000

Due from State Government .......................................... Revenues ................................................................... To record grant due from state.

3,000,000

250,000

200,000

6,000,000 60,000

60,000

3,000,000

16–13

Ch. 16—Problems

Problem 16-3, Continued 2019 Apr. 30

May

June 10

(2)

Encumbrances ............................................................... Fund Balance—Assigned .......................................... To record encumbrance for contract.

7,000,000

Cash ............................................................................... Due from State Government ...................................... To record receipt of grant.

1,000,000

Advance from General Fund .......................................... Cash ........................................................................... To record payment of loan.

250,000

Fund Balance—Assigned ............................................... Encumbrances ........................................................... To reverse encumbrance for progress billing on contract.

1,200,000

Expenditures .................................................................. Contracts Payable ...................................................... Contracts Payable—Retained Percentage ................ To record expenditures on construction contract and retained amount.

1,200,000

7,000,000

1,000,000

250,000

1,200,000

1,152,000 48,000

Palmer Township Administration Center Capital Projects Fund Closing Entries June 30, 2019 Revenues ....................................................................................... Other Financing Sources ................................................................ Expenditures ............................................................................. Other Financing Uses ............................................................... Fund Balance—Restricted ........................................................ Fund Balance—Assigned .........................................................

3,000,000 6,060,000

Fund Balance—Assigned ............................................................... Encumbrances .......................................................................... To close.

5,800,000

1,400,000 60,000 2,000,000 5,600,000 5,800,000

Ch. 16—Problems

16–14

Problem 16-3, Concluded (3)

Palmer Township Administration Center Capital Projects Fund Balance Sheet June 30, 2019 Assets Cash ..................................................................................................................... $6,800,000 Due from state government.................................................................................. 2,000,000 Total assets .................................................................................................... $8,800,000 Liabilities and Fund Balance Liabilities: Contracts payable ...................................................................... $1,152,000 Contracts payable—retained percentage ................................... 48,000 Total liabilities ....................................................................... $1,200,000 Fund balance: Restricted.................................................................................... $2,000,000 Assigned .................................................................................... 5,600,000 Total fund balance ................................................................ 7,600,000 Total liabilities and fund balance .................................... $8,800,000

(4) 2018 July 1

Dec. 1

General Fund

Transfer-Out—Other Financing Uses ........ Cash ...................................................... To record transfer to the capital projects fund.

250,000

Debt Service Fund

Cash .......................................................... Other Financing Sources ....................... To record receipt of premiums.

60,000

General Amount to Be Provided for Payment Long-Term of Term Bonds ....................................... Debt Bonds Payable .................................. Account To record bond liability. Group 2019 June 10

General Fund

250,000

60,000

6,000,000 6,000,000

Cash .......................................................... Transfer-In—Other Financing Sources.. To record transfer from the capital projects fund.

250,000

General Construction in Progress............................ Fixed Assets Investment in General Fixed Assets— Account Capital Projects Fund ........................ Group To record asset.

1,200,000

250,000

1,200,000

16–15

Ch. 16—Problems

PROBLEM 16-4 (1) Appropriations ................................................................................ Estimated Other Financing Uses .................................................... Budgetary Fund Balance—Unassigned ......................................... Estimated Revenues................................................................. Estimated Other Financing Sources .........................................

640,000 25,000 305,000

Revenues ....................................................................................... Other Financing Sources ................................................................ Expenditures ............................................................................. Other Financing Uses ............................................................... Fund Balance—Assigned .........................................................

16,600 900,000

Fund Balance—Assigned ............................................................... Encumbrances ..........................................................................

80,000

(2)

20,000 950,000

686,600 15,000 215,000 80,000

City of Clark Capital Projects Fund Statement of Revenues, Expenditures, and Changes in Fund Balance For Year Ended December 31, 2019

Revenues ............................................................................................... Expenditures .......................................................................................... Excess of expenditures over revenues .................................................. Other financing sources ......................................................................... Other financing uses .............................................................................. Excess of other financing sources over uses ......................................... Excess of revenues and other financing sources over expenditures and other financing uses .................................... Fund balances, January 2, 2019 ............................................................ Fund balances, December 31, 2019 ......................................................

$ 16,600 686,600 $(670,000) $900,000 (15,000) 885,000 $ 215,000 0 $ 215,000

Ch. 16—Problems

16–16

Problem 16-4, Concluded (3)

City of Clark Capital Projects Fund Balance Sheet December 31, 2019 Assets Current: Cash ........................................................................................... Investments ................................................................................ Total current assets ..............................................................

$ 75,000 200,000 $275,000

Liabilities and Fund Balances Current: Contracts payable—retained percentage ...................................

$ 60,000

Fund balances: Assigned .................................................................................... Total fund balances .............................................................. Total liabilities and fund balances ..................................

$215,000 215,000 $275,000

PROBLEM 16-5 (1) (2) (3) (4)

d c b d

16–17

Ch. 16—Problems

PROBLEM 16-6 Fund or Date Account Group Entry Jan. 2 Capital Budgetary Fund Balance—Unassigned ...... Projects Appropriations ......................................... Fund To record budget. 5

Feb.

Capital Projects Fund

Debt Service Fund

223,400

Encumbrances ............................................ Fund Balance—Restricted ...................... To reinstate reserve.

80,000

Encumbrances ............................................ Fund Balance—Assigned ....................... To record encumbrances.

108,000

Cash ............................................................ Interest Receivable on Delinquent Special Assessments........................................... Revenues ........................................... Special Assessments Receivable— Current ........................................... To record collections and to bill interest.

237,600

Special Assessments Receivable— Delinquent ............................................... Special Assessments Receivable— Current ........................................... To reclassify delinquent special assessments.

223,400

80,000

138,000

2,400 20,000 220,000

30,000 30,000

General Long-Term Debt Account Group

Amount Available to Debt Service Fund...... Amount to Be Provided for Payment of Special Assessment Bonds ............

220,000

Debt Service Fund

Expenditures ............................................... Cash........................................................ To record matured principal and interest.

140,000

General Long-Term Debt Account Group

Capital Project Special Assessment Debt with Governmental Commitment............. Amount Available in the Debt Service Fund for Payment of Special Assessment Bonds ........................

220,000

140,000

125,000 125,000

Ch. 16—Problems

16–18

Problem 16-6, Concluded Fund or Account Group Entry Date Mar. 14 Debt Cash .................................................................. Service Special Assessments Receivable— Fund Delinquent ................................................ Interest Receivable on Delinquent Special Assessments ............................... Revenues ...................................................... To record collection of delinquent special assessments and interest. General Long-Term Debt Account Group May

Capital Projects Fund

Amount Available to Debt Service Fund............ Amount to Be Provided for Payment of Special Assessment Bonds ..................

32,650 30,000 2,400 250

30,000 30,000

Expenditures ..................................................... 220,000 Contracts Payable......................................... Contracts Payable—Retained Percentage ... To book additional expenditures on completed contract. Fund Balance—Assigned .................................. 188,000 Encumbrances .............................................. To reverse encumbrances entry on completed project.

General Fixed Assets Account Group

Improvements Other than Buildings .................. 896,000 Construction in Progress............................... Investment in General Fixed Assets— Capital Projects Funds (Special Assessments) ........................................... To record completion of project: Total cost ...................................................... Cost for 2018 ................................................ Work in progress 2017 .................................

Capital Projects Fund

209,000 11,000

188,000

676,000 220,000

$896,000 220,000 $676,000

Contracts Payable ............................................. 150,000 Cash.............................................................. To record payment.

150,000

16–19

Ch. 16—Problems

PROBLEM 16-7 (1) b, f (2) b, e (3) d, b (4) a, c PROBLEM 16-8 (1) Entries in the Internal Service Fund: Expenses—Claims and Judgments ................................................ Cash ......................................................................................... Claims and Judgments Liability ................................................ To record losses incurred and claims paid.

4,000,000

Cash ............................................................................................... Revenues—Insurance Premiums ............................................. To record premium revenue from other departments.

5,000,000

2,300,000 1,700,000

5,000,000

(2) Entries in General Fund: Expenditures ................................................................................... Cash ......................................................................................... To record premium transferred to insurance internal service fund.

3,200,000 3,200,000

Entries in Utility Enterprise Fund: Expenses ........................................................................................ Cash ......................................................................................... To record premium transferred to insurance internal service fund.

1,800,000 1,800,000

(3) If the county elects to use a general fund for its self-insurance activity, revenue can be recognized from other funds up to the amount of actual losses incurred ($4,000,000) or 80% of the amount actually billed and transferred from other funds. The $1,000,000 excess of transfers over actual losses must be reported as an interfund transfer. Similarly, the funds transferring the premium would be limited to their share of actual losses in the recognition of expenditures/expenses.

PROBLEM 16-9 (1) General Fixed Assets Account Group

(6) Private-Purpose Trust

(2) General Fixed Assets Account Group

(7) Agency Fund

(3) General Long-Term Debt Account Group

(8) Agency Fund

(4) Internal Service Fund

(9) Permanent Fund

(5) General Long-Term Debt Account Group

(10) Special Revenue Fund

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Ch. 16—Problems

16–20

PROBLEM 16-10 Fund or Date Account Group Entry Jan. 2 Capital Estimated Revenues ......................................... 350,000 Projects Estimated Other Financing Sources.................. 550,000 Fund Appropriations ($900,000 × 70%) ................. Budgetary Fund Balance—Unassigned ........ To record budget.

Estimated revenues: Special assessments .................. County grant ...............................

250,000 100,000

Other financing sources: Bond proceeds ............................ General fund transfer ..................

500,000 50,000

630,000 270,000

Capital Projects Fund

Due from County ............................................... 100,000 Due from General Fund..................................... 50,000 Revenues ...................................................... Other Financing Sources .............................. To record amounts receivable.

General Fund

Other Financing Uses........................................ Due to Capital Projects Fund ........................ To record required transfer.

Capital Projects Fund

Special Assessments Receivable—Current ...... 250,000 Revenues ...................................................... To record levy of assessments.

250,000

Debt Service Fund

Special Assessments Receivable—Noncurrent 500,000 Deferred Inflow of Resources ...................... To record levy of assessments.

500,000

Capital Projects Fund

Cash .................................................................. 150,000 Due from County ........................................... Due from General Fund ................................ To record amounts received.

100,000 50,000

General Fund

Due to Capital Projects Fund ............................ Cash.............................................................. To record cash transfer.

50,000

Capital Projects Fund

Encumbrances .................................................. 675,000 Fund Balance—Assigned for Encumbrances.......................................... To record encumbrances.

100,000 50,000

50,000 50,000

50,000

675,000

16–21

Ch. 16—Problems

Problem 16-10, Continued Fund or Account Group Entry Date Feb. 1 Capital Cash .................................................................. Projects Special Assessments Receivable—Current Fund To record collections.

250,000

Mar.

Cash .................................................................. Other Financing Sources .............................. Other Financing Sources—Premium ............ To record bond sale at premium.

505,000

Other Financing Uses........................................ Cash.............................................................. To record premium to be transferred.

5,000

Debt Service Fund

Cash .................................................................. Other Financing Sources .............................. To record premium due.

5,000

General Long-Term Debt Account Group

Amount to Be Provided for Payment of Special Assessment Serial Bonds ............................. Special Assessment Bonds Payable ........ To record commitment on guaranteed bond issue.

Capital Projects Fund

Investments ....................................................... Cash.............................................................. To record investment.

600,000

Capital Projects Fund

Other Financing Uses........................................ Cash.............................................................. To record transfer for interest.

10,000

Debt Service Fund

Cash .................................................................. Other Financing Sources .............................. To record cash transfer from capital projects fund.

10,000

Debt Service Fund

Expenditures ..................................................... Cash.............................................................. To record interest payment.

15,000

Capital Projects Fund

Fund Balance—Assigned for Encumbrances.... Encumbrances .............................................. To reverse encumbrances.

595,000

Expenditures ..................................................... Contracts Payable......................................... Contracts Payable—Retained Percentage ... To record contractor’s invoice.

600,000

Aug. 31

Sept. 1

Dec. 15

Capital Projects Fund

250,000

500,000 5,000

5,000

500,000 500,000

600,000

10,000

15,000

595,000

540,000 60,000

Ch. 16—Problems

16–22

Problem 16-10, Concluded Fund or Account Group Entry Date Dec. 29 Capital Cash .................................................................. Projects Investments................................................... Fund Revenues ...................................................... To record partial liquidation of investments. 30

Capital Projects Fund

416,600 400,000 16,600

Contracts Payable ............................................. Cash.............................................................. To record payment to contractor.

540,000

Expenditures ..................................................... Vouchers Payable ......................................... To record vouchers.

76,600

Vouchers Payable ............................................. Cash.............................................................. To record voucher payment.

76,600

Debt Service Fund

Special Assessments Receivable—Current ...... Special Assessments Receivable— Noncurrent ................................................ To reclassify receivables.

250,000

Debt Service Fund

Deferred Inflow of Resources ............................ Revenues ...................................................... To reclassify deferred revenues from special assessments.

250,000

General Fixed Assets Account Group

Construction in Progress ................................... Investment in General Fixed Assets— Capital Projects Funds (special assessments) ........................................... To capitalize expenditures to date.

676,600

540,000

76,600

250,000

676,600

16–23

Ch. 16—Problems

PROBLEM 16-11 City of Boniville Internal Service Fund Statement of Cash Flows Cash flows from operating activities: Collections (for services) from other funds................................................... Wages and salaries paid .............................................................................. Purchase of supplies .................................................................................... Net cash provided by operating activities..................................................... Cash flows from noncapital financing activities: Loans from other funds ................................................................................ Repayment of loans from other funds .......................................................... Net cash used for noncapital financing activities ......................................... Cash flows from capital and related financing activities: Proceeds of revenue bonds ......................................................................... Proceeds from sale of capital assets ........................................................... Purchase of capital assets ........................................................................... Interest paid on long-term debt .................................................................... Net cash used for capital and related financing activities ............................ Cash flows from investing activities: Proceeds from sale of investments .............................................................. Interest from investments ............................................................................. Purchase of investments .............................................................................. Net cash used for investing activities ........................................................... Net increase in cash .......................................................................................... Cash on hand beginning of year .................................................................. Cash on hand end of year ............................................................................

$ 6,000 (3,100) (1,650) $ 1,250 $

600 (680) $ (80) $

900 23 (900) (150) $ (127) $

33 145 (440) $ (262) $ $

781 122 903

PROBLEM 16-12 (1) (a) Inventory of Materials and Supplies.......................................... Vouchers Payable ............................................................... To record purchases on account.

72,000

(b) Operating Expenses ................................................................. Inventory of Materials and Supplies .................................... To record inventory adjustment ($80,000 + $72,000 – $65,000).

87,000

(c) Operating Expenses ................................................................. Cash ................................................................................... To record salaries and wages paid.

235,000

72,000

87,000

235,000

Ch. 16—Problems

16–24

Problem 16-12, Concluded (d) Operating Expenses ................................................................. Cash ................................................................................... To record payment of utility charge.

40,000

(e) Operating Expenses ................................................................. Allowance for Depreciation—Building ................................. Allowance for Depreciation—Computer Equipment............ To record depreciation.

139,500

(f) Due from General Fund ............................................................ Due from Water and Sewer Fund ............................................. Due from Special Revenue Fund.............................................. Operating Revenues ........................................................... To record billings.

392,000 84,000 42,000

(g) Cash ......................................................................................... Due from General Fund ($140,000 + $392,000 – $136,000)............................... Due from Water and Sewer Fund ....................................... Due from Special Revenue Fund ($42,000 – $16,000) ...... To record collections.

506,000

(h) Vouchers Payable..................................................................... Cash ................................................................................... To record voucher payment ($41,000 + $72,000 – $19,000).

94,000

(2) Closing Entries: Operating Revenues ................................................................. Operating Expenses ($87,000 + $235,000 + $40,000 + $139,500) ............... Income Summary ................................................................ To close nominal accounts. Income Summary...................................................................... Net Position—Unrestricted.................................................. To close Income Summary.

40,000

6,500 133,000

518,000

396,000 84,000 26,000

94,000

518,000 501,500 16,500 16,500 16,500

16–25

Ch. 16—Problems

PROBLEM 16-13 (1) Landfill Expense ............................................................................. Landfill Closure and Post-Closure Care Liability ........................ To record (300,000 ÷ 6,000,000) × $10,000,000.

500,000

(2) Landfill Expense ............................................................................. Landfill Closure and Post-Closure Care Liability ...................... To record (300,000 + 300,000) ÷ 5,800,000 × $10,200,000 less $500,000 already recognized.

555,172

500,000

555,172

(3) If the landfill is accounted for in the general fund, then the liability would be recognized in the general long-term debt account group. No entries would be made in the general fund until actual payments are made.

PROBLEM 16-14 Bedrock City’s Employees’ Retirement System Fund Statement of Plan Net Position As of June 30, 2018 Assets Cash and short-term investments .......................................................... Receivables: Employer .......................................................................................... Interest and dividends ...................................................................... Total receivables .............................................................................. Investments, at fair value ....................................................................... Total assets ......................................................................................

$ 38,000 $4,000 5,000 9,000 497,000 $544,000

Liabilities Refunds payable .................................................................................... Annuities payable................................................................................... Total liabilities................................................................................... Net position held in trust for pension benefits ........................................

$1,000 3,000 $ 4,000 $540,000

Ch. 16—Problems

16–26

Problem 16-14, Concluded Bedrock City’s Employees’ Retirement System Fund Statement of Changes in Plan Net Position For Year Ended June 30, 2018 Additions Contributions: Employer ($16,000 + $4,000) .......................................................... Plan members .................................................................................. Total contributions ...................................................................... Investment income: Net appreciation (depreciation) in fair value..................................... Interest and dividend income ($30,000 + $5,000) ............................ Net investment income..................................................................... Total additions ............................................................................

$20,000 32,000 $ 52,000 $13,500 35,000 48,500 $100,500

Deductions Benefits ($13,000 + $3,000)................................................................... Refunds of contributions ($2,500 + $1,000) ........................................... Administrative expense .......................................................................... Total deductions ............................................................................... Net increase ........................................................................................... Net position held in trust for pension benefits: July 1, 2017 ...................................................................................... June 30, 2018 ..................................................................................

$16,000 3,500 5,000 24,500 $ 76,000 464,000 $540,000

16–27

Ch. 16—Problems

PROBLEM 16-15 Accounts Taxes Receivable—Current ............................... Allowance for Uncollectible Taxes ................ Revenues ...................................................... To record tax levy. Revenues ........................................................... Taxes Receivable—Current .......................... To correct tax levy error. Taxes Receivable for Other Funds .................... Due to Other Governmental Units ................. To record taxes to be collected. Cash ................................................................... Taxes Receivable for Other Funds ............... To record tax collection. Due to Other Governmental Units ...................... Cash .............................................................. To record cash distribution. Expenditures ...................................................... Cash ................................................................... Taxes Receivable—Current .......................... Revenues ...................................................... To record cash received by general funds.

Tilburg County Tax Agency Fund Dr. Cr. ............... ................ ............... ................ ............... ................

Tilburg County General Fund Dr. Cr. 3,600,000 ............... ................ 100,000 ................ 3,500,000

Reed City General Fund Dr. Cr. 1,800,000 ............... ............... 60,000 ............... 1,740,000

Newport Township General Fund Dr. Cr. 600,000 ............ ............ 40,000 ............ 560,000

............... ...............

................ ................

............... ...............

10,000 ............

............ 10,000

5,990,000 ...............

................ 5,990,000

................ ................

............... ...............

............ ............

1,440,000 ...............

................ 1,440,000

................ ................

............... ...............

............ ............

1,440,000 ...............

................ 1,440,000

................ ................

............... ...............

............ ............

............... ............... ............... ...............

................ ................ ................ ................

................ 875,520* ................ ................

............... ............... 864,000 11,520

8,640 423,360* ............... ...............

............... ............... 432,000 ...............

2,880 141,120* ............ ............

............ ............ 144,000 ............

*Calculation of cash distribution:

Cash collected ................................................... Composite rate .................................................. 2% charge/earnings .......................................... Cash distribution ...............................................

Tilburg County General Fund $1,440,000 × 60% $ 864,000 11,520 $ 875,520

Reed City Newport Township General Fund General Fund $1,440,000 $1,440,000 × 30% × 10% $ 432,000 $ 144,000 (8,640) (2,880) $ 423,360 $ 141,120

part.

Ch. 16—Problems

16–28

PROBLEM 16-16 Fund or Account Group (1)

(2)

(3)

(4)

(5)

Journal Entry

General Fund

Estimated Revenues ............................................. 4,500,000 Appropriations ................................................... Budgetary Fund Balance—Unassigned ............ To record the budget.

Special Revenue Fund

Estimated Revenues ............................................. Appropriations ................................................... Budgetary Fund Balance—Unassigned ............ To record budget for gas tax.

General Fund

Taxes Receivable—Current .................................. 3,000,000 Allowance for Uncollectible Current Taxes ....... Revenues .......................................................... To record tax levy.

Capital Projects Fund

Cash ...................................................................... Expenditures .......................................................... Other Financing Uses ............................................ Other Financing Sources .................................. To record bond sale.

4,450,000 50,000

264,500 250,000 14,500

60,000 2,940,000

985,000 5,000 10,000

General Debt Account Group

Amount to Be Provided for Payment of Term Bonds ................................................... 1,000,000 Term Bonds Payable .................................... To record long-term debt.

Capital Projects Fund

Encumbrances ....................................................... 1,000,000 Fund Balance—Assigned for Encumbrances ... To record signed contract.

1,000,000

16–29

Ch. 16—Problems

Problem 16-16, Concluded

(6)

(7)

(8)

(9)

(10)

Fund or Account Group

Journal Entry

Capital Projects Fund

Fund Balance—Assigned for Encumbrances ........ 1,000,000 Encumbrances .................................................. To liquidate encumbrances.

1,000,000

Capital Projects Fund

Expenditures .......................................................... 1,250,000 Cash .................................................................. To record school cost.

1,250,000

General Fixed Assets Account Group

Buildings ................................................................ 1,250,000 Investment in General Fixed Assets— Capital Projects Fund ................................... To record fixed asset.

General Fund

Other Financing Uses ............................................ Cash .................................................................. To record transfer to debt service fund.

100,000

Debt Service Fund

Cash ...................................................................... Other Financing Sources .................................. To record transfer from general fund.

100,000

General Fixed Assets Account Group

Land ....................................................................... Investment in General Fixed Assets— Donations...................................................... To record land donation.

500,000

Special Revenue Fund

Cash ...................................................................... Due from State Government .................................. Revenues .......................................................... To record state gas taxes.

205,000 60,000

Special Revenue Fund

Expenditures .......................................................... Vouchers Payable ............................................. To record vouchers approved for payment.

410,000

1,250,000

100,000

500,000

265,000

410,000

Ch. 16—Problems

16–30

PROBLEM 16-17 Village of Fay Transactions for Fiscal Year Ended June 30, 2019 Transaction No.

Fund or Account Group

(1)

General Fund

Estimated Revenues........................................... Appropriations ................................................ Budgetary Fund Balance—Unassigned ......... To record budgetary fund balances.

400,000

General Fund

Taxes Receivable—Current................................ Allowance for Uncollectible Current Taxes ......................................................... Revenues ....................................................... To record tax levy.

390,000

PrivateInvestments ........................................................ Purpose Fund Balance ................................................. Principal Fund To record the value of securities donated.

50,000

PrivateCash ................................................................... Purpose Revenues ....................................................... Earnings Fund To record revenues earned.

5,500

(2)

(3a)

(3b)

(4a)

(4b)

(5)

(6a)

Account Title and Explanation

Amount Debit Credit 394,000 6,000

7,800 382,200

50,000

5,500

General Fund

Other Financing Uses ......................................... Cash ............................................................... To record establishment of intragovernmental fund.

5,000

Internal Service Fund

Cash ................................................................... Interfund Transfer Fee.................................... To record contribution from general fund.

5,000

Capital Projects Fund

Estimated Other Financing Sources ................... Estimated Revenues........................................... Appropriations ................................................

3,000 72,000

Capital Projects Fund

Due from General Fund ...................................... Special Assessments Receivable ....................... Revenues ....................................................... Other Financing Sources................................

3,000 72,000

5,000

75,000

72,000 3,000

16–31

Ch. 16—Problems

Problem 16-17, Continued Transaction No.

Fund or Account Group

(6b)

Capital Projects Fund

Cash ................................................................... Special Assessments Receivable .................. Due from General Fund..................................

75,000

General Fund

Other Financing Uses ......................................... Due to Capital Projects Fund .........................

3,000

General Fund

Due to Capital Projects Fund ............................. Cash ............................................................... To record cash payment.

3,000

Capital Projects Fund

Encumbrances .................................................... Fund Balance—Assigned for Encumbrances. To record contract for lighting.

75,000

Capital Projects Fund

Fund Balance—Assigned for Encumbrances ..... Encumbrances ............................................... To reverse encumbrances.

75,000

Expenditures ....................................................... Cash ............................................................... Contracts Payable—Retained Percentage.....

75,000

General Fixed Assets Account Group

Improvements Other than Buildings ................... Investments in General Fixed Assets— Capital Projects Fund ................................ To record improvements.

75,000

Internal Service Fund

Inventory ............................................................. Cash or Vouchers Payable............................. To record purchase of supplies.

1,900

General Fund

Cash ................................................................... Taxes Receivable—Current ........................... Revenues ....................................................... To record collections.

393,000

General Fund

Allowance for Uncollectible Current Taxes ......... Revenues ....................................................... To correct tax revenues. $7,800 original allowance – ($390,000 – $386,000).

3,800

(6c) (6d)

(7a)

(7b)

(7c)

(8)

(9a)

(9b)

Account Title and Explanation

Amount Debit Credit 72,000 3,000 3,000 3,000

75,000

71,250 3,750

75,000

1,900

386,000 7,000

3,800

Ch. 16—Problems

16–32

Problem 16-17, Concluded Transaction No.

Fund or Account Group

(10a)

Capital Projects Fund

Cash ................................................................... Other Financing Sources................................ To record issuance of bonds.

General Long-Term Debt Account Group

Amount to Be Provided for Payment of Bonds ......................................................... General Obligation Bonds Payable ............ To record liability.

General Fund

Fund Balance—Committed for Encumbrances .. Encumbrances ............................................... To record cancellation of encumbrances upon payment for fire truck.

145,000

General Fund

Expenditures ....................................................... Cash ............................................................... To record purchase of fire truck.

150,000

General Fixed Assets Account Group

Fire Truck............................................................ Investment in General Fixed Assets— General Fund Revenues ............................ To record acquisition.

150,000

(10b)

(11a)

(11b)

(11c)

Account Title and Explanation

Amount Debit Credit 500,000 500,000

500,000 500,000

145,000

150,000

PROBLEM 16-18 (1) $104,500

(6) $104,500

(2) $30,000

(7) $386,000 ($364,000 + $22,000)

(3) $42,000

(8) $100,000

(4) $236,000

(9) $181,000

(5) $6,000

(10) $190,000

16–33

Ch. 16—Problems

PROBLEM 16-19 (1)

(9)

(16)

$5,600,000

(2)

(10)

(17)

$4,550,000

(3)

(11)

(18)

$1,000,000

(4)

(12)

(19)

$1,080,000

(5)

(13)

(20)

$2,273,000 ($1,080,000 + $1,220,000 – $27,000)

(6)

(14)

(21)

$800,000

(7)

(15)

(22)

$2,032,000 ($900,000 + $52,000 + $1,080,000)

(8)

PROBLEM 16-20 (1) Transaction No. (a)

Fund or Account Group

Account Title and Explanation

Amount Debit Credit

Capital Projects Fund

Estimated Other Financing Sources ................... Appropriations ................................................

600,000

Capital Projects Fund

Expenditures ....................................................... Cash ............................................................... Vouchers Payable ..........................................

150,000

Capital Projects Fund

Cash ................................................................... Other Financing Sources................................

459,000

Capital Projects Fund

Other Financing Uses ......................................... Cash ...............................................................

9,000

Debt Service Fund

Cash ................................................................... Other Financing Sources................................

9,000

General Long-Term Debt Account Group

Amount to Be Provided in the Debt Service Fund .................................................. Bonds Payable ...........................................

Capital Projects Fund

Vouchers Payable............................................... Cash ...............................................................

100,000

General Land .................................................................... Long-Term Investment in General Fixed Assets............... Debt Account Group

150,000

(b)

(c)

(d)

600,000 50,000 100,000 459,000 9,000 9,000 450,000 450,000

100,000 150,000

Ch. 16—Problems

16–34

Problem 16-20, Continued Transaction No. (e) (f)

(g)

(h)

(i)

(j)

Fund or Account Group

Account Title and Explanation

Amount Debit Credit

Capital Projects Fund

Encumbrances .................................................... Fund Balance—Assigned for Encumbrances.

400,000

Capital Projects Fund

Fund Balance—Assigned for Encumbrances ..... Encumbrances ...............................................

200,000

Capital Projects Fund

Expenditures ....................................................... Cash ...............................................................

200,000

General Fund

Other Financing Uses ......................................... Cash ...............................................................

9,000

Debt Service Fund

Cash ................................................................... Other Financing Sources................................

9,000

Debt Service Fund

Expenditures ....................................................... Cash ...............................................................

18,000

Capital Projects Fund

Cash ................................................................... Other Financing Sources................................

100,000

General Long-Term Debt Account Group

Amount to Be Provided in the Debt Service Fund .................................................. Bonds Payable ...........................................

Capital Projects Fund

Fund Balance—Assigned for Encumbrances ..... Encumbrances ...............................................

200,000

Capital Projects Fund

Expenditures ....................................................... Cash ...............................................................

210,000

Capital Projects Fund

Cash ................................................................... Revenues .......................................................

12,000

400,000 200,000 200,000 9,000 9,000 18,000 100,000 100,000 100,000

200,000 210,000 12,000

(2) Closing and Adjusting Entries: Fund or Account Group

Account Title and Explanation

Amount Debit Credit

Capital Projects Fund

Appropriations .......................................................... Estimated Other Financing Sources ....................

600,000

(Closing entries)

Revenues ................................................................. Other Financing Sources .......................................... Other Financing Uses .......................................... Expenditures ........................................................ Fund Balance—Restricted ...................................

12,000 559,000

600,000

9,000 560,000 2,000

16–35

Ch. 16—Problems

Problem 16-20, Concluded Fund or Account Group

Account Title and Explanation

Amount Debit Credit

(Transfer Interfund Transfers-Out ............................................ residual equity Cash ..................................................................... to debt Fund Balance—Restricted........................................ service fund) Interfund Transfers-Out ........................................

2,000

General Fixed Land.......................................................................... Assets Account Building ..................................................................... Group Investment in General Fixed Assets— (Capitalize total Capital Projects Fund ...................................... expenditures for land and building)

150,000 410,000

(3)

2,000 2,000 2,000

560,000

Mountain View Statement of Revenues, Expenditures, and Changes in Fund Balance For Year Ended December 31, 2018 Library Construction Project Revenues ..................................................................................................... Expenditures ................................................................................................ Excess (deficiency) of revenues over expenditures ............................... Other financing sources (uses): Bond proceeds ....................................................................................... Operating transfers-out .......................................................................... Total other financing sources (uses) ................................................ Excess (deficiency) of revenues and other financing sources over expenditures and other financing uses .................................................. Interfund transfer to debt service fund ......................................................... Fund balance—January 1, 2018 .................................................................. Fund balance—December 31, 2018 ............................................................

$ 12,000 560,000 $(548,000) $ 559,000 9,000 $ 550,000 $ $

2,000 (2,000) 0 0

CHAPTER 17 UNDERSTANDING THE ISSUES 4. The purpose of the MD&A is to give a concise overview and analysis of the information in the government’s financial statements. Required information includes a brief discussion of the basic financial statements, including how they relate to each other and the significant differences in the information they provide; condensed current and prior-year financial information from the government-wide financial statements; an analysis of the government’s overall financial position and results of operations, including impact of important economic factors; an analysis of individual fund financial information, including the reasons for significant changes in fund balances (or net position) and whether limitations significantly affect the future use of the resources; an analysis of significant variations between original and final budget amounts and between final budget amounts and actual budget results for the general fund; a description of changes in capital assets and longterm liabilities during the year; a discussion of the condition of infrastructure assets; and a description of currently known facts, decisions, or conditions that have or are expected to have a material effect on the financial position or results of operations.

1. The new reporting model adopts full accrual accounting for the government-wide statements for both governmental and business-type activities. Therefore, a conversion of the governmental fund activity is necessary in order to present government-wide financial statements. Since business-type activities are already recorded at full accrual, there is no conversion necessary from fund to government-wide financial statements. 2. Both fund and government-wide financial statements are required in the new model. Fund statements include (1) the governmental fund balance sheet and statement of revenues, expenditures, and changes in fund balances; (2) the proprietary fund statement of net position, statement of revenues, expenses, and changes in net position, and statement of cash flows; and (3) the fiduciary fund statement of net position and statement of changes in net position. The fund statements provide information on flows of financial revenues. Government-wide statements include a statement of net position and a statement of activities. They provide full accrual, consolidated government-wide reports. Budgetary comparison information may be reported in a statement and in a schedule accompanying the financial statements.

5. The budgetary comparisons may be included as an additional statement or in a schedule. The original as well as amended budget must be included with a comparison of actual results reported on a budgetary basis.

3. Major funds are those funds that management chooses to disclose in a separate column in the fund statements either due to their relative size or because they are of particular interest or convey unique information. The general fund is always considered a major fund. Funds whose assets and deferred outflows, liabilities and deferred inflows, revenues, or expenditures/ expenses are at least 10% of all funds in a category (all governmental or all enterprise) and are at least 5% of all government and enterprise funds combined must be considered major funds.

6. Interfund transactions are recorded separately from other transactions. Interfund payables and receivables are eliminated when governmentwide statements are prepared. Interfund payables and receivables are “netted” and shown separately as internal balances. In addition, internal service fund revenues and expenses are eliminated, and charges are adjusted to eliminate the internal profit by decreasing expenses for internal service fund services in the various funds.

Ch. 17—Exercises

17–2

EXERCISES EXERCISE 17-1 Note to Instructor: The 2013 CAFR of the city of Milwaukee needs to be examined to answer these questions. The general fund is always considered a major fund. Every other governmental fund from the combining statements must be examined to determine if it is at least 10% of all the governmental funds and at least 5% of all government and enterprise funds combined. Every enterprise fund from the combining statements must also be examined to determine if it is at least 10% of all the enterprise funds and at least 5% of all government and enterprise funds combined. The size tests are based on assets and deferred outflows, liabilities and deferred inflows, revenues, and expenditures/expenses. Internal service funds are not considered major funds. In addition, management may determine funds that it wishes to disclose in a separate column in the fund statements because they are of particular interest or convey unique information, even though they do not meet the size test.

EXERCISE 17-2 Note to Instructor: This assignment can also include a class presentation or class discussion as part of a student project. It may be useful to have student groups or teams work on this assignment.

EXERCISE 17-3 (1) Governmental Fund Statement of Revenues, Expenditures, and Changes in Fund Balances General Fund

Special Revenue Fund C

Capital Projects Fund A

Capital Projects Fund B

Total Nonmajor Funds

Total Government Funds

(2) Proprietary Fund Statement of Revenues, Expenses, and Changes in Net Position Total Enterprise Funds Enterprise Fund D

Enterprise Fund F

Other Enterprise Funds

Totals

Total Internal Service Funds

17–3

Ch. 17—Exercises

EXERCISE 17-4 (1)

(2)

(3)

(4)

(5)

(6)

(7)

(8)

(9)

(10)

When moving from modified accrual to full accrual accounting, many long-term liabilities may need to be adjusted. Both expenditures for debt principal and capital outlays must be eliminated and converted to expenses. In addition, depreciation expense must be recorded. The government-wide statements report internal service funds among the governmental activities and do not include fiduciary funds. Component units are included in government-wide statements. All capital assets, including infrastructure, must be included in the government-wide statements. In addition, all capital assets must be depreciated. Governments may elect the modified approach in lieu of depreciation if they meet the criteria set forth for the modified approach. The government-wide statements do not include fiduciary funds but do include component units, and internal service funds are included with governmental activities. An up-to-date inventory and a current condition assessment are necessary for the modified approach. In addition, governments must keep the capital assets maintained at or above the predetermined condition level. Revenue that is specific to a particular activity, function, or program, such as fees for services, specific tax revenue, operating grants, or capital grants, is considered program revenue. Other revenue is considered general government revenue necessary to support all activities not covered by specific program revenues. The government-wide statements report internal service funds among the governmental activities. The reason is that these are internal cost allocation mechanisms and not business-type activities. Thus, internal service funds are included in the Governmental Activities column in the government-wide statements. The reconciliation is necessary for the governmental funds to convert the modified accrual fund information to the full accrual government-wide governmental activities information. In addition, internal service fund balances must be added to the governmental funds as part of the conversion. Reconciliation may be either on face of financial statement or as a separate statement. The statement of cash flows is part of the proprietary fund financial statements but is not part of the government-wide statements.

EXERCISE 17-5 To convert from the governmental fund balance sheet to the government-wide statement of net position, the following adjustments are necessary: • • • • •

Add general capital assets, including infrastructure, net of accumulated depreciation. Add general long-term liabilities. Add assets and liabilities of most internal service funds. Adjust balances of assets and liabilities from modified accrual to full accrual. Convert fund balances to three categories of net position—invested in capital, restricted, and unrestricted.

These adjustments are necessary to convert from the modified accrual basis to the full accrual basis.

Ch. 17—Exercises

17–4

EXERCISE 17-6 (1)

The governmental cash flow statement contains four parts: operating, capital-related financing, non-capital-related financing, and investing.

(2)

In the fund statements, proprietary funds are included in the proprietary fund balance sheet; statement of revenues, expenses, and changes in net position; and statement of cash flows. In the government-wide statements, proprietary funds are included in Business-Type Activities columns in both the statement of net position and the statement of changes in net position.

(3)

Account groups are not reported in either the fund or government-wide statements.

(4)

Total columns are not required for combining statements but are quite commonly shown. Total columns are required in both the fund and government-wide combined statements under the new reporting model.

(5)

A statement of cash flows is required for all enterprise funds.

(6)

Construction in progress will be reported in the government-wide statements as a capital asset. Capital assets are not reported in the fund statements.

EXERCISE 17-7 The new reporting model requires that all capital assets, including infrastructure assets, be included on the financial statements. In addition, these assets must be depreciated. (The rules are effective three years after the requirement for implementing the new reporting model.) Governments may adopt a “modified approach” to depreciation if they have an up-to-date inventory of their infrastructure assets and have a current condition assessment. As long as the assets are maintained at an agreed-upon condition, depreciation does not need to be recorded. The advantage of recording depreciation is ease of implementation. The disadvantages include recording the additional expense on the statement of activities and the lack of useful information in the opinion of many governmental managers and financial statement users. The advantage of the modified approach is that as long as assets are maintained, there is no depreciation expense recorded on the statement of activities. The disadvantage is the cost of implementation and monitoring. Also, if the condition drops below the required level, the government must record depreciation. Infrastructure assets must be depreciated on the statement of activities.

17–5

Ch. 17—Problems

PROBLEMS PROBLEM 17-1 (1)

The statement of activities is presented using a net program expense format where program revenues are subtracted from program expenses to determine the amount funded by general revenues.

(2)

Special purpose governments that provide business-type activities only are permitted to report the financial statements required for enterprise funds. Since these are already on an economic measurement focus using full accrual accounting and all of the expenses are covered by program revenues, there is no need to convert to government-wide statements.

(3)

The government-wide financial statements include a statement of net position and a statement of activities with an economic resources measurement focus and are prepared on a full accrual basis of accounting. Governmental activities and business-type activities of the primary government are included as well as financial information about component units.

(4)

Budgetary comparison may be included as a separate statement or schedule. The budgetary comparisons are considered required supplementary information and not part of the basic financial statements.

(5)

Combining statements are used to add together nonmajor funds of the same type in order to present summary data in the combined statements. They are not considered part of the basic financial statements but are included in the comprehensive annual financial statement.

(6)

The three major sections of the comprehensive annual financial statement are the introductory section, the financial section, and the statistical section. The MD&A and the auditor's report are part of the financial section.

(7)

(8)

The new reporting model requires that all capital assets, including infrastructure, be recorded and depreciated. Governments have the option of choosing a modified approach for infrastructure assets. Under the modified approach, governments do not report depreciation if they have an up-to-date inventory of capital assets, a condition assessment of all infrastructure assets, and maintenance of them at or above a predetermined level.

(9)

Major funds are those funds that management chooses to disclose in a separate column in the fund statements either due to their relative size or because they are of particular interest or convey unique information. Funds whose assets and deferred outflows, liabilities and deferred inflows, revenues, or expenditures/expenses are at least 10% of all funds in a category (all governmental or all enterprise) and at least 5% of all government and enterprise funds combined must be considered a major fund. The general fund is always considered a major fund.

Ch. 17—Problems

17–6

Problem 17-1, Concluded (10)

The Office of Management and Budget (OMB) sets standards for audits of recipients of federal financial assistance. Guidance for the “single audit” is found in OMB Circular A-133.

(11)

OMB Circular A-133 applies to state, local, and not-for-profit organizations that receive more than $300,000 of federal financial assistance in the form of grants, contracts, etc.

(12)

The expenditures threshold for having an A-133 single audit (for fiscal years beginning on or after January 1st, 2015) is $750,000.

PROBLEM 17-2 Note to Instructor: This assignment can also include a class presentation or class discussion as part of a student project. It may also be useful to have student groups or teams work on this assignment. PROBLEM 17-3 The authority is not a component unit but should be disclosed in the notes as a related organization. The city appoints the authority’s separate governing board but is not financially accountable for the authority. The budgetary approval authority is not substantive, and there are no other indications that the city can impose its will on the UDA. Moreover, the city is not entitled to surpluses of the authority and is not obligated for its deficits or debts, so there is no financial benefit or burden relationship. PROBLEM 17-4 (1) The school district is not legally separate, so it is part of the city and not a component unit. (2) The authority is legally separate, the city has financial accountability, and so it is a component unit. Because it leases equipment exclusively to the city, the financial information will be blended in the fund and government-wide statements. (3) The mayor appoints all members of the board so it can be assumed that there is control over the board. Since the housing authority does not primarily serve the city, the financials will be discretely presented in the government-wide statements. (4) Since the hospital is owned by the city, it is not legally separate and therefore part of the city and not a component unit. (5) The water utility is a joint venture and not a component unit. The city’s equity interest will be presented in the government-wide statements as an asset. (6) The school district is a special purpose government unit separate from the city.

17–7

Ch. 17—Problems

PROBLEM 17-5 The financial reporting entity of a government includes the primary government and all its component units. An example of a primary government is a city. An example of a component unit is a legally separate hospital for which the city is financially accountable. Component units can either be blended into the financial reports of the primary government or discretely presented in a separate column. Blending is required if the component unit is established primarily to serve the primary government or if the two boards are essentially the same.

PROBLEM 17-6 (1) Budgetary Fund Balance............................................................ Estimated Other Financing Uses ............................................... Appropriations ............................................................................ Estimated Other Financing Sources ...................................... Estimated Revenues..............................................................

295,000 15,000 600,000 900,000 10,000

(2) Statement of Revenues, Expenditures, and Changes in Fund Balances For the Year Ended December 31, 2019 Revenues ..................................................................................................... Expenditures ................................................................................................ Excess of revenue over expenditures .......................................................... Other financing sources ............................................................................... Other financing uses .................................................................................... Excess of revenue and other financing sources over expenditures and other financing uses .......................................... Fund balance, January 2, 2019.................................................................... Fund balance, December 31, 2019 ..............................................................

$ 41,600 (586,600) $(545,000) 800,000 (5,000) $ 250,000 0 $ 250,000

(3) Balance Sheet as of December 31, 2019 Cash .................................. Investments .......................

$110,000 250,000

Total Assets ......................

$360,000

Contracts payable...................... Fund balance—assigned ........... Unassigned................................ Total fund balance................. Total liabilities and fund balance

$ 110,000 $ 80,000 170,000 $ 250,000 $ 360,000

Ch. 17—Problems

17–8

PROBLEM 17-7

Revenues ..................................... Other Financing Sources ............. Expenditures ................................ Other Financing Uses .................. Bonds Payable ............................. Capital Assets ..............................

Fund (41,600) (800,000) 586,600 5,000 0 0

Debit

Credit

(2) 800,000 586,600 (1) 800,000 (2) (1) 586,600

GovernmentWide (41,600) 0 0 5,000 (800,000) 586,600

The adjustments will convert (eliminate) other financing sources and transfer that balance into bonds payable. The expenditure for capital assets will be eliminated since capital assets must be recorded on the government-wide statement of net position.

PROBLEM 17-8 City of Lucas Statement of Net Position June 30, 2019 Governmental Activities Assets: Cash and cash equivalents .................... Receivables ............................................ Inventories .............................................. Capital assets (net)................................. Total assets ......................................

Business-Type Activities

Total Primary Government

$ 280,000 36,000 0 1,500,000 $1,816,000

75,000 145,000 56,000 1,100,000 $1,376,000

$ 355,000 181,000 56,000 2,600,000 $3,192,000

Liabilities: Accounts payable ................................... Noncurrent liabilities ............................... Total liabilities ...................................

65,000 500,000 $ 565,000

56,000 300,000 $ 356,000

$ 121,000 800,000 $ 921,000

Net position: Invested in capital, net of related debt....................................... Restricted ............................................... Unrestricted ........................................... Total net position ..............................

$1,000,000 65,000 186,000 $1,251,000

$ 800,000 36,000 184,000 $1,020,000

$1,800,000 101,000 370,000 $2,271,000

Note: Unrestricted amounts were computed to balance.

17–9

Ch. 17—Problems

PROBLEM 17-9 City of Rose Statement of Activities As of June 30, 2019

Expenses

Program Revenues Net Revenue Change in Net Position Charges Businessfor Operating Capital Governmental Type Services Grants Grants Activities Activities Total

Governmental activities: General government .................. Public safety ............................... Public works ............................... Health and sanitation ................. Culture and recreation................ Interest on long-term debt .......... Total governmental activities ..

$1,300,000 240,000 1,000,000 650,000 450,000 60,000 $3,700,000

$ 100,000 25,000 0 250,000 200,000 0 $ 575,000

0 70,000 0 150,000 0 0 $220,000

$(1,200,000) $ (145,000) (1,000,000) (250,000) (250,000) (60,000) $(2,905,000) $

Business-type activities: Water and sewer system............ Parking system........................... Total business-type activities .. Total primary government ..........

$1,500,000 45,000 $1,545,000 $5,245,000

$1,800,000 40,000 $1,840,000 $2,415,000

0 0 $ 0 $220,000

Property taxes .............................................................................................. Sales taxes................................................................................................... Investment earnings ..................................................................................... Special item—gain on sale........................................................................... Transfers between funds.............................................................................. Total general revenues ............................................................................ Change in net position ................................................................................. Net position—July 1, 2018 ........................................................................... Net position—June 30, 2019 ....................................................................

0 0 0 0 0 0 0

0 $ 300,000 $ 300,000 0 (5,000) (5,000) $ 0 $ 295,000 $ 295,000 $(2,905,000) $ 295,000 $(2,610,000) $ 2,500,000 2,000,000 0 140,000 (70,000) $ 4,570,000 $ 1,665,000 1,400,000 $ 3,065,000

0 0 30,000 0 70,000 $ 100,000 $ 395,000 2,500,000 $ 2,895,000

Note: Unrestricted amounts were computed to balance.

$(1,200,000) (145,000) (1,000,000) (250,000) (250,000) (60,000) $(2,905,000)

part.

$ 2,500,000 2,000,000 30,000 140,000 0 $ 4,670,000 $ 2,060,000 3,900,000 $ 5,960,000

Ch. 17—Problems

17–10

PROBLEM 17-10 (1) The basic financial statements in the new reporting model include both government-wide financial statements and fund financial statements. The government-wide financial statement presents the financial picture of Minneapolis from an economic resources measurement focus using the full accrual basis of accounting. Governmental and businesstype activities are presented separately. The government-wide statements include all assets and all liabilities (including infrastructure assets and long-term debt). In addition, certain interfund activity and interfund payables and receivables have been eliminated. The fund financial statements include separate statements for each of the three categories of activities—governmental, proprietary, and fiduciary. The governmental activities statements present information from a current financial resources measurement focus using the modified accrual basis of accounting. The proprietary activities are presented from an economic resources measurement focus using the full accrual basis of accounting. The only fiduciary fund of Minneapolis is an agency fund presented in a balance sheet. In addition to the examples shown in the text, the financial section includes the auditors’ opinion and detailed notes and supplementary information. Minneapolis has no fiduciary funds and no permanent funds. (2) The management’s discussion and analysis is a requirement in the new reporting model. It provides an overview of the city’s financial activities for the fiscal year and is subject to audit. The MD&A provides an objective and easily readable analysis of the government’s financial activities based on currently known facts, conditions, or decisions. The focus is on the primary government. There are eight specific requirements for the MD&A as listed in the text. No additional information can be included. Governments can, however, provide as much detail as they wish about the required information. The MD&A differs from the letter of transmittal. The letter of transmittal is optional; governments can choose any format to communicate information. It provides a forum for government officials to discuss plans and other information that may not meet the “currently known facts, conditions, or decisions” criteria for the MD&A. (3) Budgetary comparison information is reported as required supplementary information. A description of the annual budget, comparison of departmental expenditure totals from prior years, and a budgetary comparison schedule with original, final, and actual amounts (and a variance column) are included. (4) Minneapolis has four major governmental funds: Community Planning and Economic Development, Convention Center, Permanent Improvement, and Special Assessment. Minneapolis uses the GASB Statement No. 34 criteria for determining major funds—meeting the test of 10% of total governmental assets, liabilities, revenues, or expenditures, and at least 5% of the corresponding total for all governmental and enterprise funds. In addition, certain funds are presented as major funds because the city believes the financial position and activities of these funds are significant to the city as a whole. Nonmajor governmental funds (found on the combining statements): Special revenue: Arena Reserve, Board of Estimate and Taxation, HUD Consolidated Plan, Convention Facilities Reserve, Convention Facilities Reserve, Employee Retirement, Grants—Federal, Grants—Other, Police

17–11

Ch. 17—Problems

Problem 17-10, Concluded Debt service: Community Planning and Economic Development, General Debt Service Capital projects: none Permanent funds: none (5) Minneapolis capitalizes and depreciates (or amortizes) all capital assets (including infrastructure) using the straight-line method over the lesser of the capital lease period or estimated useful lives in the government-wide statements and proprietary fund. Estimated useful lives of infrastructure assets range from 15 to 100 years.

PROBLEM 17-11 (1) The measurement focus for governmental funds is financial resources, and the basis of accounting for governmental funds statements is modified accrual. The proprietary and fiduciary fund statements adopt economic resources as the measurement focus and use the full accrual accounting basis. The government-wide statements measure economic resources and report activities using full accrual accounting for both governmental and business-type activities. (2) Differences between fund financial statements and government-wide statements: Fund Statements

Government-Wide Statements

Component units

Only blended component units are included.

Both blended and discretely presented component units are included.

Fiduciary funds

Separate fiduciary fund statements include a statement of net position and a statement of changes in net position.

Fiduciary funds are not included.

Internal service funds

Internal service funds are included in the proprietary fund statements.

Internal service funds are included in governmental activities.

(3) The three net asset categories found in the statement of net position: Invested in capital assets, net of related debt

Fixed assets of the government less all fixed asset-related debt (current and noncurrent)

Restricted

Externally restricted assets less any liabilities payable from these restricted assets

Unrestricted

Difference between the remaining assets and liabilities as well as reclassified restricted assets

Ch. 17—Problems

17–12

PROBLEM 17-12 (1) Major programs for the audit will include Programs 1, and 3. These three programs are identified due to their size (over $750,000 in expenditures) and risk assessment (not classified as low risk). (2) Program 2 is assessed as high risk, and should also be audited.

PROBLEM 17-13 Packer City Reconciliation Schedules (1)

Balance Sheet to Statement of Net Position

Total fund balances for governmental funds ....... Add: Land .............................................................. Construction in progress ............................... Land improvements....................................... Buildings........................................................ Machinery and equipment ............................. Library collection ........................................... Infrastructure ................................................. Deferred bond issue costs ............................ Special assessments receivable ................... Advance to water utility ................................. Deduct: Accumulated depreciation ............................. General obligation debt ................................. Community development .............................. Compensated absences ............................... Accrued interest payable............................... Net position of governmental activities ...............

$ 15,462,380 $ 3,871,054 748,411 1,880,024 10,844,461 5,968,095 1,580,523 10,026,505 104,357 66,008 1,402,904 (8,048,495) $(23,403,178) (2,000,000) (2,611,738) (133,627)

28,443,847

(28,148,543) $ 15,757,684

17–13

Ch. 17—Problems

Problem 17-13, Continued (2)

Statement of Revenues, Expenditures, and Changes in Fund Balances to Statement of Activities

Net change in fund balances—total governmental funds Changes in capital assets: Increase in total capital assets*..................... $ 4,157,074 Book value, assets sold ................................ (76,506) Depreciation .................................................. (1,291,691) Principal payments received ......................... Amortization of bond issue cost .................... Add to deferred debits ................................... Decrease in special assessments received .. Changes in long-term debt: General obligation bonds repaid ................... $ 1,982,514 General obligation bonds issued ................... (3,025,000) Net increase in accrued uncompensated absences .................................................. (487,276) Increase in accrued interest .......................... (18,862) Change in net position of governmental activities ........................................................

$ (1,326,268)

2,788,877 (189,417) (12,777) 6,389 (44,394)

(1,548,624) $ (326,214)

*Not all capital expenditures are capitalized.

Ch. 17—Problems

17–14

Problem 17-13, Continued (3)

Packer City Statement of Net Position Government Activities December 31, 2019 Governmental Funds

Assets: Cash .............................................................. Accounts receivable ...................................... Due from other governments ........................ Taxes receivable ........................................... Special assessments receivable ................... Due from other funds .................................... Prepaid expenses ......................................... Advance to water utility ................................. Deferred bond issue cost .............................. Land .............................................................. Construction in progress ............................... Land improvements....................................... Buildings........................................................ Machinery and equipment ............................. Library collection ........................................... Infrastructure ................................................. Accumulated depreciation ............................. Total assets ................................................... Liabilities: Accounts payable .......................................... Accrued liabilities .......................................... Due to other funds......................................... Due to other governments............................. Accrued interest payable............................... General obligation debt ................................. Community development bonds.................... Compensated absences ............................... Total liabilities................................................ Deferred Inflows of Resources: Deferred inflow of resources ......................... Total Deferred inflow of resources ................ Net position: Held for investment purposes ....................... Capital assets net of debt.............................. Restricted ...................................................... Unrestricted ................................................... Total net position ...................................... Liabilities, deferred inflows and net position..

Adjustments

Total

$16,445,619 604,403 36,580 10,751,122 133,222 $ 66,009 1,900 8,689 1,402,904 1,402,904 104,357 3,871,054 748,411 1,880,024 10,844,461 5,968,095 1,580,523 10,026,505 (8,048,495) $29,384,439 $28,443,848

$16,445,619 604,403 36,580 10,751,122 199,231 1,900 8,689 2,805,808 104,357 3,871,054 748,411 1,880,024 10,844,461 5,968,095 1,580,523 10,026,505 (8,048,495) $57,828,287

$ 1,043,544 142,235 1,900 320,000

$ 133,627 23,403,178 2,000,000 2,611,738 $ 1,507,679 $28,148,543

$ 1,043,544 142,235 1,900 320,000 133,627 23,403,178 2,000,000 2,611,738 $29,656,222

$ 12,414,380 $ $12,414,380 $

$12,414,380 $12,414,380

— b

4,377,735 11,084,645c $15,462,380 $29,384,439

0 0

$ 3,467,400a 4,377,735 7,912,550 $15,757,685 $57,828,287

Total of land through infrastructure less Accumulated depreciation = $26,870,578 – $23,403,178. Total of reserved fund balances from the governmental funds balance sheet. c Total of unreserved fund balances from the governmental funds balance sheet. b

17–15

Ch. 17—Problems

Problem 17-13, Continued (4)

Packer City Statement of Activities December 31, 2019

Expenses General government ......................... $ 3,249,306 Protection .......................................... 6,161,176 Highway ............................................ 3,102,827 Health................................................ 863,461 Economic development ..................... 86,788 Education and recreation .................. 2,102,422 Interest expense ............................... 1,076,481 Bond issue expense.......................... 63,884 Unallocated depreciation .................. 525,089 Total ............................................ $17,231,434 General revenues ............................. Property tax ................................. Transfers-in ................................. Transfers-out ............................... Loss on assets sale..................... Net change........................................

Governmental Funds Fines, Fees, Operating Net (Expense) Charges Grants Revenue $ (456,271) $(2,583,307) $ (209,728) (154,270) (6,006,906) (159,636) (2,943,191) (863,461) (86,788) (3,651,389) 1,548,967 (1,076,481) (63,884) (525,089) $(10,226,561) $ 9,910,221 2,613,353 (2,576,241) (46,986) $ (326,214)

Ch. 17—Problems

17–16

Problem 17-13, Concluded Support Schedule General Fund

Debt Service

Capital Project

Nonmajor

Adjustments: Property tax ........................................... $ 8,466,838 $1,666,729

Intergovernment .................................... 1,530,215 Commercial revenues ........................... 232,598 6,745 $ Licenses and permits ............................ 639,103 Charges for services ............................. 691,659 Fines, forfeitures, and penalties ............ 154,270 Public improvement revenues ............... Intergovernmental charges .................... 102,637 Interdepartmental revenue .................... 69,672 283,962 Total revenues and other sources ......... $11,886,992 $1,957,436 $

51,217

Transfer-in ............................................. Transfer-out ........................................... Sale of capital asset .............................. Debt refunded ....................................... Long-term debt issue............................. Totals .................................................... Net change ........................................ (1) Increase capital assets. (2) Book value of assets sold. (3) Depreciation.

$10,144,032

413,989 360,725

1,944,204 651,285 639,103 3,000,104 154,270 159,636 102,637 353,634 $17,148,905

159,636 $3,253,260

Expenditures: General government.............................. $ 2,618,262 Protection .............................................. 4,945,330 Highway and transportation ................... 1,423,885 Health and sanitation............................. Economic development ......................... Education and recreation ...................... 1,768,889 Debt principal ........................................ $1,157,514 Debt interest .......................................... Bond issuance costs ............................. Capital outlay ........................................ Unallocated depreciation ....................... Total ......................................................

10,465

2,308,445

51,217

$ 143,768 295,846 863,461 86,788 130,257

1,057,619 $ 57,496 4,005,427

673,283

Total

1,513,980

$ 2,762,030 5,241,176 1,423,885 863,461 86,788 1,899,146 1,157,514 1,057,619 57,496 6,192,690

Debit (6) $ (11)

Adjustments

Credit

44,394 189,417

$ 9,910,221 1,944,204 651,285 639,103 3,000,104 154,270 159,636 102,637 353,634 $16,915,094

(9) $

487,276

$ 3,249,306 5,241,176 1,423,885 863,461 86,788 1,899,146 (7) $1,157,514

(10) (4)

18,862 12,777

(3)

1,291,691

(5) (1)

6,389 4,157,074

$20,741,805 647,067 (147,846) 29,520

635,600

1,330,686 (2,413,299)

(15,096) (825,000) 825,000 2,200,000

(4) Bond issue cost amortization. (5) New issue cost. (6) Decrease in special assessments.

$ 2,613,353 (2,576,241) 29,520 (825,000) 3,025,000 $(1,326,268)

(2)

76,506

(8)

3,025,000 $ 5,145,923 $(1,000,054)

1,076,481 63,884 2,035,616 1,291,691 $17,231,434 $ 2,613,353 (2,576,241) (46,986)

(7)

825,000 $6,145,977

$ (326,214)

(10) Increase in accrued interest. (7) Repayment of bonds. (8) New bond issue. (11) Principal payments received in advance. (9) Increase in uncompensated absences.

Add facts: Capital outlays total $2,035,616 ($920,000 protection and the balance is Highway). .

Total

part.

CHAPTER 18 UNDERSTANDING THE ISSUES of goods or services, and realized and unrealized earnings from investments.

1. Separating the accounting for current activities into restricted and unrestricted funds allows for detailed reporting of resources and spending. This is often done to satisfy donors and/or grantors who require detailed reporting of inflows and outflows. In addition, the information generated assists in the overall financial reporting that requires net assets to be shown as restricted, temporarily restricted, and permanently restricted.

4. A contribution is a nonreciprocal transaction where one part gives something of value and does not expect something in return. An agency transaction is where one party gives something of value to an intermediary organization (e.g., a foundation) that receives this gift on behalf of another organization. In the first example, public support is recorded at the fair value of the contribution. In the second example, a liability to the ultimate recipient is recorded.

2. Users of not-for-profit financial information are interested in the fair value of investments regardless of their trading status. Not-for-profits, particularly foundations and pension plans, have large portfolios. Up-todate information on the status of investments in these portfolios is necessary for donors, governments, and other grantors in their funding decisions. Thus, FASB Statement No. 124 does not differentiate among investment categories.

5. A VHWO must include a statement of functional expense as part of its financial statements in order to detail the total expenses in each program and supporting services reported on the statement of activities. This allows users of the financial statements, including donors, potential donors, grantors, lenders, and governments, to better evaluate spending and identify detailed expense patterns by program.

3. Public support captures all forms of donations to a not-for-profit organization, including direct contributions of all types (cash, assets, services, reduced liabilities, free rent, reduced rates, etc.), net proceeds from fund-raising events, gifts from legacies and bequests, and indirect giving from umbrella charitable campaigns, e.g., United Way. Revenue captures amounts earned from exchange transactions— where both parties gain and something of value is given or returned. Examples of revenue are dues and subscriptions, membership fees, proceeds from the sale

6. (Appendix) A VHWO may wish to present its financial information on a fund basis rather than simply on an organization-wide basis if this detailed presentation was requested or helpful to the users. Since historically this information was presented in funds-based statements, keeping some notion of funds in the reporting may be useful to board members, lenders, and other oversight bodies. Many VHWOs still use funds-based financial systems that can easily generate this detailed information.

Ch. 18—Exercises

18–2

EXERCISES EXERCISE 18-1 Note to Instructor: You might wish to have students look for information on not-for-profit organizations in your community and compare what links, if any, are found to state or national organizations (both foundations and not-for-profit centers or portals).

EXERCISE 18-2 (1) C

There is a permanent restriction on this donation.

(2) A

Because the restriction is met in the same period the income is received, the organization can record the income as unrestricted (consistent with their policy).

(3) A

If there is no law regarding recognition of unrealized gains/losses, an organization may recognize them as unrestricted if they occur in the same period as the restrictions are met, consistent with the organization’s policy of recognizing all contributions as unrestricted if donated in the same period restrictions are met.

(4) B

Investment income from donor-restricted permanent endowments is recognized as temporarily restricted if the donor restricts the income as to use or specific time period.

(5) B

The gain is not permanently restricted unless there is a donor stipulation or legal requirement. The income is temporarily restricted because it is to be expended in a future period.

EXERCISE 18-3 (1) The measurement focus of state and local government’s government-type activities is flows of financial resources, whereas the measurement focus of voluntary health and welfare organizations (VHWOs) is flows of economic resources. Some financial activities of a government, such as those of operating a utility, may be better reported (i.e., the financial information may be more useful) using a flow of economic resources measurement focus given their similarity to business enterprises where goods and services are provided for fees. For these operations, governments use the accrual basis of accounting. The financial activities of a VHWO, on the other hand, are more similar to government-type activities where the relationship between revenues and costs of goods and services provided is vague. Were VHWOs under the jurisdiction of the GASB, they would be included under the standard guiding them to use the flows of financial resources measurement focus and to report revenues and expenditures on an accrual basis. Financial reporting standards for VHWOs, however, under the auspices of the FASB, require VHWOs to use the flows of economic measurement focus and accrual basis of accounting.

18–3

Ch. 18—Exercises

Exercise 18-3, Concluded (2) State and local governments present revenues and expenditures for the governmental funds separate from the proprietary funds. In addition, government-wide financial statements are prepared. VHWOs are not required to report their activities by funds. Financial reporting for organization-wide activities of both governments and VHWOs includes a statement of activities and a statement of net assets (called the statement of financial position for VHWOs). (3) Depreciation expense is reported in the statement of activities of a government. Accumulated depreciation is reported in the statement of net assets. VHWOs report depreciation expense in the statement of activities and accumulated depreciation in the statement of financial position. (4) A voluntary health and welfare organization may use a separate fund to account for fixed assets called the Plant Fund or Land, Building, and Equipment Fund. If capital assets are purchased by the Plant Fund, the usual entry is made as follows: Land, Building, and Equipment ................................................. Cash or Some Payable .......................................................

xxx xxx

The purpose of a voluntary health and welfare organization is to provide a service to the community. Because there are usually numerous voluntary health and welfare organizations competing for donations, it is only proper that donors be able to evaluate the cost of the services provided in an effort to see which organizations use donations most efficiently. The use of fixed assets in an organization represents a cost of providing a service, and so it is appropriate for a voluntary health and welfare organization to show depreciation as a cost of providing its service to the community. The Land, Building, and Equipment Fund records any gain or loss on the sale of fixed assets as revenue of the fund. If the proceeds of the sale are not legally required to be reinvested in fixed assets, the funds should be transferred to the unrestricted fund by entries reflected as direct additions and reductions to the respective fund balances. Governmental units, on the other hand, do not create a separate fund for fixed assets. If fixed assets are acquired for use in a trust, an enterprise, or an internal service fund, these assets are included within the fund and depreciated in a similar manner and for the same purpose as in a commercial enterprise. If fixed assets are acquired for use by a fund other than the above funds within a governmental unit, the assets are recorded in the general fixed assets account group (not a fund). The general fixed assets account group is a memorandum record of fixed assets maintained for stewardship purposes only. In governmental accounting, except in the three types of funds mentioned earlier, the cost of a fixed asset is matched against revenues in the period of acquisition. This is done to reflect the outflow of funds (stewardship concept) within a given period. Because the cost of the fixed asset is matched with revenues in this manner, depreciation is not necessary.

Ch. 18—Exercises

18–4

EXERCISE 18-4 (1) d

Donated works of art, historical treasures, or similar objects that are not held for public inspections, education, or research, are not protected and preserved, and are not subject to the provision that all proceeds from their sale be used to acquire other items for the collection must be capitalized.

(2) d

Investments are reported at their most reliable measure of fair value.

(3) b

Contributed services must be provided by persons possessing specialized skills that would need to be purchased if not donated. There is no licensing requirement.

(4) b

If a donor receives something of value in exchange, then the transaction is not a contribution.

(5) b

Rather than requiring restricted contributions to first be classified as restricted and then “released” as the restrictions are met, this exception is allowed if both happen in the same reporting period.

EXERCISE 18-5 Supporting schedule Drug Alcohol Rehabilitation Recovery

Secretarial salary ...... Office supplies .......... Printing ...................... Depreciation .............. Instruction ................. Rent .......................... Total ....................

0 600 1,600 800 2,700 6,000 $ 11,700

0 300 1,600 800 2,250 4,000 $8,950

Weight Control

Fund Raising

0 300 1,600 800 3,150 6,000 $ 11,850

0 300 2,400 0 900 0 $3,600

General and Administrative

Total Amount

$ 2,000 1,500 800 1,600 0 4,000 $9,900

$ 2,000 3,000 8,000 4,000 9,000 20,000 $ 46,000

18–5

Ch. 18—Exercises

Exercise 18-5, Concluded Whole Life Clinic Statement of Activities For Year Ended December 31, 2019 Unrestricted

Temporarily Restricted

Total All Funds

Public support and revenue: Public support ............................................................. Revenue ...................................................................... Net assets released from restriction: Satisfaction of equipment acquisition restrictions ....... Total public support and revenues ....................................

4,000 $ 51,000

Expenses: Program services: Drug rehabilitation ................................................. Alcohol recovery .................................................... Weight control ....................................................... Total program services................................................

$ 11,700 8,950 11,850 $ 32,500

Supporting services: General and administrative ................................... Fund raising .......................................................... Total supporting services ............................................ Total expenses..................................................................

$ 9,900 3,600 $ 13,500 $ 46,000

Change in net assets ........................................................ Net assets, January 1, 2019 ............................................. Net assets, December 31, 2019 .......................................

$ 5,000 22,000 $ 27,000

$ 35,000 12,000

$ 35,000 12,000 $ (4,000) $ (4,000)

$ (4,000) 40,000 $ 36,000

0 $ 47,000

$ 1,000 62,000 $ 63,000

EXERCISE 18-6 (1) Cash ............................................................................................... Revenue—Dues ....................................................................... To record receipt of membership dues.

9,000

(2) Cash ............................................................................................... Pledges Receivable ........................................................................ Contributions—Unrestricted...................................................... To record cash and pledges received.

22,000 32,000

(3) Provision for Uncollectible Pledges ................................................ Allowance for Uncollectible Pledges ......................................... To provide for uncollectible pledges.

3,200

9,000

54,000

3,200

Ch. 18—Exercises

18–6

Exercise 18-6, Concluded (4) Cash ............................................................................................... Special Events Support ............................................................ To record gross revenues from the fund-raising dinner.

12,000

Cost of Special Events ................................................................... Cash ......................................................................................... To record payment of costs [($15 × 420) + $200].

6,500

(5) Car for Resale ................................................................................ Contributions—Temporarily Restricted ..................................... To record the receipt of a classic car to be auctioned next period.

75,000

(6) Cash ($70,000 – $20,000) .............................................................. Pledges Receivable ........................................................................ Fund-Raising Expense ................................................................... Contributions—Unrestricted...................................................... To record result of professional fund-raising group.

50,000 30,000 20,000

Provision for Uncollectible Pledges ................................................ Allowance for Uncollectible Pledges ......................................... To record estimated uncollectibles at 5% of gross of $30,000.

1,500

12,000

6,500

75,000

100,000

1,500

EXERCISE 18-7 (1) Cash ............................................................................................... Contributions—Temporarily Restricted ..................................... To record contribution to be used when building addition is completed.

20,000

(2) Cash ............................................................................................... Accumulated Depreciation .............................................................. Land, Building, and Equipment ................................................. Gain on Sale of Plant Assets—Unrestricted ............................. To record sale of equipment.

10,000 9,000

(3) Depreciation Expense .................................................................... Accumulated Depreciation ........................................................ To record depreciation expense.

9,000

20,000

17,000 2,000

9,000

18–7

Ch. 18—Exercises

Exercise 18-7, Concluded (4) Land, Building, and Equipment ....................................................... Accounts Payable (or Vouchers Payable) ................................ To record purchase of equipment, terms n/30. Reclassification Out—Temporarily Restricted— Satisfaction of Equipment Acquisition....................................... Reclassification In—Unrestricted—Satisfaction of Equipment Acquisition ................................................ (5) Accounts Payable (or Vouchers Payable) ...................................... Cash ......................................................................................... To record payment.

18,000 18,000

18,000 18,000 18,000 18,000

EXERCISE 18-8 (1) Cash ............................................................................................... Legacies and Bequests—Permanently Restricted ................... To record legacy received.

400,000

Endowment Investments ................................................................ Cash ......................................................................................... To record investment in 10% bonds.

400,000

(2) Cash ............................................................................................... Investments .............................................................................. Gain on Sale of Endowments—Unrestricted ............................ Investment Revenue—Temporarily Restricted ......................... To record sale of $200,000 of bonds plus $5,000 interest.

207,000

(3) Cash ............................................................................................... Investment Revenue—Temporarily Restricted ......................... To record temporarily restricted earnings on endowments.

15,000

(4) Increase in Carrying Value ............................................................. Unrealized Gain in Investments—Unrestricted .........................

7,000

400,000

200,000 2,000 5,000

15,000

7,000

Ch. 18—Problems

18–8

PROBLEMS PROBLEM 18-1 (1) a

Fund raising and administrative and general expenses are classified as supporting services.

(2) b

Amounts received (or promised) and restricted for future periods are recorded as public support—temporarily restricted. $650,000 federated campaign + $100,000 current-year pledges not received = $750,000 (unrestricted).

(3) d

Amounts not available to spend until 2018 are classified as temporarily restricted. $15,000 cash designated for operations + $30,000 pledges for next year = $45,000 (temporarily restricted).

(4) c

The asset would be recorded at fair value, which would become the basis for depreciation computation.

(5) a

Contributions are $400,000 shown in the statement of activities as follows: Public support: Contributions—unrestricted ...................................

$400,000

The $60,000 provision for uncollectible pledges is considered an expense. (6) c

Printing an annual report is an administrative function.

PROBLEM 18-2 (1) b

To be recognized as donated services, the service must be of a skilled nature and purchased by the organization if not provided by volunteers. Since the volunteers were doing the work of a previously paid secretary, that salary ($10,000) is included along with the $150,000 salaries paid.

(2) d

Net Assets are reported in three categories: unrestricted net assets, temporarily restricted net assets, and permanently restricted net assets.

(3) a

Depreciation expense is included as an element of expense shown in the statement and is allocated to program and support services.

(4) b

Gains and losses should be reported in the statement of activities as increases or decreases in unrestricted net assets unless otherwise stipulated by donor or by law.

(5) c

Both unrestricted and restricted contributions are recognized in the period made. ($200,000 + $150,000) × 90% = $315,000.

18–9

Ch. 18—Problems

PROBLEM 18-3 (1) e

Both are recorded as a contribution increasing public support in the period received. The endowment is classified as permanently restricted. The donation for the child care center is temporarily restricted until spent on the donor-specified purpose.

(2) b

The contributions have not yet been expended. They are part of resources and temporarily restricted for acquisition of fixed assets. Restrictions are released either (1) when fixed assets are acquired or (2) over the useful life of the asset to match depreciation.

(3) a

The entry given is the typical journal entry to record board-designated intentions for future actions. Because the entry debits Unrestricted Net Assets—Undesignated, the unrestricted net asset class has been internally designated, not externally donorrestricted.

(4) d

Not-for-profit organizations may choose to record unrealized gains/losses on marketable securities in a separate account, Net Increases (or Decreases) in Carrying Value of Investments.

(5) d

When investments are carried at fair value, changes in total fair value are recorded periodically in Net Decrease (Increase) in Carrying Value of Investments, which is shown in the revenue section of the statement of activities. These (losses) gains may be unrestricted, temporarily restricted, or permanently restricted.

PROBLEM 18-4 (1) Event (a) Accounts Receivable ............................................................... Patient Service Revenue ...................................................

2,200,000

Provision for Uncollectible Accounts Receivable .................... Allowance for Uncollectibles and Contractual Adjustments .................................................................

92,000

Contractual Adjustments ......................................................... Allowance for Uncollectibles and Contractual Adjustments .................................................................

120,000

(b) Allowance for Uncollectibles and Contractual Adjustments .... Accounts Receivable .........................................................

60,000

(c) Investments ............................................................................. Contributions—Temporarily Restricted .............................

75,000

(d) Furniture .................................................................................. Cash ..................................................................................

45,000

2,200,000

92,000

120,000 60,000 75,000 45,000

Ch. 18—Problems

18–10

Problem 18-4, Continued (e) Assets Whose Use Is Limited—Cash...................................... Cash .................................................................................. Note: No outside restriction exists. An additional entry to designate the unrestricted net assets may also be recorded:

50,000

Unrestricted Net Assets........................................................... Unrestricted Net Assets—Designated ...............................

50,000

Cash ........................................................................................ Pledges Receivable ................................................................ Nonoperating Revenue—Unrestricted Contributions ........

20,000 60,000

Provision for Uncollectible Pledges ......................................... Allowance for Uncollectible Pledges .................................

6,000

(f)

Reclassification Out—Temporarily Restricted— Expiration of Time Restrictions .......................................... Reclassification In—Unrestricted—Expiration of Time Restrictions ................................................ (g) Plant and Equipment ............................................................... Accounts Payable ..............................................................

50,000

80,000 6,000 10,000 10,000 250,000 250,000

(h) Nursing Services Expenses .................................................... 1,120,000 Dietary Services Expenses ..................................................... 230,000 Maintenance Services Expenses ............................................ 115,000 Administrative Services Expenses .......................................... 285,000 Interest Expense ..................................................................... 160,000 Depreciation Expense ............................................................. 60,000 Cash .................................................................................. Accounts Payable (or Accrued Expenses) ........................ Allowance for Depreciation ................................................ Reclassification Out—Temporarily Restricted— Satisfaction of Equipment Acquisition Restrictions........................................................................ Reclassification In—Unrestricted—Satisfaction of Equipment Acquisition Restrictions .....................

1,657,000 253,000 60,000

20,000 20,000

18–11

Ch. 18—Problems

Problem 18-4, Concluded (2)

Fall Nursing Home, Inc. Statement of Activities For Year Ended December 31, 2019 Unrestricted

Patient service revenue (net of $120,000 contractual adjustments) ..........................................................

Temporarily Permanently Restricted Restricted

$2,020,000

Total $2,020,000

Net assets released from restrictions: Satisfaction of equipment acquisition restrictions (depreciation) ................................................... Expiration of time restrictions (term endowment expired) ............................... Total revenue and other support ...........................

20,000

$(20,000)

10,000 $2,050,000

(10,000) $(30,000)

0 $2,020,000

Operating expenses: Nursing services .................................................... Dietary services ..................................................... Maintenance services ........................................... Administrative services ......................................... Interest expense .................................................... Depreciation .......................................................... Provision for uncollectible patient accounts .......... Provision for uncollectible pledges ........................ Total operating expenses .................................

$1,120,000 230,000 115,000 285,000 160,000 60,000 92,000 6,000 $2,068,000

Loss from operations.................................................. Contributions .............................................................. Change in net assets .................................................

$ (18,000) 80,000 $ 62,000

$ (30,000) 75,000 $ 45,000

0 0

$ (48,000) 155,000 $ 107,000

$ $ $

Ch. 18—Problems

18–12

PROBLEM 18-5 (1) Land, Building, and Equipment ...................................................... Cash ......................................................................................... Mortgage Payable..................................................................... To record purchase of land and building.

200,000

(2) Land, Building, and Equipment ....................................................... Accounts Payable ..................................................................... To record purchase of office furniture on open account.

9,000

(3) Land, Building, and Equipment ....................................................... Contributions—Temporarily Restricted ..................................... To record donation of partitions and increase in temporarily restricted net assets.

14,000

(4) Mortgage Payable ......................................................................... Interest Expense (14% × $160,000) ............................................... Cash ......................................................................................... To record payment of mortgage interest and payment on principal.

10,000 22,400

(5) Cash ............................................................................................... Accumulated Depreciation .............................................................. Land, Building, and Equipment ................................................. Miscellaneous Revenue (or Gain on Sale of Plant Assets)—Unrestricted ................................................ To record sale of office equipment.

1,800 2,000

(6) Accumulated Depreciation .............................................................. Land, Building, and Equipment ................................................. To remove fully depreciated asset.

7,000

(7) Depreciation Expense .................................................................... Accumulated Depreciation ........................................................ To record annual depreciation.

46,000

Reclassification Out—Temporarily Restricted Satisfaction of Equipment Acquisition Restrictions ...................................... Reclassification In—Unrestricted Satisfaction of Equipment Acquisition Restrictions ........................... To record expiration of restriction to match depreciation expenses over life of asset.

40,000 160,000

9,000

14,000

32,400

3,000 800

7,000

46,000

20,000 20,000

(8) Land, Building, and Equipment ....................................................... Cash ......................................................................................... To record theater installation. Reclassification of temporarily restricted net assets will occur over life of asset.

75,000

(9) Accounts Payable ........................................................................... Cash ......................................................................................... To record payment.

9,000

75,000

9,000

18–13

Ch. 18—Problems

PROBLEM 18-6 (1) Pledges Receivable ........................................................................ Contributions—Unrestricted......................................................

800,000

Cash ............................................................................................... Contributions—Temporarily Restricted .....................................

95,000

Pledges Receivable ........................................................................ Contributions—Temporarily Restricted .....................................

50,000

Assets Restricted to Long-Term Investment................................... Contributions—Permanently Restricted....................................

1,000

(2) Cash ............................................................................................... Pledges Receivable ..................................................................

470,000

(3) Cash ............................................................................................... Special Events Support—Unrestricted ..................................... Legacies and Bequests—Unrestricted ..................................... Membership Dues—Unrestricted.............................................. Investment Revenue—Unrestricted ..........................................

35,000

(4) Medical Services Program ............................................................. Community Information Services Program ..................................... Vouchers Payable.....................................................................

60,000 15,000

(5) Management and General Services ............................................... Fund-Raising Services ................................................................... Vouchers Payable.....................................................................

150,000 200,000

(6) Buildings and Equipment ................................................................ Cash .........................................................................................

18,000

Reclassification Out—Temporarily Restricted—Satisfaction of Equipment Acquisition in Restrictions................................... Reclassification In—Unrestricted—Satisfaction of Equipment Acquisition Restrictions ...............................

800,000 95,000 50,000 1,000 470,000 12,000 10,000 8,000 5,000

75,000

350,000 18,000 18,000 18,000

(7) Depreciation Expense .................................................................... Accumulated Depreciation ........................................................

15,000

Medical Services Program .............................................................. Community Information Services Program ..................................... Fund-Raising Services ................................................................... Management and General Services ............................................... Depreciation Expense...............................................................

4,000 3,000 2,000 6,000

(8) Vouchers Payable .......................................................................... Cash .........................................................................................

330,000

15,000

15,000 330,000

Ch. 18—Problems

18–14

PROBLEM 18-7 (1) Event

Journal Entry

Debit

(a) Cash ........................................................................................ Revenue—Annual Dues ....................................................

20,000

(b) Cash ........................................................................................ Revenue—Snack Bar and Soda Fountain ........................

31,000

(c) Cash ........................................................................................ Investment Revenue—Unrestricted ..................................

6,000

(d) Expense—House .................................................................... Expense—Snack Bar and Soda Fountain ............................... Expense—General and Administrative ................................... Accounts Payable ..............................................................

17,000 26,000 11,000

(e) Accounts Payable.................................................................... Cash ..................................................................................

55,000

(f)

Assessments Receivable ........................................................ Public Support—Contributions—Temporarily Restricted...

10,000

(g) Cash ........................................................................................ Public Support—Unrestricted Bequests ............................

5,000

(h) Investments ............................................................................. Unrealized Gain on Investments—Unrestricted ................

7,000

(i)

9,000

(j)

Depreciation Expense—House ............................................... Depreciation Expense—Snack Bar and Soda Fountain ............................................................................ Depreciation Expense—General and Administrative .............. Accumulated Depreciation—Building ................................ Accumulated Depreciation—Furniture and Equipment ..............................................................

20,000 31,000 6,000

54,000 55,000 10,000 5,000 7,000

2,000 1,000 4,000 8,000

Expense—Snack Bar and Soda Fountain ............................... Inventories .........................................................................

4,000

(k) Cash ........................................................................................ Contributions—Temporarily Restricted .............................

35,000

(l)

100,000

Pledges Receivable ................................................................ Public Support—Contributions—Permanently Restricted .

Credit

4,000 35,000 100,000

18–15

Ch. 18—Problems

Problem 18-7, Concluded (2)

Mayfair Sports Club Statement of Activities For Year Ended March 31, 2019 Unrestricted

Temporarily Restricted

Permanently Restricted

$35,000

$100,000

$35,000

$100,000

$135,000 5,000 $140,000

$ 20,000 31,000 6,000 7,000 $ 64,000

$100,000

$204,000

$ 32,000 26,000 12,000 $ 70,000

$100,000 400,000 $500,000

$134,000 464,000 $598,000

Public support and revenue: Public support: Contributions .............................................. Unrestricted bequests ................................ Total public support ...............................

$ 5,000 $ 5,000

Revenue: Annual dues ............................................... Snack bar and soda fountain sales ............ Investment revenue .................................... Unrealized gain on investments ................. Total revenue.........................................

$20,000 31,000 6,000 7,000 $64,000

Total public support and revenue .........................

$69,000

$35,000

Expenses: Snack bar and soda fountain .......................... House .............................................................. General and administrative ............................. Total expenses ...........................................

$32,000 26,000 12,000 $70,000

Change in net assets ........................................... Net assets, April 1, 2018 ...................................... Net assets, March 31, 2019 .................................

$ (1,000) 12,000 $11,000

$35,000 52,000 $87,000

Total

PROBLEM 18-8 (1) Total of allocable operating expenses financed by donor-restricted contributions: Salaries and payroll taxes..................................................................... $ 33,000 Telephone and miscellaneous .............................................................. 2,000 Nursing and medical fees ..................................................................... 70,000 Educational seminars ........................................................................... 50,000 Research .............................................................................................. 26,000 Medical supplies ................................................................................... 22,000 Rent ...................................................................................................... 10,000 Total ................................................................................................ $213,000 Allocation of total operating expenses: 60% to Alcohol and Drug Abuse Program ........................................... 40% to Outreach to Teens Program .................................................... Total allocated to programs ............................................................

$127,800 85,200 $213,000

Ch. 18—Problems

18–16

Problem 18-8, Continued Journal entry: Alcohol and Drug Abuse Program ............................................ Outreach to Teens Program ..................................................... Salaries and Payroll Taxes ................................................. Telephone and Miscellaneous Expenses ........................... Nursing and Medical Fees .................................................. Educational Seminars Expense .......................................... Research Expense ............................................................. Medical Supplies Expense .................................................. Rent Expense ..................................................................... To assign allocable operating expenses to programs and to close expense accounts. (2)

127,800 85,200 33,000 2,000 70,000 50,000 26,000 22,000 10,000

Outreach Clinic Allocation of Expenses Financed by Unrestricted Resources For Year Ended December 31, 2019

Expense Allocated

Total Amount

Salaries and payroll taxes ........................ Telephone and miscellaneous ................. Nursing and medical fees......................... Educational seminars ............................... Research .................................................. Medical supplies ...................................... Provision for uncollectible pledges........... Total expenses ..................................

$ 73,000 20,000 70,000 46,000 130,000 65,000 26,000 $430,000

Programs Alcohol and Outreach Drug Abuse to Teens $ 21,900 4,000 49,000 13,800 78,000 58,500 $225,200

$ 14,600 4,000 21,000 27,600 52,000 6,500 $125,700

(3) Alcohol and Drug Abuse Program .................................................. Outreach to Teens Program ........................................................... Management and General Services ............................................... Fund-Raising Services .................................................................. Salaries and Payroll Taxes ....................................................... Telephone and Miscellaneous Expenses ................................. Nursing and Medical Fees ....................................................... Educational Seminars Expenses ............................................. Research Expense ................................................................... Medical Supplies Expense ....................................................... Provision for Uncollectible Pledges .......................................... To assign allocable operating expenses financed by unrestricted funds to program and support services and to close expense accounts.

Supporting Services ManageFund ment Raising $21,900 3,000

$14,600 9,000 4,600

$24,900

26,000 $54,200

225,200 125,700 24,900 54,200 73,000 20,000 70,000 46,000 130,000 65,000 26,000

18–17

Ch. 18—Problems

Problem 18-8, Concluded (4) Alcohol and Drug Abuse Program .................................................. Outreach to Teens Program ........................................................... Management and General Services .............................................. Fund-Raising Services ................................................................... Interest Expense ....................................................................... Depreciation Expense............................................................... To allocate expenses relating to plant on the basis of the percentages given (50/10/30/10) and to close expenses.

24,000 4,800 14,400 4,800 8,000 40,000

PROBLEM 18-9 (1)

We Care Statement of Activities For Year Ended December 31, 2019 Unrestricted

Public support and revenue: Public support: Contributions ........................................................... Special events support (net of direct costs of $18,000) ............................ Legacies and bequests ........................................... Total public support ................................................. Revenue: Investment revenue ................................................ Gain on sale of investments.................................... Total revenue .......................................................

$407,000

Temporarily Permanently Restricted Restricted

$ 254,000

$661,000

30,000 $407,000

$ 284,000

$ 13,000 $ 13,000

$ 11,000 8,000 $ 19,000

Total

$ 30,000 $ 30,000

30,000 30,000 $721,000

$ 25,000 $ 25,000

$ 24,000 33,000 $ 57,000

Net assets released from restriction: Satisfaction of program restrictions ..................... Satisfaction of equipment acquisition restrictions ........................................................ Total net assets released from restriction............

$143,000

$(143,000)

20,000 $163,000

(20,000) $(163,000)

Total public support, revenue, and other support ...........

$583,000

$ 140,000

$ 55,000

$778,000

Expenses: Adult Services Program ............................................. Education Program..................................................... Management and general services ............................ Fund-raising services ................................................. Total expenses ................................................................

$322,200 184,100 27,600 50,100 $584,000

Change in net assets ...................................................... Net assets, January 1, 2019 ........................................... Net assets, December 31, 2019 .....................................

$ (1,000) 202,000 $201,000

$ 140,000 196,000 $ 336,000

$ 55,000 201,000 $256,000

$194,000 599,000 $793,000

0 0

Ch. 18—Problems

18–18

Problem 18-9, Concluded (2) Closing entries: Contributions—Unrestricted...................................................... Investment Revenue—Unrestricted .......................................... Reclassification In—Unrestricted—Satisfaction of Program Restrictions ...................................................... Reclassification In—Unrestricted—Satisfaction of Equipment Acquisition Restrictions................................. Unrestricted Net Assets ............................................................ Adult Services Program ...................................................... Education Program ............................................................. Management and General Services ................................... Fund-Raising Services ........................................................

407,000 13,000 143,000 20,000 1,000 322,200 184,100 27,600 50,100

Contributions—Temporarily Restricted ..................................... Special Events Support—Temporarily Restricted ..................... Investment Revenue—Temporarily Restricted ......................... Gain on Sale of Investments—Temporarily Restricted ............. Cost of Special Events ........................................................ Reclassification Out—Temporarily Restricted— Satisfaction of Program Restrictions ............................. Reclassification Out—Temporarily Restricted— Satisfaction of Equipment Acquisition Restrictions ....... Temporarily Restricted Net Assets .....................................

254,000 48,000 11,000 8,000

Legacies and Bequests—Permanently Restricted ................... Gain on Sale of Investments—Permanently Restricted............ Permanently Restricted Net Assets ....................................

30,000 25,000

18,000 143,000 20,000 140,000

55,000

18–19

Ch. 18—Problems

PROBLEM 18-10 We Care Statement of Functional Expenses For Year Ended December 31, 2019

Salaries and payroll taxes*......... Telephone and miscellaneous expenses ............................... Nursing and medical fees........... Educational seminars expenses Research expense ..................... Medical supplies expense .......... Rent expense (60/40 to programs) ............................ Interest expense (50/10/30/10) .. Provision for uncollectible pledges .................................. Total before depreciation expense .......................... Depreciation expense (50/10/30/10) ....................... Total expenses†.......................... *Each of the first six expenses has its allocation determined using the process illustrated for salaries: From unrestricted resources (Use solution of Problem 18-8 or percentage allocations in Problem 18-8.) ................................... From donor-restricted contributions (split 60/40 to programs only) ................. Totals ................................

Program Services Total Alcohol and Outreach All Funds Drug Abuse to Teens

Supporting Services** Total ManageFund Total Programs ment Raising Supporting

$106,000

$ 41,700

$ 27,800

$ 69,500 $21,900 $14,600 $36,500

22,000 140,000 96,000 156,000 87,000

5,200 91,000 43,800 93,600 71,700

4,800 49,000 47,600 62,400 15,300

10,000 140,000 91,400 156,000 87,000

10,000 8,000

6,000 4,000

4,000 800

10,000 4,800

26,000

3,000

2,400

9,000

12,000

4,600

800

3,200

26,000

$651,000

$357,000

$211,700

$568,700 $27,300 $55,000 $82,300

40,000 $691,000

20,000 $377,000

4,000 $215,700

24,000 12,000 4,000 16,000 $592,700 $39,300 $59,000 $98,300

$ 73,000

$ 21,900

$ 14,600

$ 36,500 $21,900 $14,600 $36,500

33,000 $106,000

19,800 $ 41,700

13,200 $ 27,800

33,000 $ 69,500 $21,900 $14,600 $36,500

**Because no part of the expenses funded by donor-restricted resources was allocated to supporting services, the portion assigned to supporting services consists only of the allocated expenses funded by unrestricted revenues as shown in the solution to Problem 18-8 or determined by use of the percentages stated in that problem. †

The total expenses assigned to the individual programs and supporting services must agree with those shown in the statement of activities in the solution to Problem 18-8.

CHAPTER 19 UNDERSTANDING THE ISSUES contribution can be restricted. It is less important in public universities where both contributions and grants are considered restricted revenues.

1. The measurement focuses used by public universities under GASB Statement No. 34 are both the flows of financial resources and the flows of economic resources. Private universities use a measurement focus of economic resources. Both entities use full accrual accounting and must focus on the recovery of costs. However, a public university also must adhere to the governmental reporting model and yearly funding and budgetary issues of governments. Therefore, they have unique needs for a financial resources (working capital) focus.

4. Assets limited as to use are not restricted, merely board (or internally) designated. Only a donor can impose a restriction per FASB ASC 958-605. 5. A hospital will bill out to all types of patients (with and without insurance and with different types of insurance coverage) the same amount. This adherence to gross revenue determination is designed to get the maximum revenue to cover costs. Adjustments are then determined in the contractual negotiations with HMOs and other insurance providers. Medicare and Medicaid reimbursements are considerably lower than most hospital gross revenues due to formulas that average cost reimbursement across all of the rural and urban hospitals in the United States.

2. Accounting for contributions for a private university requires recognizing revenue in the period the unconditional contribution (or promise to give) is received. If a donorimposed restriction as to use or time period is present, the contribution is recognized as temporarily restricted revenue in the period received. When donor-imposed restrictions are satisfied, the restriction is released. In a public university, contributions of cash or investments to the unrestricted current fund may be recorded as revenue in the period received unless the contribution is designated for future periods. Contributions designated for future periods are recognized as deferred revenue.

6. Accounting for medical malpractice claims is of special concern to health care organizations because of the potential for very large expenses and the inability to fully insure against the risk of loss. Accounting for medical malpractice claims is similar to accounting for contingencies. “… costs should be accrued when the incidents occur that give rise to the claims if it can be determined that it is probable that the liabilities have been incurred and if the amounts of the losses can be reasonably estimated.” This basic rule applies to both claims that have occurred and incidents that have occurred but have not yet been reported as of the balance sheet date.

3. In order for the government grant to be a contribution, the grantor may not receive anything of value from the use of the funds by the receiving organization. If something of value is given in return for the grant, the grant is an exchange transaction that will recognize an equal amount of earned revenue when expenses are made in accordance with the provisions of the grant. This distinction is important in private universities since under FASB ASC 958-605 only a

Ch. 19—Exercises

19–2

EXERCISES EXERCISE 19-1 (1)

Recognized in period received.

(2)

Recognized in period received. Restriction is released when expenses are incurred.

(3)

Recognized in period made.

(4)

Recorded at present value at time promise to give is received.

(5)

Endowment principal cannot be spent. Earnings are unrestricted.

(6)

Recognized in period received. Restriction released either (1) when asset is placed in service or (2) over its useful life.

(7)

Recognized when conditions are met.

(8)

Recorded at fair value when received.

(9)

Donated services of a skilled nature that would otherwise be purchased.

(10)

Not skilled services. May be footnoted.

(11)

Recognized in period received. Restriction is released when time restriction is satisfied.

(12)

Recognized in period received. Restriction is released when expenses are incurred.

(13)

Recognized revenue as expenses are incurred for research project.

(14)

Recognized in period received. Restriction is released either (1) when asset is placed in service or (2) over useful life of asset.

(15)

a, b, or f (If collection is displayed to the public or otherwise held for exhibit, the university is not required to recognize contributions as revenue.)

EXERCISE 19-2 (1) Public University (a) Cash ........................................................................................ Nonoperating Revenues—Contributions ............................

200,000

(b) Expenditures—Public Support ................................................ Cash ...................................................................................

110,000

(c) Interfund Transfer-Out ............................................................. Due to Endowment Fund ....................................................

90,000

200,000 110,000 90,000

19–3

Ch. 19—Exercises

Exercise 19-2, Concluded (d) Cash ........................................................................................ Interfund Transfer-In..........................................................

15,000 15,000

(2) Private University (a) Cash ........................................................................................ Revenues—Temporarily Restricted Contributions ............

200,000

(b) Expenses ................................................................................ Cash ..................................................................................

110,000

Reclassifications Out—Temporarily Restricted— Satisfaction of Program Restrictions ................................. Reclassifications In—Unrestricted— Satisfaction of Program Restrictions ..................... (c) Reclassifications Out—Temporarily Restricted— Satisfaction of Program Restrictions ................................. Reclassifications In—Permanently Restricted— Satisfaction of Program Restrictions ..................... Permanently Restricted Net Assets—Mandatory Transfer-Out ...................................................................... Due to Endowment Fund .............................................

200,000 110,000 110,000 110,000 90,000 90,000 90,000 90,000

Note to Instructor: The following entry would be made in the endowment fund: Due from Restricted Current Fund .......................................... Permanently Restricted Net Assets—Mandatory Transfer-In ...................................................................

90,000

(d) Cash ........................................................................................ Revenues—Temporarily Restricted Contributions ............

15,000

90,000 15,000

EXERCISE 19-3 (1) Cash ............................................................................................... Accounts Receivable ...................................................................... Expenses—Uncollectible Accounts ................................................ Revenues—Educational and General ...................................... Allowance for Uncollectibles .....................................................

575,000 25,000 4,000

(2) Cash ............................................................................................... Accounts Receivable ...................................................................... Revenues—Auxiliary Enterprises .............................................

80,000 20,000

Expenses—Auxiliary Enterprises ................................................... Cash ......................................................................................... Accounts Payable .....................................................................

105,000

600,000 4,000

100,000 90,000 15,000

Ch. 19—Exercises

19–4

Exercise 19-3, Concluded (3) Mandatory Transfer for Mortgage Payment .................................... Cash .........................................................................................

75,000

(4) Expenses—Student Aid .................................................................. Cash ......................................................................................... Accounts Receivable ................................................................

35,000

(5) Cash ............................................................................................... Revenues—Temporarily Restricted Contributions* ..................

10,000

(6) Due from Endowment Fund ............................................................ Revenues—Unrestricted Endowment Income ..........................

11,760

75,000 25,000 10,000 10,000 11,760

*Revenues – Restricted (if public university)

EXERCISE 19-4 (1) Cash ............................................................................................... Revenues—Temporarily Restricted Contributions....................

420,000

(2) Loans Receivable ........................................................................... Cash .........................................................................................

380,000

Reclassifications Out—Temporarily Restricted— Satisfaction of Program Restrictions......................................... Reclassifications In—Unrestricted—Satisfaction of Program Restrictions .....................................................

420,000 380,000 380,000 380,000

(3) Cash on Deposit at Credit Union .................................................... Cash .........................................................................................

40,000

(4) Cash ............................................................................................... Loans Receivable ..................................................................... Revenues—Unrestricted Investment Income ...........................

20,800

(5) Cash ............................................................................................... Revenues—Unrestricted Investment Income ...........................

1,400

(6) Allowance for Uncollectibles ........................................................... Loans Receivable .....................................................................

1,000

40,000 20,000 800 1,400 1,000

19–5

Ch. 19—Exercises

EXERCISE 19-5 (1) Cash ............................................................................................... Revenues—Permanently Restricted Contributions ..................

250,000

Endowment Investments ................................................................ Cash .........................................................................................

250,000

(2) Cash ............................................................................................... Endowment Investments .......................................................... Revenues—Temporarily Restricted Endowment Income .........

11,250

(3) Temporarily Restricted Net Assets—Mandatory Transfer-Out ....... Cash .........................................................................................

10,583

250,000 250,000 667 10,583 10,583

Note to Instructor: The following entry would be made in the current restricted fund: Cash ............................................................................................... Temporarily Restricted Net Assets—Mandatory Transfer-In ....

10,583

(4) Cash ............................................................................................... Endowment Investments ($250,000 – $667) ............................ Revenues—Temporarily Restricted Gain on Sale of Endowment Investments ................................................

260,500

10,583 249,333 11,167

EXERCISE 19-6 (1) Investments .................................................................................... Annuities Payable ..................................................................... Revenues—Temporarily Restricted Contributions....................

90,000

(2) Cash ............................................................................................... Revenues—Temporarily Restricted Investment Income ..........

2,000

34,068 55,932 2,000

*The same entry would be made annually when dividends are received. (3) Actuarial Adjustment on Annuities Payable .................................... Annuities Payable ($34,068 × 10%) .........................................

3,407

Annuities Payable ........................................................................... Cash .........................................................................................

6,000

(4) Actuarial Adjustment on Annuities Payable .................................... Annuities Payable [($34,068 + $3,407 – $6,000) × 10%] .........

3,148

Annuities Payable .......................................................................... Cash .........................................................................................

6,000

3,407 6,000 3,148 6,000

Ch. 19—Exercises

19–6

Exercise 19-6, Concluded (5) Annuities Payable ........................................................................... Revenues—Temporarily Restricted Contributions ($34,068 + $3,407 – $6,000 + $3,148 – $6,000) ................

28,623

(6) Cash ............................................................................................... Investments .............................................................................. Revenues—Temporarily Restricted Gain on the Sale of Annuity Investments ...............................................

92,000

Temporarily Restricted Net Assets—Mandatory Transfer-Out ............................................................................. Cash ................................................................................... {$92,000 + [($2,000 – $6,000) × 2]}

28,623 90,000 2,000 85,000 85,000

Note to Instructor: The following entry would be made in the student loan fund: Cash ............................................................................................... Temporarily Restricted Net Assets—Mandatory Transfer-Out .......................................................................

85,000 85,000

EXERCISE 19-7 (1) Cash ............................................................................................... Unrestricted Net Assets—Mandatory Transfer-In .....................

250,000 250,000

Note to Instructor: The following entry would be made in the current fund: Unrestricted Net Assets—Mandatory Transfer-Out ........................ Cash .........................................................................................

250,000

(2) Cash ............................................................................................... Revenues—Temporarily Restricted Contributions....................

30,000

Expenses—Operation and Maintenance of Plant ........................... Cash .........................................................................................

20,000

250,000 30,000 20,000 20,000 20,000

(3) Mortgage Liability ........................................................................... Cash .........................................................................................

50,000

(4) Building ........................................................................................... Accounts Payable ..................................................................... Cash .........................................................................................

220,000

50,000 35,000 185,000

19–7

Ch. 19—Exercises

Exercise 19-7, Concluded (5) Equipment ...................................................................................... Cash ......................................................................................... Reclassifications Out—Temporarily Restricted—Satisfaction of Equipment Acquisition Restrictions ...................................... Reclassifications In—Unrestricted—Satisfaction of Equipment Acquisition Restrictions ...............................

25,000 25,000 25,000 25,000

(6) Building ........................................................................................... Revenues—Unrestricted Contributions ....................................

300,000

(7) Depreciation Expense .................................................................... Allowance for Depreciation .......................................................

75,000

(8) Loss on Equipment ......................................................................... Equipment.................................................................................

2,000

300,000 75,000 2,000

EXERCISE 19-8 (1) Patient service revenues include charges to patients for routine services, nursing services, and professional services. Other operating revenues include revenues from services other than health care provided to patients as well as from sales and services to persons other than patients. Nonoperating revenues are primarily from gifts, grants, and investment income and gains that are peripheral or incidental to the major operation of the hospital. (2) a. b. c.

OO N PS

d. PS e. N f. N

g. OO h. PS i. OO

j. k.

PS N

EXERCISE 19-9 (1) Accounts Receivable ...................................................................... Patient Service Revenues ........................................................ To record billings.

860,000

(2) Inventory ......................................................................................... Other Operating Revenues—Unrestricted (contributions) ........ To record donation of drugs from doctor.

20,000

(3) Cash ............................................................................................... Other Operating Revenues—Unrestricted ................................ To record cash revenues.

25,200

860,000

20,000

25,200

Ch. 19—Exercises

19–8

Exercise 19-9, Concluded (4) Charity Services ............................................................................. Accounts Receivable ................................................................ To record charity allowance.

22,000

(5) Contractual Adjustments ................................................................ Accounts Receivable ................................................................ To record adjustments for Medicare charges.

108,000

(6) Provision for Bad Debts .................................................................. Allowance for Uncollectible Receivables .................................. To record increase in allowance.

26,000

22,000

108,000

26,000

EXERCISE 19-10 (1) Accounts Receivable ...................................................................... Revenues..................................................................................

5,000,000

Contractual Adjustments ................................................................ Allowance for Contractual Adjustments ....................................

2,500,000

Cash ............................................................................................... Contractual Adjustments ................................................................ Allowance for Contractual Adjustments .......................................... Accounts Receivable ................................................................

2,160,000 340,000 2,500,000

Cash ............................................................................................... Contractual Adjustments...........................................................

250,000

Contractual Adjustments ................................................................ Cash .........................................................................................

100,000

5,000,000 2,500,000

5,000,000 250,000 100,000

(2) Net patient service revenues = $2,310,000 ($5,000,000 – $2,500,000 – $340,000 + $250,000 – $100,000) (3) Net cash flow from transactions with Medicare = $2,310,000 ($2,160,000 + $250,000 – $100,000) (4) Assuming the $100,000 payment back to Medicare was in settlement, the revenue account will be closed along with the contra-revenue account “Contractual Adjustments.” The net amount will appear on the financial statements.

19–9

Ch. 19—Exercises

EXERCISE 19-11 Recover Rehabilitation Hospital Statement of Activities For Year Ended December 31, 2019 Unrestricted Patient service revenues (net of $16,000 contractual adjustments) ....................................... Other operating revenues: Seminar income .................................................... Child day care income ........................................... Parking fees .......................................................... Total other operating revenue .......................... Total operating revenues ........................................... Operating expenses: Nursing services .................................................... Professional fees ................................................... General and administrative ................................... Depreciation expense ........................................... Interest expense .................................................... Repairs and maintenance ..................................... Provision for uncollectibles.................................... Total operating expenses ................................. Loss from operations.................................................. Nonoperating revenue: Interest income ...................................................... Donations .............................................................. Endowment income ............................................... Gains on sale of endowments ............................... Total nonoperating revenue ............................. Change in net assets ................................................. Net assets, January 1, 2019 ...................................... Net assets, December 31, 2019 ................................

Temporarily Restricted

Permanently Restricted

Total

$ 824,000

$ 23,000 15,000 3,500 $ 41,500 $ 865,500

23,000 15,000 3,500 $ 41,500 $ 865,500

$ 230,000 140,000 250,000 60,000 13,000 210,000 14,000 $ 917,000 $ (51,500)

3,000

$ 3,000 $ (48,500) 900,000 $ 851,500

38,000 220,000 66,000 $ 324,000 $ 324,000 855,000 $1,179,000

$ $ $

0 0 0 850,000 $850,000

3,000 38,000 220,000 66,000 $ 327,000 $ 275,500 2,605,000 $2,880,500

EXERCISE 19-12 (1) e

A designation is not the same as a donor-imposed restriction. The designated assets stay in the unrestricted net assets category.

(2) a

Income from board-designated assets is unrestricted.

(3) c

The restricted donation is an increase in temporarily restricted net assets.

(4) a

The purchase of a building releases the restriction in entry (3).

(5) a

This donated service is recognized as unrestricted revenues and expenses because it requires specialized skills and would have to be purchased if it were not donated.

(6) d

The donated assets are permanently restricted; income will be temporarily restricted.

Ch. 19—Problems

19–10

PROBLEMS PROBLEM 19-1 (1) b

The three financial statements for private universities are the statement of financial position, the statement of activities, and the statement of cash flows.

(2) c

Only donors can restrict funds. Assets held at the discretion of the board are unrestricted.

(3) a

Nonexpendable contributions are permanently restricted.

(4) a

Endowment income is recognized in the endowment fund. A transfer to another fund will occur, depending on donor-stipulation as to use.

(5) a

Plant funds include unexpended plant funds, plant fund for renewals and replacements, plant fund for retirement of indebtedness, and investment in plant.

(6) d

Only nonexpendable principals are permanently restricted. The term endowment is temporarily restricted. The designation is not externally restricted and is classified as unrestricted.

(7) b

Net assets = Total assets – Total liabilities.

(8) b

Loans to students, faculty, and staff are accounted for in the loan fund.

(9) c

The $10,000 earnings from internal designated funds are unrestricted. Only a donor may restrict assets given to an organization.

(10) d

Since Marimount Private College is not the trustee, contribution revenue is recognized only when income is due (or received).

PROBLEM 19-2 (1) b

Assets – Liabilities = Fund balance.

(2) d

Revenue is recognized when contributions are received. Restricted gifts and contributions are reclassified as unrestricted when expended for donor-specified purposes.

(3) b

Tuition remissions and scholarships are student aid expenditures.

(4) b

The rate of pay normally commanded by a paid person performing a given function would serve as the measurement basis for the amount. Because they regularly contribute their services, the employer-employee relationship would seem to exist.

(5) a

Institutional support expenditures are those of central administration. Scholarships and fellowships are expenditures—student aid. The $200,000 is expenditures—operation and maintenance of plant.

19–11

Ch. 19—Problems

Problem 19-2, Concluded (6) a

All of the items result in plant fund balances.

(7) a

Endowment income is recognized as unrestricted and temporarily restricted upon receipt.

(8) b

Board designation does not create an endowment or restriction.

(9) c

The $300,000 is only a restriction within the current unrestricted fund and is not externally imposed.

(10) d

A public university engaged only in business-type activities may report under GASB Statement No. 34 as a proprietary fund.

PROBLEM 19-3 (1) Contribution transaction: Cash ............................................................................................... Revenues—Unrestricted Contributions ....................................

100,000

Cost of Special Events ................................................................... Cash .........................................................................................

47,500

100,000 47,500

(2) Contribution transaction: Cash ............................................................................................... 1,000,000 Revenues—Temporarily Restricted Contributions....................

1,000,000

(3) Contribution transaction: Cash ............................................................................................... Revenues—Permanently Restricted Contributions ..................

550,000 550,000

(4) Contribution transaction: Building ........................................................................................... 1,050,000 Revenues—Unrestricted Contributions ....................................

1,050,000

Note to Instructor: Some colleges will recognize property acquisitions and gifts as additions to temporarily restricted net assets if an institutional policy is adopted that releases restrictions over the life of the donated assets. (5) Contribution transaction. Recognize as revenues when condition is met. Record as temporarily restricted; when restriction is met, reclassify revenues to unrestricted. (6) Neither contribution nor exchange transaction—not recorded. Contributed service that does not meet the criterion of requiring specialized skills. Do not recognize but include in footnote disclosure.

Ch. 19—Problems

19–12

Problem 19-3, Concluded (7) Contribution transaction. Intention to give. Do not recognize currently because the will can be changed prior to death. (8) Exchange transaction: Cash ............................................................................................... U.S. Government Grants Refundable .......................................

200,000 200,000

(9) Neither contribution nor exchange transaction—recorded as an agency transaction. Cash ............................................................................................... Assets Held in Trust for Others.................................................

75,000 75,000

PROBLEM 19-4 (1) Letter (a)

(b) (c)

(d) (e)

Entry Accounts

Current Funds Unrestricted Restricted Debit Credit Debit Credit

Cash ................................................................ Accounts Receivable .................................. Revenues—Tuition and Fees ..................... Prepaid Tuition—Tuition and Fees .............

3,000,000

Prepaid Tuition—Tuition and Fees .................. Revenues—Tuition and Fees .....................

25,000

Allowance for Uncollectibles............................ Accounts Receivable .................................. Revenues—Student Tuition and Fees ............ Allowance for Uncollectibles [$10,000 – ($15,000 – $13,000)] ............

13,000

State Appropriations Receivable ..................... Revenues—Governmental Appropriations .

60,000

Cash ................................................................ Revenues—Private Gifts and Grants .......... Fund Balance (or Nonmandatory Transfer to Loan Fund) ............................................. Cash .......................................................

80,000

362,000 2,500,000 138,000 25,000 13,000 8,000 8,000 60,000 80,000 30,000 30,000

19–13

Ch. 19—Problems

Problem 19-4, Continued

Letter (f)

(g)

(h)

(i) (j)

Entry Accounts

Current Funds Unrestricted Restricted Debit Credit Debit Credit

Cash ................................................................ Investments ................................................ Fund Balance .............................................. Investments ..................................................... Cash ........................................................... Cash ................................................................ Fund Balance .............................................. Expenditures*—General.................................. Accounts Payable ....................................... Accounts Payable............................................ Cash ($100,000 + $2,500,000 – $75,000) ..

31,000 25,000 6,000 40,000 40,000 18,000 18,000 2,500,000 2,500,000 2,525,000 2,525,000

Accounts Payable ........................................... Cash ........................................................... Expenditures*—Research ............................... Cash ........................................................... Fund Balance .................................................. Revenues—Other Income ..........................

5,000 5,000 10,000 10,000 10,000 10,000

Due to Other Funds ......................................... Cash ...........................................................

40,000

Expenditures*—General.................................. Prepaid Expenses .......................................

10,000

40,000 10,000

*Public universities use the term “expenditures.”

Ch. 19—Problems

19–14

Problem 19-4, Concluded (2)

Tree State University Statement of Current Funds Revenues, Expenses, and Other Changes For Fiscal Year Ended July 31, 2019 Unrestricted Revenues: Tuition and fees ..................................................... Governmental appropriations ................................ Private gifts and grants ......................................... Other income ......................................................... Total revenues................................................. Expenses: General ................................................................. Research ............................................................... Total expenses ................................................ Other transfers and additions (deductions): Excess of restricted receipts over transfers to revenues....................................... Transfers to other funds ........................................ Net increase for the year ............................................. Fund balance—beginning of year ............................... Fund balance—end of year .........................................

Current Funds Restricted

Total

$ 10,000 $ 10,000

$2,517,000 60,000 80,000 10,000 $2,667,000

$ 10,000 $ 10,000

$2,510,000 10,000 $2,520,000

$ 14,000

$2,517,000 60,000 80,000 $2,657,000 $2,510,000 $2,510,000

$ (30,000) $ 117,000 435,000 $ 552,000

$ 14,000 215,000 $229,000

14,000 (30,000) $ 131,000 650,000 $ 781,000

PROBLEM 19-5 Event

Fund

(1)

Unexpended Plant Fund

(2)

Journal Entry Cash ...................................................................... 22,385,000 Bonds Payable—7% ......................................... Due to Retirement of Indebtedness Plant Fund..................................................... To record sale of bonds with accrued interest for three months ($22,000,000 × 7% × 3/12 = $385,000).

Unexpended Plant Fund

Due to Retirement of Indebtedness Plant Fund..... Cash .................................................................. To record accrued interest transfer.

385,000

Plant Fund for Retirement of Indebtedness Unexpended Plant Fund

Cash ...................................................................... Fund Balance—Restricted ................................ To record receipt of cash transfer. Construction in Progress ...................................... Cash .................................................................. To record payment for construction to date.

385,000

22,000,000 385,000

385,000

385,000 5,000,000 5,000,000

19–15

Ch. 19—Problems

Problem 19-5, Continued Event

Fund

(3)

Unrestricted Current Fund

Journal Entry Mandatory Transfers for Principal and Interest Payment ...................................................... Cash........................................................ To record cash transferred for interest payments.

385,000 385,000

Plant Fund for Retirement of Indebtedness

Cash ................................................................ Fund Balance—Restricted .......................... To record cash received for interest payment.

385,000

Plant Fund for Retirement of Indebtedness

Fund Balance—Restricted ............................... Cash ............................................................ To record bond interest payment.

770,000

(5)

Unexpended Plant Fund

Construction in Progress ................................. 17,000,000 Retained Percentage Contract Payable ...... 1,000,000 Cash ............................................................ 16,000,000 To record payment to contractor and account payable.

(6)

Unexpended Plant Fund

Bonds Payable—7% ........................................ 22,000,000 Construction in Progress ............................. 22,000,000 To record transfer of completed complex and related bond issue.

Investment in Plant

Buildings .......................................................... 22,000,000 Bonds Payable—7% ................................... 22,000,000 To record transfer of completed complex and related bond issue.

Unrestricted Current Fund

Mandatory Transfers for Principal and Interest Payments .................................................... Cash........................................................ To record cash transfer for serial and interest payments.

(4)

(7)

Plant Fund for Retirement of Indebtedness

Cash ................................................................ Fund Balance—Restricted .......................... To record cash received for serial and interest payments.

385,000

770,000

2,770,000 2,770,000

Ch. 19—Problems

19–16

Problem 19-5, Concluded Event

Fund

(8)

Plant Fund for Retirement of Indebtedness

Fund Balance—Restricted ............................... Cash ............................................................ To record payments made.

2,770,000

Investment in Plant

Bonds Payable—7% ........................................ Net Investment in Plant ...............................

2,000,000

Investment in Plant

Land ................................................................. Buildings .......................................................... Mortgage Payable ....................................... Net Investment in Plant ............................... To record contribution.

200,000 350,000

(9)

Journal Entry 2,770,000

2,000,000

90,000 460,000

(10)

Unexpended Plant Fund

No entry. Public universities account for pledges under the cash basis of accounting.

(11)

Unexpended Plant Fund

Cash ................................................................ Fund Balance—Restricted .......................... To record contribution for first editions.

100,000

Unrestricted Current Fund

Fund Balance................................................... Cash ............................................................ To record transfer to Unexpended Plant Fund for first editions.

60,000

Unexpended Plant Fund

Cash ................................................................ Fund Balance—Unrestricted ....................... To record receipt of cash transferred by the board.

60,000

Unexpended Plant Fund

Fund Balance—Unrestricted............................ Fund Balance—Restricted ............................... Cash ............................................................ To record payment for first editions.

60,000 100,000

Library Books ................................................... Net Investment in Plant ............................... To record additions of first editions to library.

160,000

(12)

Investment in Plant

100,000

60,000

160,000

19–17

Ch. 19—Problems

PROBLEM 19-6 (1) (a) Cash ......................................................................................... Revenues—Temporarily Restricted Contributions .............. Revenues—Permanently Restricted Contributions.............

90,000

Endowment Investments .......................................................... Cash ...................................................................................

45,000

45,000 45,000 45,000

(b) Cash ......................................................................................... 1,686,000 Accounts Receivable ................................................................ 148,000 Deferred Revenues................................................................... 66,000 Revenues—Student Tuition and Fees ................................ Cash ......................................................................................... Deferred Revenues .............................................................

158,000

(c) Cash ......................................................................................... Allowance for Uncollectible Tuition and Fees ........................... Accounts Receivable ..........................................................

308,000 12,000

Expenses—Institutional Support (Provision for Uncollectible Tuition and Fees) ................................................................ Allowance for Uncollectible Tuition and Fees ...............

158,000

320,000 9,000 9,000

(d) Cash ......................................................................................... Revenues—Unrestricted Investment Income .....................

6,000

(e) Cash ......................................................................................... State Appropriations Receivable.........................................

75,000

State Appropriations Receivable .............................................. Revenues—State Government Appropriations ...................

40,000

Cash ......................................................................................... Revenues—Temporarily Restricted Contributions ..............

30,000

(g) Cash ......................................................................................... Investments ........................................................................ Revenues—Temporarily Restricted Gain on the Sale of Investments................................................................... Revenues—Temporarily Restricted Investment Income.....

24,000

(f)

1,900,000

6,000 75,000 40,000 30,000 21,000 1,100 1,900

Ch. 19—Problems

19–18

Problem 19-6, Continued (h) Expenses—Instruction .............................................................. Expenses—Research ............................................................... Expenses—Institutional Support............................................... Expenses—Student Aid ............................................................ Expenses—Student Services ................................................... Expenses—Operation and Maintenance of Plant ..................... Accounts Payable ............................................................... Cash ...................................................................................

500,000 400,000 100,000 100,000 200,000 500,000

(i)

13,000

Expenses—Research ............................................................... Cash ................................................................................... Reclassifications Out—Temporarily Restricted—Satisfaction of Program Restrictions ...................................................... Reclassifications In—Unrestricted—Satisfaction of Program Restrictions ................................................

(j)

60,000 1,740,000 13,000 13,000 13,000

Accounts Payable ..................................................................... Cash ...................................................................................

40,000

(k) Cash ......................................................................................... Revenues—Temporarily Restricted Endowment Income ...

7,000

(l)

16,000 14,000

Cash ......................................................................................... Pledges Receivable .................................................................. Revenues—Unrestricted Contributions............................... Expenses—Institutional Support Provision for Uncollectible Contributions ....................................................................... Allowance for Uncollectible Contributions .....................

40,000 7,000

30,000 2,000 2,000

19–19

Ch. 19—Problems

Problem 19-6, Concluded (2)

Washbud Private University Statement of Activities For Year Ended June 30, 2019 Unrestricted

Temporarily Restricted

Permanently Restricted

Total

$1,900,000 30,000

$ 75,000

$45,000

$1,900,000 150,000

$45,000

40,000 7,000 1,100 7,900 $2,106,000

$45,000

0 $2,106,000

$ 0 $45,000 50,000 $95,000

$ 500,000 413,000 111,000 100,000 500,000 200,000 $1,824,000 $ 282,000 577,000 $ 859,000

Changes in net assets: Revenues and gains: Tuition and fees ................................................ Contributions ..................................................... Government appropriations, grants, and contracts ...................................................... Endowment income .......................................... Net realized gains on investments .................... Other investment income .................................. Total revenues and gains ............................ Net assets released from restrictions: Satisfaction of program restrictions ....................... Total revenues and gains and other support .........

6,000 $1,976,000

7,000 1,100 1,900 $ 85,000

13,000 $1,989,000

(13,000) $ 72,000

Expenses and losses: Instruction .............................................................. Research ............................................................... Institutional support ............................................... Student aid............................................................. Operation and maintenance of plant ..................... Student services .................................................... Total expenses and losses ............................... Increase (decrease) in net assets ......................... Net assets at beginning of year ................................... Net assets at end of year .............................................

$ 500,000 413,000 111,000 100,000 500,000 200,000 $1,824,000 $ 165,000 487,000 $ 652,000

40,000

$ 0 $ 72,000 40,000 $112,000

PROBLEM 19-7 (1) Journal entries: (a) Cash ......................................................................................... 20,000,000 Bonds Payable .................................................................... 20,000,000 Cash ......................................................................................... Revenues—Temporarily Restricted Contributions ..............

5,000,000

(b) Construction in Progress .......................................................... Cash ...................................................................................

7,000,000

(c) Expenses—Operation and Maintenance of Plant (Interest Expense) .............................................................. Cash..............................................................................

5,000,000 7,000,000 800,000 800,000

Ch. 19—Problems

19–20

Problem 19-7, Continued (d) Building .................................................................................. 25,000,000 Construction in Progress.................................................. Cash ................................................................................ Retained Percentage—Liability to Contractor .................. Reclassifications Out—Temporarily Restricted—Satisfaction of Plant Restrictions ......................................................... Reclassifications In—Unrestricted—Satisfaction of Plant Restrictions............................................... (e) Mortgage Payable.................................................................. Expenses—Operation and Maintenance of Plant (Interest Expense) ........................................................... Cash........................................................................... (f)

5,000,000 5,000,000 2,000,000 800,000 2,800,000

Land ....................................................................................... Building .................................................................................. Mortgage Payable ............................................................ Revenues—Unrestricted Contributions............................

200,000 350,000

(g) Contributions Receivable ....................................................... Revenues—Temporarily Restricted Contributions ...........

200,000

Expenses—Institutional Support (Provision for Uncollectible Contributions) .................................................................. Allowance for Uncollectible Contributions ..................

90,000 460,000 200,000 20,000 20,000

(h) Investments ........................................................................... Revenues—Temporarily Restricted Contributions ...........

500,000

(i)

10,000

(j)

Cash ...................................................................................... Revenues—Temporarily Restricted Investment Income.. Expenses—Operation and Maintenance of Plant (Depreciation Expense) ................................................... Accumulated Depreciation .........................................

7,000,000 16,000,000 2,000,000

500,000 10,000 25,000 25,000

19–21

Ch. 19—Problems

Problem 19-7, Concluded (2)

Kronke Private University Statement of Activities For Period Ended June 30, 2018 Unrestricted

Temporarily Restricted

Permanently Restricted

Changes in net assets: Revenues and gains: Contributions ................................................... Other investment earnings.............................. Total unrestricted revenues and gains ......

$ 460,000 0 $ 460,000

$ 5,700,000 10,000 $ 5,710,000

$6,160,000 10,000 $6,170,000

Net assets released from restrictions: Satisfaction of plant acquisition restrictions......... Total revenues and gains and other support ..

5,000,000 $5,460,000

(5,000,000)* 710,000

0 $6,170,000

Expenses: Operations and maintenance of plant ................. Institutional support ............................................. Total expenses ...............................................

$1,625,000 20,000 $1,645,000

Increase (decrease) in net assets ..........

$3,815,000

710,000

$4,525,000

Total

*Note to Instructor: The reclassification amount would total $25,000 if Kronke’s policy is to release the restrictions over the life of the assets rather than when placed into operation.

Ch. 19—Problems

19–22

PROBLEM 19-8 (1) Closing entries: Each asset class is closed separately.

Revenues—Tuition and Fees ...................................... 2,500,000 Revenues—Government Appropriations ..................... 700,000 Revenues—Unrestricted Contributions ....................... 365,000 Revenues—Unrestricted Other Investment Income .... 150,000 Reclassifications In—Unrestricted—Satisfaction of Program Restrictions............................................... 75,000 Reclassifications In—Unrestricted—Satisfaction of Plant Acquisition Restrictions .................................. 250,000 Reclassifications In—Unrestricted—Expiration of Time Restrictions .................................................... 50,000 Unrestricted Net Assets ....................................... Expenses—Research ............................................. Expenses—Instruction ............................................ Expenses—Academic Support ............................... Expenses—Student Services.................................. Expenses—Institutional Support ............................. Expenses—Operation and Maintenance of Plant ... Expenses—Student Aid .......................................... Revenues—Sales and Services of Auxiliary Enterprises .............................................................. Unrestricted Net Assets ............................................ Expenses—Auxiliary Enterprises ............................ Revenues—Temporarily Restricted Contributions ...... Revenues—Temporarily Restricted Endowment Income .................................................................... Revenues—Temporarily Restricted Net Realized Gains on Endowment .............................................. Temporarily Restricted Net Assets .......................... Reclassifications Out—Temporarily Restricted— Satisfaction of Program Restrictions................... Reclassifications Out—Temporarily Restricted— Expiration of Time Restrictions ........................... Reclassifications Out—Temporarily Restricted— Satisfaction of Equipment Acquisition Restrictions ......................................................... Revenues—Permanently Restricted Contributions ........................................................... Permanently Restricted Net Assets ................

745,000 840,000 1,130,000 200,000 200,000 325,000 300,000 350,000

300,000 275,000 575,000 100,000 15,000 25,000 235,000 75,000 50,000 250,000 500,000 500,000

19–23

Ch. 19—Problems

Problem 19-8, Concluded (2)

Excel Private College Statement of Activities For Year Ended December 31, 2018

Changes in net assets: Revenues and gains: Tuition and fees .................................................... Contributions ........................................................ Government appropriations, grants, and contracts .......................................................... Investment income on endowment ...................... Net realized gains on endowment investments.... Other investment income ................................ Sales and services of auxiliary enterprises .......... Total revenues and gains ................................

Unrestricted

Temporarily Permanently Restricted Restricted

$2,500,000 365,000

$ 100,000

$ 500,000

$2,500,000 965,000

$ 500,000

700,000 15,000 25,000 150,000 300,000 $4,655,000

700,000 15,000 25,000 150,000 300,000 $4,015,000

Net assets released from restrictions: Satisfaction of program restrictions ........................... Satisfaction of equipment acquisition restrictions ..... Satisfaction of time restrictions ................................. Total net assets released from restrictions .......... Total revenues and gains and other support ...

75,000 250,000 50,000 $ 375,000 $4,390,000

Expenses: Research ................................................................... Instruction .................................................................. Academic support...................................................... Student services ........................................................ Institutional support ................................................... Operation and maintenance of plant ......................... Student aid ................................................................ Auxiliary enterprises .................................................. Total expenses ..................................................... Increase (decrease) in net assets ................... Net assets, January 1, 2018 .......................................... Net assets, December 31, 2018 ...................................

$ 840,000 1,130,000 200,000 200,000 325,000 300,000 350,000 575,000 $3,920,000 $ 470,000 675,000 $1,145,000

$ 140,000 $ (75,000) (250,000) (50,000) $(375,000) $(235,000)

$ 0 $(235,000) 975,000 $ 740,000

Total

$ 500,000

0 0 0 $ 0 $4,655,000

$ 0 $ 500,000 2,500,000 $3,000,000

$ 840,000 1,130,000 200,000 200,000 325,000 300,000 350,000 575,000 $3,920,000 $ 735,000 4,150,000 $4,885,000

Ch. 19—Problems

19–24

PROBLEM 19-9 Excel Private College Statement of Financial Position December 31, 2018 Assets: Cash ............................................................................................................. Accounts receivable ..................................................................................... Contributions receivable............................................................................... Inventory of supplies .................................................................................... Student loans receivable .............................................................................. Land, buildings, and equipment (net) ........................................................... Endowment investments .............................................................................. Total assets ..........................................................................................

$ 255,000 625,000 185,000 175,000 300,000 1,450,000 3,025,000 $6,015,000

Liabilities: Accounts payable ......................................................................................... Amounts held on behalf of others ................................................................ Long-term debt ............................................................................................. U.S. government grants refundable ............................................................. Total liabilities ......................................................................................

$ 120,000 250,000 660,000 100,000 $1,130,000

Net assets: Unrestricted .................................................................................................. Temporarily restricted .................................................................................. Permanently restricted ................................................................................. Total net assets .................................................................................... Total liabilities and net assets ............................................................................

$1,145,000 740,000 3,000,000 $4,885,000 $6,015,000

PROBLEM 19-10 (1) b

Goods and services that otherwise would be purchased are recorded as other operating revenues.

(2) c

The $300,000 is part of unrestricted net assets because there are no external donor restrictions on the use of the funds.

(3) a

For hospitals, property, plant, and equipment and their related liabilities are within the unrestricted or temporarily restricted (if donated) net asset classes.

(4) b

To meet GAAP, reporting must be on the accrual basis.

(5) a

Both board-designated funds and plant assets are part of the unrestricted net assets of the hospital. Restrictions by outsiders have been “released.”

(6) a

Report as unrestricted nonoperating revenues at fair value.

19–25

Ch. 19—Problems

Problem 19-10, Concluded (7) d

Because the assets are not under the control of the hospital, they should not appear in the hospital’s financial statements.

(8) a

Charity allowances and discounts are contra-revenue accounts.

(9) d

Donated goods and services are not recorded unless they would have otherwise been purchased and are of a skilled nature.

(10) b

The valuation allowance must be decreased by $40,000 in order for the allowance balance to be $10,000 at the end of 2020.

PROBLEM 19-11 (1) c

This is an internal designation of unrestricted resources. Only donor-imposed restricted contributions are temporarily or permanently restricted.

(2) d

All of the third-party reimbursements are unrestricted revenue.

(3) a

The release of restrictions will be reported as operating expenses are incurred.

(4) a

Inventory donated is used for the hospital’s principal operations and is part of other operating revenues.

(5) b

This is revenue from sales or services to persons other than patients.

(6) b

The fair value of the gift is considered an unrestricted revenue.

(7) d

Only donor-imposed external stipulations are restrictions.

(8) d

All of these organizations sponsor health care organizations.

(9) d

Earnings are available for expenditure but must be spent on specific items. Thus, they are temporarily restricted.

(10) b

Only donor-imposed external stipulations are restrictions.

Ch. 19—Problems

19–26

PROBLEM 19-12 (1)

Bayshore Community Health Care Association Statement of Activities For Year Ended June 30, 2018 Unrestricted

Public support and revenue: Public support: Contributions............................................................... Annual auction proceeds (net of $11,000 expense) ... Total public support ................................................. Revenues: Membership dues ....................................................... Program service fees .................................................. Investment income ..................................................... Endowment income .................................................... Total revenue ..........................................................

$300,000 31,000 $331,000

Temporarily Permanently Restricted Restricted

$15,000 $15,000

Total

$315,000 31,000 $346,000

$ 25,000 30,000 10,000 20,000 $ 85,000

$ 0 $431,000

$ 25,000 30,000 10,000 $ 65,000

$20,000 $20,000

Net assets released from restrictions: Satisfaction of program restrictions ............................... Total public support, revenue, and other support .............

$ 5,000 $401,000

$ (5,000) $30,000

Expenses: Program services: Blind children .............................................................. Deaf children...............................................................

$150,000 120,000

$ 150,000 120,000

Supporting services: Management and general........................................... Fund raising ................................................................ Total expenses .................................................................. Change in net assets ........................................................ Net assets, July 1, 2017 .................................................... Net assets, June 30, 2018 ................................................

51,000* 9,000 $330,000 $ 71,000 38,000 $109,000

51,000 9,000 $330,000 $101,000 291,000 $392,000

$ 0 $30,000 3,000 $33,000

$ $

0 0 250,000 $250,000

*$49,000 + $2,000 provision for uncollectible pledges

Get complete Order ﬁles download link below

19–27

Ch. 19—Problems

Problem 19-12, Concluded (2)

Bayshore Community Health Care Association Statement of Financial Position June 30, 2018 Assets: Cash ....................................................................................................... Pledges receivable (net of $3,000 allowance) ....................................... Bequest receivable ................................................................................. Accrued interest receivable .................................................................... Long-term investments ........................................................................... Endowment investments ........................................................................ Total assets ......................................................................................

$ 40,000 9,000 5,000 1,000 140,000 250,000 $445,000

Liabilities: Accounts payable and accrued expenses .............................................. Refundable deposits .............................................................................. Total liabilities ...................................................................................

$ 51,000 2,000 $ 53,000

Net assets: Unrestricted ............................................................................................ Temporarily restricted ............................................................................ Permanently restricted ........................................................................... Total net assets ................................................................................ Total liabilities and net assets ......................................................................

$109,000 33,000 250,000 $392,000 $445,000

Ch. 19—Problems

19–28

PROBLEM 19-13 Prospect Private Hospital Statement of Activities For Year Ended December 31, 2018 Unrestricted Patient service revenues (net of $1,543,500 contractual adjustments and charity care) .....................................

Temporarily Permanently Restricted Restricted

$8,505,700

Total $8,505,700

Other operating revenues: Research grant ........................................................... Contributions ............................................................... Donated services ........................................................ Cafeteria meal sales ................................................... Parking lot fees ........................................................... Vending machine sale................................................. Total other operating revenue .................................

180,000 108,000 11,000 68,000 $ 728,000

$ 225,000

Net assets released from restrictions: Satisfaction of plant acquisition restrictions ................ Satisfaction of program restrictions ............................ Total operating revenue and other support .............

220,000 125,000 $9,578,700

(220,000) (125,000) $ (120,000)

Operating expenses: Nursing services ......................................................... Dietary services .......................................................... Maintenance services ................................................. Administrative services ............................................... Interest expense ......................................................... Depreciation and amortization .................................... Provision for uncollectibles ......................................... Total operating expenses ........................................

$6,589,100 511,200 938,300 112,500 172,200 378,200 241,600 $8,943,100

Income (loss) from operations .......................................

$ 635,600

Nonoperating revenues: Interest income ........................................................... Contributions ............................................................... Investment income ...................................................... Endowment income .................................................... Loss on sale of endowment investments .................... Total nonoperating revenues ................................... Change in net assets ..................................................... Net assets, January 1, 2018 .......................................... Net assets, December 31, 2018 ....................................

$ 361,000

$ 361,000 225,000 180,000 108,000 11,000 68,000 $ 953,000

0 0 $9,458,700

$6,589,100 511,200 938,300 112,500 172,200 378,200 241,600 $8,943,100

$ (120,000)

$ 515,600

$ 100,200 107,000 12,000 (5,300) $ 213,900

$ 540,000

$ 150,000

$ 565,000

$ 150,000

$ 790,200 107,000 37,000 (5,300) $ 928,900

$ 849,500 625,000 $1,474,500

$ 445,000 825,000 $1,270,000

$ 150,000 2,350,000 $2,500,000

$1,444,500 3,800,000 $5,244,500

$ 225,000

25,000

19–29

Ch. 19—Problems

PROBLEM 19-14 Lakeside Hospital Statement of Cash Flows For Year Ended December 31, 2018 Cash flows from operating activities: Cash received from patients ........................................................................ Cash received from third-party payors ......................................................... Cash received from operation of gift shop ................................................... Cash received from unrestricted gifts........................................................... Cash paid to employees............................................................................... Cash paid to suppliers.................................................................................. Cash paid for consultation services ............................................................. Interest paid ................................................................................................. Net cash provided by operating activities ...............................................

$ 2,061,900 6,500,000 517,700 323,500 (1,151,000) (6,200,000) (800,000) (147,000) $ 1,105,100

Cash flows from investing activities: Purchase of property and equipment ........................................................... Net cash used by investing activities ....................................................

$ (501,200) $ (501,200)

Cash flows from financing activities: Repayment of long-term debt....................................................................... Contributions received restricted for endowment ......................................... Contributions received restricted for purchase of property and equipment.. Net cash provided by financing activities ...............................................

$ (242,300) 500,000 183,000 $ 440,700

Net increase in cash .......................................................................................... Cash at beginning of year .................................................................................. Cash at year-end ...............................................................................................

$ 1,044,600 275,900 $ 1,320,500

PROBLEM 19-15 Lakeside Hospital Reconciliation of Change in Net Assets to Net Cash Provided by Operating Activities For Year Ended December 31, 2018 Change in net assets ......................................................................................... Adjustments to reconcile change in net assets to net cash provided by operating activities: Depreciation and amortization .............................................................. Noncash gifts and bequests ................................................................. Increase in expense and liability for estimated malpractice costs ........ Increase in patient accounts receivable................................................ Decrease in supplies inventory ............................................................. Increase in accounts payable ............................................................... Contributions restricted for endowment ................................................ Contributions restricted for purchase of property and equipment ......... Net cash provided by operating activities ..........................................................

$1,635,200 422,500 (37,500) 12,300 (266,300) 11,800 10,100 (500,000) (183,000) $1,105,100

CHAPTER 20 UNDERSTANDING THE ISSUES 3. It is important to separately account for the income and principal of an estate for several reasons. First, the decedent may have created a will that has special provisions relating to both principal and income. Second, the income of an estate is subject to tax. These taxes are either imposed on the estate or the recipient of the income.

1. Several of the important goals of estate planning are to identify and clearly communicate the desires and wishes of the decedent, maximize the value of the estate’s net assets, minimize the taxes that may be assessed against the assets and income of the estate, achieve the necessary liquidity of the estate’s assets so that desired conveyances and distributions may be received, and provide a proper and timely accounting of the activities of the estate and its fiduciary.

The sum of intended legacies may be larger than the available assets of an estate. In those instances, a procedure referred to as abatement is applied. This procedure requires that legacies be satisfied to whatever extent possible, beginning with the highest priority level of legacies. If demonstrative legacy cannot be satisfied, the unsatisfied amount is considered a general legacy. If there are inadequate resources to satisfy general legacies, available resources are allocated proportionately among the identified parties.

2. Given a married couple, when the first spouse dies the decedent's estate may be passed to the surviving spouse without incurring any estate tax at the time of the decedent's death. This marital exclusion does not necessarily eliminate estate tax but rather it defers the tax until the death of the surviving spouse assuming a taxable estate continues to exist. When a spouse dies, any unified credit that is not used in the determination of the decedent's estate tax may be transferred to the surviving spouse. The executor of the decedent's estate must elect to transfer the unused unified credit. In essence, no unused unified credit will be lost under the concept of portability.

Ch. 20—Exercises

20–2

EXERCISES EXERCISE 20-1 Scenario A

Scenario B

General legacies as set forth in will: Amount due The Nature Conservancy ......................... Equal amounts due three grandchildren .......................

$ 50,000 150,000

Unsatisfied demonstrative legacies that constitute a general legacy: Amount not satisfied by insurance proceeds ................ Total needed to satisfy general legacies ..............................

20,000 $220,000

20,000 $ 220,000

Available cash to satisfy general legacies: Cash at date of death ................................................... Sale of Kachina collection............................................. Insurance proceeds (policy number 48002) ................. Sale of residence .......................................................... Total ..............................................................................

$ 40,000 45,000 40,000 220,000 $345,000

$ 15,000 — 40,000 — $ 55,000

Amount available for residual legacies ................................

$125,000

$(165,000)

Amount of cash received by: Grandchild Riley: General legacy at amount stated in will (see Notes A and B) ...........................................

$ 50,000

$ 12,500

Son Calvin, Jr.: Insurance policy number 14378 death benefit ......... Residual legacy: One-half of available amount ........ Total ..............................................................................

$ 50,000 62,500 $112,500

$ 50,000 — $ 50,000

Note A:

Under scenario A, there is enough cash available to satisfy all general legacies. Therefore, Riley will receive the stated amount of $50,000.

Note B:

Under scenario B, there is only $55,000 available to satisfy all general legacies, which total $220,000. Therefore, only 25% ($55,000/$220,000) of each stated legacy will be satisfied. Accordingly, Riley will receive $12,500 (25% × $50,000).

20–3

Ch. 20—Exercises

EXERCISE 20-2 (1) The unified gift and estate tax exclusion amount is .................. Less the prior taxable gifts ........................................................ Largest taxable estate without incurring any estate tax ............

$ 5,340,000 (1,200,000) $ 4,140,000

(2) Taxable estate .......................................................................... Post 1976 taxable gifts: Prior taxable gift ................................................................... Taxable gifts to children (($50,000 – $14,000) × 4) ............. Unified tax base ........................................................................

$12,000,000

Tentative tax ............................................................................. Less unified credits: Traceable to George ............................................................ Traceable to Helen's remaining credit: Tax on Helen's taxable gifts ............................................. Less Unified credit ........................................................... Total gift and estate tax ............................................................ Tax on taxable gifts of $856,000 plus $144,000 ....................... Net estate tax ........................................................................... (3)

856,000 144,000 $13,000,000 $ 5,145,800 (2,081,800) 545,800 (2,081,800)

Helen

(1,536,000) $1,528,000 (345,800) $1,182,200 George

Taxable estate .......................................................................... Less marital deduction .............................................................. Taxable estate .......................................................................... Post 1976 taxable gifts: Prior taxable gift ................................................................... Taxable gifts to children (($50,000 – $14,000) × 4) ............. Unified tax base ........................................................................

$10,000,000 $8,160,000 (6,160,000) 0 $ 3,840,000 $8,160,000 1,500,000 — $ 5,340,000

Tentative tax ............................................................................. Less unified credits: .................................................................. Total gift and estate tax ............................................................ Tax on taxable gifts of $856,000 plus $144,000 ....................... Net estate tax ...........................................................................

$ 2,081,800 $3,552,200 (2,081,800) (2,081,800) $ — $1,470,400 (345,800) $1,124,600

856,000 144,000 $9,016,000

(4) Residual legacy: Remaining bank balance to sister Ann ($60,000 – $40,000) ................. Amount to children (6 × $40,000) ........................................................... Total .......................................................................................................

$ 20,000 240,000 $260,000

Amount to be allocated between residual legatees .................................... Portion allocated to sister Ann ($20,000/$260,000) ................................... Amount allocated to sister Ann ...................................................................

$195,000 × 20/260 $ 15,000

(5) The sum of the residual legacies would be: Remaining bank balance to sister Ann ($60,000 – $40,000) ................. Amount to children (6 × $40,000) ........................................................... Amount to University of Oklahoma ......................................................... Total needed from sale of land ...............................................................

$ 20,000 240,000 100,000 $360,000

Ch. 20—Exercises

20–4

EXERCISE 20-3 (1) Only $1,000 of the gift to the grandson would be considered taxable. Gifts to charities and spouses are not taxable. The $8,000 to the granddaughter is below the annual exclusion amount. (2) Previous taxable gifts to grandchildren [($25,000 – $14,000) × 4 × 3 years] ...........................................................

$ 132,000

Lifetime exclusion ....................................................................................... Used on previously taxed gifts .................................................................... Remaining exclusion .................................................................................. Number of grandchildren ............................................................................ Remaining exclusion per grandchild ........................................................... Plus annual exclusion amount .................................................................... Maximum gift per grandchild ......................................................................

$5,340,000 (132,000) $5,208,000 4 $1,302,000 14,000 $1,316,000

(3) Cumulative taxable gifts: Gift to 3 children [($200,000 – $14,000) × 3].......................................... Gift to brother ($50,000 – $14,000) ........................................................ Gifts to grandchildren (all less than annual exclusion) ........................... Gift to 2 nieces [($50,000 – $14,000) × 2] .............................................. Total of prior gifts ................................................................................... Gift to sister ($5,348,000 – $14,000) ...................................................... Total of all gifts ....................................................................................... Tax on total gifts ..................................................................................... Less lifetime exclusion amount .............................................................. Net gift tax (none was due prior to current year) ....................................

$ 558,000 36,000 — 72,000 $ 666,000 5,334,000 $6,000,000 $2,345,800 (2,081,800) $ 264,000

(4) Total of prior gifts ...................................................................... Gift to sister ($5,348,000 – ($14,000 × 2))................................ Total of all gifts .........................................................................

Spouse $ 666,000 2,660,000 $3,326,000

Spouse $ 100,000 2,660,000 $2,760,000

After consideration of the lifetime exclusion amount, no tax would be due by either spouse.

20–5

Ch. 20—Exercises

EXERCISE 20-4 Principal Assets received: Personal residence ....................................................... Cash ............................................................................. Securities ...................................................................... Personal effects ............................................................ Sailboat ......................................................................... Loss on realization of securities.................................... Bond interest ................................................................ Dividends ...................................................................... Total .........................................................................

Income

$350,000 230,000 210,000 12,000 8,000 (14,000) 7,000 $803,000

$ 4,000 20,000 $ 24,000

Assets disbursed: Amount conveyed to Sierra Club .................................. Mortgage principal ........................................................ Mortgage interest .......................................................... Funeral and administrative fees.................................... Medical expenses ......................................................... Income taxes ................................................................ Real estate taxes, interest, and penalties ..................... Residence utilities and repairs ...................................... Repair of roof and lawn care......................................... Yacht club dues and charges ....................................... Total .........................................................................

$200,000 16,000 2,000 27,000 21,000 13,000 14,000 1,200 15,000 1,400 $310,600

6,000 3,000 2,800 $ 17,800

Balance before distributions/transfers .................................. Amount (80%) paid out to Margaret.............................. Amount (20%) transferred to corpus............................. Ending balances ..................................................................

$492,400 — 1,240 $493,640

$ 6,200 (4,960) (1,240) $ —

$ 6,000

Ch. 20—Exercises

20–6

EXERCISE 20-5 (1) Determination of estate tax: Gross estate ............................................................................. Less: Debts .................................................................................... Transfer to charitable remainder trust .................................. Charitable contribution to art museum ................................. Administrative and funeral expenses ................................... Federal and state income taxes ........................................... Taxable estate ..........................................................................

$7,008,000 $380,000 560,000 25,000 30,000 13,000

1,008,000 $6,000,000

Estate tax before credits ........................................................... Less unified credit ..................................................................... Estate tax due ...........................................................................

$2,345,800 (2,081,800) $ 264,000

(2) Gross estate ............................................................................. Distribution before general legacies: Debts .................................................................................... Transfer to charitable remainder trust .................................. Charitable contribution to art museum ................................. Administrative and funeral expenses ................................... Federal and state income taxes ........................................... Estate tax due ...................................................................... Securities to married daughter ............................................. Life insurance proceeds to trust ........................................... Subtotal .................................................................................... Gain on sale of hunting land ..................................................... Cash available for general legacies ..........................................

$7,008,000 $ 380,000 560,000 25,000 30,000 13,000 264,000 600,000 1,200,000

3,072,000 $3,936,000 5,000 $3,941,000

Allocation of cash available for general legacies: Intended Legacy Hunting friend #1 .................................................. $ 40,000 Hunting friend #2 .................................................. 40,000 Hunting friend #3 .................................................. 40,000 Friend Ernest Kampmeyer ................................... 3,880,000 $4,000,000

Percentage of Total 1% 1% 1% 97% 100%

Allocated Amount $

39,410 39,410 39,410 3,822,770 $3,941,000

20–7

Ch. 20—Exercises

EXERCISE 20-6 Determination of estate tax liability assuming not trusts are created: Initial gross estate equal to net assets ........... Add: Spouse’s remaining estate (see Note A).. Subsequent appreciation (see Note B) .... Subsequent gross estate ............................... Less: Administrative and funeral expenses ....... Charitable contributions ........................... Marital deduction ...................................... Taxable estate ...............................................

Edith Leppert $4,300,000 $

Gerald Leppert $2,400,000 $4,125,000 1,028,503

$4,300,000 $

25,000 150,000 4,125,000

Estate tax before credits ................................ Less unified credit: Edith's unused credit ................................ Available to Gerald ................................... Estimated estate tax due ...............................

5,153,503 $7,553,503

25,000 150,000

4,300,000 $ 0

175,000 $7,378,503

$2,897,201

(2,081,800) (815,401) $ 0

Determination of estate tax liability assuming a credit shelter trust is created: Initial gross estate equal to net assets ........... Add: Spouse’s remaining estate (see Note A).. Subsequent appreciation (see Note D) .... Subsequent gross estate ............................... Less: Administrative and funeral expenses ....... Charitable contributions ........................... Marital deduction (see Note C) ................ Taxable estate ............................................... Estate tax before credits ................................ Less unified credit: Available to Edith ..................................... Edith's unused credit ................................ Available to Gerald ................................... Estimated estate tax due ...............................

Edith Leppert $4,300,000

Gerald Leppert $2,400,000 $ 625,000 476,816

$4,300,000 $

25,000 150,000 625,000

1,101,816 $3,501,816

25,000 150,000

800,000 $3,500,000

175,000 $3,326,816

$1,345,800

$1,657,389

(1,345,800) $

(736,000) (921,389) $ 0

Ch. 20—Exercises

20–8

Exercise 20-6, Concluded Note A:

This is the amount of the marital deduction.

Note B:

Subsequent appreciation is on $2,400,000 traceable to husband plus $4,125,000 traceable to wife or $6,525,000. Compounded at 5% for three years this amount grows to $7,553,503 ($6,525,000 × ((1.05)3))or appreciation of $1,028,503.

Note C:

Gross estate less expenses and charitable contributions is $4,125,000 ($4,300,000 – $25,000 –$150,000). Of this amount $3,500,000 is contributed to a credit shelter trust leaving a balance of $625,000 subject to the marital deduction.

Note D:

Subsequent appreciation is on $2,400,000 traceable to husband plus $625,000 traceable to wife or $3,025,000. Compounded at 5% for three years this amount grows to $3,501,816 ($3,025,000 × ((1.05)3))or appreciation of $476,816.

EXERCISE 20-7 (a)

Transfer of assets into trust ................................ Subsequent discovery of assets ......................... Sale of real estate partnership ............................ Receipt of IBM dividend ...................................... Receipt of interest income .................................. Distribution of assets to children ......................... Payment of trustee’s fees ................................... Purchase of bonds .............................................. Receipt of timber income .................................... Depletion of forest land ....................................... Payment of real estate taxes .............................. Distribution from real estate partnership ............. Receipt of interest on bonds ............................... Payment of taxes on trust income ....................... Sale of IBM stock ................................................ Subtotal ............................................................... Distribution to oldest child ................................... Totals ..................................................................

Cash $ 100,000 220,000 20,000 5,000 (32,000) (10,000) (84,000) 22,000

(b) Noncash Assets $ 750,000 40,000 (200,000)

(c)

Trust Principal $ 850,000 40,000 20,000 20,000 (27,000) (5,000)

Trust Income

$ 5,000 (5,000) (5,000)

84,000 15,400

(6,000) 22,000 3,200 (6,000) 80,100 $ 334,300 (316,100) $ 18,200

(d)

400 (60,000) $ 614,000 $ 614,000

20,100 $ 933,900 (311,300) $ 622,600

22,000 (15,400)* (6,000) 22,000 2,800** (6,000) $ 14,400 (4,800) $ 9,600

*Depletion is 11% × ($200,000 – $60,000). **The interest on the bonds is $3,200 (8% × $80,000 × 1/2 year). Of this amount, $400 ($4,000 premium amortized over 10 periods) represents a return of principal.

20–9

Ch. 20—Exercises

EXERCISE 20-8 Principal Cash ........................................................................................ Land ....................................................................................................... Investment in Merkt Stock ...................................................................... Investment in GTE Stock ....................................................................... Dividends Receivable—GTE Stock ....................................................... Investment in Trident Bond Fund ........................................................... Interest Receivable—Trident Bond Fund ............................................... Royalties Receivable ............................................................................. Estate Principal ................................................................................ To record estate inventory.

15,000 130,000 54,000 13,000 1,000 40,000 2,000 17,000

(1) Funeral and Administrative Expenses ............................................ Principal Cash........................................................................... To record payments.

22,000

(2) Investment in IRA Account ............................................................. Assets Subsequently Discovered ............................................. To record IRA account discovered.

37,000

(3) Principal Cash ................................................................................ Income Cash .................................................................................. Dividends Receivable—GTE Stock .......................................... Estate Income ........................................................................... To record receipt of dividends.

1,000 2,700

(4) Principal Cash ................................................................................ Land .......................................................................................... Gain on Sale of Principal Assets .............................................. To record sale of land.

140,000

(5) Income Cash .................................................................................. Principal Cash ................................................................................ Estate Income ........................................................................... Royalties Receivable ................................................................ Interest Receivable—Trident Bond Fund.................................. To record payment received for royalties and interest.

400 19,000

(6) Debts of Decedents Paid ................................................................ Principal Cash........................................................................... To record payment of tax and various other claims.

28,000

(7) Legacies Distributed ....................................................................... Principal Cash........................................................................... To record legacy paid to High Adventure Climbing School.

15,000

(8) Funeral and Administrative Expenses ............................................ Expenses Chargeable against Income ........................................... Principal Cash........................................................................... Income Cash............................................................................. To record payment of administrative expenses.

3,100 100

272,000

22,000

37,000

1,000 2,700

130,000 10,000

400 17,000 2,000

28,000

15,000

3,100 100

Ch. 20—Exercises

20–10

EXERCISE 20-9 (1)

Estate of Jason Jackson ________________ , Executor Charge and Discharge Statement For Period _________ to _________ As to Principal I charge myself with: Assets per original inventory ...................................................... Assets subsequently discovered ................................................ Gain on sale of principal assets ................................................. Total charges........................................................................

$272,000 37,000 10,000

I credit myself with: Funeral and administrative expenses ........................................ Debts of decedent paid .............................................................. Legacies distributed ................................................................... Total credits ..........................................................................

$ 25,100 28,000 15,000

Balances as to estate principal, consisting of: Cash—principal .......................................................................... Investment in Merkt stock .......................................................... Investment in GTE stock ............................................................ Investment in Trident bond fund ................................................. Investment in IRA account .........................................................

$319,000

68,100 $106,900 54,000 13,000 40,000 37,000

$250,900

As to Income I charge myself with: Estate income ............................................................................

$3,100

I credit myself with: Expenses chargeable against income .......................................

100

Balance as to estate income, consisting of: Cash—income ............................................................................

$3,000

(2) Entries to transfer assets to trust: Principal Assets Transferred to Trust ............................................... Cash—Principal ........................................................................ Investment in Merkt Stock ........................................................ Investment in GTE Stock .......................................................... Investment in Trident Bond Fund.............................................. Investment in IRA Account .......................................................

250,900

Income Assets Transferred to Trust ................................................. Cash—Income ..........................................................................

3,000

106,900 54,000 13,000 40,000 37,000 3,000

20–11

Ch. 20—Problems

PROBLEMS PROBLEM 20-1 Strategies to minimize estate tax should include: 1.

Maximizing the use of the annual gift tax exclusion amount per donor per donee. Both James and Susan could gift to their children and grandchildren.

James should implement a credit shelter trust in order to take advantage of the unified credit that is available to him.

Recognition that tuition payments to an educational organization made on another's behalf are not considered taxable gifts if paid directly to the organization.

Recognition that charitable contributions reduce the amount of a taxable estate.

5. The executor of the decedent's estate should make the election to insure the portability of the unified credit. Consideration of the above strategies and factors set forth in the problem could result in a significant reduction in estate taxes determined as follows: Initial gross estate ......................................... Add: Spouse’s remaining estate (see Note A). Subsequent appreciation (see Note B) ... Subsequent gross estate .............................. Less: Debts ....................................................... Administrative and funeral expenses ...... Gifts exempt from tax (see Note C)......... Tuition payments for grandchild .............. Charitable contributions .......................... Marital deduction (see Note D) ............... Taxable estate ..............................................

James Wagner $12,700,000

Susan Wagner $4,800,000 $6,805,000 450,000

$12,700,000 $ 210,000 25,000 70,000 50,000 200,000 6,805,000

Estate tax before credits ............................... Less unified credit ......................................... Estimated estate tax due .............................. Remaining estate after payment of estate taxes Note A:

This is the amount of the marital deduction.

Note B:

Appreciation of $150,000 per year times 3 years.

7,360,000 $5,340,000 $2,081,800 (2,081,800) $ 0

0 25,000 280,000 0 4,000,000 0

7,255,000 $12,055,000

4,305,000 $7,750,000 $3,045,800 (2,081,800) $964,200 $6,786,000

Ch. 20—Problems

20–12

Problem 20-1, Concluded Note C:

Gifts to each of the two children and the three grandchildren could be made by both spouses as follows: Gifts during current year ..................................... Gifts during 1 year after ...................................... Gifts during 2 year after ...................................... Gifts during 3 year after ...................................... Total ...................................................................

Note D:

By James $70,000 0 0 0 $70,000

By Susan $ 70,000 70,000 70,000 70,000 $280,000

The marital deduction amount reflects the creation of a credit shelter trust in the amount of $5,340,000. The tax on this amount will be offset by the unified credit.

PROBLEM 20-2 Entries to record activities of estate: Principal Cash ................................................................................ 50,000 Personal Residence ....................................................................... 450,000 Automobile and Sailboat ................................................................. 65,000 Investment in Mutual Funds ........................................................... 3,280,000 Collection of Antique Duck Decoys ................................................ 85,000 Death Benefit of Life Insurance Policy ............................................ 500,000 Farmland in Ozaukee County ......................................................... 800,000 Mortgage on Personal Residence ............................................ Life Insurance Policy Loan........................................................ Credit Cards Payable................................................................ Estate Principal ......................................................................... To record initial estate inventory. Devises Distributed ......................................................................... Mortgage on Personal Residence .................................................. Personal Residence.................................................................. To record transfer of personal residence to sister.

300,000 150,000

Legacies Distributed ....................................................................... Collection of Antique Duck Decoys...........................................

85,000

Legacies Distributed ....................................................................... Automobile and Sailboat ........................................................... To record contribution of sailboat and gift of automobile.

65,000

Funeral and Administrative Expenses ............................................ Principal Cash...........................................................................

25,000

150,000 50,000 5,000 5,025,000

450,000

85,000 65,000

25,000

20–13

Ch. 20—Problems

Problem 20-2, Continued Principal Cash ................................................................................ Life Insurance Policy Loan ............................................................. Death Benefit of Life Insurance ................................................ To record collection of death benefit and payment of policy loan.

450,000 50,000

Credit Cards Payable ..................................................................... Principal Cash........................................................................... To record payment of credit card balances.

5,000

Principal Cash ................................................................................ Income Cash .................................................................................. Investment in Mutual Funds...................................................... Estate Income ........................................................................... To record sale of mutual funds.

170,000 10,000

Principal Assets Transferred to Trust ............................................. Income Assets Transferred to Trust ............................................... Investment in Mutual Funds...................................................... Farmland in Ozaukee County ................................................... Principal Cash........................................................................... Income Cash............................................................................. To transfer estate assets to children’s trust.

3,929,000 10,000

Estate Principal ............................................................................... Estate Income ................................................................................. Devises Distributed ................................................................... Legacies Distributed ................................................................. Funeral and Administrative Expenses ...................................... Estate Tax Expense.................................................................. Principal Assets Transferred to Trust ....................................... Income Assets Transferred to Trust ......................................... To close out balances.

5,025,000 10,000

500,000

5,000

170,000 10,000

3,110,000 800,000 19,000 10,000

300,000 150,000 25,000 621,000 3,929,000 10,000

Ch. 20—Problems

20–14

Problem 20-2, Concluded Entries to record activities of trust: Principal Cash ................................................................................ 19,000 Income Cash .................................................................................. 10,000 Investment in Mutual Funds ........................................................... 3,110,000 Farmland in Ozaukee County ......................................................... 800,000 Trust Principal ........................................................................... Trust Income ............................................................................. To record distribution from estate. Income Cash .................................................................................. Trust Income ............................................................................. To record rental income.

25,000

Expenses Chargeable against Income ........................................... Income Cash............................................................................. To record property taxes and operating expenses.

8,000

Principal Cash ................................................................................ Income Cash .................................................................................. Investment in Mutual Funds...................................................... Trust Income ............................................................................. To record sale of mutual funds.

170,000 7,000

Income Cash .................................................................................. Trust Income ............................................................................. To record income on mutual funds.

22,000

Distribution of Corpus ..................................................................... Principal Cash........................................................................... To record distribution of corpus to daughter.

25,000

Distribution to Income Beneficiary .................................................. Income Cash............................................................................. To record distribution of income.

15,000

Investment in Mutual Funds ........................................................... Principal Cash........................................................................... Income Cash............................................................................. To record investment of all cash except $5,000 in mutual funds.

200,000

3,929,000 10,000

25,000

8,000

170,000 7,000

22,000

25,000

15,000

164,000 36,000

20–15

Ch. 20—Problems

PROBLEM 20-3 (1) Assuming no credit shelter trust is employed:

Decedent Spencer Cook $8,600,000 $ 180,000 210,000 500,000 7,710,000

8,600,000 $ —

Decedent Sara Cook $ 13,300,000 $420,000 — 500,000 —

Estate tax before credits ............................... Less unified credit Unused credit traceable to Spencer ........ Credit traceable to Sara .......................... Net estate tax due .........................................

920,000 $ 12,380,000 $ 4,897,800 (2,081,800) (2,081,800) $ 734,200

(2) Assuming a credit shelter trust is employed:

Gross estate.................................................. Less allowable deductions: Funeral, administrative, etc., expenses... Other debts ............................................. Charitable contributions .......................... Marital exclusion ..................................... Taxable estate .............................................. Estate tax before credits ............................... Less unified credit ......................................... Net estate tax due .........................................

Decedent Spencer Cook $ 8,600,000 $ 180,000 210,000 500,000 2,370,000

3,260,000 $ 5,340,000 $ 2,081,800 (2,081,800) $ —

Decedent Sara Cook $11,400,000 $420,000 — 500,000 —

920,000 $10,480,000 $ 4,137,800 (2,081,800) $ 2,056,000

Ch. 20—Problems

20–16

PROBLEM 20-4 Calculation of estate tax: Gross estate: Rug and pottery collection ...................................................................... Personal residence ................................................................................ Brokerage account at Wachovia Securities ........................................... Brokerage account at Schmidt Investment Services .............................. Antique pistol collection .......................................................................... Buffalo County hunting land ................................................................... Life insurance proceeds ......................................................................... All other assets ....................................................................................... Total .................................................................................................

120,000 550,000 2,200,000 900,000 85,000 750,000 250,000 1,500,000 $ 6,355,000

Less allowable deductions: Deductions excluding charitable donations ............................................ Donation to Museum of Northern New Mexico ...................................... Donation to First Church of Brookfield ................................................... Total ................................................................................................. Taxable estate ...................................................................................................

235,000 120,000 200,000 $ 555,000 $ 5,800,000

Estate tax [$780,800 + (45% × $3.3 million)] ...................................................... Less unified credit .............................................................................................. Net estate tax .....................................................................................................

$ 2,265,800 (2,081,800) $ 184,000

Available cash to satisfy general legacies: Excess amount realized on Buffalo County hunting land ....................... Excess insurance policy proceeds ......................................................... Liquidated value of other assets ............................................................ Subtotal ............................................................................................ Less: Allowable deductions excluding charitable contributions .............. Less: Net estate tax ............................................................................... Total cash available to satisfy general legacies ..................................... General legacies as set forth in will: Amount due eight grandchildren ............................................................ Amount due three children ..................................................................... Unsatisfied demonstrative legacies that constitute a general legacy: Not satisfied by Wachovia Securities account for brother Thomas ........ Not satisfied by Schmidt Investment Services account for two sisters .. Total needed to satisfy general legacies ............................................................

50,000 50,000 1,500,000 $ 1,600,000 (235,000) (184,000) $ 1,416,000 $

400,000 1,200,000

300,000 100,000 $ 2,000,000

General legacies can be satisfied at the rate of 70.8% ($1,416,000/$2,000,000) and are satisfied as follows: Amount due eight grandchildren (allocated equally) .............................. $ 283,200 Amount due three children (allocated equally) ....................................... 849,600 Amount due brother Thomas ................................................................. 212,400 Amount due two sisters (allocated equally) ............................................ 70,800 Total ................................................................................................. $ 1,416,000

20–17

Ch. 20—Problems

PROBLEM 20-5 At Date of Death

At Alternative Valuation Date

Gross estate: Google stock .............................................................................. Macon County real estate .......................................................... Household effects ...................................................................... Bank accounts............................................................................ Gold coins .................................................................................. Exxon Mobil stock. ..................................................................... Medcap insurance policy............................................................ Total ...........................................................................................

$2,700,000 3,250,000 Excluded 780,000 310,000 22,000 N/A $7,062,000

$2,340,000 3,050,000 Excluded 780,000 250,000 23,000 N/A $6,443,000

Deductions allowed: Loan against real estate ............................................................. Funeral and administrative expenses ........................................ Property taxes ............................................................................ Income taxes .............................................................................. Total ...........................................................................................

$307,200 45,000 4,000 27,000 $383,200

Taxable estate .................................................................................

$6,678,800

$6,059,800

$6,000,000

Post-1976 taxable gifts: Gift in year prior to diagnosis ..................................................... In the year of being diagnosed: Gift to First Baptist Church ................................................... Gift to Red Cross .................................................................. Gift to Medcap* .................................................................... Payment to Princeton ........................................................... Gift to sister* ......................................................................... Gift to nieces* ....................................................................... In the year of death: Gifts to family* ...................................................................... Total .....................................................................................

Not taxable Not taxable 87,000 Not taxable 56,000 3,000

56,000 3,000

55,000 $6,201,000

Unified tax base ...............................................................................

$12,879,800 $12,260,800

Estate tax: Tentative tax on total transfers ................................................... Less unified credit ...................................................................... Net gift and estate tax ................................................................ Less tax on taxable gifts** .......................................................... Net estate tax .............................................................................

$ 4,850,120 (2,081,800) $ 2,768,320) (344,400) $ 2,423,920

87,000

Ch. 20—Problems

20–18

Problem 20-5, Concluded

Tax due by year: Gift tax***…………………. Estate tax………………… Total tax…………………

Year Prior to Diagnosis $264,000 — $264,000

Year of Diagnosis $58,400 — $58,400

Year of Death $ 22,000 2,423,920 $2,445,920

Total $ 344,400 2,423,920 $2,768,320

*The amount of these gifts has been reduced by the $14,000 annual exclusion. ** This is tax of $2,426,200 on a gift of $6,201,000 less the lifetime exclusion amount of $2,081,800. ***The gift tax for each year is determined as follows:

Cumulative gift……………. Tentative tax………………….. Less unified credit…………….. Cumulative tax……………………….. Less prior year tax……………. Current year tax………..

Year Prior to Diagnosis $ 6,000,000 $ 2,345,800 (2,081,800) $ 264,000 — $ 264,000

Year of Diagnosis $ 6,146,000 $ 2,404,200 (2,081,800) $ 322,400 (264,000) $ 58,400

Year of Death $ 6,201,000 $ 2,426,200 (2,081,800) $ 344,400 (322,400) $ 22,000

20–19

Ch. 20—Problems

PROBLEM 20-6 (1)

Estate of Eleanor Matsun James Madison, Personal Representative Charge and Discharge Statement For the Period June 1 through December 31 of the Year of Death As to Principal

I charge myself with: Assets per original inventory ...................................................... Assets subsequently discovered: Gold coin collection .............................................................. Dividend on Pal Corp. common stock .................................. Undistributed income of partnership .................................... Gain (loss) on realization of principal assets: Sale of condominium ............................................................ Sale of partnership interest .................................................. Sale of personal residence ................................................... Total charges .............................................................................

$441,300 18,000 2,500 10,000 $

5,000 10,000 (8,000)

7,000 $478,800

I credit myself with: Payment of credit cards ............................................................. Funeral expenses....................................................................... Legal fees 2,500 Cost associated with sale of residence ...................................... Payment to personal representative .......................................... Payment of mortgage and accrued interest ............................... Income tax payments ................................................................. Total credits................................................................................

28,000 4,000 82,800 6,400 $142,600

Balance as to estate principal, consisting of: Cash ........................................................................................... Pal Corporation common stock .................................................. BVD Corporation common stock ................................................ RTC bonds ................................................................................. Gold coin collection .................................................................... Total estate principal ..................................................................

$188,300 60,000 40,000 29,900 18,000 $336,200

2,900 16,000

As to Income I charge myself with: Income from partnership ............................................................ Interest on RTC bonds ............................................................... Total charges .............................................................................

5,000 800 5,800

I charge myself with: None applicable .........................................................................

—

Balance as to estate principal, consisting of cash ...........................

5,800

Ch. 20—Problems

20–20

PROBLEM 20-7 (1) Cash—Principal [($40,000 × 1.03) + accrued interest] ................... Cash—Income ($40,000 × 0.08 × 1/12) ......................................... Pittsburgh 8% Bonds (fair value, February 1, 2016) ................. Accrued Interest on Pittsburgh Bonds ($40,000 × 0.08 × 1/12) Estate Income ($40,000 × 0.08 × 1/12) .................................... Gain on Realization of Principal Assets [$40,000 × (1.03 – 1.01)] .................................................... To record sale of bonds that were included in estate principal.

41,467 267

(2) Investment in 5% Detroit Bonds ..................................................... Accrued Interest on Detroit Bonds ($50,000 × 0.05 × 5/12) ........... Discount on Detroit Bonds Purchased ...................................... Cash—Principal [($50,000 × 0.98) + $1,042] ........................... To record purchase of Detroit bonds.

50,000 1,042

(3) Investment in 7% Newark Bonds .................................................... Accrued Interest on Newark Bonds ($10,000 × 0.07 × 3/12) ......... Premium on Newark Bonds ($10,000 × 0.02) ................................ Cash—Principal ........................................................................ To record purchase of Newark bonds.

10,000 175 200

(4) Cash—Principal .............................................................................. Cash—Income ($50,000 × 0.05 × 1/12) ......................................... Accrued Interest on Detroit Bonds ............................................ Estate Income ........................................................................... To record interest received on Detroit bonds. Discount on purchased bonds is not amortized to prevent excess distribution of income.

1,042 208

(5) Cash—Principal (amortization + accrued interest) ......................... Cash—Income ................................................................................ Premium on Newark Bonds [($200 ÷ 21 months) × 3 months] . Accrued Interest on Newark Bonds .......................................... Estate Income ($175 – $29) ..................................................... To record interest received on Newark bonds. Cash—Principal is increased by the amount of the accrued interest plus the amortization of premium.

202 148

(6) Cash—Income ($50,000 × 0.05 × 5/12) ......................................... Cash—Principal ($50,000 × 1.01) .................................................. Discount on Detroit Bonds Purchased ............................................ Investment in 5% Detroit Bonds ............................................... Estate Income ........................................................................... Gain on Realization of Principal Assets ($50,500 – $49,000) .. To record sale of Detroit bonds. Gain is the difference between the bond sale price and purchase price.

1,042 50,500 1,000

40,400 267 267 800

1,000 50,042

10,375

1,042 208

29 175 146

50,000 1,042 1,500

CHAPTER 21 UNDERSTANDING THE ISSUES 3. If a creditor is fully secured, by definition no portion of their claim will become unsecured. However, if the value of the assets securing their claim exceeds the amount of the claim, such excess amounts will become available to unsecured creditors. The claims of partially secured creditors exceed the value of the assets securing their claims. Therefore, the unsecured amounts are combined with the other existing unsecured claims. Once the total of all unsecured claims is identified, those unsecured claims will proceed against the remaining assets of the company in order of priority.

1. Given a restructuring that is not under bankruptcy law, the gain on restructuring is measured as the amount by which the book value of the debt, including accrued interest, exceeds the total of all restructured principal and interest payments. If the total payments exceed the book value, no gain is recognized. Note that the present value of the payments received is not considered in the determination of the gain. For a restructuring that is under bankruptcy law, the gain is measured as the amount by which the book value of the debt, including accrued interest, exceeds the fair value of the restructured consideration received. The value of the consideration received is the net present value of the restructured payments.

4. The statement of realization and liquidation serves several purposes. First, it provides a reporting of the activities of the trustee in liquidation and helps discharge the fiduciary responsibility. The statement also documents that available assets are being distributed properly among the various creditors and in the proper order of priority. A review of the statement may also provide outstanding creditors with some sense of how much they may receive in satisfaction of their claims.

2. A corporate reorganization is a legal remedy designed to restructure the debt and/or equity of a troubled company so that the company may continue to operate and ultimately become financially sound. The ultimate goal of a reorganization is to provide a more attractive alternative than liquidation and allow the company to continue its business purpose. A corporate liquidation does not hold promise for a recovery but rather is designed to facilitate a termination of the business. Assets of the company are converted into a distributable form and conveyed to creditors and shareholders to whatever extent possible. Upon completion of the distribution of assets, the business entity ceases to exist.

Ch. 21—Exercises

21–2

EXERCISES Note: Some calculations may vary due to rounding or method of calculation. Answers presented have been determined using Excel.

EXERCISE 21-1 Alternative A—Income Statement Impact First Month: Gain on land: Fair market value ......................................................................... Carrying value .............................................................................. Gain .............................................................................................

$ 380,000.00 (260,000.00) $ 120,000.00

Gain on restructuring: Remaining carrying value of debt: Original carrying value ............................................................. Value of land ........................................................................... Current carrying value .............................................................

$ 566,974.50 (380,000.00) $ 186,974.50

It must be determined whether the new loan is substantially different from the original loan (i.e., the 10% test). Using the original loan's effective of interest rate of 0.5% (6% divided by 12 months), the net present value of the restructured loan is $183,306 determined as follows: Where:

The number of payments is .......................................... The periodic payment is ............................................... The future value is ....................................................... Periodic interest rate is ................................................

40 $5,067.60 $ — 0.50%

The new loan is not substantially different ($183,306 vs. $186,974) and therefore, the restructuring should be accounted for as a modification rather than an extinguishment of debt. Therefore, no gain or loss on restructuring is recognized. Interest expense: Effective interest rate is 0.40% per month where n = 40, present value is $186,974.50, and payment is $5,067.60. Interest expense: Current carrying value ................................................................. Interest rate.................................................................................. Interest expense ..........................................................................

$ 186,974.50 0.40% $ 747.90

21–3

Ch. 21—Exercises

Exercise 21-1, Continued Second Month: Interest expense: Current carrying value ................................................................. where n = 39, interest rate = 0.40%, and the payment is $5,067.60. Interest rate.................................................................................. Interest expense ..........................................................................

$ 182,654.73

0.40% 730.62

Alternative B—Income Statement Impact First Month: Gain on land: Fair market value ......................................................................... Carrying value .............................................................................. Gain .............................................................................................

$ 380,000.00 (260,000.00) $ 120,000.00

Gain on restructuring: Using the original loan's effective of interest rate of 0.5% (6% divided by 12 months), the net present value of the restructured loan is $155,177 determined as follows: Where:

60 $3,000.00 $ — 0.50%

The new loan is substantially different ($155,177 vs. $186,974) and therefore, the restructuring should be accounted for as an extinguishment of debt rather than a modification. Remaining carrying value of debt: Original carrying value ............................................................. Value of land ........................................................................... Current carrying value ............................................................. Less: Fair value of new debt ........................................................ Gain on restructuring ...................................................................

$ 566,974.50 (380,000.00) $ 186,974.50 160,000.00 $ 26,974.50

Interest expense: The implicit interest rate on the new debt is 0.39% per month determined as follows: Where: The number of payments is .......................................... 60 The periodic payment is ............................................... $ 3,000.00 The future value is ....................................................... $ — The present value is .................................................... $160,000.00 Interest expense: Current carrying value ................................................................. Interest rate.................................................................................. Interest expense ..........................................................................

$ 160,000.00 0.39% $ 624.00

Ch. 21—Exercises

21–4

Exercise 21-1, Concluded Second Month: Interest expense: Current carrying value ................................................................. where n = 59, interest rate = 0.39%, and payment is $3000. Interest rate.................................................................................. Interest expense ..........................................................................

$ 157,838.63

0.39% 615.57

EXERCISE 21-2 Interest Bearing Debt ...................................................................... Preferred Stock (at par) ............................................................ Paid-In Capital in Excess of Par ............................................... Gain on Restructuring ............................................................... To record extinguishment of debt.

300,000

Gain on Restructuring ..................................................................... Retained Earnings .................................................................... To close gain to retained earnings.

50,000

Common Stock (at par) .................................................................. Paid-In Capital in Excess of Par ..................................................... Paid-In Capital from Treasury Stock ............................................... Treasury Stock.......................................................................... To record retirement of treasury stock.

100,000 30,000 20,000

Accumulated depreciation .............................................................. Retained Earnings .......................................................................... Inventory ................................................................................... Equipment................................................................................. To record write down of inventory and equipment.

360,000 220,000

Paid-In Capital from Reduction in Stock Par Value ........................ Retained Earnings .................................................................... To record reduction in par value.

470,000

50,000 200,000 50,000

50,000

150,000

80,000 500,000

470,000

21–5

Ch. 21—Exercises

EXERCISE 21-3 (1) The impact on the ratios is directly related to how each of the actions taken by management impacts the financial statements. The recognition of impairment losses will decrease long-lived assets and decrease net income and corresponding shareholders’ equity. Future periods will base depreciation/amortization on the long-lived assets on the lower impaired value, which will increase future income. The restructuring of the long-term debt will result in a restructuring gain. However, since the future cash payments are less than the carrying basis of the original debt, no interest expense will be recognized in future periods. The adjustment of the par value of common stock in order to eliminate the deficit in retained earnings will have no impact on net income nor will it change the total amount of shareholders’ equity. Given the above, it would appear that the current ratio would be affected by the current portion of the restructured debt. Given the fact that the payments are less than the carrying basis of the original debt, the current portion could very easily be less and, therefore, the current ratio could increase. It is clear that the debt restructuring would leave the company with less debt, which, absent any other information, would result in a decrease in the debt-to-equity ratio. However, the net effect on income of the impairment loss and the gain on restructuring will obviously have an impact on equity. Therefore, the debt-to-equity ratio must also reflect any changes due to these transactions. The return on equity would be affected by the net effect on income of the impairment loss and the restructuring gain. This net effect would obviously impact net income and the balance in retained earnings. The adjustment of par would have no effect on the return on equity because the total equity is not changed as a result of eliminating the deficit. (2) Net income in future periods would be affected by lower depreciation/amortization expense and no interest expense on the new restructured debt.

Ch. 21—Exercises

21–6

EXERCISE 21-4

Total amount due .............................. Less amounts applied against debt: Value of assets transferred ......... Value of stock transferred ........... Remaining debt ................................. Total of periodic payments to be applied against remaining debt ......

A $ 84,000 (80,000) $

4,000

—

Outstanding Debt B C $ 520,000 $328,000

D $350,000

(120,000) (380,000) $ 20,000

— — $328,000

$301,661

$300,000

$320,000

—

(48,339)

Regarding Debt A: A gain on restructuring of $4,000 would be recognized because no other consideration is being conveyed to satisfy the remaining debt. There would be no interest expense. Regarding Debt B: A gain on restructuring of $20,000 would be recognized because no other consideration is being conveyed to satisfy the remaining debt. There would be no interest expense. Regarding Debt C: Because the total of the periodic payments is less than the remaining debt, there would be a gain of restructuring in the amount of $28,000. Furthermore, because the periodic payments are less than the remaining debt, no interest expense would be recognized. All periodic payments are considered to be a reduction of the revised principal amount due of $300,000. Regarding Debt D: Because the total of the periodic payments exceeds the remaining debt, there is no gain on restructuring. The periodic payments totaling $320,000 therefore represent a payment of the remaining principal amount due of $301,661 and total interest in the amount of $18,339. The interest rate is that rate which discounts the five semiannual payments so that their present value is $301,661. This semiannual rate is 2% which is less than the original debt's semiannual effective rate of 3%. Therefore, the creditor has made a concession. The interest for the first six months is $6,033 (2% × $301,661).

21–7

Ch. 21—Exercises

EXERCISE 21-5

July 1 Debt A (see note 1): Gain on transfer of land……..………$175,000 Gain on restructuring………………… 64,000 Interest expense……………………… $239,000 Debt B (see Note 2): Gain on restructuring……………….… $ 0 Interest expense……………..……… $ 0 Note 1

Quarter 3

Quarter 4

Total $

0 0

$21,482.50 $21,482.50

0 0

$19,245.59 $19,245.59

Original carrying value of debt ..................................................... Less: Fair value of land ................................................................ Remaining carry value ................................................................. Sum of restructured payments (8 × $70,000) .............................. Gain on restructuring ...................................................................

175,000 64,000 0 239,000

$ 0 40,728.09 $40,728.09 $1,224,000 (600,000) 624,000 (560,000) $ 64,000

Because the sum of the restructured payments equal the restructured carry value of the debt, there is no recognized interest expense. Note 2

Original carrying value of debt ..................................................... Less: Fair value of stock .............................................................. Remaining carry value ................................................................. Sum of restructured payments (7 × $193,553.02 plus $400,000)

$2,152,500.00 (500,000.00) $1,652,500.00 $1,754,871.14

Because the sum of the restructured payments exceed the restructured carry value of the debt, there is implicit interest expense. The quarterly implicit interest rate is ............................................ Where: PV equals ................................................................... FV equals ................................................................... Payment equals ......................................................... N equals .....................................................................

Beginning balance Payment 1 Payment 2 Payment 3 Payment 4 Payment 5 Payment 6 Payment 7

Payment

Interest

Principal

$193,553.02 193,553.02 193,553.02 193,553.02 193,553.02 193,553.02 593,553.02

$21,482.50 19,245.59 16,979.59 14,684.14 12,358.84 10,003.31 7,617.17

$172,070.52 174,307.43 176,573.43 178,868.88 181,194.18 183,549.71 585,935.85

1.30% 1,652,500.00 400,000.00 193,553,02 7 Balance $1,652,500.00 1,480,429.48 1,306,122.05 1,129,548.62 950,679.74 769,485.56 585,935.85 —

Ch. 21—Exercises

21–8

EXERCISE 21-6 (1) Item Loan A restructuring: $3,580,000 restructured at 10%, 8 years, and monthly installments. The monthly payment is $50,000..................................... Loan B restructuring: No effect on cash outflows.................................................................... Loan C restructuring: Debt to be paid in installments is $1,787,500 ($2,000,000 + $37,500 – $250,000). Given n = 20 and i = 2.25%, the payment is $111,973 ...................................................................... Total quarterly cash outflows.. ..................................................................... (2) Item Loan A restructuring: Gain on forgiveness of debt ................................................ ...

Quarterly Cash Outflows

$150,000 0

111,973 $261,973

Effect on Net Income If Part of a Not Part of a Formal Filing Formal Filing $500,000

$500,000

Gain on restructuring of remaining debt: Total payments = $4,800,000 (96 × $50,000). Net present value of payments at 10% is $3,295,074 vs. carrying basis of $3,580,000 ........................................................................ 284,926

—

The effective interest rate on the restructured note (0.64% per month) is less than the effective interest rate of the original note (1% per month). Therefore, the lender has made a concession. Interest expense: Based on stated rate of 10% ............................................... .. Based on imputed rate of 7.6640% (see note) .................... ..

(81,812) (68,071)

Loan B restructuring: Gain on forgiveness of accrued interest. ............................... Gain on exchange of preferred stock.....................................

25,000 100,000

Loan C restructuring: Gain on transfer of land ......................................................... Interest based on 9% ........................................................... ..

50,000 (40,219)

The effective interest rate on the restructured note (2.25% per quarter) is less than the effective interest rate of the original note (3% per quarter). Therefore, the lender has made a concession. Total effect on net income for the first quarter ...........................

$837,895

$566,710

Note: This is the interest rate given a periodic payment of $50,000, the 96 monthly periods, and a present value of $3,580,000.

21–9

Ch. 21—Exercises

EXERCISE 21-7

Accounts payable .......................... Note payable—A ........................... Note payable—B ........................... Mortgage payable ......................... Accrued interest ............................ Other liabilities ...............................

Fully Secured $130,000

$560,000 300,000

Liabilities Unsecured With Without Priority Priority $150,000 40,000 200,000

$860,000

$10,000 $10,000

Partially Secured

180,000 12,000 $322,000

14,000 $404,000

Total $ 280,000 600,000 500,000 180,000 12,000 24,000 $1,596,000

Realizable Value Assets to be applied against the liabilities: Inventory Inventory .................................... Receivables ............................... Equipment .................................. Equipment .................................. Land ........................................... Cash ........................................... Other assets............................... Dividend .....................................

$ 150,000 $130,000 $ 20,000 $ 150,000 200,000 $200,000 200,000 360,000 360,000 360,000 300,000 300,000 300,000 60,000 60,000 60,000 260,000 192,000 68,000 260,000 60,000 $10,000 50,000 60,000 45,000 45,000 45,000 $1,435,000 $322,000 $860,000 $10,000 $243,000 $1,435,000 100.0%

Total consideration to be received by Note B: Received toward partially secured portion ............................. Received toward unsecured portion: Unsecured portion ........................................................... Dividend........................................................................... Total consideration received ..................................................

100.0%

60.15%

$300,000 $200,000 × 60.15%

120,300 $420,300

Ch. 21—Exercises

21–10

EXERCISE 21-8

Claims against the bankrupt estate: Bank loan balance and accrued interest ........................ Dealer-financed vehicle loan .......................................... Accounts payable due vendors ...................................... Line of credit due............................................................ Payroll and taxes due..................................................... Expenses to administer the estate ................................. Accrued payroll .............................................................. Shareholder loans .......................................................... Other unsecured creditors without priority ..................... Subtotal .......................................................................... Assets available to satisfy fully and partially secured claims Net unsatisfied balance........................................................ Reclassify as unsecured without priority .............................. Subtotal ................................................................................ Assets available to satisfy unsecured claims ....................... Net unsatisfied balance........................................................ Dividend to unsecured creditors ..........................................

Amounts received by each major class of creditor: Amounts received: Secured amount received .......................................... Unsecured amount received: 100% Dividend on $39,200 ................................... 47.77% Dividend on $10,000 ................................ 47.77% Dividend on $111,000 .............................. Total ...........................................................................

Fully Secured $ 85,000 — — 30,000 — — — — — $115,000 (115,000) $ — — $ — — $ —

Partially Secured $ — 18,000 21,000

Fully Secured

Partially Secured

$115,000

$29,000

Unsecured With Without Priority Priority $ — $ —

23,000 12,000 4,200 $ 39,000 (29,000) $ 10,000 (10,000) $ — — $ —

$39,200 $39,200 $39,200 (39,200) $ — 100.00%

80,000 31,000 $111,000 $111,000 10,000 $121,000 (57,800) $ 63,200 47.77%

Unsecured With Without Priority Priority

$39,200 $33,777

Total $144,000

4,777 $115,000

Total $ 85,000 18,000 21,000 30,000 23,000 12,000 4,200 80,000 31,000 $304,200 (144,000) $160,200 — $160,200 (97,000) $ 63,200

$39,200

$53,023 $53,023

39,200 4,777 53,023 $241,000

Note: Although the solution to this exercise is fairly straightforward, setting up a presentable schedule may be a challenge to students. This is an excellent occasion to discuss with students the importance of documenting one’s work in an understandable and user friendly manner.

part.

21–11

Ch. 21—Exercises

EXERCISE 21-9 (1)

The Rodak Corporation Statement of Realization and Liquidation For Period July 1, 2014, to August 12, 2014 Liabilities Assets Cash Noncash

Beginning balances, assigned July 1, 2014............................. $ 12,000 Cash receipts: Sale of inventory ..................... Collection on receivables ........ Sale of securities..................... Sale of machinery ...................

30,000 39,000 22,500 36,000

Cash disbursements: Payment of loan ...................... Payment of accounts payable . Payment of bank loan .............

(12,000) (25,000) (36,000)

Subsequently discovered: Liabilities ................................. Ending balance .......................... $ 66,500

$590,000

Unsecured With Without Priority Priority

Fully Secured

Partially Secured

$200,000

$175,000 $54,000

$150,000

Owners’ Equity $ 23,000

(25,000) (54,000) (18,000) (45,000)

5,000 (15,000) 4,500 (9,000) (12,000) (25,000) (50,000)

$448,000

$163,000

$125,000 $54,000

(2) Estimated assets available: Cash ..................................................................................................... Estimated value of noncash assets ...................................................... Value of all liabilities excluding unsecured creditors without priority....................................................................................... Assets available for unsecured creditors without priority ............................

14,000 15,000 $179,000

(15,000) $ (6,500)

$ 66,500 410,000 $476,500 342,000 $134,500

Estimated dividend to unsecured creditors without priority: $134,500 ÷ $179,000 = 75%

Ch. 21—Problems

21–12

PROBLEMS PROBLEM 21-1 Jan. 1, 2014 Cash ................................................................................ 4,915,562 Deferred Debt Issuance Costs ......................................... 84,438 Loan Payable .............................................................

5,000,000

To record issuance of debt. June 30, 2014 Interest Expense ............................................................ Deferred Debt Issuance Costs ................................... Cash...........................................................................

157,298 7,298 150,000

To record semi-annual interest at the effective interest rate of 3.20% per six months. Where, PV = $4,915,562, FV = $5,000,000, interest = $150,000, and n = 10. Effective interest rate per six months ............................. Interest Payment Jan. 1, 2014 June 30, 2014 Dec. 31, 2014 June 30, 2015

(150,000) (150,000) (150,000)

Deferred Debt Issuance 84,438 (7,298) (7,532) (7,773) 61,836

3.20%

Interest Expense

NPV of Debt 4,915,562 4,922,860 4,930,392 4,938,164

157,298 157,532 157,773

Dec. 31, 2014 Interest Expense ............................................................. Deferred Debt Issuance Costs ................................... Cash...........................................................................

157,532 7,532 150,000

To record semi-annual interest at the effective rate of 3.2%. June 30, 2015 Interest Expense ............................................................ Deferred Debt Issuance Costs ................................... Loan Payable (accrued interest) ................................ The effective interest rate on the original debt prior to restructuring was Where:

Number of periods is……….… Periodic payment is…………... Future value is………………… Net present value is……………

7,773 150,000 3.11% semiannual

7 $ 150,000 $5,150,000 ($5,000,000 + $150,000 unpaid interest) $5,088,164 ($4,938,164 + $150,000 unpaid interest)

The effective interest rate on the restructured debt is ............................ Where:

157,773

3.09% semiannual

10 $ 165,000 $5,000,000 $5,088,164

21–13

Ch. 21—Problems

Problem 21-1, Concluded Based on a comparison of the above effective interest rates (3.11% vs. 3.09%), it is apparent that the creditor has made a concession. Therefore, the restructuring qualifies as a troubled debt restructuring. June 30, 2015 Debt Issuance Expense ................................................. Cash...........................................................................

50,000 50,000

To record payment of fee upon restructuring. There is no gain on restructuring because the sum of the cash flows per the restructuring are greater than the carrying amount of the debt prior to restructuring. Cash flows per restructuring: Periodic interest (10 semi-annual payments at $165,000)………..…. Repayment of principal……………………………...…………………… Total cash outflows………………………………………………………. Carrying amount of the debt prior to restructuring: Loan payable……………………………………………………………… Unamortized debt issuance costs………………………………………. Accrued Interest Payable……………………………………………......

1,650,000 5,000,000 6,650,000 5,000,000 (61,836) 150,000 5,088,164

Accrued Interest Payable ....................................................................... Deferred Debt Issuance Costs ............................................

150,000 150,000

To reclassify accrued interest as part of unamortized discount/premium. Dec. 31, 2015 Interest Expense ............................................................. Deferred Debt Issuance Costs ................................... Cash......................................................................

157,342 7,658 165,000

To record semiannual interest at the effective interest rate of 3.09%.

0 1 2 3 4 5 6 7 8 9 10

Payment

Interest Expense

$165,000 165,000 165,000 165,000 165,000 165,000 165,000 165,000 165,000 5,165,000

$157,342 157,105 156,861 156,609 156,350 156,082 155,807 155,522 155,229 154,927

Loan Payable $5,000,000

(5,000,000)

Deferred Debt Issuance* $88,164 (7,658) (7,895) (8,139) (8,391) (8,650) (8,918) (9,193) (9,478) (9,771) (10,073)

Net Loan Value** $5,088,164 5,080,506 5,072,611 5,064,472 5,056,082 5,047,432 5,038,514 5,029,321 5,019,843 5,010,073 (0)

*Previous deferred debt issuance costs of $61,836 debit plus reclassification of $150,000 credit. **Previous carrying value of $5,088,164.

Ch. 21—Problems

21–14

PROBLEM 21-2 (a) Cash ............................................................................................... Accumulated Amortization .............................................................. Loss on Sale of Patents .................................................................. Patents...................................................................................... To record the sale of patents.

20,000 115,000 5,000

(b) Impairment Loss ............................................................................. Goodwill .................................................................................... To record impairment loss on goodwill.

100,000

(c) Cash ............................................................................................... Transaction Expense ...................................................................... Loss on Disposal of Land ............................................................... Vacant Land.............................................................................. To record sale of vacant land.

185,000 10,000 15,000

Mortgage Payable .......................................................................... Accrued Interest Payable ............................................................... Cash ......................................................................................... Gain on Restructuring ............................................................... To record gain on restructuring of mortgage.

230,000 15,000

(d) Loan from Shareholder ................................................................... Accrued Interest Payable ............................................................... Restructured Shareholder Loan................................................ Cash ......................................................................................... To record restructuring of shareholder loan. The net present value of the 16 payments given an interest rate of 6% is $124,500. Based on a comparison of effective interest rates, the creditor has made a concession.

150,000 4,500

(e) Vendor Account Payable ................................................................ Cash ......................................................................................... Vendor Note Payable................................................................ Gain on Restructuring ............................................................... To record restructuring of vendor payable.

85,000

(f)

140,000

100,000

210,000

185,000 60,000

124,500 30,000

Bank Debt ....................................................................................... 510,000 Accrued Interest Payable ............................................................... 22,000 Investment Securities ............................................................... Treasury Stock.......................................................................... Contributed Capital from Treasury Stock .................................. Restructured Bank Debt ........................................................... Gain on Sale of Investments..................................................... To record restructuring of bank debt. Based on a comparison of effective interest rates, the creditor has made a concession.

15,000 60,000 10,000

62,000 150,000 50,000 252,000 18,000

21–15

Ch. 21—Problems

Problem 21-2, Concluded (g) Bank Note ....................................................................................... Restructured Bank Note ........................................................... Gain on Restructuring ............................................................... To record restructuring of bank note.

60,000 51,000 9,000

(h) Creditor Debt .................................................................................. 120,000 Accumulated Depreciation .............................................................. 150,000 Equipment................................................................................. Gain on Disposal of Equipment ................................................ Restructured Creditor Debt ....................................................... To record restructuring of creditor debt. The modified debt is not significantly different that the original debt balance based on the discounting at the original loan's effective interest rate.

220,000 10,000 40,000

Total Interest Expense in Connection with First Quarterly Payment

Mortgage payable ............ Shareholder loan .............. Vendor payable ................ Bank debt ......................... Bank note ......................... Secured creditor ...............

Original Balance $245,000 154,500 85,000 532,000 60,000 120,000

Reduction in Balance $245,000 30,000 25,000 280,000 9,000 80,000

Mortgage payable ............ Shareholder loan .............. Vendor payable ................ Bank debt ......................... Bank note ......................... Secured creditor ...............

Unpaid Balance $ 0 124,500 60,000 252,000 51,000 40,000

Quarterly Interest Rate 0.00% 1.50 0.00 1.60 0.00 1.40

Unpaid Balance $ 0 124,500 60,000 252,000 51,000 40,000

Quarterly Payment $ 0 8,810.25 10,000.00 27,470.38 17,000.00 6,997.12

Implicit Number Quarterly of Interest Payments Rate 0 0.00% 16 1.50 6 0.00 10 1.60 3 0.00 6 1.40

Interest $ 0 1,867.50 0 4,032.00 0 560.00

Ch. 21—Problems

21–16

PROBLEM 21-3 (1)

Original December 31, 2017 Dr. (Cr.) Debit Cash ...................................... $ (15,000) Accounts receivable (net)...... 500,000 (a) Inventory ............................... 150,000 (a) Plant and equipment (net) ..... 1,560,000 (b) Goodwill ................................ 150,000 (b) Other assets: Current portion ................ 6,209 (c) $ 1,616 Noncurrent portion .......... 28,791 (c) Accounts payable .................. (320,000) 7% Note payable: Current portion ................ 0 (d) Noncurrent portion .......... (1,500,000) (d) 300,000 Common stock at par ............ (550,000) (e) 1,000,000 (e) Contributed capital in excess of par ............................... (550,000) (e) 550,000 0 Retained earnings ................. 300,000 (e) 2017 Net income ................... 240,000 (e) Impairment loss ..................... (a) 95,000 Impairment loss ..................... (b) 425,000 (d) (e) Total ................................ $ 0 $2,371,616

Adjusted December 31, 2017 Credit Dr. (Cr.) $ (15,000) $ 75,000 425,000 20,000 130,000 275,000 1,285,000 150,000 0 7,825 27,175 (320,000)

1,616 240,000 550,000

(240,000) (1,200,000) (100,000)

300,000 240,000

0 0

60,000 460,000 $2,371,616

(a) To recognize impairment in the value of receivables and inventory. (b) To recognize impairment in the value of equipment and goodwill. (c) To reclassify note between current and noncurrent given the new payment of $10,450 ($35,000 is the present value of four payments at 7.5% interest). (d) To recognize restructuring gain. 12 payments of $120,000 = $1,440,000. Therefore, the restructuring gain is $60,000, and all payments are considered to be principal only. Because the total of all payments is less than the book value of the note, all payments are considered to be principal. (e) To record quasi-reorganization by adjusting par value of common stock and eliminating contributed capital in excess of par. (2) Calculation of ratios: Current ratio ............................................ Debt-to-equity..........................................

Before Actions

After Actions

2.00 3.25

0.98 NA*

*The debt-to-equity ratio is not meaningful in that there is negative equity. The adjusted assets total $1,475,000, and the adjusted debt totals $1,760,000. All assets are being financed by debt capital.

21–17

Ch. 21—Problems

Problem 21-3, Concluded (3) The above ratios have not improved as a result of management’s actions. However, several benefits may not be apparent from the ratio analysis. First, management has a balance sheet that more clearly reflects market values. Second, the recognition of impairment losses on equipment will translate into lower depreciation expense in future years. It is also possible that impairment losses on current assets will result in lower near-term expense levels associated with bad debt expense and cost of sales. These adjustments to expense levels will result in an improved measure of income. Third, the restructuring of the 7% note payable results in the company paying out a lower net present value on the debt than would have been the case had the debt not been restructured. Finally, the elimination of the deficit will make it easier for the company to be in a position to return a dividend to its shareholders.

PROBLEM 21-4 1. Classification of Liabilities: Portion of Liability Fully Secured Accounts payable…………………… $ 0 Note payable………………………… 24,000 Accrued interest……………………… Mortgage payable…………………… 1,000,000 Unsecured creditors with priority…… Total…………………………………… $1,024,000

Partially Secured Secured Unsecured $200,000 $ 50,000 250,000 350,000

$450,000

Unsecured $ 90,000

70,000 $160,000

$400,000

Total $ 340,000 600,000 24,000 1,000,000 70,000 $2,034,000

Allocation of Assets: Asset Net Realizable Value Allocated to Fully Secured Free assets……………………………$ 0 Inventory……………………………… Equipment…………………………… Land and building…………………… 1,024,000 Total…………………………………… $1,024,000

Partially Secured Secured Unsecured $ 0 $ 0 330,000 120,000 $450,000

Totally Unsecured $ 85,000

326,000 $411,000

Total 85,000 330,000 120,000 1,350,000 $1,885,000

Ch. 21—Problems

21–18

Problem 21-4, Concluded Dividend to general unsecured creditors: Proceeds available to unsecured creditors………….…….……… $411,000 Less: Unsecured with priority…………………………….…….…... (70,000) Proceeds available to unsecured without priority…………........... 341,000 Total claims of unsecured without priority…………………………. $490,000 Dividend ($341,000 divided by $490,000) of $0.70 on the dollar or 70% Amount received by holders of note payable: Amount secured by specific assets: Amount secured by inventory……………………………………. $130,000 Amount secured by equipment…………………………………... 120,000 Dividend on unsecured portion ($350,000 × 70%)………………… 245,000 Total consideration received by note holder………………………... $495,000 2.

Target present value of restructured note ($495,000 + $80,000) ... Given a: Target quarterly payment of ....................................... Target rate of .............................................................. The minimum term of the restructured note is ..........................

$575,000 52,716 6.00% 12.00 quarters

Carrying value of mortgage: Principal balance ...................................................................... $1,000,000 Accrued interest ........................................................................ 24,000 Total carrying value .................................................................. $1,024,000 Annual implicit interest rate is ................................................... Where: PV equals ............................................................... $1,024,000 FV equals ............................................................... $100,000 Payment equals ..................................................... $15,195.39 N equals ................................................................. 72

4.80%

21–19

Ch. 21—Problems

PROBLEM 21-5 (a) Note Payable—Officer .................................................................... Patents (net) ............................................................................. Gain on Patents ........................................................................ To record transfer of patents against note.

230,000

(b) Mortgage Payable .......................................................................... Cash ......................................................................................... To record payment on mortgage payable.

100,000

210,000 20,000

100,000

(c) Bank A Note Payable ($980,000 + $95,000) .................................. 1,075,000 Development Land.................................................................... Marketable Securities (other current assets) ............................ Gain on Land ............................................................................ Gain on Marketable Securities.................................................. To record transfer of land and securities against note. (d) Bank B Note Payable ..................................................................... Loss on Equipment ......................................................................... Equipment (net) ........................................................................ To record transfer of equipment against note.

220,000 20,000

Bank B Note Payable ..................................................................... Gain on Restructuring ............................................................... To record gain on restructuring. The 10 payments of $55,000 are less than the remaining balance on the note of $600,000 ($820,000 – $220,000).

50,000

(e) Note Payable—Officer .................................................................... Mortgage Payable .......................................................................... Bank A Note Payable ..................................................................... Bank B Note Payable ..................................................................... Interest Expense ............................................................................. Cash ......................................................................................... To record June 30, payments on notes (see Note A).

33,327 23,178 95,770 55,000 45,075

(f)

Common Stock ($10 par value) ...................................................... Common Stock ($5 par value) .................................................. Paid-In Capital from Reduction in Par Value ............................ To record reduction in par value.

200,000

Paid-In Capital from Reduction in Par Value .................................. Paid-In Capital in Excess of Par ..................................................... Retained Earnings .................................................................... To eliminate deficit in retained earnings.

100,000 100,000

700,000 80,000 280,000 15,000

240,000

50,000

252,350

100,000 100,000

200,000

Ch. 21—Problems

21–20

Problem 21-5, Concluded Note A:

Note payable—officer....... Mortgage payable ............ Bank A note payable ........ Bank B note payable ........

Original Balance $ 400,000 1,500,000 2,100,000 820,000

Reduction in Balance $ 230,000 100,000 1,075,000 270,000

Note payable—officer....... Mortgage payable ............ Bank A note payable ........ Bank B note payable ........

Unpaid Balance $ 170,000 1,400,000 1,025,000 550,000

Quarterly Interest Rate 1.00% 2.00 1.50 0.00

Unpaid Balance $ 170,000 1,400,000 1,025,000 550,000

Quarterly Payment $ 35,026.77 51,178.05 111,145.03 55,000.00

Payment $ 35,026.77 51,178.05 111,145.03 55,000.00 $252,349.85

Interest $ 1,700 28,000 15,375

— $45,075

Implicit Number Quarterly of Interest Payments Rate 5 1.00% 40 2.00 10 1.50 10 0.00

Principal $ 33,327 23,178 95,770 55,000 $207,275

21–21

Ch. 21—Problems

PROBLEM 21-6 St. John Corporation Statement of Realization and Liquidation For the Period January 1, 2016, to June 30, 2016 Liabilities Assets Cash Noncash

Fully Secured

Partially Secured

Unsecured With Without Shareholders’ Priority Priority Equity

Beginning balances, assigned January 1, 2016 ...................... $42,000 $5,910,000 Accounts payable.................... $ 400,000 $ 320,000 $ 92,000 Note payable—officer ............. 400,000 Bank A note payable ............... 2,100,000 Bank B note payable ............... 820,000 Mortgage payable ................... 1,500,000 Other liabilities ........................ 90,000 $ 35,000 95,000 Beginning balances................. $42,000 $5,910,000 $2,810,000 $2,820,000 $ 35,000 $187,000 Subsequently discovered items: Additional assets ..................... Administrative expenses .........

$100,000

15,000

Cash receipts: Sale of inventory ..................... 480,000 Sale of equipment ................... 700,000 Sale of patent .......................... 250,000 Sale of development land ....... 360,000 Sale of other assets ................ 100,000 Collection of receivables ......... 150,000

15,000 (20,000)

20,000 (430,000) (800,000) (210,000) (300,000) (130,000) (150,000)

Cash disbursements: Inventory completion costs ..... (25,000) Payment of accounts payable ................................ (400,000) (400,000) Payment of accounts payable ................................ Payment of broker’s fee .......... (10,000) Payment to Bank A ................. (940,000) (940,000) Payment of other liabilities ...... (110,000) (90,000) (20,000) Payment of administrative expenses ............................. (10,000) (10,000) Ending balances ......................... $ 602,000 $3,890,000 $2,320,000 $1,880,000 $ 25,000 $187,000

50,000 (100,000) 40,000 60,000 (30,000)

(25,000)

(10,000)

$ 80,000

Ch. 21—Problems

21–22

PROBLEM 21-7 Debt A The original effective interest rate on the note is 1.81% per quarter determined as follows: Where: Number of periods is…………….... 12 Periodic payments are……………. $ 45,000 (6%/4 × $3,000,000) Future value is……………………... $3,000,000 Present value is……………..……... $2,900,000 ($3,000,000 – $100,000 of debt issuance costs) The carrying value of the note at the time of the restructuring is $2,923,018 determined as follows: Where:

Number of periods is………….…….. Periodic payments are…………..….. Future value is……………………..… Effective interest rate………………...

9 $ 45,000 (6%/4 × $3,000,000) $3,000,000 1.81% per quarter

Balance in note payable……………………………. $ 3,000,000 Unamortized debt issuance costs…………………. $ (76,982) Net carrying value…………………………………… $ 2,923,018 The net present value of the new debt, based on the original debt's effective interest rate is $3,317,347 determined as follows: Where: Number of periods is………………….. 13 Periodic payments are………………... $ 54,400 (6.4%/4 × $3,500,000) Future value is……………………........ $3,400,000 Effective interest rate…………………. 1.81% per quarter The new loan is substantially different from the original loan in that the net present value (NPV) of the new loan's cash flows are at least 10% different than the net present value of the original loan's remaining cash flows determined as follows: Net present value of new loan……...…… Net present value of original loan………. Difference in net present value…………. Difference as a % of original loan NPV…

$3,317,347 $2,923,018 $ 394,329 13.49%

The transaction qualifies as an extinguishment of debt and the required impact on the income statement is as follows: Gain (loss) on extinguishment of debt: Net carrying value of old loan…………… $2,923,018 Increase in principal amount……………. 400,000 Subtotal……………………………………. $3,323,018 Fair value of new loan…………………… 3,300,000 Gain (loss) on extinguishment………….. $ 23,018

21–23

Ch. 21—Problems

Problem 21-7, Continued Interest expense recognized on December 31, 2014: Effective interest rate on new debt is 1.86% determined as follows: Where: Number of periods is………………... 13 Periodic payments are……………… $ 54,400 Future value is……………………….. $3,400,000 Present value is……………………… $3,300,000 Interest expense is $ determined as follows: Fair value of new loan………………. $3,300,000 Effective interest rate……………….. 1.86% Interest expense…………………….. $ 61,272 Debt B This qualifies as a troubled debt restructuring in that the debtor is experiencing financial difficulties and the creditor has made a concession. The concession is obvious in that the sum of the restructured payments are less than the carrying amount of the original debt and therefore, the new effective interest rate is less than zero. Carrying value of original debt: NPV after three payments………… Accrued interest payable…………… Carrying value of original debt……

$2,923,018 $45,000 $2,968,018

Sum of cash payment on new debt: Principal payment………………………….. $2,500,000 Remainder of unpaid interest……………… 30,000 Periodic interest……………………………… 225,000 (4%/4 × $2,500,000 Sum of payments on new debt……………… $2,755,000 × 9 payments) The required impact on the income statement is as follows: Gain (loss) on restructuring of debt: Carrying value of original debt………………. $2,968,018 Sum of payments on new debt……………… 2,755,000 Gain (loss) on restructuring………………….. $ 213,018 Interest expense recognized on December 31, 2014: No interest expense since the sum of the payments on the new debt are less than the carrying value on the original debt immediately prior to the restructuring. Debt C The effective interest rate on the original note immediately prior to restructuring is 2.91% semiannual determined as follows: Where: Number of periods is…………….. 7 Periodic payments are…………… $ 180,000 (6%/2 × $6,000,000) Future value is…………………….. $6,180,000 Present value is…………………… 6,180,000 ($6,000,000 face value + $180,000 accrued interest payable)

Ch. 21—Problems

21–24

Problem 21-7, Concluded The effective interest rate on the restructured note is 1.87 % semiannual determined as follows: Where: Number of periods is………………. 5 Periodic payments are…………….. $ 150,000 (5%/2 × $6,000,000) Future value is……………………… $6,000,000 Present value is…………………….. $6,180,000 The creditor is deemed to have made a concession because the effective interest rate on the restructured note is less than the effective interest rate on the original note immediately prior to restructuring. Effective interest rate on restructured note……………………….. Effective interest rate on original note prior to restructuring…….

1.87% 2.91%

This qualifies as a troubled debt restructuring because the debtor is experiencing financial difficulties and the creditor is deemed to have made a concession. The required impact on the income statement is as follows: Gain (loss) on restructuring of debt: No gain or loss is recognized since the sum of the payments on the restructured loan exceed the carrying basis of the original loan prior to restructuring. Interest expense recognized on December 31, 2015: Carrying value of note………………………………….…. $6,180,000 Effective interest rate………………………………..…….. 1.87% Interest expense…………………………………...………. $ 115,319

SPECIAL APPENDIX 1 UNDERSTANDING THE ISSUES 1. (a) Company E net income ......................... Parent’s share .......................................

$35,000 × 30% $10,500

Less: Equipment amortization {[$170,000 – ($500,000 × 30%)] ÷ 5} .... Investment income ................................

(4,000) $ 6,500

(b) Beginning balance ................................. Investment income ................................ Less dividends ($10,000 × 30%) ........... Investment balance ...............................

$200,000 6,500 (3,000) $203,500

(c) The investment balance is the cost of the investment plus the investor’s share of the investee’s undistributed income, less the amortization of the excess of the price paid over the investor’s share of book value. 2. (a) Fair value of investment, year-end, ....... Cost of investment ................................. Unrealized gain ...................................... Dividends received ($10,000 × 30%) .... Investment income ................................

$220,000 170,000 $ 50,000 3,000 $ 53,000

(b) Fair value at year-end............................

$220,000

(c) The investment balance is the fair value on December 31, 2015. 3. (a) Company E income ............................... Gain on sale of equipment..................... Realized gain ($20,000 ÷ 5) .................. Parent’s share ....................................... Investment income ................................

$ 50,000 (20,000) 4,000 $ 34,000 × 30% $ 10,200

There is no further adjustment for the profit on the equipment. (b) Investment income = $50,000 × 30% = $15,000 Adjustment for equipment profit: Gain on Sale of Equipment ($20,000 × 30%) ............................... Deferred Gain ................................ Deferred Gain ($6,000/5) .................... Realized Gain on Equipment Sale

6,000 6,000 1,200 1,200

4. (a) Investment income = $10,000 dividends × 10% = $1,000 (b) Investment income = [($100,000 × 1/2) × 10%] + [($100,000 × 1/2) × 25%] = $17,500 (c) Investment income = [($100,000 × 1/2) × 30%] + ($10,000 dividends × 10%) = $16,000

SA1–2 5. Cost of investment ....................................... 2010–2014 income (25% × $200,000)......... 2015–2019 loss [25% × ($300,000)] ............ Unrecorded loss ...........................................

$ 20,000 50,000 (75,000) $ (5,000)

2020 Income (25% × $30,000 reported income) – Unrecorded $5,000 prior loss = $2,500 Investment balance = ($5,000 unrecorded loss) – (25% × $30,000 reported income) = $2,500

SA1–3

Special Appendix 1—Exercises

EXERCISES EXERCISE SA1-1 (a) Investment in Lincoln ............................................................................. Investment Income ........................................................................... To record 2017 investment income. Investment in Lincoln ............................................................................. Dividends Receivable ............................................................................ Investment Income ........................................................................... To record 2018 investment income and dividends receivable (20,000 shares × 25% × $0.25 per share). Lincoln Company income ................................................................. Adjustment for inventory profit ($5,000 profit × 20%)....................... Adjusted income .............................................................................. Ownership percentage ..................................................................... Less amortization of excess: Equipment ($10,000 ÷ 5 years) .................................................. Investment income ........................................................................... (b) Investment in Lincoln ............................................................................. Investment Income ........................................................................... To record 2017 unrealized gain on investment.

4,250 4,250 4,000 1,250 5,250

2017 $25,000 $25,000 × 25% $ 6,250

2018 $30,000 (1,000) $29,000 × 25% $ 7,250

(2,000) $ 4,250

(2,000) $ 5,250

15,000

Investment in Lincoln ............................................................................. 10,000 Dividends Receivable ............................................................................ 1,250 Unrealized Gain on Investment ........................................................ Dividend Income .............................................................................. To record 2018 unrealized gain on investment and dividends receivable (20,000 shares × 25% × $0.25 per share).

15,000

10,000 1,250

EXERCISE SA1-2 Determination and Distribution of Excess Schedule Price paid for investment ........................ Less book value of interest acquired: Common stock ($10 par)................... $100,000 Paid-in capital in excess of par ......... 20,000 Retained earnings ............................. 130,000 Total stockholders’ equity ............ $250,000 Interest acquired ............................... × 30% Excess of cost over book value (debit) ...

$90,000

75,000 $15,000

Building, amortized over 20 periods, $750 per year

Special Appendix 1—Exercises

SA1–4

Exercise SA1-2, Concluded Minnie Company Income Distribution Profit in ending inventory Internally generated net (40% × $40,000) ...................... $16,000 income .................................. Realized profit on beginning inventory (40% × $10,000) ... Adjusted income ......................... Turf’s ownership interest ............ Share of income ......................... Less building depreciation .......... Turf’s net share of income ..........

Investment in Minnie ........................................................................ Investment Income .....................................................................

13,650

Gain on Sale of Machine ($5,000 × 30%) ........................................ Deferred Gain.............................................................................

1,500

Deferred Gain ($1,500 ÷ 5) .............................................................. Realized Profit on Machine Sale ................................................

300

$60,000 4,000 $48,000 × 30% $14,400 (750) $13,650

13,650 1,500 300

EXERCISE SA1-3 Werl Corporation Income Distribution Profit in ending inventory (30% × $30,000) ...................... Gain on sale of machine ...............

$9,000 5,000

Internally generated net income ................................ Realize 1/5 of machine profit .................................... Realize profit on beginning inventory (30% × $20,000) .. Adjusted net income ................. Ownership interest .................... Interest on adjusted income ...... Less equipment depreciation .... Net investment income .............

Investment in Werl ........................................................................... Investment Income .....................................................................

21,700

Cash................................................................................................. Investment in Werl (30% × $20,000 dividends) .........................

6,000

$90,000 1,000 6,000 $83,000 × 30% $24,900 (3,200) $21,700

21,700 6,000

SA1–5

Special Appendix 1—Exercises

EXERCISE SA1-4 Determination and Distribution of Excess Schedule 10% purchase: Price paid ................................................................. Less interest acquired: Total stockholders’ equity................................... Interest acquired ...................................................... Goodwill ................................................................... 15% purchase: Price paid ................................................................. Less interest acquired: Total stockholders’ equity................................... Interest acquired ...................................................... Excess of book value over cost (credit balance) ...... Decrease in equipment (4-year life) .........................

$80,000 $750,000 × 10%

75,000 $ 5,000 Dr. $110,000

$800,000 × 15%

(1) Investment in Novic .................................................................. Retained Earnings .............................................................. To record equity “catch-up” entry.

120,000 $ (10,000) 10,000 Cr. $ 0 5,000 5,000

Calculations: Increase in retained earnings, January 1, 2016, to January 1, 2018.......................................................... Ownership interest .............................................................. Equity “catch-up” adjustment .............................................. (2) Investment in Novic .................................................................. Cash (50,000 shares × 25% × $0.20 per share) ...................... Investment Income ............................................................. To record net share of subsidiary income and dividends received.

$50,000 × 10% $ 5,000 10,000 2,500 12,500

Novic Company Income Distribution Reported income ...................... Ownership interest .................... Share of income........................ Decrease in equipment depreciation expense ($10,000 ÷ 4)....................... Investment income, net of amortizations ......................

$40,000 × 25% $10,000 2,500 $12,500

Special Appendix 1—Exercises

SA1–6

EXERCISE SA1-5 Determination and Distribution of Excess Schedule Price paid ................................................................. Equity interest purchased (30% × $400,000) ........... Excess of cost over book value (debit balance) ....... Allocate to machinery (30% × $50,000, 5-year life, $3,000 per year) ................................................. Goodwill

$200,000 120,000 $ 80,000 15,000 Dr. $ 65,000 Dr.

Calculation of investment account balance, January 2, 2019: Original cost ............................................................. Share of income: 2017 ................................................................... 2018 ................................................................... Dividends paid: 2017 ................................................................... 2018 ...................................................................

$200,000 $50,000 45,000 $95,000 × 30%

28,500

$10,000 10,000 $20,000 × 30%

(6,000)

Amortization of excess: Machinery ($3,000 × 2 years) ............................ Balance .................................................................... Entry: Cash......................................................................... Investment in Aluma-Boat Company.................. Realized Gain on Sale of Investment .................

(6,000) $216,500 230,000 216,500 13,500

SA1–7

Special Appendix 1—Problems

PROBLEMS PROBLEM SA1-1 Determination and Distribution of Excess Schedule Price paid for investment in Fowler .......................... Less interest acquired: Total stockholders’ equity................................... Interest acquired ...................................................... Excess of cost over book value (debit balance) ....... Attributable to long-lived assets: Less undervaluation of building ($40,000 × 0.25, 10 years, $1,000 per year) Goodwill (no amortization) .......................................

$300,000 $1,000,000 × 25%

250,000 $ 50,000 10,000 $ 40,000

Fowler Company Income Distribution (2016) Reported net income .....................

$52,000

Adjusted net income ...................... Ownership interest ........................ Share of income ............................ Less excess amortization .............. Net share of income ......................

$52,000 × 25% $13,000 1,000 $12,000

2016 Entries: Cash ($10,000 × 25%) ............................................................... Investment in Fowler ($12,000 – $2,500 dividends) .................. Investment Income ............................................................... Sales ($9,000 × 25%) ................................................................ Realized Gross Profit (1/5 × $2,250 × 1/2 year) ................... Deferred Gross Profit ...........................................................

2,500 9,500 12,000 2,250 225 2,025

Special Appendix 1—Problems

SA1–8

Problem SA1-1, Concluded Fowler Company Income Distribution (2017) Profit in ending inventory ($2,000 × 25%) ........................

Reported net income ................

$60,000

Adjusted net income ................. Ownership interest ................... Share of income ....................... Less excess amortization ......... Net share of income .................

$59,500 × 25% $14,875 1,000 $13,875

$500

2017 Entries: Cash ($10,000 × 25%) ............................................................... Investment in Fowler ($13,875 – $2,500 dividends) .................. Investment Income ............................................................... Deferred Gross Profit ($2,250/5 years) ...................................... Realized Gross Profit ...........................................................

2,500 11,375 13,875 450 450

Fowler Company Income Distribution (2018) Profit in ending inventory ($3,000 × 25%) ........................

$750

Reported net income ................. $65,000 Beginning inventory profit ($2,000 × 25%) .................... 500 Adjusted net income .................. $64,750 Ownership interest .................... × 25% Share of income ........................ $16,187 Less excess amortization .......... 1,000 Share of income ........................ $15,187

2018 Entries: Cash ($10,000 × 25%) ............................................................... Investment in Fowler ($15,187 – $2,500 dividends) .................. Investment Income ............................................................... Deferred Gross Profit ($2,250/5 years) ...................................... Realized Gross Profit ...........................................................

2,500 12,687 15,187 450 450

SA1–9

Special Appendix 1—Problems

PROBLEM SA1-2 2016 Entries: Cash ($10,000 × 25%) ............................................................... Investment in Fowler ($360,000 – $300,000)............................. Dividend Income .................................................................. Unrealized Gain on Investment ............................................ 2017 Entries: Cash ($10,000 × 25%) ............................................................... Investment in Fowler ($425,000 fair value – $360,000 cost) ..... Dividend Income .................................................................. Unrealized Gain on Investment ............................................ 2018 Entries: Cash ($10,000 × 25%) ............................................................... Unrealized Loss on Investment ($410,000 – $425,000 fair value) ...................................................................................... Dividend Income .................................................................. Investment in Fowler ...........................................................

2,500 60,000 2,500 60,000 2,500 65,000 2,500 65,000 2,500 15,000 2,500 15,000

PROBLEM SA1-3 December 31, 2016: Investment in Cramer Company ................................................ Cash (for dividends) ................................................................... Investment Income ............................................................... Reported income of Cramer ($60,000 – $18,000 tax) ............................... Ownership interest .............................................

$42,000 × 25%

Less amortizations of excess cost: Equipment ($7,500 ÷ 10 years) ............................................ Adjusted income......................................................................... Provision for Income Tax (30% × 20%* × $10,500) ......................... Income Tax Payable (30% × 20%* × $1,250) ............................ Deferred Tax Liability ................................................................. To record provision for tax; amortizations of excess are not deductible. *100% – 80% dividend exclusion December 31, 2017: Investment in Cramer Company ................................................ Cash (for dividends) ................................................................... Investment Income (See IDS, which follows) .......................

8,500 1,250 9,750

$10,500 750 $ 9,750 630 75 555

9,963 2,500 12,463

Special Appendix 1—Problems

SA1–10

Problem SA1-3, Continued Provision for Income Tax (30% × 20%* × $13,213) ......................... Income Tax Payable (30% × 20%* × $2,500) ............................ Deferred Tax Liability ................................................................. *100% – 80% dividend exclusion

793

Sales ($4,000 × 40% × 25% interest) income before amortization .. Deferred Gross Profit on Sales to Investee................................

400

Deferred Tax Liability ....................................................................... Provision for Income Tax ........................................................... Tax on deferred gross profit on ending inventory (30% × $400).

120

150 643

400 120

Cramer Company Income Distribution (2017) Gain on machine sale ...................

$5,000 Reported net income ................. Realized gain on machine* .......

$80,000 500

Adjusted income ....................... Income tax (30%) ...................... Net income ................................ Ownership interest .................... Interest in income ...................... Less amortization of excess cost (as above)....................

$75,500 22,650 $52,850 × 25% $13,213

Net investment income..............

$12,463

750

*$5,000 × 1/2 year × 1/5 December 31, 2018: Investment in Cramer Company ................................................ Cash (for dividends) ................................................................... Investment Income (See IDS, which follows) ....................... Provision for Income Tax (30% × 20%* × $17,675) income before amortization .................................................................................. Income Tax Payable (30% × 20%* × $2,500) ............................ Deferred Tax Liability ................................................................. *100% – 80% dividend exclusion

14,425 2,500 16,925 1,061 150 911

Sales (net increase $1,000* × 40% × 25% interest) ........................ 100 Deferred Gross Profit on Sales to Investee................................ *$5,000 ending inventory profit – $4,000 beginning inventory profit = net increase Provision for Income Tax ................................................................. Deferred Tax Liability ................................................................. Tax on increase in deferred gross profit on ending inventory (30% × $100).

100

30 30

SA1–11

Special Appendix 1—Problems

Problem SA1-3, Concluded Cramer Company Income Distribution (2018) Reported net income ................. Realized gain on machine .........

$100,000 1,000

Adjusted income ........................ Income tax (30%) ...................... Net income ................................ Ownership interest..................... Interest in income ...................... Less amortization of excess cost (as above) ....................

$101,000 30,300 $ 70,700 × 25% $ 17,675

Net investment income ..............

$ 16,925

750

SPECIAL APPENDIX 2 UNDERSTANDING THE ISSUES 1. (a) No equity investment would be shown in this case. The Primary Beneficiary could own various debt or equity securities, but it is not required in order to consolidate. (b) The consolidation is required because the primary beneficiary/VIE requirements are met. The VIE debt is guaranteed and the primary beneficiary has decision control. The accounts of the VIE must be increased by $1,000,000 in total to reflect the fair value of the VIE company on the date control is achieved. 2. It is based on a contractual agreement that could include interest on intercompany debt or management fees.

Special Appendix 2—Exercises

SA2–2

EXERCISES EXERCISES SA2-1 Determination and distribution of excess schedule: Fair value of equity ................................... $600,000 Less book value of equity ......................... (80,000) Excess of fair value over book value ........ 520,000 Less amounts assigned to: Building ............................................. (300,000) Equipment......................................... (150,000) Goodwill .................................................... 70,000

EXERCISES SA2-2 Income Distribution Schedule: VIE Company Income Distribution (A1) Depreciation adjustment ........ $20,000 Internally generated net income .................................. Adjusted income ......................... 10% revenues and service fees to Primary Co. ....................... NCI interest ................................

$70,000 $50,000 39,000 $11,000

Primary Company Income Distribution Internally generated net income .................................. 10% revenues and service fees to Primary Co. ....................... Controlling interest ......................

$240,000 39,000 $279,000

SA2–3

Special Appendix 2—Problems

PROBLEMS PROBLEM SA2-1 Determination and distribution of excess schedule: Fair value of equity ................................... $170,000 Less book value of equity ......................... (80,000) Excess of fair value over book value ........ 90,000 Less amounts assigned to: Equipment......................................... (50,000) Goodwill .................................................... 40,000

Special Appendix 2—Problems

SA2–4

Primary Company and VIE Company Consolidated Balance Sheet December 31, 2015 Balance Sheets, Dec. 31, 2015 Cash ........................................................... Accounts receivable ...................................... Inventory...................................................... Loan receivable from VIE Co. ........................ Land ............................................................ Building ....................................................... Accumulated depreciation ............................. Equipment ................................................... Accumulated depreciation ............................. Goodwill ...................................................... Accounts payable ......................................... Loan from Primary Company ......................... 5% Bond Payable ......................................... Common stock, $1 par – Primary Co. ............. Paid in capital in excess of par – Primary Co. .. Retained earnings – Primary Co..................... Common stock, $1 par – VIE Co. ................... Paid in capital in excess of par – VIE Co. ........ Paid-in Capital on Revaluation – VIE Co. ........ Retained earnings – VIE Co........................... Totals .................................................... Total NCI .....................................................

EL D

Primary Company 200,000 400,000 300,000 50,000 500,000 (150,000) 400,000 (50,000)

Eliminations

VIE Company 80,000 400,000

NCI

EL 300,000

360,000 (60,000)

50,000

40,000

300,000 EL 400,000

300,000

50,000 500,000 (150,000) 810,000 (110,000) 40,000 (80,000)

80,000

(400,000) (100,000) (900,000) (570,000)

100,000 900,000 570,000 10,000 50,000 D 1,650,000 1,650,000

780,000

20,000 780,000

390,000

90,000

(10,000) (50,000) (90,000) (20,000)

390,000 (170,000) (170,000) 0

Eliminte loan from Primary Company to VIE Company. Distribute excess to equipment (D1), goodwill (D2).

Consolidated Balance Sheet 280,000 400,000 400,000

part.

SA2–5

Special Appendix 2—Problems

PROBLEM SA2-2 Determination and distribution of excess schedule: Fair value of equity ................................... $170,000 Less book value of equity ......................... (80,000) Excess of fair value over book value ........ 90,000 Less amounts assigned to: Equipment......................................... (50,000) Goodwill .................................................... 40,000

Special Appendix 2—Problems

SA2–6 Primary Company and VIE Company Consolidated Trial Balance December 31, 2016 Trial Balances, Dec. 31, 2016

Cash ................................................ Accounts receivable .............................. Inventory............................................ Loan receivable from VIE Co. .................. Land ................................................. Building ............................................. Accumulated depreciation ....................... Equipment .......................................... Accumulated depreciation ....................... Goodwill ............................................ Accounts payable ................................. Loan from Primary Company ................... 6% Bond Payable ................................. Common stock, $1 par – Primary Co. ......... Paid in capital in excess of par – Primary Co. Retained earnings – Primary Co. ............... Common stock, $1 par – VIE Co. .............. Paid in capital in excess of par – VIE Co. ..... Paid-in capital on revaluation – VIE Co. ....... Retained earnings – VIE Co. .................... Sales ................................................ Interest revenue ................................... Processing revenue .............................. Cost of goods sold ................................ Depreciation expense ............................ Selling expenses .................................. Administrative expense .......................... Interest expense .................................. Totals............................................ Consolidated net income ........................ To NCI .......................................... To controlling interest......................... NCI .................................................. Retained earnings, controlling interest, December 31, 2016...............................

Primary Company 305,000 425,000 300,000 50,000 500,000 (175,000) 400,000 (100,000)

VIE Company 110,000 425,000

Income Statement

NCI

Controlling Consolidated Retained Balance Earnings Sheet 415,000 425,000 425,000

EL 300,000

360,000 (90,000)

50,000

40,000

300,000 EL 400,000

300,000

50,000 500,000 (175,000) 810,000 (195,000) 40,000 (30,000)

5,000

30,000

(400,000) (100,000) (900,000)

100,000 900,000 570,000

(570,000) 10,000 50,000 D 20,000 220,000 5,000 20,000

800,000 30,000 500,000 75,000 90,000 60,000 2,430,000

2,430,000

EL Eliminate loan from Primary Company to VIE Company; D I Eliminate $30,000 intercompany interest

Eliminations

133,000 30,000 20,000 3,000 34,000 1,025,000

30,000

5,000

I 1,025,000

425,000

90,000 (1,020,000) (5,000) (20,000) 633,000 110,000 110,000 63,000 30,000 4,000 425,000 (125,000) 9,000 116,000

(10,000) (50,000) (90,000) (20,000)

(9,000) (116,000) (179,000)

(179,000) (686,000)

Distribute excess to equipment (D1), goodwill (D2); A1

Increase depreciation $5,000 for current year;

part.

(686,000) 0

SA2–7

Special Appendix 2—Problems

Income Distribution Schedule: VIE Company Income Distribution (A1) Depreciation adjustment ........

$5,000 Internally generated net income ..................................

$25,000

Adjusted income ......................... $20,000 5% of sales revenue to Primary Co.. 11,000 NCI interest ................................ $ 9,000 Primary Company Income Distribution Internally generated net income . $105,000 5% of sales revenue to Primary Co 11,000 Controlling interest ......................

$116,000

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