SOLUTIONS MANUAL For Advanced Accounting 12th Edition. Floyd Beams Joseph Anthony Bruce Kenneth Smit by StudyGuide

Chapter 1 BUSINESS COMBINATIONS Answers to Questions 1

A business combination is a union of business entities in which two or more previously separate and independent companies are brought under the control of a single management team. Three situations establish the control necessary for a business combination, namely, when one or more corporations become subsidiaries, when one company transfers its net assets to another, and when each combining company transfers its net assets to a newly formed corporation.

The dissolution of all but one of the separate legal entities is not necessary for a business combination. An example of one form of business combination in which the separate legal entities are not dissolved is when one corporation becomes a subsidiary of another. In the case of a parent-subsidiary relationship, each combining company continues to exist as a separate legal entity even though both companies are under the control of a single management team.

A business combination occurs when two or more previously separate and independent companies are brought under the control of a single management team. Merger and consolidation in a generic sense are frequently used as synonyms for the term business combination. In a technical sense, however, a merger is a type of business combination in which all but one of the combining entities are dissolved and a consolidation is a type of business combination in which a new corporation is formed to take over the assets of two or more previously separate companies and all of the combining companies are dissolved.

Goodwill arises in a business combination accounted for under the acquisition method when the cost of the investment (fair value of the consideration transferred) exceeds the fair value of identifiable net assets acquired. Under GAAP, goodwill is not amortized for financial reporting purposes and will have no effect on net income, unless the goodwill is deemed to be impaired. If goodwill is impaired, a loss will be recognized.

A bargain purchase occurs when the acquisition price is less than the fair value of the identifiable net assets acquired. The acquirer records the gain from a bargain purchase as an ordinary gain during the period of the acquisition. The gain equals the difference between the investment cost and the fair value of the identifiable net assets acquired.

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Business Combinations

SOLUTIONS TO EXERCISES Solution E1-1 1 2 3 4

a b a c

Solution E1-2 [AICPA adapted] 1

a Plant and equipment should be recorded at the $220,000 fair value.

c Investment cost Less: Fair value of net assets Cash Inventory Property and equipment — net Liabilities Goodwill

$1,600,000 $

160,000 380,000 1,120,000 (360,000) $

1,300,000 300,000

Solution E1-3 Stockholders’ equity — Pal Corporation on January 2 Capital stock, $10 par, 1,200,000 shares outstanding

$ 12,000,000

[$6,000,000 + $6,000,000] Other paid-in capital [$800,000 + $6,000,000 – $20,000]

6,780,000

Retained earnings [$2,400,000 - $40,000] Total stockholders’ equity

2,360,000 $21,140,000

Entry to record combination Investment in Sip Capital stock, $10 par Other paid-in capital

12,000,000 6,000,000 6,000,000

Investment expense Other paid-in capital Cash Check: Net assets per books (book value) Goodwill and write-up of assets Less: Expense of direct costs

40,000 20,000 60,000 $15,200,000 6,000,000 (40,000)

Chapter 1

1-3

Solution E1-4 Journal entries on Pan’s books to record the acquisition Investment in Set 20,400,000 Common stock, $10 par 9,600,000 Additional paid-in capital 10,800,000 To record issuance of 960,000 shares of $10 par common stock with a fair value of $20,400,000 for the common stock of Set in a business combination. Additional paid-in capital 120,000 Investment expenses 360,000 Other assets (or Cash) 480,000 To record costs of registering and issuing securities as a reduction of paidin capital, and record direct and indirect costs of combination as expenses. Current assets 8,800,000 Plant assets 17,600,000 Liabilities 2,400,000 Investment in Set 20,400,000 Gain from bargain purchase 3,600,000 To record allocation of the $20,400,000 cost of Set Company to identifiable assets and liabilities according to their fair values, and the gain from the bargain purchase,computed as follows: Cost $20,400,000 Fair value of net assets acquired 24,000,000 Bargain purchase amount $ 3,600,000

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Business Combinations

Solution E1-5 Journal entries on the books of Pan Corporation to record merger with Sis Corporation Investment in Sis 1,060,000 Common stock, $10 par 360,000 Additional paid-in capital 300,000 Cash 400,000 To record issuance of 36,000 common shares and payment of cash in the acquisition of Sis Corporation in a merger. Investment expenses 140,000 Additional paid-in capital 60,000 Cash 200,000 To record costs of registering and issuing securities and additional direct costs of combination. Cash 80,000 Inventories 200,000 Other current assets 40,000 560,000 Plant assets — net Goodwill 320,000 Current liabilities 60,000 Other liabilities 80,000 Investment in Sis 1,060,000 To record allocation of cost to assets received and liabilities assumed on the basis of their fair values and to goodwill computed as follows: Cost of investment Fair value of net assets acquired Goodwill

$1,060,000 740,000 $ 320,000

Chapter 1

1-5

SOLUTIONS TO PROBLEMS Solution P1-1 Preliminary computations Fair Value: Cost of investment in San at January 2 (120,000 shares  $40)

$4,800,000

Book value of net assets ($4,000,000 - $480,000)

(3,520,000)

Excess fair value over book value

$1,280,000

Excess assigned to: Current assets

Remainder to goodwill Excess fair value over book value Note: $200,000 direct costs of combination are expensed. The excess fair value of Pin’s buildings is not considered.

320,000 960,000

$1,280,000

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Business Combinations

Problem 1-1 (continued) Pin Corporation Balance Sheet at January 2, 2011 Assets Current assets ($1,040,000 + $480,000 + $320,000 excess - $320,000 direct costs)

$ 1,520,000

Land ($400,000 + $800,000)

1,200,000

Buildings — net ($2,400,000 + $800,000)

3,200,000

Equipment — net ($1,760,000 + $1,920,000)

3,680,000

Goodwill

960,000

Total assets

$10,560,000

Liabilities and Stockholders’ Equity Current liabilities ($400,000 + $480,000)

880,000

Capital stock, $10 par ($4,000,000 + $1,200,000 new issue)

5,200,000

Additional paid-in capital [$400,000 + ($30  120,000 shares) — $120,000 costs of issuing and registering securities]

3,880,000

Retained earnings (subtract $200,000 expensed direct cost) Total liabilities and stockholders’ equity

600,000 $10,560,000

Chapter 1

1-7

Solution P1-2 Preliminary computations Fair Value: Cost of acquiring Sea Fair value of assets acquired and liabilities assumed Goodwill from acquisition of Sea

$1,650,000 1,340,000 $ 310,000

Pet Corporation Balance Sheet at January 2, 2011 Assets Current assets Cash [$300,000 + $60,000 - $280,000 expenses paid]

80,000 540,000

Accounts receivable — net [$460,000 + $80,000 fair value] Inventories [$1,040,000 + $240,000 fair value]

1,280,000

Plant assets Land [$800,000 + $300,000 fair value]

1,100,000

Buildings — net [$2,000,000 + $600,000 fair value]

2,600,000

Equipment — net [$1,000,000 + $500,000 fair value]

1,500,000

Goodwill Total assets

310,000 $7,410,000

Liabilities and Stockholders’ Equity Liabilities Accounts payable [$600,000 + $80,000] Note payable [$1,200,000 + $360,000 fair value]

680,000 1,560,000

Stockholders’ equity Capital stock, $10 par [$1,600,000 + (66,000 shares  $10)]

2,260,000

Other paid-in capital [$1,200,000 - $80,000 + ($1,650,000 - $660,000)]

2,110,000

Retained earnings (subtract $200,000 expensed direct costs) Total liabilities and stockholders’ equity

800,000 $7,410,000

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Business Combinations

Solution P1-3 Par issues 25,000 shares of stock for Sin’s outstanding shares 1a

Investment in Sin 1,500,000 Capital stock, $10 par 250,000 Additional paid-in capital 1,250,000 To record issuance of 25,000, $10 par shares with a market price of $60 per share in a business combination with Sin. Investment expenses 60,000 Additional paid-in capital 40,000 Cash 100,000 To record costs of combination in a business combination with Sin. Cash 20,000 Inventories 120,000 Other current assets 200,000 Land 200,000 700,000 Plant and equipment — net Goodwill 360,000 Liabilities 100,000 Investment in Sin 1,500,000 To assign investment cost to identifiable assets and liabilities according to their fair values and the remainder to goodwill. Goodwill is computed: $1,500,000 cost - $1,140,000 fair value of net assets acquired.

Par Corporation Balance Sheet January 2, 2011 (after business combination) Assets Cash [$240,000 + $20,000 - $100,000] Inventories [$100,000 + $120,000] Other current assets [$200,000 + $200,000] Land [$160,000 + $200,000] Plant and equipment — net [$1,300,000 + $700,000] Goodwill Total assets Liabilities and Stockholders’ Equity Liabilities [$400,000 + $100,000] Capital stock, $10 par [$1,000,000 + $250,000] Additional paid-in capital [$400,000 + $1,250,000 $40,000] Retained earnings (subtract $60,000 direct costs) Total liabilities and stockholders’ equity

160,000 220,000 400,000 360,000 2,000,000 360,000 $3,500,000 $

500,000 1,250,000 1,610,000

140,000 $3,500,000

Chapter 1

1-9

Solution P1-3 (continued) Par issues 15,000 shares of stock for Sin’s outstanding shares 2a

900,000 Investment in Sin (15,000 shares  $60) Capital stock, $10 par 150,000 Additional paid-in capital 750,000 To record issuance of 15,000, $10 par common shares with a market price of $60 per share. Investment expense 60,000 Additional paid-in capital 40,000 Cash 100,000 To record costs of combination in the acquisition of Sin. Cash 20,000 Inventories 120,000 Other current assets 200,000 Land 200,000 700,000 Plant and equipment — net Liabilities 100,000 Investment in Sin 900,000 Gain on bargain purchase 240,000 To record Sin’s net assets at fair values and the gain on the bargain purchase. Fair value of net assets acquired Investment cost (Fair value of consideration) Gain on Bargain Purchase

$1,140,000 900,000 $ 240,000

Par Corporation Balance Sheet January 2, 2011 (after business combination) Assets Cash [$240,000 + $20,000 - $100,000] Inventories [$100,000 + $120,000] Other current assets [$200,000 + $200,000] Land [$160,000 + $200,000] Plant and equipment — net [$1,300,000 + $700,000] Total assets Liabilities and stockholders’ equity Liabilities [$400,000 + $100,000] Capital stock, $10 par [$1,000,000 + $150,000] Additional paid-in capital [$400,000 + $750,000 $40,000] Retained earnings (subtract $60,000 direct costs and add $240,000 Gain from bargain purchase) Total liabilities and stockholders’ equity

160,000 220,000 400,000 360,000 2,000,000 $3,140,000 $

500,000 1,150,000 1,110,000 380,000

$3,140,000

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Business Combinations

Solution P1-4 1

Schedule to allocate investment cost to assets and liabilities Investment cost (fair value), January 1 Fair value acquired from Sun ($360,000  100%) Excess fair value over cost (bargain purchase gain)

$300,000 360,000 $ 60,000

Allocation: Allocation 10,000 20,000 30,000 100,000 150,000 150,000 (30,000) (70,000) (60,000) $ 300,000

Cash Receivables — net Inventories Land Buildings — net Equipment — net Accounts payable Other liabilities Gain on bargain purchase Totals

Pub Corporation Balance Sheet at January 1, 2011 (after combination) Liabilities

Assets Cash Receivables — net Inventories Land Buildings — net Equipment — net

25,000 60,000 150,000 145,000 350,000 330,000

Total assets $1,060,000

Accounts payable Note payable (5 years) Other liabilities Liabilities

120,000 200,000 170,000 490,000

Stockholders’ Equity Capital stock, $10 par Other paid-in capital Retained earnings* Stockholders’ equity Total equities

300,000 100,000 170,000 570,000 $1,060,000

* Retained earnings reflects the $60,000 gain on the bargain purchase.

Chapter 1

1-11

Solution P1-5 1

Journal entries to record the acquisition of Saw Corporation Investment in Saw 5,000,000 Capital stock, $10 par 1,000,000 Other paid-in capital 3,000,000 Cash 1,000,000 To record acquisition of Saw for 100,000 shares of common stock and $1,000,000 cash. Investment expense 200,000 Other paid-in capital 100,000 Cash 300,000 To record payment of costs to register and issue the shares of stock ($100,000) and other costs of combination ($200,000). Cash 480,000 Accounts receivable 720,000 Notes receivable 600,000 Inventories 1,000,000 Other current assets 400,000 Land 400,000 Buildings 2,400,000 Equipment 1,200,000 Accounts payable 600,000 Mortgage payable, 10% 1,200,000 Investment in Saw 5,000,000 Gain on bargain purchase 400,000 To record the net assets of Saw at fair value and the gain on the bargain purchase. Gain on Bargain Purchase Calculation Acquisition price Fair value of net assets acquired Gain on bargain purchase

$5,000,000 5,400,000 $ 400,000

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Business Combinations

Solution P1-5 (continued) 2

Pat Corporation Balance Sheet at January 2, 2011 (after business combination) Assets Current Assets Cash Accounts receivable — net Notes receivable — net Inventories Other current assets Plant Assets Land Buildings — net Equipment — net Total assets

$ 5,180,000 3,320,000 3,600,000 6,000,000 1,800,000 $ 4,400,000 20,400,000 21,200,000

$19,900,000

46,000,000 $65,900,000

Liabilities and Stockholders’ Equity Liabilities Accounts payable Mortgage payable, 10%

$ 2,600,000 11,200,000

$13,800,000

Stockholders’ Equity Capital stock, $10 par $21,000,000 Other paid-in capital 18,900,000 Retained earnings* 12,200,000 Total liabilities and stockholders’ equity

52,100,000 $65,900,000

* Subtract $200,000 direct combination costs and add $400,000 gain on bargain purchase.

Chapter 2 STOCK INVESTMENTS — INVESTOR ACCOUNTING AND REPORTING Answers to Questions 1

Only the investor’s accounts are affected when outstanding stock is acquired from existing stockholders. The investor records the investment at its cost. Since the investee company is not a party to the transaction, its accounts are not affected. Both investor and investee accounts are affected when unissued stock is acquired directly from the investee. The investor records the investment at its cost and the investee adjusts its asset and owners’ equity accounts to reflect the issuance of previously unissued stock.

Goodwill arising from an equity investment of 20 percent or more is not recorded separately from the investment account. Under the equity method, the investment is presented on one line of the balance sheet in accordance with the one-line consolidation concept.

Dividends received from earnings accumulated before an investment is acquired are treated as decreases in the investment account balance under the fair value/cost method. Such dividends are considered a return of a part of the original investment.

The equity method of accounting for investments increases the investment account for the investor’s share of the investee’s income and decreases it for the investor’s share of the investee’s losses and for dividends received from the investee. In addition, the investment and investment income accounts are adjusted for amortization of any investment cost-book value differentials related to the interest acquired. Adjustments to the investment and investment income accounts are also needed for unrealized profits and losses from transactions between the investor and investee companies. A fair value adjustment is optional under SFAS No. 159.

The equity method is referred to as a one-line consolidation because the investment account is reported on one line of the investor’s balance sheet and investment income is reported on one line of the investor’s income statement (except when the investee has extraordinary gain/loss or discontinued operations). In addition, the investment income is computed such that the parent company’s income and stockholders’ equity are equal to the consolidated net income and consolidated stockholders’ equity that would result if the statements of the investor and investee were consolidated.

If the equity method of accounting is applied correctly, the income of the parent company will generally equal the controlling interest share of consolidated net income.

The difference in the equity method and consolidation lies in the detail reported, but not in the amount of income reported. The equity method reports investment income on one line of the income statement whereas the details of revenues and expenses are reported in the consolidated income statement.

The investment account balance of the investor will equal underlying book value of the investee if (a) the equity method is correctly applied, (b) the investment was acquired at book value which was equal to fair value, the pooling method was used, or the cost-book value differentials have all been amortized, and (c) there have been no intercompany transactions between the affiliated companies that have created investment account-book value differences.

The investment account balance must be converted from the cost to the equity method when acquisitions increase the interest held to 20 percent or more. The amount of the adjustment is the difference between the investment income reported under the cost method in prior years and the income that would have been reported if the equity method of accounting had been used. Changes from the cost to the equity method of accounting for equity investments are changes in the reporting entity that require restatement of prior years’ financial statements when the effect is material. Copyright © 2015 Pearson Education, Inc. 2-1

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Stock Investments — Investor Accounting and Reporting

The one-line consolidation is adjusted when the investee’s income includes extraordinary items and gains or losses from discontinued operations. In this case, the investor’s share of the investee’s ordinary income is reported as investment income under a one-line consolidation, but the investor’s share of extraordinary items and gains and losses from discontinued operations is combined with similar items of the investor.

The remaining 15 percent interest in the investee is accounted for under the fair value/cost method, and the investment account balance immediately after the sale becomes the new cost basis.

Yes. When an investee has preferred stock in its capital structure, the investor has to allocate the investee’s income to preferred and common stockholders. Then, the investor takes up its share of the investee’s income allocated to common stockholders in applying the equity method. The allocation is not necessary when the investee has only common stock outstanding.

Goodwill impairment losses are calculated by business reporting units. For each reporting unit, the company must first determine the fair values of the net assets. The fair value of the reporting unit is the amount at which it could be purchased in a current market transaction. This may be based on market prices, discounted cash flow analyses, or similar current transactions. This is done in the same manner as is done to originally record a combination. The first step requires a comparison of the carrying value and fair value of all the net assets at the business reporting level. If the fair value exceeds the carrying value, goodwill is not impaired and no further tests are needed. If the carrying value exceeds the fair value, then we proceed to step two. In step two, we calculate the implied value of goodwill. Any excess measured fair value over the net identifiable assets is the implied fair value of goodwill. The company then compares the goodwill’s implied fair value estimate to the carrying value of goodwill to determine if there has been an impairment during the period.

Yes. Impairment losses for subsidiaries are computed as outlined in the solution to question 13. Companies compare fair values to book values for equity method investments as a whole. Firms may recognize impairments for equity method investments as a whole, but perform no separate goodwill impairment tests. SOLUTIONS TO EXERCISES

Solution E2-1 1 2 3 4 5

d c c d b

Chapter 2

2-3

Solution E2-2 [AICPA adapted] 1 2 3 4

6 7 8

d b d b Gar’s investment is reported at its $600,000 cost because the equity method is not appropriate and because Gar’s share of Med’s income exceeds dividends received since acquisition [($520,000  15%) > $40,000]. c Dividends received from Zef for the two years were $10,500 ($70,000  15% - all in 2012), but only $9,000 (15% of Zef’s income of $60,000 for the two years) can be shown on Two’s income statement as dividend income from the Zef investment. The remaining $1,500 reduces the investment account balance. c [$100,000 + $300,000 + ($600,000  10%)] a d Investment balance January 2 $250,000 30,000 Add: Income from Pod ($100,000  30%) Investment in Pod December 31 $280,000

Solution E2-3 1

Bow’s percentage ownership in Tre Bow’s 10,000 shares/(30,000 + 10,000) shares = 25%

Goodwill Investment cost Book value ($500,000 + $250,000)  25% Goodwill

$250,000 (187,500) $ 62,500

Solution E2-4 Income from Med for 2011 Share of Med’s income ($200,000  1/2 year  30%)

$ 30,000

Stock Investments — Investor Accounting and Reporting

2-4

Solution E2-5 1

Income from Oak Share of Oak’s reported income ($400,000  30%) Less: Excess allocated to inventory Less: Depreciation of excess allocated to building ($100,000/4 years) Income from Oak

120,000 (50,000) (25,000)

45,000

Investment account balance at December 31 Cost of investment in Oak Add: Income from Oak Less: Dividends ($100,000 x 30%) Investment in Oak December 31

$1,000,000 45,000 (30,000) $1,015,000

Alternative solution Underlying equity in Oak at January 1 ($750,000/.3) Income less dividends Underlying equity December 31 Interest owned Book value of interest owned December 31 Add: Unamortized excess Investment in Oak December 31

$2,500,000 300,000 2,800,000 30% 840,000 175,000 $1,015,000

Solution E2-6 Journal entry on Man’s books Investment in Nib ($1,200,000 x 40%) Loss from discontinued operations Income from Nib

480,000 80,000

To recognize income from 40% investment in Nib.

560,000

Chapter 2

2-5

Solution E2-7 1

a Dividends received from Ben ($120,000  15%) Share of income since acquisition of interest 2011 ($20,000  15%) 2012 ($80,000  15%) Excess dividends received over share of income Investment in Ben January 3, 2011 Less: Excess dividends received over share of income Investment in Ben December 31, 2012

b Cost of 10,000 of 40,000 shares outstanding Book value of 25% interest acquired ($4,000,000 stockholders’ equity at December 31, 2011 + $1,400,000 from additional stock issuance)  25% Excess fair value over book value(goodwill)

d The investment in Moe balance remains at the original cost.

c Income before extraordinary item Percent owned Income from Kaz Products

18,000

(3,000) (12,000) 3,000

$ $

50,000 (3,000) 47,000

$1,400,000 1,350,000 $ 50,000

$ $

200,000 40% 80,000

Stock Investments — Investor Accounting and Reporting

2-6

Solution E2-8 Preliminary computations Cost of 40% interest January 1, 2011 Book value acquired ($8,000,000  40%) Excess fair value over book value Excess allocated to Inventories $200,000  40% Equipment $400,000  40% Goodwill for the remainder Excess fair value over book value

$4,800,000 (3,200,000) $1,600,000 $

80,000 160,000 1,360,000 $1,600,000

Ray’s underlying equity in Ton ($11,000,000  40%) Add: Goodwill Investment balance December 31, 2014

$4,400,000 1,360,000 $5,760,000

Alternative computation Ray’s share of the change in Ton’s stockholders’ equity ($3,000,000  40%) Less: Excess allocated to inventories ($80,000  100%) Less: Excess allocated to equipment ($160,000/4 years  4 years) Increase in investment account Original investment Investment balance December 31, 2014

$1,200,000 (80,000) (160,000) 960,000 4,800,000 $5,760,000

Chapter 2

2-7

Solution E2-9 1

Income from Run Share of income to common ($400,000 - $30,000 preferred dividends)  30%

Investment in Run December 31, 2012 NOTE: The $50,000 direct costs of acquiring the investment must be expensed when incurred. They are not a part of the cost of the investment. Investment cost Add: Income from Run Less: Dividends from Run ($200,000 dividends - $30,000 dividends to preferred)  30% Investment in Run December 31, 2012

111,000

$1,200,000 111,000 (51,000) $1,260,000

Solution E2-10 1

Income from Tee ($400,000 – $300,000)  25% Investment income October 1 to December 31 Investment balance December 31 Investment cost October 1 Add: Income from Tee Less: Dividends Investment in Tee at December 31

Sales Expenses Net Income

December 31 $1,200,000 800,000 $400,000

25,000

600,000 25,000 --625,000

October 1 $900,000 600,000 $300,000

Stock Investments — Investor Accounting and Reporting

2-8

Solution E2-11 Preliminary computations Goodwill from first 10% interest: Cost of investment Book value acquired ($210,000  10%) Excess fair value over book value Goodwill from second 10% interest: Cost of investment Book value acquired ($250,000  10%) Excess fair value over book value

Correcting entry as of January 2, 2012 to convert investment to the equity basis Accumulated gain/loss on stock available for Sale Valuation allowance to record Fed at fair Value To remove the valuation allowance entered on December 31, 2011 under the fair value method for an available for sale security. Investment in Fed Retained earnings To adjust investment account to an equity basis computed as follows: Share of Fed’s income for 2011 Less: Share of dividends for 2011

$ $ $ $

25,000 (21,000) 4,000 50,000 (25,000) 25,000

25,000 25,000

4,000 4,000 $ $

10,000 (6,000) 4,000

Income from Fed on original 10% investment

5,000

Income from Fed on second 10% investment Income from Fed

5,000 10,000

Income from Fed for 2012

Chapter 2

2-9

Solution E2-12 Preliminary computations Stockholders’ equity of Tal on December 31, 2011 Sale of 12,000 previously unissued shares on January 1, 2012 Stockholders’ equity after issuance on January 1, 2012 Cost of 12,000 shares to Riv Book value of 12,000 shares acquired $630,000  12,000/36,000 shares Excess fair value over book value

$380,000 250,000 $630,000 $250,000 210,000 $ 40,000

Excess is allocated as follows Buildings $60,000  12,000/36,000 shares Goodwill Excess fair value over book value

$ 20,000 20,000 $ 40,000

Journal entries on Riv’s books during 2012 January 1 Investment in Tal Cash To record acquisition of a 1/3 interest in Tal. During 2012 Cash Investment in Tal To record dividends received from Tal ($90,000  1/3).

250,000 250,000

30,000

December 31 Investment in Tal 38,000 Income from Tal To record investment income from Tal computed as follows: Share of Tal’s income ($120,000  1/3) Depreciation on building ($20,000/10 years) Income from Tal

30,000

38,000 $ 40,000 (2,000) $ 38,000

Stock Investments — Investor Accounting and Reporting

2-10

Solution E2-13 1

Journal entries on BIP’s books for 2012 Cash

120,000

Investment in Cow (30%) To record dividends received from Cow ($400,000  30%). Investment in Cow (30%) Extraordinary loss (from Cow) Income from Cow To record investment income from Cow computed as follows:

120,000

240,000 24,000

Share of income before extraordinary item $680,000  30% Add: Excess fair value over cost realized in 2012 $200,000  30% Income from Cow before extraordinary loss 2

264,000

204,000

60,000 264,000

Investment in Cow balance December 31, 2012 Investment cost Add: Income from Cow after extraordinary loss Less: Dividends received from Cow Investment in Cow December 31

780,000 240,000 (120,000) $900,000

Check: Investment balance is equal to underlying book value ($2,800,000 + $600,000 - $400,000)  30% = $900,000 3

BIP Corporation Income Statement for the year ended December 31, 2012 Sales Expenses Operating income Income from Cow (before extraordinary item) Income before extraordinary item Extraordinary loss (net of tax effect) Net income

$4,000,000 2,800,000 1,200,000 264,000 1,464,000 24,000 $1,440,000

Chapter 2

2-11

Solution E2-14 1

Income from Wat for 2012 Equity in income ($108,000 - $8,000 preferred)  40%

40,000

290,000 40,000 (16,000) 314,000

Investment in Wat December 31, 2012 Cost of investment in Wat common Add: Income from Wat Less: Dividends ($40,000* x 40%) Investment in Wat December 31 * $48,000 total dividends less $8,000 preferred dividend

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Stock Investments — Investor Accounting and Reporting

Solution E2-15 Since the total fair value of Sel has declined by $30,000 while the fair value of the net identifiable assets is unchanged, the $30,000 decline is the impairment in goodwill for the period. The $30,000 impairment loss is deducted in calculating Par’s income from continuing operations. Solution E2-16 Goodwill impairments are calculated at the business reporting unit level. Increases and decreases in fair values across business units are not offsetting. Flash must report an impairment loss of $5,000 in calculating 2012 income from continuing operations.

Chapter 2

2-13

SOLUTIONS TO PROBLEMS Solution P2-1 1

Goodwill Cost of investment in Tel on April 1 $686,000 Book value acquired: Net assets at December 31 $2,000,000 80,000 Add: Income for 1/4 year ($320,000  25%) Less: Dividends paid March 15 (40,000) Book value at April 1 2,040,000 Interest acquired 30% 612,000 Goodwill from investment in Tel $ 74,000

Income from Tel for 2011 Equity in income before extraordinary item ($240,000  3/4 year  30%)

Investment in Tel at December 31, 2011 Investment cost April 1 Add: Income from Tel plus extraordinary gain Less: Dividends ($40,000  3 quarters)  30% Investment in Tel December 31

$ 686,000 78,000 (36,000) $ 728,000

Equity in Tel’s net assets at December 31, 2011 Tel’s stockholders’ equity January 1 Add: Net income Less: Dividends Tel’s stockholders’ equity December 31 Investment interest Equity in Tel’s net assets

$2,000,000 320,000 (160,000) 2,160,000 30% $ 648,000

Extraordinary gain for 2011 to be reported by Rit Tel’s extraordinary gain  30%

54,000

24,000

Stock Investments — Investor Accounting and Reporting

2-14

Solution P2-2 1

Cost method Investment in Sel July 1, 2011 (at cost) Dividends charged to investment Investment in Sel balance at December 31, 2011 July 1, 2011 Investment in Sel Cash To record initial investment for 80% interest. November 1, 2011 Cash Dividend income To record receipt of dividends ($16,000  80%).

$220,000 (8,800) $211,200

220,000 220,000

12,800 12,800

December 31, 2011 Dividend income 8,800 Investment in Sel To reduce investment for dividends in excess of earnings ($16,000 dividends - $5,000 earnings)  80%. 2

8,800

Equity method Investment in Sel July 1, 2011 Add: Share of reported income Deduct: Dividends charged to investment Deduct: Excess Depreciation Investment in Sel balance at December 31, 2011 July 1, 2011 Investment in Sel Cash To record initial investment for 80% interest of Sel. November 1, 2011 Cash Investment in Sel To record receipt of dividends ($16,000  80%).

$220,000 4,000 (12,800) (6,600) $204,600

220,000 220,000

12,800 12,800

December 31, 2011 Income from Sel 2,600 Investment in Sel 2,600 To record income from Sel computed as follows: Share of Sel’s income ($10,000  1/2 year  80%) less excess depreciation ($132,000/10 years  1/2 year).

Chapter 2

2-15

Solution P2-3 Preliminary computations Cost of investment in Zel Book value acquired ($2,000,000  30%) Excess fair value over book value

$662,000 600,000 $ 62,000

Excess allocated Undervalued inventories ($60,000  30%) Overvalued building (-$120,000  30%) Goodwill for the remainder Excess fair value over book value

$ 18,000 (36,000) 80,000 $ 62,000

Income from Zel Share of Zel’s reported income ($200,000  30%) Less: Excess allocated to inventories sold in 2011 Add: Amortization of excess allocated to overvalued building $36,000/10 years Income from Zel — 2011

$ 60,000 (18,000) 3,600 $ 45,600

Investment balance December 31, 2011 Cost of investment Add: Income from Zel Less: Share of Zel’s dividends ($100,000  30%) Investment in Zel balance December 31

$662,000 45,600 (30,000) $677,600

Vat’s share of Zel’s net assets Share of stockholders’ equity ($2,000,000 + $200,000 income - $100,000 dividends)  30%

$630,000

Stock Investments — Investor Accounting and Reporting

2-16

Solution P2-4 Preliminary computations Investment cost of 40% interest Book value acquired [$500,000 + ($100,000  1/2 year)]  40% Excess fair value over book value

$380,000 220,000 $160,000

Excess allocated Land $30,000  40% Equipment $50,000  40% Remainder to goodwill Excess fair value over book value

$ 12,000 20,000 128,000 $160,000

July 1, 2011 Investment in Jill 380,000 Cash To record initial investment for 40% interest in Jill. November 2011 Cash (other receivables) Investment in Jill To record receipt of dividends ($50,000  40%).

380,000

20,000 20,000

December 31, 2011 Investment in Jill 20,000 Income from Jill To record share of Jill’s income ($100,000  1/2 year  40%).

20,000

December 31, 2011 Income from Jill Investment in Jill To record depreciation on excess allocated to Undervalued equipment ($20,000/5 years  1/2 year).

2,000

Chapter 2

2-17

Solution P2-5 1

Schedule to allocate fair value — book value differentials Investment cost January 1 Book value acquired ($3,900,000 net assets  30%) Excess fair value over book value

$1,680,000 1,170,000 $ 510,000

Allocation of excess Inventories Land Buildings — net Equipment — net Bonds payable Assigned to identifiable net assets Remainder to goodwill Excess fair value over book value 2

Fair Value — Percent Book Value Acquired $200,000 30% 800,000 30% 500,000 30% (700,000) 30% (100,000) 30%

Income from Tremor for 2011 Equity in income ($1,200,000  30%) Less: Amortization of differentials Inventories (sold in 2011) Buildings — net ($150,000/10 years) Equipment — net ($210,000/7 years) Bonds payable ($30,000/5 years) Income from Tremor Investment in Tremor balance December 31, 2011 Investment cost Add: Income from Tremor Less: Dividends ($600,000  30%) Investment in Tremor December 31

Allocation $ 60,000 240,000 150,000 (210,000) (30,000) 210,000 300,000 $ 510,000 $

360,000

(60,000) (15,000) 30,000 6,000 321,000

$1,680,000 321,000 (180,000) $1,821,000

Check: Underlying equity ($4,500,000  30%) Unamortized excess: Land Buildings — net ($150,000 - $15,000) Equipment — net ($210,000 - $30,000) Bonds payable ($30,000 - $6,000) Goodwill Investment in Tremor account

$1,350,000 240,000 135,000 (180,000) (24,000) 300,000 $1,821,000

Stock Investments — Investor Accounting and Reporting

2-18

Solution P2-6 1

Income from Sap Investment in Sap July 1, 2011 at cost Book value acquired ($130,000  60%) Excess fair value over book value

$96,000 78,000 $18,000

Pal’s share of Sap’s income for 2011 ($20,000  1/2 year  60%) Less: Excess Depreciation ($18,000/10 years  1/2 year) Income from Sap for 2011

$ 6,000 900 $ 5,100

Investment balance December 31, 2011 Investment cost July 1 Add: Income from Sap Less: Dividends ($12,000  60%) Investment in Sap December 31

$96,000 5,100 (7,200) $93,900

Solution P2-7 Dil Corporation Partial Income Statement for the year ended December 31, 2013 Investment income Income from Lar (equity basis) Income before extraordinary item

$45,000 45,000

Extraordinary gain Share of Lar’s operating loss carryforward Net income

30,000 $ 75,000

Chapter 2

2-19

Solution P2-8 Preliminary computations Investment cost of 90% interest in Jen

$1,980,000

Implied total fair value of Jen ($1,980,000 / 90%) Book value($2,525,000 + $125,000) Excess book value over fair value

$2,200,000 (2,650,000) $ (450,000)

Excess allocated Overvalued plant assets Undervalued inventories Excess book value over fair value

$ (500,000) 50,000 $ (450,000)

Investment income for 2011 Share of reported income ($250,000  1/2 year  90%) Add: Depreciation on overvalued plant assets (($500,000 x 90%) / 9 years)  1/2 year Less: 90% of Undervaluation allocated to inventories Income from Jen — 2011 Investment balance at December 31, 2012 Underlying book value of 90% interest in Jen (Jen’s December 31, 2012 equity of $2,700,000  90%) Less: Unamortized overvaluation of plant assets ($50,000 per year  7 1/2 years) Investment balance December 31, 2012 Journal entries to account for investment in 2013 Cash (or Dividends receivable) 135,000 Investment in Jen To record receipt of dividends ($150,000  90%).

112,500

25,000 (45,000) 92,500

$2,430,000 (375,000) $2,055,000

135,000

Investment in Jen 230,000 Income from Jen 230,000 To record income from Jen computed as follows: Laura’s share of Jen’s reported net income ($200,000  90%) plus $50,000 amortization of overvalued plant assets. Check: Investment balance December 31, 2012 of $2,055,000 + $230,000 income from Jen - $135,000 dividends = $2,150,000 balance December 31, 2013 Alternatively, Jen’s underlying equity ($2,000,000 paid-in capital + $750,000 retained earnings)  90% interest - $325,000 unamortized excess allocated to plant assets = $2,150,000 balance December 31, 2013.

Stock Investments — Investor Accounting and Reporting

2-20

Solution P2-9 1

Market price of $24 for Tricia’s shares Cost of investment in Lisa (40,000 shares  $24) The $80,000 direct costs must be expensed. Book value acquired ($2,000,000 net assets  40%) Excess fair value over book value

960,000

800,000 160,000

Allocation of excess Fair Value — Book Value Inventories $ 200,000 Land 400,000 (400,000) Buildings — net 200,000 Equipment — net Assigned to identifiable net assets Remainder assigned to goodwill Total allocated 2

Percent Acquired 40% 40% 40% 40%

Market price of $16 for Tricia’s shares Cost of investment in Lisa (40,000 shares  $16) Other direct costs are $0 Book value acquired ($2,000,000 net assets  40%) Excess book value over fair value Excess allocated to Fair Value — Percent Book Value Acquired Inventories $200,000 40% Land 400,000 40% (400,000) 40% Buildings — net 200,000 40% Equipment — net Bargain purchase gain

Allocation $ 80,000 160,000 (160,000) 80,000 (320,000) $(160,000)

Allocation $ 80,000 160,000 (160,000) 80,000 160,000 0 $ 160,000

640,000 800,000 $ (160,000)

Chapter 2

2-21

Solution P2-10 1

Income from Prima — 2011 Fred’s share of Prima’s income for 2011 $40,000  1/2 year  15%

Investment in Prima balance December 31, 2011 Investment in Prima at cost Add: Income from Prima Less: Dividends from Prima November 1 ($15,000  15%) Investment in Prima balance December 31

$ 48,750 3,000 (2,250) $ 49,500

Income from Prima — 2012 Fred’s share of Prima’s income for 2012: $60,000 income  15% interest  1 year $60,000 income  30% interest  1 year $60,000 income  45% interest  1/4 year Fred’s share of Prima’s income for 2012

9,000 18,000 6,750 $ 33,750

Investment in Prima December 31, 2012 Investment balance December 31, 2011 (from 2) Add: Additional investments ($99,000 + $162,000) Add: Income for 2012 (from 3) Less: Dividends for 2012 ($15,000  45%) + ($15,000  90%) Investment in Prima balance at December 31 Alternative solution Investment cost ($48,750 + $99,000 + $162,000) Add: Share of reported income 2011 — $40,000  1/2 year  15% 2012 — $60,000  1 year  45% 2012 — $60,000  1/4 year  45% Less: Dividends 2011 — $15,000  15% 2012 — $15,000  45% 2012 — $15,000  90% Investment in Prima

3,000

$ 49,500 261,000 33,750 (20,250) $324,000 $309,750

$ 3,000 27,000 6,750 $ 2,250 6,750 13,500

36,750

(22,500) $324,000

Note: Since Fred’s investment in Prima consisted of 9,000 shares (a 45% interest) on January 1, 2012, Fred correctly used the equity method of accounting for the 15% investment interest held during 2011. The alternative of reporting income for 2011 on a fair value/cost basis and recording a prior period adjustment for 2012 is not appropriate in view of the overwhelming evidence of an ability to exercise significant influence by the time 2011 income is recorded.

Stock Investments — Investor Accounting and Reporting

2-22

Solution P2-11 Income from Sue

As reported Correct amounts Overstatement

2011

2012

2013

2014

Total

$40,000 20,000a $20,000

$32,000 32,000b $ -0-

$52,000 52,000c $ -0-

$48,000 48,000d $ -0-

$172,000 152,000 $ 20,000

 1/2 year  40%)  40%) c($130,000  40%) d($120,000  40%) a($100,000 b($80,000

Investment in Sue balance December 31, 2014 Investment in Sue per books December 31 Less: Overstatement Correct investment in Sue balance December 31

$400,000 20,000 $380,000

Check Underlying equity in Sue ($900,000  40%) Add: Goodwill ($300,000-(700,000  40%)) Investment balance

$360,000 20,000 $380,000

Correcting entry (before closing for 2014) Retained earnings 20,000 Investment in Sue 20,000 To record investment and retained earnings accounts for prior error.

Chapter 2

2-23

Solution P2-12 1

Schedule to allocate excess cost over book value Investment cost (14,000 shares  $13) $10,000 direct costs must be expensed. Book value acquired $190,000  70% Excess fair value over book value

$182,000 133,000 $ 49,000

Excess allocated Interest Fair Value — Book Value  Acquired = $ 50,000 $60,000 70% 50,000 30,000 70% 135,000 95,000 70%

Inventories Land Equipment — net Remainder to goodwill Excess fair value over book value 2

Investment income from Jojo Share of Jojo’s reported income $60,000  70% Add: Overvalued inventory items Less: Depreciation on undervalued equipment ($28,000/4 years)  3/4 year Investment income from Jojo

Allocation $ (7,000) 14,000 28,000 14,000 $ 49,000

$ 42,000 7,000 (5,250) $ 43,750

Investment in Jojo account at December 31, 2011 Investment cost Add: Income from Jojo Less: Dividends received (14,000 shares  $2) Investment in Jojo balance December 31 Check Underlying equity at December 31, 2011 ($210,000*  70%) Add: Unamortized excess of cost over book value Land Equipment Goodwill Investment balance * $100,000 (C/S) + $70,000 (R/E) + $80,000 (current earnings) -$40,000 (Dividends) = $210,000

$182,000 43,750 (28,000) $197,750 $147,000 14,000 22,750 14,000 $197,750

CHAPTER 3 AN INTRODUCTION TO CONSOLIDATED FINANCIAL STATEMENTS Answers to Questions 1

A corporation becomes a subsidiary when another corporation either directly or indirectly acquires a controlling financial interest (generally over 50 percent) of its outstanding voting stock.

Amounts assigned to identifiable assets and liabilities in excess of recorded amounts on the books of the subsidiary are not recorded separately by the parent. Instead, the parent records the fair value/purchase price of the interest acquired in an investment account. The assignment to identifiable asset and liability accounts is made through working paper entries when the parent and subsidiary financial statements are consolidated.

The land would be shown in the consolidated balance sheet at $100,000, its fair value, assuming that the purchase price of the subsidiary is greater than the book value of the subsidiary’s net assets. If the parent had acquired an 80 percent interest and the implied fair value of the subsidiary was greater than the book value of the subsidiary’s net assets, the land would still appear in the consolidated balance sheet at $100,000. Under GAAP, the noncontrolling interest is also reported based on fair values at the acquisition date.

Parent company—a corporation that owns a controlling interest in the outstanding voting stock of another corporation (its subsidiary). Subsidiary company—a corporation that is controlled by a parent that owns a controlling interest in its outstanding voting stock, either directly or indirectly. Affiliates—companies that are controlled by a single management team through parent-subsidiary relationships. (Although the term affiliate is a synonym for subsidiary, the parent is included in the total affiliation structure.) In many annual reports, the term includes all investments accounted for by the equity method. Associates—companies that are controlled through parent-subsidiary relationships or whose operations can be significantly influenced through equity investments of 20 percent to 50 percent.

A noncontrolling interest is the equity interest in a subsidiary that is owned by stockholders outside of the affiliation structure. In other words, it is the equity interest in a subsidiary (recorded at fair value) that is not held by the parent or subsidiaries of the parent.

Under GAAP, a subsidiary will not be consolidated if control does not rest with the majority owner, such as in the case of a subsidiary in reorganization or bankruptcy, or when the subsidiary operates under severe foreign exchange restrictions or other governmentally imposed uncertainties. Other conditions for not consolidating a subsidiary are: (1) formation of joint ventures, (2) the acquisition of an asset or group of assets that does not constitute a business, (3) combination between entities under common control and (4) combination between not-for-profit entities or the acquisition of a for-profit business by a not-for-profit entity.

Consolidated financial statements are intended primarily for the stockholders and creditors of the parent, according to GAAP.

The amount of capital stock that appears in a consolidated balance sheet is the total par or stated value of the outstanding capital stock of the parent.

Goodwill from consolidation may appear in the general ledger of the surviving entity in a merger or consolidation accounted for as an acquisition. But goodwill from consolidation would not appear in the general ledger of a parent or its subsidiary. Goodwill is entered in consolidation working papers when the Copyright © 2015 Pearson Education, Inc. 3-1

3-2

An Introduction to Consolidated Financial Statements

reciprocal investment and equity amounts are eliminated. Working paper entries affect consolidated financial statements, but they are not entered in any general ledger. 10

The parent’s investment in subsidiary does not appear in a consolidated balance sheet if the subsidiary is consolidated. It would appear in the parent’s separate balance sheet under the heading “investments” or “other assets.” Investments in unconsolidated subsidiaries are shown in consolidated balance sheets as investments or other assets. They are accounted for under the equity method if the parent can exercise significant influence over the subsidiary; otherwise, they are accounted for by the fair value / cost method.

Parent’s books: Investment in subsidiary Sales Accounts receivable Interest income Dividends receivable Advance to subsidiary

Reciprocal accounts are eliminated in the process of preparing consolidated financial statements in order to show the financial position and results of operations of the total economic entity that is under the control of a single management team. Sales by a parent to a subsidiary are internal transactions from the viewpoint of the economic entity and the same is true of interest income and interest expense and rent income and rent expense arising from intercompany transactions. Similarly, receivables from and payables to affiliates do not represent assets and liabilities of the economic entity for which consolidated financial statements are prepared.

The stockholders’ equity of a parent under the equity method is the same as the consolidated stockholders’ equity of a parent and its subsidiaries except for the noncontrolling interest.

No. The amounts that appear in the parent’s statement of retained earnings under the equity method and the amounts that appear in the consolidated statement of retained earnings are identical, assuming that the noncontrolling interest is included as a separate component of stockholders’ equity.

Income attributable to noncontrolling interest is not an expense, but rather it is an allocation of the total income to the consolidated entity between controlling and noncontrolling stockholders. From the viewpoint of the controlling interest (the stockholders of the parent), income attributable to noncontrolling interest has the same effect on consolidated net income as an expense. This is because consolidated net income is income to all stockholders. Alternatively, you can view total consolidated net income as being allocated to the controlling and noncontrolling interests.

The computation of noncontrolling interest is comparable to the computation of retained earnings. It is computed:

Reciprocal accounts on subsidiary’s books: Capital stock and retained earnings Cost of Goods Sold Accounts payable Interest expense Dividends payable Advance from parent

Noncontrolling interest beginning of the period Add: Income attributable to noncontrolling interest Deduct: Noncontrolling interest dividends Deduct: Noncontrolling interest of amortization of excess of fair value over book value Add: Noncontrolling interest of amortization of excess of book value over fair value Noncontrolling interest end of the period 17

XX XX (XX) (XX) XX XX

It is acceptable to consolidate the annual financial statements of a parent and a subsidiary with different fiscal periods, provided that the dates of closing are not more than three months apart. Any significant developments that occur in the intervening three-month period should be disclosed in notes to the financial statements. In the situation described, it is acceptable to consolidate the financial statements of the Copyright © 2015 Pearson Education, Inc.

Chapter 3

3-3

subsidiary with an October 31 closing date with the financial statements of the parent with a December 31 closing date. 18

The acquisition of shares from noncontrolling stockholders is not a business combination. It must be accounted for as a treasury stock transaction if the acquirer is the controlling interest. It is not possible, by definition, to acquire a controlling interest from noncontrolling stockholders.

SOLUTIONS TO EXERCISES Solution E3-1

Solution E3-2

1 2 3 4 5

1 2 3 4 5 6 7

b c d d a

d b d d a b c

Solution E3-3 [AICPA adapted] 1 c $275,000

Advance to Hill $75,000 + receivable from Ward $200,000 =

Zero, goodwill has an indeterminate life and is not amortized.

a Pow accounts for Sap using the equity method, therefore, consolidated retained earnings is equal to Pow’s retained earnings, or $2,480,000.

4 d On the consolidated balance sheet, intercompany receivables should be zero. Solution E3-4 (in thousands) 1

Implied fair value of San ($3,600 / 90%) $4,000 Less: Book value of San (3,600) Excess fair value over book value $ 400 Equipment undervalued 120 Goodwill at January 1, 2011 $ 280 Goodwill at December 31, 2011 = Goodwill from consolidation $ 280 Since goodwill is not amortized

Consolidated net income Pin’s reported net income Less: Correction to income from San for depreciation on excess allocated to equipment [($120,000/3 years)x 90%] Controlling share of consolidated net income Noncontrolling share of consolidated net income: ($400,000 - $40,000 depreciation) x 10% Copyright © 2015 Pearson Education, Inc.

$1,960 (36) $1,924 $36

3-4

An Introduction to Consolidated Financial Statements

Controlling share of consolidated net income Consolidated net income

1,924 $1,960

Solution E3-5 (in thousands) 1

$2,400, the dividends of Pan

$1,320, equal to $1,200 dividends payable of Pan plus $120 (30% of $400) dividends payable to noncontrolling interests of Sad.

Solution E3-6 (in thousands) Preliminary computation Cost of Sli stock (Fair value) Fair value of Sli’s identifiable net assets Goodwill 1

$5,000 4,000 $1,000

Journal entry to record push down values Inventories Land Buildings — net Equipment — net Goodwill Retained earnings Note payable Push-down capital

80 200 600 320 1,000 840 40 3,000 Sli Corporation Balance Sheet January 1, 2011 (in thousands)

Assets Cash Accounts receivable Inventories Land Buildings — net Equipment — net Goodwill Total assets Liabilities Accounts payable Note payable Total liabilities Stockholders’ equity Capital stock Push-down capital Total stockholders’ equity Total liabilities and stockholders’ equity

280 320 400 800 2,000 1,200 1,000 $6,000 $

400 600 1,000

$2,000 3,000 5,000 $6,000

Chapter 3

3-5

Solution E3-7 1

Pas Corporation and Subsidiary Consolidated Income Statement for the year 2012 (in thousands) Sales ($4,000 + $1,600) Less: Cost of sales ($2,400 + $800)

$5,600 (3,200)

Gross profit Less: Depreciation expense ($200 + $160) Other expenses ($796 + $360)

2,400 (360) (1,156)

Consolidated net income Less: Noncontrolling interest share ($280  30%) Controlling interest share of cnsolidated net income

Pas Corporation and Subsidiary Consolidated Income Statement for the year 2012 (in thousands) Sales ($4,000 + $1,600) Less: Cost of sales ($2,400 + $800)

$5,600 (3,200)

Gross profit Less: Depreciation expense ($200 + $160 - $24) Other expenses ($796 + $360)

2,400 (336) (1,156)

Consolidated net income Less: Noncontrolling interest share [($280  30%)+ ($24 depreciation x 30%)] Controlling interest share of consolidated net income Supporting computations Depreciation of excess allocated to overvalued equipment: $120/5 years = $24

884 (84) 800

908

(91.2) 816.8

3-6

An Introduction to Consolidated Financial Statements

Solution E3-8 (in thousands) 1

Capital stock The capital stock appearing in the consolidated balance sheet at December 31, 2011 is $7,200, the capital stock of Pob,the parent company.

Goodwill at December 31, 2011 Investment cost at January 2, 2011 (80% interest) Implied total fair value of Sof ($2,800 / 80%) Book value of Sof(100%) Excess is considered goodwill since no other fair value information is given.

$3,200 1,200 (720) $3,680

Noncontrolling interest at December 31, 2011 Capital stock and retained earnings of Sof on January 2 Add: Sof’s net income Less: Dividends declared by Sof Sof’s stockholders’ equity December 31 Noncontrolling interest percentage Noncontrolling interest at book value Add: 20% Goodwill Noncontrolling interest December 31

$1,100

Consolidated retained earnings at December 31, 2011 Pob’s retained earnings January 2 (equal to beginning consolidated retained earnings Add: Net income of Pob (equal to controlling share of consolidated net income) Less: Dividends declared by Pob Consolidated retained earnings December 31

$2,800 $3,500 (2,400)

$2,400 360 (200) 2,560 20% $ 512 220 $ 732

Dividends payable at December 31, 2011 Dividends payable to stockholders of Pob Dividends payable to noncontrolling stockholders ($100  20%) Dividends payable to stockholders outside the Consolidated entity

$ 360 20 $ 380

Chapter 3

3-7

Solution E3-9 (in thousands) Pas Corporation and Subsidiary Partial Balance Sheet at December 31, 2011 Stockholders’ equity: Capital stock, $10 par Additional paid-in capital Retained earnings Equity of controlling stockholders Noncontrolling interest Total stockholders’ equity

$1,200 200 260 1,660 164 $1,824

Supporting computations Computation of consolidated retained earnings: Pas’s December 31, 2010 retained earnings Add: Pas’s reported income for 2011 Less: Pas’s dividends Consolidated retained earnings December 31, 2011

$ 140 220 (100) $ 260

Computation of noncontrolling interest at December 31, 2011 Sal’s December 31, 2010 stockholders’ equity Income less dividends for 2011 ($80 - $60) Sal’s December 31, 2011 stockholders’ equity Noncontrolling interest percentage Noncontrolling interest December 31, 2011

$800 20 820 20% $164

3-8

An Introduction to Consolidated Financial Statements

Solution E3-10 Pek Corporation and Subsidiary Consolidated Income Statement for the year ended December 31, 2013 (in thousands) Sales Cost of goods sold Gross profit Deduct: Operating expenses Consolidated net income Deduct: Noncontrolling interest share Controlling interest share

$8,400 4,400 4,000 2,220 1,780 58 $1,722

Supporting computations Investment cost January 1, 2011 (90% interest) Implied total fair value of Slo ($3,240 / 90%) Slo’s Book value acquired (100%) Excess of fair value over book value Excess allocated to: Inventories (sold in 2011) Equipment (4 years remaining useful life) Goodwill Excess of fair value over book value Operating expenses: Combined operating expenses of Pek and Slo Add: Depreciation on excess allocated to equipment ($80/4 years) Consolidated operating expenses

$ 3,240 $ 3,600 (2,800) $ 800 $ $

120 80 600 800

$2,200 20 $2,220

Chapter 3

3-9

SOLUTIONS TO PROBLEMS Solution P3-1 1

Pen Corporation and Subsidiary Consolidated Balance Sheet at December 31, 2011 (in thousands) Assets Cash ($128 + $72) Accounts receivable ($180 + $136 - $20) Inventories ($572 + $224) Equipment — net ($1,520 + $700) Total assets Liabilities and Stockholders’ Equity Liabilities: Accounts payable ($160 + $132 - $20) Stockholders’ equity: Common stock, $10 par Retained earnings Noncontrolling interest ($600 + $400)  20% Total liabilities and stockholders’ equity

200 296 796 2,220 $3,512

272

1,840 1,200 200 $3,512

Consolidated net income for 2012 Pen’s separate income Add: Income from Sut (80% x $360,000) Controlling interest share Add: Noncontrolling interest share (20% x $360,000) Consolidated net income

Pen’s separate income Add: Sut’s net income Consolidated net income Less: Noncontrolling interest share (20% x $360,000) Controlling share of consolidated net income

680 288 968 72 $1,040 680 360 1,040 72 $ 968

3-10

An Introduction to Consolidated Financial Statements

Solution P3-2 (in thousands) 1

Schedule to allocate fair value/book value differential Cost of investment in Set Implied fair value of Set ($700 / 70%) Book value of Set Excess fair value over book value Excess allocated: Fair Value Book Value Inventories ($200 $120) Land ($240 $200) ($360 $280) Buildings — net ($120 $160) Equipment — net Other liabilities ($160 $200) Allocated to identifiable net assets Goodwill for the remainder Excess fair value over book value

$ 700 $1,000 (440) $ 560 Allocation $ 80 40 80 (40) 40 200 360 $560

Par Corporation and Subsidiary Consolidated Balance Sheet at January 1, 2011 Assets Current assets: Cash ($140 + $80) Receivables — net ($320 + $120) Inventories ($280 + $120 + $80) Property, plant and equipment: Land ($400 + $200 + $40) Buildings — net ($440 + $280 + $80) Equipment — net ($320 + $160 - $40) Goodwill (from consolidation) Total assets Liabilities and Stockholders’ Equity Liabilities: Accounts payable ($360 + $320) Other liabilities ($40 + $200 - $40) Stockholders’ equity: Capital stock Retained earnings Equity of controlling stockholders Noncontrolling interest * Total liabilities and stockholders’ equity

$220 440 480 $640 800 440

680 200

$2,000 200 2,200 300

* 30% of implied fair value of $1,000 = $300.

$1,140

1,880 360 $3,380

880

2,500 $3,380

Chapter 3

3-11

Solution P3-3 (in thousands) Cost of investment in Sof January 1, 2011 Implied fair value of Sof ($10,800 / 80%) Book value of Sof Excess of fair value over book value

$10,800 $13,500 10,000 $ 3,500

Schedule to Allocate Fair Value — Book Value Differential

Current assets Equipment

Fair Value - Book Value $2,000 4,000

Allocation $2,000 4,000

Bargain purchase gain* Excess fair value over book value

(2,500) $3,500

*After recognizing acquired assets and liabilities at fair values, we are left with a negative excess of $2,500. Under GAAP, this difference is recorded as a gain in the consolidated income statement in the year of acquisition. The gain is attributable entirely to the controlling interest, and is recorded on the parent’s books by a debit to the Investment account and a credit to a Gain from Bargain Purchase account. An alternative calculation of this amount takes the difference between the fair values of the net assets ($16,000) and their fair value implied by the acquisition price ($13,500), which equals $2,500. Solution P3-4 (in thousands) Noncontrolling interest of $260 (fair value) plus $1,040 (fair value of Pam’s investment) equals total fair value of $1,300. Therefore, Pam’s interest is 80% ($1,040 / $1,300), and noncontrolling interest is 20% ($260 / $1,300). Total fair value Book value of Sap Excess fair value over book value

$1,300 (1,040) $ 260

Excess allocated to Plant assets — net Goodwill Total

Fair Value $840

Book Value $800 $ $

40 220 260

3-12

An Introduction to Consolidated Financial Statements

Solution P3-5 Pal Corporation and Subsidiary Consolidated Balance Sheet at December 31, 2011 (in thousands) Assets Current assets Plant assets Goodwill

$1,360 3,320 800 $5,480

Equities Liabilities Capital stock Retained earnings

$2,640 1,200 1,640 $5,480

Supporting computations Sor’s net income ($1,600 - $1,200 - $200) Less: Excess allocated to inventories that were sold in 2011 Less: Depreciation on excess allocated to plant assets ($160 /4 years) Income from Sor

200 (80) (40) 80

Plant assets ($2,000 + $1,200 + $160 - $40)

$3,320

Pal’s retained earnings: Beginning retained earnings Add: Operating income Add: Income from Sor Deduct: Dividends Retained earnings December 31, 2011

$1,360 400 80 (200) $1,640

Chapter 3

3-13

Solution P3-6 Per Corporation and Subsidiary Consolidated Balance Sheet Working Papers at December 31, 2011 (in thousands) Per per books $ 168 200

Cash Receivables — net Inventories Land

Sim per books $ 80 520

1,400 600 2,400 1,836 ______

______

$6,604

$2,000

Accounts payable Dividends payable Capital stock Retained earnings Noncontrolling interest Total equities

$1,640 240 4,000 724 ______ $6,604

200 800 400

Equipment — net Investment in Sim Goodwill Total assets

Adjustments and Eliminations

Consolidated Balance Sheet $ 248 684 1,600 1,400 2,800

a 1,836

320 40 1,200 440 ______ $2,000

400

400 $7,132

b 36 a 1,200 a 440 _______ 2,076

204 2,076

$1,960 244 4,000 724 204 $7,132

To eliminate reciprocal investment and equity accounts, record goodwill ($400), and enter noncontrolling interest [($1,640 equity + $400 goodwill)  10%)]. To eliminate reciprocal dividends receivable (included in receivables — net) and dividends payable amounts ($40 dividends  90%).

3-14

An Introduction to Consolidated Financial Statements

Solution P3-7 (in thousands) Preliminary computations Cost of 80% investment January 3, 2011 Implied total fair value of Sle ($1,120 / 80%) Book value of Sle Excess fair value over book value on January 3 = Goodwill 1

$1,120 $1,400 (1,000) $ 400

Noncontrolling interest share of income: Sle’s net income $200  20% noncontrolling interest

$ 40

Current assets: Combined current assets ($816 + $300) Less: Dividends receivable ($40  80%) Current assets

$1,116 (32) $1,084

Income from Sle: None Investment income is eliminated in consolidation.

Capital stock: $2,000 Capital stock of the parent, Por Corporation.

Investment in Sle: None The investment account is eliminated.

Excess of fair value over book value

$400

Controlling share of consolidated net income: Equals Por’s net income, or: Consolidated sales Less: Consolidated cost of goods sold Less: Consolidated expenses Consolidated net income Less: Noncontrolling interest share Controlling share

$ 2,400 (1,480) (320) $ 600 (40) $ 560

Consolidated retained earnings December 31, 2011: $808 Equals Por’s beginning retained earnings.

Consolidated retained earnings December 31, 2012 Equal to Por’s ending retained earnings: Beginning retained earnings Add: Controlling share of consolidated net income Less: Por’s dividends for 2012 Ending retained earnings

Noncontrolling interest December 31, 2012 Sle’s capital stock and retained earnings Add: Net income Less: Dividends Sle’s equity December 31, 2012 at fair value Noncontrolling interest percentage Noncontrolling interest December 31, 2012 using book value Add: Noncontrolling interest share of Goodwill Noncontrolling interest December 31, 2012 at fair value

808 560 (240) $1,128 $1,200 200 (100) 1,300 20% $ 260 80 $ 340

Chapter 3

3-15

Solution P3-8 [AICPA adapted] Preliminary computations Investment cost: Saw (2,000 shares  80%)  $280

Saw

Sun

448,000

Sun (6,000 shares  70%)  $160

672,000

Implied total fair values: Saw ($448,000 / 80%) 560,000 Sun ($672,000/ 70%)

960,000

Book value of stockholders’ equity Saw Sun Excess fair value over book value at acquisition (Goodwill) 1

280,000 480,000 280,000

480,000

a. Journal entries to account for investments January 1, 2011 — Acquisition of investments Investment in Saw (80%) Cash To record acquisition of 1,600 shares of Saw common stock at $280 per share. Investment in Sun (70%) Cash

448,000 448,000 672,000

672,000 To record acquisition of 4,200 shares of Sun common stock at $160 per share. b. During 2011 — Dividends from subsidiaries Cash 51,200 Investment in Saw (80%) 51,200 To record dividends received from Saw ($64,000  80%). Cash 25,200 Investment in Sun (70%) 25,200 To record dividends received from Sun ($36,000  70%). c. December 31, 2011 — Share of income or loss Investment in Saw (80%) 115,200 Income from Saw 115,200 To record investment income from Saw ($144,000  80%). Loss from Sun 33,600 Investment in Sun (70%) 33,600 To record investment loss from Sun ($48,000  70%).

3-16

An Introduction to Consolidated Financial Statements

Solution P3-8 (continued) 2

Noncontrolling interest December 31, 2011 * Common stock Capital in excess of par Retained earnings Equity December 31 Noncontrolling interest percentage Noncontrolling interest December 31 Plus: Goodwill x 20% $280,000 x 20% $480,000 x 30% Noncontrolling interest, December 31

Saw $200,000 160,000 360,000 20% $ 72,000

Sun $240,000 80,000 76,000 396,000 30% $118,800

56,000 $128,000

144,000 $262,800

* Fair value equals book value. 3

Consolidated retained earnings December 31, 2011 Consolidated retained earnings is reported at $1,218,400, equal to the retained earnings of Pod Corporation, the parent, at December 31, 2011.

Investment balance December 31, 2011: Investment cost January 1

Saw $448,000

Sun $672,000

Add (deduct): Income (loss) Deduct: Dividends received Investment balances December 31

115,200 (51,200) $512,000

(33,600) (25,200) $613,200

Check: Investment balances should be equal to the underlying book value plus goodwill Saw ($360,000  80%) + ($280,000 x 80%) = $512,000 Sun ($396,000  70%) + ($480,000 x 70%) = $613,200 After consolidation, the Investment balances are $0.

Chapter 3

3-17

Solution P3-9 Preliminary computations (in thousands) Cost of 90% investment January 1, 2011 Implied total fair value of Son ($14,400 / 90%) Book value of Son Excess fair value over book value on January 1 Allocation to equipment Remainder is Goodwill Additional annual depreciation on equipment ($3,200 / 8 years)

$14,400 $16,000 (10,800) $ 5,200 $ 3,200 $ 2,000 $ 400

Pan Corporation and Subsidiary Consolidated Balance Sheet Working Papers at December 31, 2011 (in thousands)

Cash Receivables — net Dividends receivable Inventory Land Buildings — net Equipment — net Investment in Son Goodwill Total assets

Pan $ 1,200 2,400

a b

Adjustments and Eliminations

360 2,800 2,400 8,000

2,400 2,800 4,000

6,000

3,200

2,800

15,120 _______ $38,280

________ $ 14,800

2,000

b a a

360 8,000 4,000 _______

Accounts payable $ 1,200 Dividends payable 2,000 Capital stock 28,000 Retained earnings 7,080 Noncontrolling interest _______ Total equities

90% Son 800 1,600

$38,280

Consolidated Balance Sheet $ 2,000 4,000

360 5,200 5,200 12,000 12,000

a 15,120

2,400 400 8,000 4,000 ________

2,000 $42,400

$ 14,800

17,160

1,680

$ 3,600 2,040 28,000 7,080 1,680

17,160

$42,400

To eliminate reciprocal investment and equity accounts, enter unamortized excess allocated to equipment, record goodwill, and enter noncontrolling interest (at fair value). To eliminate reciprocal dividends receivable and dividends payable amounts.

3-18

An Introduction to Consolidated Financial Statements

Solution P3-10 1

Purchase price of investment in Sun (in thousands) Underlying book value of investment in Sun: Equity of Sun January 1, 2011 Add: Excess investment fair value over book value: Goodwill at December 31, 2015 Fair value of Sun January 1, 2011

240 $1,120

Purchase price of 80% investment at fair value($1,120 x 80%) 2

Sun’s stockholders’ equity on December 31, 2014 (in thousands) 20% noncontrolling interest at fair value $248 20% goodwill (48) 20% noncontrolling interest’s equity at book value $200 Total equity = Noncontrolling interest’s equity $200/20% = $1,000

Pan’s investment in Sun account balance at December 31, 2014 (in thousands) Underlying book value in Sun December 31, 2014 $800 ($1,000  80%) Add: 80% of Goodwill December 31, 2014 (20% is attributable to the noncontrolling interest) 192 Investment in Sun December 31, 2014 $992 Alternative solution: Investment cost January 1, 2011 Add: 80% of Sun’s increase since acquisition ($1,000 - $880)  80% Investment in Sun December 31, 2014

$896 96 $992

Pan’s capital stock and retained earnings December 31, 2015 (in thousands) Capital stock $1,600 Retained earnings $ 120 Amounts are equal to capital stock and retained earnings shown in the consolidated balance sheet.

880

896

Chapter 3

3-19

Solution P3-11 Preliminary computations (in thousands) Cost of 70% investment in Stu Implied fair of Stu($2,800 / 70%) Book value of Stu (100%) Excess Excess allocated: Inventories Plant assets Goodwill Excess

$2,800 $4,000 3,200 $ 800 $ $

Investment balance at January 1, 2011 Share of Stu’s retained earnings increase ($240  70%) Less: Amortization 70% of excess allocated to inventories (sold in 2011) 70% of excess allocated to plant assets ($320 /8 years) Investment balance at December 31, 2011

80 320 400 800

$2,800 168 (56) (28) $2,884

Noncontrolling interest at December 31 30% of Stu’s book value at December 31 ($3,440 x 30%) 30% of Goodwill 30% Unamortized excess for plant assets 30% x ($320 - $40 amortization) Noncontrolling at December 31 (fair value)

$1,032 120 84 $1,236

Pop Corporation and Subsidiary Consolidated Balance Sheet Working Papers at December 31, 2011 (in thousands) Cash Accounts receivable — net Accounts receivable — Pop Dividends receivable Inventories Land

Pop $ 240 1,760

70% Stu 80 800

Adjustments and Eliminations

Consolidated Balance Sheet $ 320 2,560

28 2,000 400 2,800

1,280 600 1,400

280

2,884 ______

______

400

$10,112

$ 4,200

Accounts payable Account payable to Stu Dividends payable Long-term debt Capital stock Retained earnings Noncontrolling interest

$ 1,200 40 160 2,400 4,000 2,312

($4,120,000  30%) Equities

_______

a 1,236

1,236

$10,112

$ 4,200

4,188

$12,040

Plant assets — net Investment in Stu Goodwill Assets

3,280 1,000 4,480 a 2,884 400 $12,040

320 40 400 2,000 1,440

$ 1,520 b c

40 28

172 2,800 4,000 2,312

a 2,000 a 1,440

3-20

An Introduction to Consolidated Financial Statements

Chapter 3

3-21

Solution P3-12 Preliminary computations (in thousands) 80% Investment in Sam at cost January 1, 2011 Implied total fair value of Sam ($3,040 / 80%) Sam book value Excess fair value over book value recorded as goodwill

2011 2012 2013

Sam Dividends $160 200 240 $600

Sam Net Income $ 320 400 480 $1,200

$ 3,040 $ 3,800 3,600 $ 200

80% of Net Income $256 320 384 $960

Sam’s dividends for 2012 ($160 / 80%)

200

Sam’s net income for 2012 ($320 / 80%)

400

Goodwill — December 31, 2012

200

Noncontrolling interest share of income — 2013 Sam’s income for 2013 ($192 dividends received/80%)  2 Noncontrolling interest percentage Noncontrolling interest share

480 20% 96

Noncontrolling interest December 31, 2013 Equity of Sam January 1, 2011 Add: Income for 2011, 2012 and 2013 Deduct: Dividends for 2011, 2012 and 2013 Equity book value of Sam December 31, 2013 Goodwill Equity fair value of Sam December 31, 2013 Noncontrolling interest percentage Noncontrolling interest December 31, 2013

$3,600 1,200 (600) 4,200 200 $4,400 20% $ 880

Controlling share of consolidated net income for 2013 Pen’s separate income Add: Income from Sam Controlling share of consolidated net income

$1,120 384 $1,504

Pen’s net income Sam’s net income Consolidated net income Less: Noncontrolling interest share ($480 x 20%) Controlling interest share

$1,120 480 $1,600 96 $1,504

Chapter 4 CONSOLIDATION TECHNIQUES AND PROCEDURES Answers to Questions 1

Under the equity method, a parent amortizes patents from its subsidiary investments by adjusting its subsidiary investment and income accounts. Since patents and patent amortization accounts are not recorded on the parent’s books, they are created for consolidated statement purposes through workpaper entries.

Noncontrolling interest share is entered in the consolidation workpapers by preparing a workpaper adjusting entry in which noncontrolling interest share is debited and noncontrolling interest is credited. The noncontrolling interest share (debit) is carried to the consolidated income statement as a deduction, and the credit to noncontrolling interest for noncontrolling interest share is added to the beginning noncontrolling interest. The noncontrolling interest share is calculated based on the subsidiary’s reported net income adjusted to reflect fair value through the amortization of the excess of fair value over book value. This is the approach illustrated throughout this text.

Workpaper procedures for the investment in subsidiary, income from subsidiary, and subsidiary equity accounts are alike in regard to the objectives of consolidation. Regardless of the configuration of the workpaper entries, the final result of adjustments for these items is to eliminate them through workpaper entries. In other words, the investment in subsidiary, income from subsidiary, and the capital stock, additional paid-in capital, retained earnings, and other stockholders’ equity accounts of the subsidiary never appear in consolidated financial statements.

When the parent does not amortize fair value/book value differentials on its separate books, the parent’s income from subsidiary and investment in subsidiary accounts are overstated in the year of acquisition. In subsequent years, the income from the subsidiary, investment in subsidiary, and parent’s beginning retained earnings will be overstated. The error may be corrected in the workpapers with the following entries: Year of acquisition Income from subsidiary Investment in subsidiary Subsequent year Income from subsidiary Retained earnings — parent Investment in subsidiary

XXX XXX XXX XXX XXX

By entering a correcting entry, all other workpaper entries are the same as if the parent provided for amortization on its separate books. If the errors are not corrected through the workpaper entries suggested above, the entry to eliminate the income from subsidiary in the year of acquisition is prepared in the usual manner without further complications because neither the beginning investment nor retained earnings accounts are affected by the omission. In subsequent years the entry to eliminate income from subsidiary and dividends from subsidiary will have to be changed to correct the beginning-of-the-period retained earnings as follows: Income from subsidiary Retained earnings — parent Dividends (subsidiary) Investment in subsidiary

XXX XXX

4-2

Consolidation Techniques and Procedures

Workpaper adjustments are not normally entered in the general ledger of the parent or any other entity. They are used in the preparation of consolidated financial statements for a conceptual entity for which there are no formal accounting records. An exception occurs when the adjusting entries involve the correction of an error. For example, if a parent does not record a dividend from a subsidiary. Then the workpaper entry is recorded in the parent’s separate books.

Workpapers are tools of the accountant that facilitate the consolidation of parent and subsidiary financial statements. Given the tools available, the accountant should select those that are most convenient in the circumstances. If financial statements are to be consolidated, the financial statement approach is the appropriate tool. The trial balance approach is most convenient when the data are presented in the form of a trial balance. The accountant needs to be familiar with both approaches to perform the work as efficiently as possible.

Workpaper adjustment and elimination entries as illustrated in this text are exactly the same when the trial balance approach is used as when the financial statement approach is used.

The retained earnings of the parent will equal consolidated retained earnings if the equity method of accounting has been correctly applied. In consolidating the financial statements of affiliated companies, the beginning retained earnings of the parent are used as beginning consolidated retained earnings. If the equity method has not been correctly applied, parent beginning retained earnings will not equal beginning consolidated retained earnings. In this case, retained earnings of the parent are adjusted to a correct equity basis in order to establish the correct amount of beginning consolidated retained earnings. Thus, workpaper adjustments to beginning retained earnings of the parent are needed whenever the beginning retained earnings of the parent do not correctly reflect the equity method.

The noncontroling interest that appears in the consolidated balance sheet can be checked by first adjusting the equity of the subsidiary on the consolidated balance sheet date to fair value (i.e., adjusting for any unamortized excess of fair value over book value) and then multiplying by the noncontrolling interest percentage. Consolidated retained earnings at a balance sheet date can be checked by comparing the amount with the parent’s retained earnings on the same date. If consolidated retained earnings and parent retained earnings are not equal, either consolidated retained earnings have been computed incorrectly, or parent retained earnings do not reflect a correct equity method of accounting.

Consolidated assets and liabilities are reported for all equity holders—noncontrolling as well as controlling. Therefore, the change in net cash from operations for a period results from noncontrolling interest share and controlling interest share.

No. It relates to all interests in the consolidated entity. This difference is one of many inconsistencies in the concepts underlying consolidated financial statements. Consider, for example, the error that could result from dividing cash provided by operations by outstanding parent shares to compute cash flow per share.

SOLUTIONS TO EXERCISES Solution E4-1 1 d 2 c 3 a 4 d 5 b

6 7 8 9 10

d b b a b

Chapter 4

4-3

Solution E4-2 Preliminary computations (in thousands) Investment cost January 2 Implied total fair value of Sal ($1,200 / 80%) Less: Book value Excess fair value over book value Excess allocated to: Inventory Remainder to goodwill Excess fair value over book value 1

$1,200 $1,500 (1,000) $ 500 $ 50 450 $500

Income from Sal Sal’s reported net income Less: Excess allocated to inventory (sold in 2011) Sal adjusted income Pan’s 80% share

$280 (50) $230 $184

Noncontrolling interest share Sal’s adjusted income $230  20% noncontrolling interest

$ 46

Noncontrolling interest December 31 Sal’s equity book value Add: Unamortized excess (Goodwill) Sal’s equity fair value 20% noncontrolling interest

$1,040 450 $1,490 $ 298

Investment in Sal December 31 Investment cost January 2 Add: Income from Sal (given)* Less: Dividends ($120  80%) Investment in Sal December 31 * Assumes this is based on Sal’s adjusted income

Noncontrolling interest share Controlling interest share equals Parent NI under equity method. Consolidated net income Investment income is given as $200,000 = $250,000 x 80% Noncontrolling interest share is $250,000 x 20% = $50,000

$1,200 200 (192) $1,208 $ 50 720.8 $770.8

4-4

Consolidation Techniques and Procedures

Solution E4-3 1 $1,400,000

($600,000 + $880,000 - $80,000 intercompany)

Preliminary computations for 2 and 3 Investment cost on January 1, 2011 Implied total fair value of San ($56,000 / 70%) Book value of San Excess allocated entirely to Goodwill 2

$56,000 $80,000 60,000 $20,000

Peg’s separate income for 2013 Loss from investment in San ($2,000  70%) Controlling share of consolidated net income Add: Noncontrolling share of consolidated net income (2,000 Loss x 30%) Consolidated net income

$48,000 (1,400) $46,600

Investment cost January 1, 2011 Add: Share of income less dividends 2011 — 2013 ($2,800 income - $2,000 dividends)  70% Investment balance December 31, 2013

$56,000

(600) $46,000

560 $56,560

Chapter 4

4-5

Solution E4-4 Preliminary computations Investment cost Implied total fair value of Sin ($1,160,000 / 80%) Book value Total excess fair value over book value

$1,160,000 $1,450,000 1,200,000 $ 250,000

Excess allocated to: Equipment (5-year life) Patents (10-year amortization period) Total excess fair value over book value

$ 100,000 150,000 $ 250,000

Income from Sin Sin’s reported net income Less: Depreciation of excess allocated to equipment Less: Amortization of patents Sin’s adjusted income Income from Sin (80%) 1

2011 $240,000 (20,000) (15,000) $205,000 $164,000

2012 $300,000 (20,000) (15,000) $265,000 $212,000

Consolidated net income for 2011 Pen’s net income = controlling share of consolidated net income under equity method Add: Noncontrolling interest share($205,000 x 20%) Consolidated net income

$680,000 41,000 $721,000

Investment in Sin December 31, 2011 Cost January 1 Add: Income from Sin — 2011 Less: Dividends from Sin — 2011 ($160,000  80%) Investment in Sin December 31

$1,160,000 164,000 (128,000) $1,196,000

Noncontrolling interest share — 2011 ($205,000 adjusted income  20%)

$ 41,000

Noncontrolling interest December 31, 2012 Sin’s equity book value at acquisition date Add: Income less dividends for 2011 and 2012 (see note) Sin’s equity book value at December 31, 2012 Unamortized excess at December 31, 2012 Sin’s equity fair value at December 31, 2012 Noncontrolling interest percentage Noncontrolling interest December 31, 2012

$1,200,000 200,000 1,400,000 180,000 $1,580,000 20% $ 316,000

Note: Sin’s income less dividends: 2011 Net Income 2011 Dividends 2012 Net Income 2012 Dividends Total

$240,000 (160,000) 300,000 (180,000) $200,000

4-6

Consolidation Techniques and Procedures

Solution E4-5 1 2 3 4 5

c a b c d

Solution E4-6 Par Corporation and Subsidiary Partial Consolidated Cash Flows Statement for the year ended December 31, Cash Flows from Operating Activities Controlling interest share of consolidated net income Adjustments to reconcile controlling interest share of consolidated net income to net cash provided by operating activities: Noncontrolling interest share $100,000 Undistributed income of equity investees (10,000) Loss on sale of land 200,000 Depreciation expense 240,000 Patents amortization 32,000 Increase in accounts receivable (210,000) Increase in inventories (90,000) Decrease in accounts payable (40,000) Net cash flows from operating activities

$200,000

222,000 $422,000

Chapter 4

4-7

Solution E4-7 Pro Corporation and Subsidiary Partial Consolidated Cash Flows Statement for the year ended December 31, Cash Flows from Operating Activities Cash received from customers Dividends received from equity investees Less: Cash paid to suppliers Cash paid to employees Cash paid for other operating items Cash paid for interest expense Net cash flows from operating activities

$645,000 14,000 $365,000 54,000 47,000 24,000

490,000 $169,000

4-8

Consolidation Techniques and Procedures

Solutions to Problems Solution P4-1 (in thousands of $) Preliminary computations Investment in Sen (75%) January 1, 2011 Implied fair value of Sen ($4,800 / 75%) Book value of Sen Total excess of fair value over book value Excess allocated: 10% to inventories (sold in 2011) 40% to plant assets (use life 8 years) 50% to goodwill Total excess of fair value over book value 1

Goodwill at December 31, 2015 (not amortized)

Noncontrolling interest share for 2015 Net income ($2,000 sales - $1,200 expenses) Less: Amortization of excess Plant assets ($640 / 8 yrs.) Adjusted Sen income 25% Share

$4,800 $6,400 (4,800) $1,600 $

160 640 800 $1,600 $

800

$ $

(80) 720 180

Consolidated retained earnings December 31, 2014 Equal to Pea’s December 31, 2014 retained earnings Since this a trial balance, reported retained earnings equals beginning of 2015 retained earnings.

$3,340

Consolidated retained earnings December 31, 2015 Pea’s retained earnings December 31, 2014 Add: Pea’s net income for 2015 Less: Pea’s dividends for 2015 Consolidated retained earnings December 31

$3,340 2,170 (1,000) $4,510

Consolidated net income for 2015 Consolidated sales Less: Consolidated expenses ($7,570 + $80 depreciation) Total consolidated income Less: Noncontrolling interest share Controlling share of consolidated net income for 2015

$10,000 (7,650) 2,350 (180) $ 2,170

Noncontrolling interest December 31, 2014 Sen’s stockholders’ equity at book value Unamortized excess after four years: Inventory Plant assets ($640 - $320) Goodwill Sen’s stockholders’ equity at fair value 25% Sen’s stockholders’ equity at fair value

$4,800 0 320 800 $5,920 $1,480

Chapter 4

4-9

Solution P4-1 (continued) 7

Noncontrolling interest December 31, 2015 Sen’s stockholders’ equity at book value Unamortized excess after five years: Inventory Plant assets ($640 - $400) Goodwill Sen’s stockholders’ equity at fair value 25% Sen’s stockholders’ equity at fair value

$5,200 0 240 800 $6,240 $1,560

4-10

Consolidation Techniques and Procedures

Solution P4-2 Pal Corporation and Subsidiary Consolidation Workpapers for the year ended December 31, 2011 (in thousands)

80% Sal

Pal Income Statement Sales Income from Sal Cost of goods sold Operating expenses Consolidated NI Noncontrol. share ($60,000 30%)

$1,240 42 800* 308*

174

Retained Earnings Retained earnings — Pal

260

Accounts payable Other liabilities Capital stock Other paid-in capital Retained earnings

260* 80*

1,060* 388* $ 192

18*

174✓

60✓

120*

40*

174

260

b 44 174 a c

28 12

120*

314

182 240 96 480 196 ______

60 120 80 140

242 360 176 620

$1,194

$ 400

$1,398

120 80 600 80

314✓ $1,194

Noncontrolling interest January 1 Noncontrolling interest December 31 *

$1,640 a 42

Retained earnings — Sal Controlling Share of net income Dividends

Balance Sheet Cash Receiv. — net Inventories PP&E — net Investment in Sal

$ 400

Consolidated Statements

c 18

Controlling share

Retained earnings December 31

Adjustments and Eliminations

a 14 b 182

_____ 72 48 200 16

b 200 b 16

64✓ $ 400 b 78 __________ c 6 320 320

192 128 600 80 314

84 $1,398

Deduct

Workpaper entries a To eliminate income from Sal and dividends received from Sal and adjust the investment in Sal account to its beginning of the period balance. b To eliminate reciprocal investment in Sal and equity amounts of Sal and to enter beginning noncontrolling interest. c To enter noncontrolling interest share of subsidiary income and dividends.

Chapter 4

4-11

Solution P4-2 (continued) 2

Pal Corporation and Subsidiary Consolidated Income Statement for the year ended December 31, 2011 (in thousands) Sales Less: Cost of goods sold Gross profit Operating expenses Total consolidated net income Less: Noncontrolling interest share Controlling share of consolidated net income

$1,640 1,060 580 388 192 18 $ 174

Pal Corporation and Subsidiary Consolidated Retained Earnings Statement for the year ended December 31, 2011 Consolidated retained earnings January 1 Add: Controlling share of onsolidated net income Less: Dividends of Pal Consolidated retained earnings December 31

$260 174 (120) $314

Pal Corporation and Subsidiary Consolidated Balance Sheet at December 31, 2011 Assets Current assets: Cash Receivables — net Inventories Plant assets — net Total assets Liabilities and Stockholders’ Equity Liabilities: Accounts payable Other liabilities Stockholders’ equity: Capital stock, $10 par Other paid-in capital Consolidated retained earnings Add: Noncontrolling interest Total liabilities and stockholders’ equity

$242 360 176

$192 128

$600 80 314 994 84

778 620 $1,398

320

1,078 $1,398

4-12

Consolidation Techniques and Procedures

Solution P4-3 Pan Corporation and Subsidiary Consolidation Workpapers for the year ended December 31, 2011 (in thousands) Pan Income Statement Sales Income from Saf Cost of sales Other expenses Consolidated Net Income Noncontrolling share Controlling share of NI Retained Earnings Retained earnings — Pan Retained earnings — Saf Controlling share of NI Dividends Retained earnings December 31 Balance Sheet Cash Accounts receivable Dividends receivable from Saf Inventories Note receivable from Pan Land Buildings — net Equipment — net Investment in Saf

Adjustments and Eliminations

Saf 75%

$800 27.6 500* 194*

$200

______ $133.6

$1,000 a

27.6

11.2

____ $ 48

9.2

$ 68

100* 52*

Consolidated Statements

600* 257.2* 142.8 9.2* 133.6

360

$360 133.6✓ 100*

68 133.6

48✓ 32*

a f

24 8*

100*

$393.6

$ 84

393.6

$ 30 40

136 212

106 172 12 190 130 340 260 363.6

20 10 60 160 100

Patents

________ $1,573.6

____ $420

Accounts payable Note payable to Saf Dividends payable Capital stock, $10 par Retained earnings

$ 20

170 10

1,000 393.6✓ $1,573.6 Noncontrolling interest January 1 Noncontrolling interest December 31

16 300 84✓ $420

210 190 500 360

b 112

a 3.6 b 360 c 11.2

100.8 $1,708.8 $

d 10 e 12 b 300

_____ 550

190 4 1,000 393.6

b 120 f 1.2 550

*Deduct

121.2 $1,708.8

Chapter 4

4-13

Solution P4-3 (continued) Supporting Calculations Saf’s value at acquisition Book value at December 31, 2011 Less: 2011 Net income Add: 2011 Dividends Book value on January 1, 2011 Fair value of patents Saf’s fair value on January 1, 2011

$384 (48) 32 $368 112 $480

Purchase price (fair value) of Pan’s 75% share Noncontrolling interest (25%)

$360 $120

Patents have a ten-year life, so amortization is $11,200 per year. Saf’s Adjusted Income Saf’s net income Less: Amortization of Patents Saf’s adjusted income Pan’s 75% share Noncontrolling interest 25% share

$ 48 (11.2) $ 36.8 $ 27.6 $ 9.2

4-14

Consolidation Techniques and Procedures

Solution P4-4 Pal Corporation and Subsidiary Consolidation Workpapers for the year ended December 31, 2011 (in thousands) Pal Income Statement Sales Income from Sun Cost of sales Other expenses Consolidated NI Noncontrolling share Controlling share of NI Retained Earnings Retained earnings — Pal

$1,600 72 1,000* 388*

Adjustments and Eliminations

Sun 75% $400

$2,000 a

284

720

1,200* 492* $ 308 24*

$ 96

284

$720 $136

Retained earnings — Sun Controlling share of NI

200* 104* c

Consolidated Statements

b 136 284

Dividends

284✓ 200*

Retained earnings – Dec 31 $

804

$168

$804

236 320

$ 60 80

Balance Sheet Cash Accounts receivable Dividends receivable from Sun Inventories Note receivable from Pal Land

24 380

Buildings — net Equipment — net Investment in Sun

a c

260 680

40 20 120 320

520

200

Accounts payable Note payable to Sun Dividends payable Capital stock, $10 par Retained earnings

____

$3,164

$840

$ 40

2,000

32 600

804✓ $3,164

168✓ $840

Noncontrolling interest January 1 Noncontrolling interest December 31

200*

296 400

20 380 1,000 720

a 24 b 720

______

340 20

48 16

420

744

Goodwill

96✓ 64*

b 224

224 $3,440 $

d 20 e 24 b 600

b 240 __________ c 8 1,100 1,100

Deduct

380 8 2,000 804

248 $3,440

Chapter 4

4-15

Solution P4-4(continued) Supporting Calculations Sun’s value at acquisition: Book value at December 31, 2011 Less: 2011 Net income Add: 2011 Dividends Book value on January 1, 2011

$768 (96) 64 $736

Purchase price of Pal’s 75% share Implied fair value of Sun ($720 / 75%) Sun’s book value Excess allocated to Goodwill Noncontrolling interest (25% x $960)

$720 $960 736 $224 $240

Sun’s Adjusted Income Sun’s net income Less: Amortization of Goodwill Sun’s adjusted income Pal’s 75% share Noncontrolling interest 25% share

$96 (0) $96 $72 $24

4-16

Consolidation Techniques and Procedures

Solution P4-5 Preliminary computations Allocation of excess fair value over book value Cost of 70% interest January 1 Implied fair value of Sul ($980,000 / 70%) Book value of Sul Excess fair value over book value Noncontrolling interest – 30% of fair value at acquisition

$ 980,000 $1,400,000 (1,200,000) $ 200,000 $ 420,000

Excess allocated Undervalued inventory items sold in 2011 Undervalued buildings (7 year life) Undervalued equipment (3 year life) Trademark Remainder to Goodwill Excess fair value over book value

$ 10,000 28,000 42,000 80,000 40,000 $200,000

Calculation of income from Sul Sul’s net income Less: Undervalued inventories sold in 2011 Less: Additional Depreciation on building ($28,000/7 years) Less: Additional Depreciation on equipment ($42,000/3 years) Less: Trademark amortization ($80,000/40 years) Sul’s adjusted income Par’s 70% controlling interest share Noncontrolling interest’s 30% share

$200,000 (10,000) (4,000) (14,000) (2,000) $170,000 $119,000 $ 51,000

Chapter 4

4-17

Solution P4-5 (continued) Workpaper entries for 2011 a

d e f g h i

Income from Sul Dividends (Sul) Investment in Sul

119,000

Capital stock (Sul) Retained earnings (Sul) January 1 Unamortized excess Investment in Sul Noncontrolling interest January 1

1,000,000 200,000 200,000

70,000 49,000

980,000 420,000

Cost of sales (for inventory items) Buildings — net Equipment — net Trademarks Goodwill Unamortized excess

10,000 28,000 42,000 80,000 40,000

Depreciation expense Buildings — net

4,000

Depreciation expense Equipment — net

14,000

Other expenses Trademarks

2,000

Accounts payable Accounts receivable

20,000

Dividends payable Dividends receivable

28,000

Noncontrolling Interest Share Dividends — Sul Noncontrolling Interest

51,000

200,000 4,000 14,000 2,000 20,000 28,000

30,000 21,000

4-18

Consolidation Techniques and Procedures

Solution P4-5 (continued) Par Corporation and Subsidiary Consolidation Workpapers for the year ended December 31, 2011 (in thousands) Par Income Statement Sales Income from Sul Cost of sales Depreciation expense

$ 1,600 119 600* 308*

$1,400

320*

280*

Other expenses Consolidated NI Noncontrolling share

800* 120*

491

Retained Earnings Retained earnings — Par

600

Retained earnings — Sul Net income

200

491✓ 400*

Dividends Retained earnings – Dec 31 $ Balance Sheet Cash Accounts receivable Dividends receivable Inventories Other current assets Land

Buildings — net

300

172 200 28 300 140 100 280

120 140

1,140

Equipment — net Investment in Sul

119 10 4 14 2

Accounts payable Dividends payable Other liabilities Capital stock, $10 par Retained earnings

600 491

a i

70 30 $ $

g h

20 28

400* 691 292 320

660

1,828

$1,700

Noncontrolling interest January 1 Noncontrolling interest December 31

491

______

$ 3,389

500 200 300 624

$ 3,389

691✓

602* 542 51*

200 60 200 320

_______ 400 200 98 2,000

200

1,029

Trademarks Goodwill Unamortized excess

1,410* 446*

200✓ 100*

691

Consolidated Statements $3,000

a c d e f i

Controlling share of NI

Adjustments and Eliminations

Sul 70%

170 40 190 1,000

c c b

80 40 200

a 49 b 980 f 2 c 200

78 40 ______ $4,182

g h

20 28

b 1,000

300✓

550 212 288 2,000 691

$1,700 b 420 _________ i 21 1,838 1,838

Deduct

441 $4,182

Chapter 4

4-19

Solution P4-6 Supporting computations Ownership percentage 13,500/15,000 shares = 90% Investment cost (13,500 shares  $30) Implied fair value of Syn ($405,000 / 90%) Book value of Syn Excess fair value over book value

$405,000 $450,000 330,000 $120,000

Excess allocated to Land Remainder to patents Excess fair value over book value

$ 40,000 80,000 $120,000

Income from Syn Syn’s reported net income Less: Patent amortization Syn’s adjusted income

$ 48,000 (8,000) $ 40,000

Pen’s share of Syn’s income (90%) Noncontrolling interest share (10%)

$ 36,000 $ 4,000

Investment in Syn December 31, 2012 Cost January 1, 2011 Pen’s share of the change in Syn’s retained earnings ($84,000 - $30,000)  90% Less: Pen’s share (90%) of Patent amortization for 2 years Investment in Syn December 31

$405,000 48,600 (14,400) $439,200

4-20

Consolidation Techniques and Procedures

Solution P4-6 (continued) Pen Corporation and Subsidiary Consolidation Workpapers for the year ended December 31, 2012 (in thousands) Pen Income Statement Sales Income from Syn Cost of sales Other expenses Consolidated NI Noncontrolling share Controlling share of NI Retained Earnings Retained earnings — Pen

$ 800 36 500* 201.2*

$ 200

$ 134.8

134.8✓ 100*

Note receivable — Pen Investment in Syn

36 160 14.4 190

30 40

a g

20 10

130 340

Equipment — net Patents

260

100

________

_____

$1,569.6

$ 420

60 160

1,000

16 300

388.8✓ $1,569.6

84✓ $ 420

Noncontrolling interest January 1 Noncontrolling interest December 31

134.8

354

28.8 3.2

f d

10 14.4

100* $

388.8

66 190 210

a 7.2 b 432

Buildings — net

170.8 10

134.8

48✓ 32* $

600* 261.2* 138.8 4 *

439.2

Land

$ 354

Retained earnings – Dec 31 $ 388.8

Accounts payable Note payable to Syn Dividends payable Capital stock Retained earnings

$1,000 a

100* 52*

Consolidated Statements

Retained earnings — Syn Net income Dividends

Balance Sheet Cash Accounts receivable Dividends receivable Inventories

Adjustments and Eliminations

90% Syn

230 500 360 c

64 $1,620

f 10 e 10 d 14.4 b 300

_________ 562.4

180.8 1.6 1,000 388.8

b g

48 .8 562.4

Deduct

48.8 $1,620

Chapter 4

4-21

Solution P4-7 Preliminary computations Allocation of excess fair value over book value Cost of 70% interest January 1 Implied fair value of Sol ($490,000 / 70%) Book value of Sol Excess fair value over book value

$490,000 $700,000 (600,000) $100,000

Excess allocated Undervalued inventory items sold in 2011 Undervalued buildings (7 year life) Undervalued equipment (3 year life) Remainder to goodwill Excess fair value over book value

5,000 14,000 21,000 60,000 $100,000

Calculation of income from Sol Sol’s reported net income Less: Undervalued inventories sold in 2011 Less: Depreciation on building ($14,000/7 years) Less: Depreciation on equipment ($21,000/3 years) Adjusted income from Sol Par’s 70% controlling share 30% Noncontrolling interest share Workpaper entries for 2011 a Income from Sol Dividends (Sol) Investment in Sol b

e f

g h

$100,000 (5,000) (2,000) (7,000) $ 86,000 $ 60,200 $ 25,800 60,200 35,000 25,200

Capital stock (Sol) Retained earnings (Sol) - January 1 Unamortized excess Investment in Sol Noncontrolling interest - January 1

500,000 100,000 100,000

Cost of sales (for inventory items) Buildings — net Equipment — net Goodwill Unamortized excess

5,000 14,000 21,000 60,000

Depreciation expense Buildings — net

2,000

Depreciation expense Equipment — net

7,000

Noncontrolling Interest Share Dividends — Sol Noncontrolling Interest

25,800

Accounts payable Accounts receivable

10,000

Dividends payable Dividends receivable

14,000

490,000 210,000

100,000 2,000 7,000 15,000 10,800 10,000

14,000

4-22

Consolidation Techniques and Procedures

Solution P4-7 (continued) Par Corporation and Subsidiary Consolidation Workpapers for the year ended December 31, 2011 (in thousands) Par Income Statement Sales Income from Sol Gain on equipment Cost of sales Depreciation expense

Other expenses Consolidated NI Noncontrolling share Controlling share of NI Retained Earnings Retained earnings — Par

$ 700

160*

140*

255.2

$ 100

300 $ 100 255.2✓ 200*

Retained earnings – Dec 31 $ $

Buildings — net

355.2

$ 150

96 100 14 150 70 50 140

60.2

c d e

5 2 7

Accounts payable Dividends payable Other liabilities Capital stock, $10 par Retained earnings

255.2

300 255.2

a f

g h

35 15

200* $

355.2

156 160

10 14

330

914

a 25.2 b 490

$ 850

Noncontrolling interest January 1 Noncontrolling interest December 31

250 100 150 312

$1,705.2

355.2✓

300* 281 25.8*

100 30 100 160

_____

$1,705.2

b 100

60 70

________ 200 100 50 1,000

10 705* 224*

25.8

515.2

Goodwill Unamortized excess

Consolidated Statements $1,500

100✓ 50*

570

Equipment — net Investment in Sol

400* 60*

_____

Dividends

Balance Sheet Cash Accounts receivable Dividends receivable Inventories Other current assets Land

800 60.2 10 300* 155*

________

Retained earnings — Sol Controlling share of NI

Adjustments and Eliminations

Sol 70%

85 20 95 500

c 60 b 100

c 100

60 ______ $2,102

g h

10 14

b 500

150✓

275 106 145 1,000 355.2

$ 850 b 210 _________ f 10.8 919 919

Deduct

220.8 $2,102

Chapter 4

4-23

Solution P4-8 Supporting computations Ownership percentage

13,500/15,000 shares = 90%

Investment cost (13,500 shares  $15) Implied fair value of Son ($202,500 / 90%) Book value of Son Excess fair value over book value

$202,500 $225,000 165,000 $ 60,000

Excess allocated to Land Remainder to goodwill Excess fair value over book value

$ 20,000 40,000 $ 60,000

Income from Son Pun’s controlling share of Son’s income ($24,000  90%)

$ 21,600

Investment in Son December 31, 2012 Cost January 1, 2011 Pun’s share of the change in Son’s retained earnings ($42,000 - $15,000)  90% Investment in Son December 31, 2012 Noncontrolling interest at December 31, 2012 (10% of fair value) (($225,000 + $42,000 - $15,000) x 10%)

$202,500 24,300 $226,800 $ 25,200

4-24

Consolidation Techniques and Procedures

Solution P4-8 (continued) Pun Corporation and Subsidiary Consolidation Workpapers for the year ended December 31, 2012 (in thousands) Pun Income Statement Sales Income from Son Cost of sales Expenses Consolidated NI Noncontrolling share Controlling share of NI Retained Earnings Retained earnings — Pun

$ 400 21.6 250* 100.6*

$ 100

50* 26*

Retained earnings – Dec 31 $ 202

Note receivable — Pun Investment in Son

18 80 7.2 95

15 20

Equipment — net Goodwill

130

_____

$ 792

$ 210

202✓ $ 792

Noncontrolling interest January 1 Noncontrolling interest December 31

181

a c

14.4 1.6

f d

5 7.2

50* $

202

33 95 105

a 7.2 b 219.6

Buildings — net

500

10 5

65 170

85 5

300* 126.6* 73.4 2.4*

24✓ 16*

226.8

Land

2.4

$ 181 71✓ 50*

500

21.6

Dividends

Accounts payable Note payable to Son Dividends payable Capital stock Retained earnings

Consolidated Statements $

Retained earnings — Son Controlling share of NI

Balance Sheet Cash Accounts receivable Dividends receivable Inventories

Adjustments and Eliminations

90% Son

30 80

10 8 150

115 250 180 40

f 5 e 5 d 7.2 b 150

818

90 .8 500 202

42✓ $ 210 _________ 285.2

b c

24.4 .8 285.2

Deduct

25.2 818

Chapter 4

4-25

Solution P4-9 Pas Corporation and Subsidiary Consolidation Workpapers for the year ended December 31, 2011 (in thousands) Pas Income Statement Sales Income from Sel Cost of sales Depreciation expense Other expenses Consolidated NI Noncontrolling share Controlling share of NI Retained Earnings Retained earnings — Pas

$ 400 34 160* 80* 51*

$ 143

$ 220 80* 40* 20*

$ 100

8.5

Balance Sheet Cash

Trade receivables — net Dividends receivable Inventories Land Buildings — net Equipment — net Investment in Sel

59 56

b 100 143

80✓ 40* $ 140

a c

60 60 140

400

200

_____

$1,193

$ 600

$ 100 20 40 300 140✓

80 200 100 600 213✓

$1,193

80*

$ e

119 128 140 90 270

a 2 b 420 g 2.5

422 ______

32 8

$ 213

60 80

16 80 30 130

Noncontrolling interest January 1 Noncontrolling interest December 31 *

265* 130* 73.5* $ 151.5 8.5* $ 143

Retained earnings – Dec 31 $ 213

Accounts payable Dividends payable Other liabilities Capital stock Retained earnings

34 25 10 2.5

$ 150

143✓ 80*

Dividends

Consolidated Statements $ 620

a b d g

$ 150

Retained earnings — Sel Controlling share of NI

Patents

Adjustments and Eliminations

80% Sel

640

47.5 $1,434.5

e f

8 16

b 300

172 204 140 600 213

$ 600 b 105 _________ c .5 604 604

Deduct

105.5 $1,434.5

4-26

Consolidation Techniques and Procedures

Solution P4-9 (continued) Supporting computations Investment cost January 1, 2011 Implied fair value of Sel ($420,000 / 80%) Book value of Sel Excess fair value over book value Excess allocated: Undervalued inventory Undervalued equipment Remainder to patents Excess fair value over book value

$420,000 $525,000 400,000 $125,000 $ 25,000 50,000 50,000 $125,000

Chapter 4

4-27

Solution P4-10 Pik Corporation and Subsidiary Consolidation Workpapers for the year ended December 31, 2011 (in thousands) 80% Sel

Pik Income Statement Sales Income from Sel Cost of sales Depreciation expense Other expenses Consolidated NI Noncontrolling share Controlling share of NI Retained Earnings Retained earnings — Pik

$ 400 36 160* 80* 51*

$ 220 80* 40* 20*

_____

$ 145

36 25 10

$ 100 145✓ 80*

$ 140

Balance Sheet Cash

Trade receivables — net Dividends receivable Inventories Land Buildings — net Equipment — net Investment in Sel

59 56

60 60 140

400

200

a c

_____

$1,195

$ 600

$ 100 20 40 300

215✓

Noncontrolling interest January 1 Noncontrolling interest December 31

145

150

32 8

80* $

215

119 128

640

a 4 b 420

______

$1,195

140 90 270

424

80 200 100 600

265* 130* 71* 154 9*

145

60 80

16 80 30 130

620

b 100

80✓ 40*

Retained earnings – Dec 31 $ 215

$ a b d

$ 150

Dividends

Accounts payable Dividends payable Other liabilities Capital stock Retained earnings

Consolidated Statements

Retained earnings — Sel Controlling share of NI

Goodwill

Adjustments and Eliminations

50 $1,437

e f

8 16

b 300

140✓

172 204 140 600 215

$ 600

________ 604

b 105 c 1 604

Deduct

106 $1,437

4-28

Consolidation Techniques and Procedures

Solution P4-10 (continued) Supporting computations Investment cost January 1, 2011 Implied fair value of Sel ($420,000 / 80%) Book value of Sel Excess fair value over book value Excess allocated: Undervalued inventory Undervalued equipment Remainder to goodwill Excess fair value over book value Income from Sel Sel’s reported net income Less amortization of excess fair value: Inventory Depreciation ($50,000 / 5 years) Sel’s adjusted income Pik’s 80% controlling share 20% Noncontrolling interest share

$420,000 $525,000 400,000 $125,000 $ 25,000 50,000 50,000 $125,000 $ 80,000 (25,000) (10,000) $ 45,000 $ 36,000 $ 9,000

Chapter 4

4-29

Solution P4-11 Supporting computations Investment cost December 31, 2011 Implied fair value of Stu ($170,000 / 80%) Book value of Stu Excess fair value over book value Allocation of Excess $ 8,750 22,500 31,250 $62,500

Inventories Plant assets — net Patents

$170,000 $212,500 150,000 $ 62,500

Amortization 2012 — 2015 $ 8,750 10,000 25,000 $43,750

Unamortized Excess December 31, 2015 $ --12,500 6,250 $18,750

Pil Corporation and Subsidiary Consolidated Balance Sheet Workpapers on December 31, 2015

Assets Cash Trade receivables Dividends receivable Advance to Stu Inventories Plant assets — net Investment in Stu Patents Unamortized excess Total assets

Pil

Stu 80%

$ 41,000 60,000 8,000 25,000 125,000 300,000

$ 35,000 55,000

Adjustments and Eliminations

c d e

35,000 175,000

12,500

________

b a

6,250 18,750

$750,000

$300,000

$ 50,000

$ 45,000 10,000 25,000 100,000 120,000 ________ $300,000

191,000

Equities Accounts payable Dividends payable Advance from Pil Capital stock Retained earnings Noncontrolling interest Total equities

400,000 300,000 ________ $750,000

5,000 8,000 25,000

Consolidated Balance Sheet $ 76,000 110,000

160,000 487,500 a 191,000 b

18,750

6,250 ________ $839,750

c 5,000 d 8,000 e 25,000 a 100,000 a 120,000 _________ 295,500

$ 90,000 2,000

47,750 295,500

400,000 300,000 47,750 $839,750

4-30

Consolidation Techniques and Procedures

Solution P4-12 Preliminary computations Investment cost Implied fair value Sci ($480,000 / 80%) Book value of Sci Excess fair value over book value

$480,000 $600,000 450,000 $150,000

Allocation of differential Plant assets Goodwill Excess fair value over book value

$100,000 50,000 $150,000

Amortization Plant assets $100,000/4 years = $25,000 per year Investment account balance at December 31, 2012 Underlying book value Add: Unamortized excess allocated to plant assets ($100,000 - $50,000 depreciation) Add: Unamortized goodwill Fair value of Sci at December 31 Investment account balance at December 31 (80%) Noncontrolling interest at December 31 (20%) The investment account balance is overstated at $560,000 for the $16,000 dividend receivable.

$580,000 50,000 50,000 $680,000 $544,000 $136,000

Chapter 4

4-31

Solution P4-12 (continued) Pat Corporation and Subsidiary Consolidation Workpapers for the year ended December 31, 2012 (in thousands) Pat Income Statement Sales Income from Sci Cost of sales Operating expense Consolidated NI Noncontrolling share Controlling share of NI Retained Earnings Retained earnings — Pat

$1,800 76 1,200* 380*

$ 600 76

300* 180*

______

_____

$ 120

296

296✓ 200*

Retained earnings – Dec 31 $ 340

Plant assets — net Investment in Sci

Dividends receivable Goodwill

Accounts payable Dividends payable Other liabilities Capital stock Retained earnings

12 52 164 40 160 320 680

100

180

30 40 120 10 60 460

______

_____

$1,988

$ 720

200 1,400 340✓

Noncontrolling interest January 1 Noncontrolling interest December 31

30 20 90 400

296

244 296

120✓ 40* $

d 100 c f

b d

32 8

560

$1,988

1,500* 585* $ 315 19*

$ 244 $

Consolidated Statements $2,400

Retained earnings — Sci Controlling share of NI Dividends

Balance Sheet Cash Accounts receivable Inventories Advance to Sci Other current assets Land

Adjustments and Eliminations

Sci 80%

16 50

200* $

340

82 82 284 170 380 1,190

b 16 c 44 d 500 g 16 50 $2,238

h g

10 16

d 400

180✓

68 4 290 1,400 340

$ 720 _______ 827

d f

125 11 827

Deduct

136 $2,238

4-32

Consolidation Techniques and Procedures

Solution P4-13 Supporting computations Investment cost January 1, 2011 Implied fair value of Ski ($80,000 / 80%) Book value of Ski Excess fair value over book value

$ 80,000 $100,000 90,000 $ 10,000

Excess allocated to Inventory (sold in 2011) Equipment (4-year remaining use life) Intangible assets (40-year amortization period) Excess fair value over book value

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

Income from Ski for 2011 Ski’s net income Less: Excess allocated to inventories Less: Amortization of excess allocated to equipment ($4,000/4 years) Less: Amortization of intangibles ($5,000/40 years) Ski’s adjusted income for 2011 Ply’s 80% controlling interest share Noncontrolling interest share for 2011 (20%) Income from Ski for 2012 Ski’s net income Less: Amortization of excess allocated to equipment ($4,000/4 years) Less: Amortization of intangibles ($5,000/40 years) Ski’s adjusted income for 2012 Ply’s 80% controlling interest share Noncontrolling interest share for 2012 (20%)

$ 15,000 (1,000) (1,000) (125) $ 12,875 $ 10,300 $ 2,575 $ 20,000 (1,000) (125) $ 18,875 $ 15,100 $ 3,775

Note: Since the prior year’s income is not affected by the current year’s error of omission, the workpapers for 2012 are easier to prepare without an additional conversion-to-equity entry.

Chapter 4

4-33

Solution P4-13 (continued) Ply Corporation and Subsidiary Consolidation Workpapers for the year ended December 31, 2011 Ply Income Statement Sales Income from Ski Cost of sales Operating expenses

$ 160,000 10,300 105,000* 35,000*

Consolidated NI Noncontrolling share Controlling share of NI

30,300

Retained Earnings Retained earnings — Ply

70,000

Adjustments and Eliminations

Ski 80% $

80,000 35,000* 30,000*

$ 240,000 a 10,300 b 1,000 c 1,000 d 125 f

Retained earnings — Ski Controlling share of NI

141,000* 66,125* $

32,875 2,575*

30,300

70,000

2,575

15,000

30,000

Consolidated Statements

b 30,000 30,300

Dividends

30,300✓ 10,000*

Retained earnings – Dec 31 $

90,300

40,000

90,300

24,700 25,000

15,000 20,000

39,700 45,000

Balance Sheet Cash

Trade receivables — net Dividends receivable Inventories

15,000✓ 5,000*

4,000 40,000 100,000

0 30,000 55,000

86,300

_________

$ 280,000

$ 120,000

Plant & equipment — net Investment in Ski Intangibles

Accounts payable Dividends payable Capital stock Other paid-in capital Retained earnings

20,700 9,000 100,000 60,000 90,300✓

$ 280,000 Noncontrolling interest January 1 Noncontrolling interest December 31 *

a f

15,000 5,000 40,000 20,000

4,000 1,000

4,000

1,000

5,000

a 6,300 b 80,000 d 125

10,000*

70,000 158,000

4,875 $ 317,575 $

e 4,000 b 40,000 b 20,000

40,000✓

35,700 10,000 100,000 60,000 90,300

$ 120,000 ________ 118,000

b 20,000 f 1,575 118,000

Deduct

21,575 $ 317,575

4-34

Consolidation Techniques and Procedures

Solution P4-13 (continued) Ply Corporation and Subsidiary Consolidation Workpapers for the year ended December 31, 2012 Ply Income Statement Sales Income from Ski Cost of sales Operating expenses

$ 170,000 16,000 110,000* 30,000*

Consolidated NI Noncontrolling share Controlling share of NI

46,000

Retained Earnings Retained earnings — Ply

90,300

35,000* 35,000*

46,000✓ 15,000*

Dividends

90,000

Consolidated Statements $ 260,000

a 16,000

Retained earnings — Ski Controlling share of NI

Adjustments and Eliminations

Ski 80%

c d

1,000 125

3,775

145,000* 66,125*

20,000

40,000

48,875 3,775*

45,100

90,300

b 40,000 45,100

20,000✓ 10,000*

a f

8,000 2,000

15,000*

Retained earnings – Dec 31 $ 121,300

50,000

$ 120,400

Balance Sheet Cash

20,000 30,000

Trade receivables — net Dividends receivable Inventories

4,000 40,000 95,000

Plant & equipment — net Investment in Ski Intangible assets Accounts payable Dividends payable Capital stock Other paid-in capital Retained earnings

26,700 45,000

4,000

3,000

1,000

4,875

a 8,000 b 86,300 d 125

94,300 _________

_________

$ 305,000

$ 140,000

17,700 6,000 100,000 60,000 121,300✓

$ 305,000 Noncontrolling interest January 1 Noncontrolling interest December 31 *

30,000 60,000

25,000 5,000 40,000 20,000

46,700 75,000 70,000 157,000

4,750 $ 353,450 $

e 4,000 b 40,000 b 20,000

50,000✓

42,700 7,000 100,000 60,000 120,400

$ 140,000 _________ 132,775

b 21,575 f 1,775 132,775

Deduct

23,350 $ 353,450

Chapter 4

4-35

Solution P4-14 Preliminary computations Investment cost Implied fair value of Sim ($99,000 / 90%) Book value of Sim Excess fair value over book value

$ 99,000 $110,000 80,000 $ 30,000

Excess allocated to: Inventories (sold in 2011) Patents (10-year remaining useful life) Excess fair value over book value

$ 10,000 20,000 $ 30,000

Analysis of investment in Sim account Fair value of Sim January 5, 2011 Add: Change in retained earnings from January 5, 2011 to December 31, 2013 Less: Amortization of excess Allocated to inventories and amortized in 2011 Allocated to patents and amortized over 10 years ($20,000/10 years)  3 years Fair value at December 31, 2013 Add: Income from Sim for 2014 Less: Dividends in 2014 Fair value at December 31, 2014

$110,000

Investment in Sim on December 31, 2013 (90% fair value) Investment in Sim on December 31, 2014 (90% fair value) Noncontrolling interest on Dec. 31, 2013 (10% fair value) Noncontrolling interest on Dec. 31, 2014 (10% fair value)

$129,600 $136,800 $ 14,400 $ 15,200

50,000 (10,000) (6,000) 144,000 18,000 (10,000) $152,000

4-36

Consolidation Techniques and Procedures

Solution P4-14 (continued) Pep Company and Subsidiary Consolidation Workpapers for the year ended December 31, 2014 Pep

Adjustments and Eliminations

Sim

Debits Cash $ 11,000 $ 15,000 Accounts receivable 15,000 25,000 Plant assets 220,000 180,000 Investment in Sim 136,800 Patents b 14,000 Cost of goods sold 50,000 30,000 Operating expenses 25,000 40,000 c 2,000 Dividends 20,000 10,000

Credits Accumulated depreciation Liabilities Capital stock Paid-in-excess Retained earnings Sales Income from Sim

Income Retained Statement Earnings

Balance Sheet $ 26,000 40,000 400,000

a 7,200 b 129,600 c 2,000

12,000 $ 80,000* 67,000*

a d

9,000 1,000

$ 20,000* ________

$477,800 $300,000

$478,000

$ 90,000 $ 50,000 80,000 30,000 100,000 60,000 b 60,000 20,000 71,600 70,000 b 70,000 100,000 90,000 16,200 ________ a 16,200

140,000 110,000 100,000 20,000 71,600 190,000

$477,800 $300,000 Noncontrolling interest Dec 31, 2013 Noncontrolling interest share ($18,000 adj. inc. x 10%) Controlling share of NI

b d

14,400

1,800

1,800* $ 41,200

Consolidated retained earnings Noncontrolling interest Dec 31, 2014

41,200 $ 92,800

________ 164,000

800 164,000

92,800 15,200 $478,000

Deduct

To eliminate income from subsidiary and dividends received and reduce the investment account to its beginning-of-the-period balance. To eliminate reciprocal investment and subsidiary equity amounts, establish beginning noncontrolling interest, and adjust patents for the unamortized excess as of the beginning of the period. To amortize excess allocated to patents for 2014. To enter noncontrolling interest share of subsidiary income and dividends.

b c d

Chapter 4

4-37

Solution P4-15 1

Journal entries on Peg’s books January 1, 2011 Investment in Sup (90%) 36,000 Cash 36,000 To record purchase of 90% of Sup’s stock for cash. July 1, 2011 Investment in Ell (25%) 14,000 Cash 14,000 To record purchase of 25% of Ell’s stock for cash. November 2011 Cash

5,400 Investment in Sup (90%) 5,400 To record receipt of 90% of Sup’s $6,000 dividends.

November 2011 Cash

2,500 Investment in Ell (25%) 2,500 To record receipt of 25% of Ell’s $10,000 dividends.

December 31, 2011 Investment in Sup (90%) 9,000 Income from Sup To record Share of Sup’s reported income ($56,000 - $46,000)  90% December 31, 2011 Investment in Ell (25%) 1,400 Income from Ell To record investment income from Ell for 2011 computed as: Share of Ell’s reported income $ 1,500 ($60,000-$48,000)1/2 year  25% Less: Amortization of excess [$14,000 – ($48,000  25%)] (100)  10 years  1/2 year $ 1,400

9,000

1,400

4-38

Consolidation Techniques and Procedures

Solution P4-15 (continued) 2

Peg’s separate company financial statements Peg Corporation Income Statement for the year ended December 31, 2011 Revenues Sales Income from Sup Income from Ell Total revenue Costs and expenses Cost of sales Other expenses Total costs and expenses Net income

$200,000 9,000 1,400 $210,400 $120,000 50,000 170,000 $ 40,400

Peg Corporation Retained Earnings Statement for the year ended December 31, 2011 Retained earnings January 1 Add: Net income Deduct: Dividends Retained earnings December 31

$ 40,000 40,400 (20,000) $ 60,400

Peg Corporation Balance Sheet at December 31, 2011 Assets Current assets: Cash Other current assets Plant assets — net Investments: Investment in Sup (90%) Investment in Ell (25%)

$ 37,900 80,000 $ 39,600 12,900

Total assets

$117,900 240,000 52,500 $410,400

Liabilities and stockholders’ equity Current liabilities Stockholders’ equity: Capital stock Retained earnings December 31

$ 50,000 $300,000 60,400

Total liabilities and stockholders’ equity

360,400 $410,400

Chapter 4

4-39

Solution P4-15 (continued) 3

Consolidation workpapers — trial balance format Peg Corporation and Subsidiary Consolidation Workpapers for the year ended December 31, 2011 Peg

90% Sup

Adjustments and Eliminations

Income Retained Statement Earnings

Debits Cash $ 37,900 $ 8,000 Other current assets 80,000 22,000 240,000 28,000 Plant assets — net

Balance Sheet $ 45,900 102,000 268,000

Investment in Sup Investment in Ell Cost of sales Other expenses Dividends

39,600 12,900 120,000 50,000 20,000

a 3,600 b 36,000

Total debits

$600,400 $110,000

$428,800

Credits Current liabilities Capital stock Retained earnings Sales Income from Sup Income from Ell Total credits

$ 50,000 $ 14,000 300,000 36,000 b 36,000 40,000 4,000 b 4,000 200,000 56,000 9,000 a 9,000 1,400 ________

$ 64,000 300,000

12,900 32,000 14,000 6,000

$152,000* 64,000* a d

5,400 600*

$ 20,000* ________

40,000 256,000 1,400

$600,400 $110,000

Noncontrolling interest - January 1

Noncontrolling interest share $10,000  10% Controlling share of NI

4,000

1,000

1,000* $ 40,400

Consolidated retained earnings Noncontrolling interest December 31

40,400 $ 60,400

________ d 400 50,000 50,000

60,400 4,400 $428,800

4-40

Consolidation Techniques and Procedures

Solution P4-15 (continued) 4

Consolidated financial statements Peg Corporation and Subsidiary Consolidated Income Statement for the year ended December 31, 2011 Revenues Sales $256,000 Income from Ell (equity method) 1,400 Total revenues Costs and expenses Cost of sales $152,000 Other expenses 64,000 Total costs and expenses Total consolidated income Less: Noncontrolling interest share Controlling share of NI

Peg Corporation and Subsidiary Consolidated Retained Earnings Statement for the year ended December 31, 2011 Consolidated retained earnings January 1 Add: Controlling share of NI Deduct: Dividends Consolidated retained earnings December 31

$257,400

216,000 41,400 1,000 $ 40,400

$ 40,000 40,400 (20,000) $ 60,400

Peg Corporation and Subsidiary Consolidated Balance Sheet at December 31, 2011 Assets Current assets: Cash Other current assets Plant assets — net Investments and other assets: Investment in Ell Total assets Liabilities and stockholders’ equity Current liabilities Stockholders’ equity: Capital stock Consolidated retained earnings Noncontrolling interest Total liabilities and stockholders’ equity

45,900 102,000

$147,900 268,000 12,900 $428,800 $ 64,000

$300,000 60,400 4,400

364,800 $428,800

Chapter 4

4-41

Solution P4-16 Partial consolidated statement of cash flows using the direct method Pil Corporation and Subsidiaries Partial Consolidated Statement of Cash Flows for the current year Cash Flows from Operating Activities Cash received from customers $3,200,000 Dividends from equity investees 80,000 Interest received from short-term loan 10,000 Cash paid for other expenses (900,000) Cash paid to suppliers (1,260,000) Net cash flow from operating activities $1,130,000

4-42

Consolidation Techniques and Procedures

Solution P4-17 Direct Method Pes Corporation and Subsidiary Consolidated Statement of Cash Flows for the year ended December 31, 2011 Cash Flows from Operating Activities Cash received from customers Cash paid to suppliers Cash paid for operating expenses Net cash flows from operating activities Cash Flows from Investing Activities Purchase of equipment Net cash flows from investing activities Cash Flows from Financing Activities Payment of cash dividends — controlling Payment of cash dividends — noncontrolling Payment of long-term liabilities Net cash flows from financing activities Decrease in cash for the year Cash on January 1 Cash on December 31

$1,340,000 $696,000 315,000

(1,011,000) 329,000

(250,000) (250,000) (72,000) (4,000) (22,000)

(98,000) (19,000) 130,000 111,000

Reconciliation of controlling share of consolidated net income to net cash provided by operating activities Controlling share of NI

$260,000

$ 10,000 102,000 1,000 44,000 (10,000) (40,000) (38,000)

69,000 $329,000

Chapter 4

Solution P4-17

4-43

(continued)

Indirect Method Pes Corporation and Subsidiary Consolidated Statement of Cash Flows for the year ended December 31, 2011 Cash Flows from Operating Activities Controlling share of NI

$260,000

Adjustments to reconcile controlling share of consolidated net income to net cash provided by operating activities: Noncontrolling interest share Depreciation Patents amortization Increase in accounts receivable Increase in inventories Increase in other current assets Increase in accounts payable Net cash flows from operating activities Cash Flows from Investing Activities Purchase of equipment Net cash flows from investing activities Cash Flows from Financing Activities Payment of cash dividends — controlling Payment of cash dividends — noncontrolling Payment of long-term liabilities Net cash flows from financing activities Decrease in cash for the year Cash on January 1 Cash on December 31

10,000 $102,000 1,000 (10,000) (40,000) (38,000) 44,000 69,000 329,000 (250,000) (250,000) (72,000) (4,000) (22,000) (98,000) (19,000) 130,000 $111,000

Note: The cash flows from investing activities and cash flows from financing activities sections of the statement of cash flows are the same under the direct and indirect method.

4-44

Consolidation Techniques and Procedures

Solution P4-18 [AICPA] Indirect Method Puh, Inc. and Subsidiary Statement of Cash Flows (Indirect Method) for the year ended December 31, 2011 Cash Flows from Operating Activities Controlling share of NI

Adjustments to reconcile controlling share of consolidated net income to net cash provided by operating activities: Noncontrolling interest share Depreciation expense Patents amortization Decrease in accounts receivable Increase in accounts and accrued payables Increase in deferred income taxes Increase in inventories Gain on marketable equity securities Gain on sale of equipment Net cash flows from operating activities Cash Flows from Investing Activities Purchase of equipment Proceeds from sale of equipment Net cash flows from investing activities Cash Flows from Financing Activities Cash received from sale of treasury stock Payment of cash dividends — controlling Payment of cash dividends — noncontrolling Payment on long-term note Net cash flows from financing activities Increase in cash for the year Cash on January 1 Cash on December 31

$ 198,000

33,000 82,000 3,000 22,000 121,000 12,000 (70,000) (11,000) (6,000)

186,000 384,000

$(127,000) 40,000 (87,000) 44,000 (58,000) (15,000) (150,000) (179,000) 118,000 195,000 $ 313,000

Listing of non-cash investing and financing activities: Issued common stock in exchange for land with a fair value of $215,000.

Chapter 4

4-45

Solution P4-18 (continued) Indirect Method Puh, Inc. and Subsidiary Workpapers for the Statement of Cash Flows (Indirect Method) for the year ended December 31, 2011 Year’s Change Asset Changes Cash Allowance to reduce MES Accounts receivable — net Inventories Land* Plant and equipment Accumulated depreciation Patents — net Total asset changes Changes in Equities Accounts & accrued payable Note payable long-term Deferred income taxes Noncontrolling interest in Sto Common stock, $10 par* Additional paid-in capital Retained earnings Treasury stock at cost Total changes in equities

118,000 11,000 (22,000) 70,000 215,000 65,000 (54,000) (3,000)

Reconciling Items Debit Credit

e f

k l m

Cash Flow From Operations

Cash Flow Investing Activities

Cash Flow Financing Activities

11,000

22,000

62,000 82,000 3,000

g 70,000 h 215,000 j 127,000 k 28,000

400,000

121,000 n 121,000 (150,000) 12,000 p 12,000 18,000 b 33,000 100,000 123,000 140,000 36,000

h 100,000 h 115,000 i 8,000 a 198,000 i 36,000

o 150,000 d

15,000

58,000

400,000

Controlling share of NI Noncontrolling interest share Gain on MES Purchase of plant and equipment Sale of equipment Gain on equipment Depreciation expense Payment on long-term note Amortization of patents Decrease in receivables Increase in inventories Increase in accounts and accrued payables Increase in deferred income taxes Proceeds from treasury stock Payment of dividends — controlling Payment of dividends — noncontrolling

a 198,000 b 33,000 e 11,000 j 127,000 k

40,000

82,000

m f

3,000 22,000

6,000

198,000 33,000 (11,000) (127,000) 40,000 (6,000) 82,000

o 150,000

(150,000)

70,000 n 121,000 p i

c 58,000 d 15,000 1,229,000

12,000 44,000

3,000 22,000 (70,000) 121,000 12,000 44,000 (58,000) (15,000)

1,229,000 384,000

Cash increase for the year = $384,000 – $87,000 – $179,000 = $118,000. * Non-cash item: Purchased $215,000 land through common stock issuance.

(87,000)

(179,000)

4-46

Consolidation Techniques and Procedures

Solution P4-19 Indirect Method Pil Corporation and Subsidiary Consolidated Statement of Cash Flows for the year ended December 31, 2011 Cash Flows from Operating Activities Controlling share of NI Adjustments to reconcile controlling share of consolidated net income to net cash provided by operating activities: Noncontrolling interest share Depreciation expense Patents amortization Increase in accounts payable Income less dividends — equity investee Increase in accounts receivable Net cash flows from operating activities Cash Flows from Investing Activities Purchase of equipment Net cash flows from investing activities Cash Flows from Financing Activities Cash received from long-term note Payment of cash dividends — controlling Payment of cash dividends — noncontrolling Net cash flows from financing activities Increase in cash for the year Cash on January 1 Cash on December 31

$1,000,000

80,000 400,000 20,000 34,000 (60,000) (420,000)

54,000 1,054,000

$(1,000,000) (1,000,000) $

400,000 (274,000) (40,000)

86,000 140,000 720,000 860,000

Chapter 4

4-47

Solution P4-19 (continued) Indirect Method Pil Corporation and Subsidiary Workpapers for the Statement of Cash Flows (Indirect Method) for the year ended December 31, 2011

Year’s Change Asset Changes Cash Accounts receivable — net Inventories Plant & equipment — net Equity investments Patents Total asset changes

Reconciling Items Debit Credit

140,000 420,000 0 600,000 F 60,000 l (20,000) h

Cash Flows From Operations

Cash Flows Investing Activities

Cash Flows Financing Activities

420,000

400,000 g 1,000,000 60,000 m 120,000 20,000

$1,200,000

Changes in Equities Accounts payable $ 34,000 Dividends payable 26,000 Long-term note payable 400,000 Common stock 0 Other paid-in capital 0 Retained earnings 700,000 Noncontrol. interest 20% 40,000 Changes in equities $1,200,000 Controlling share of NI Noncontrolling interest share Purchase of plant & equipment Depreciation — plant & equipment Amortization of patents Increase in accounts receivable Income less dividends from Investees Increase in accounts payable Received cash from long-term note

i k j

34,000 26,000 400,000

a 1,000,000 c b 80,000 d

300,000 40,000

a 1,000,000 $1,000,000 b 80,000 80,000 g 1,000,000

$(1,000,000) f h

420,000

400,000 20,000

400,000 20,000 (420,000)

120,000 l 60,000 (60,000) i 34,000 34,000 J 400,000 0 $ 400,000 c 300,000 k 26,000 (274,000) Payment of dividends — controlling d 40,000 __ _ (40,000) Payment of dividends — noncontrolling 3,900,000 3,900,000 $1,054,000 $(1,000,000) $ 86,000 Cash increase for the year = $1,054,000 - $1,000,000 + $86,000 = $140,000

4-48

Consolidation Techniques and Procedures

Solution P4-19 (continued) Direct Method Pil Corporation and Subsidiary Consolidated Statement of Cash Flows for the year ended December 31, 2011 (in thousands) Cash Flows from Operating Activities Cash received from customers Cash received from equity investees Cash paid to suppliers Cash paid for other operating expenses Net cash flows from operating activities Cash Flows from Investing Activities Purchase of equipment Net cash flows from investing activities Cash Flows from Financing Activities Cash received from long-term note Payment of cash dividends — controlling Payment of cash dividends — noncontrolling Net cash flows from financing activities Increase in cash for the year Cash on January 1 Cash on December 31 Reconciliation of controlling share of consolidated net income to net cash provided by operating activities Controlling share of NI Adjustments to reconcile controlling share of consolidated net income to net cash provided by operating activities: Noncontrolling interest share Income less dividends — equity investee Depreciation expense Patents amortization Increase in accounts payable Increase in accounts receivable Net cash flows from operating activities

$4,780 60 $ 2,866 920

(3,786) 1,054

$(1,000) (1,000) $

400 (274) (40)

86 140 720 860

$1,000

80 (60) 400 20 34 (420)

54 $1,054

Chapter 4

4-49

Solution P4-19 (continued) Direct Method Pil Corporation and Subsidiary Workpapers for the Statement of Cash Flows (Direct Method) for the year ended December 31, 2011 (in thousands)

Year’s Change Asset Changes Cash Accounts receivable — net Inventories Plant & equipment — net Equity investments Patents Total asset changes Changes in Equities Accounts payable Dividends payable Long-term note payable Retained earnings* Noncontrol.interest 20% Changes in equities Ret. earnings change* Sales Income from equity investees Cost of goods sold Depreciation expense Other operating expenses Noncontrolling interest share Dividends declared — Pil

140 420 0 600 60 (20) $1,200

Cash Flow From Operations

Cash Flow Cash Flow Investing Financing Activities Activities

a b

400

34 26 400 700 40 $1,200

f g h

34 26 400

$5,200

420

120 (2,900) (400) (940)

420

c 1,000 d 60

$4,780

f b e

34 400 20

60 (2,866) 0 (920)

(80)

(300)

g k

26 274

400

Retained earnings ______ change $ 700 Received cash from long-term note Payment of dividends — controlling Payment of dividends — noncontrolling Purchase of equipment

Reconciling Items Debit Credit

k 274 j 40 c 1,000 2,754

2,754

$1,054

$(1,000) $(1,000)

Retained earnings changes replace the retained earnings account for reconciling purposes.

Cash increase for the year = $1,054 - $1,000 + $86 = $140.

$ 400 (274) (40) __ $ 86

Chapter 5 INTERCOMPANY PROFIT TRANSACTIONS — INVENTORIES Answers to Questions 1

Profits and losses on sales between affiliates are realized for consolidated statement purposes when the purchasing affiliate resells the merchandise to parties outside of the consolidated entity. If all merchandise sold to affiliates is resold to outside parties in the same period, there will be no unrealized profit to eliminate in preparing the consolidated financial statements.

Gross profit, rather than net profit, is the concept that should be used in computing unrealized inventory profits according to GAAP.

The amount of unrealized profit to be eliminated in the preparation of consolidated financial statements is not affected by the existence of a noncontrolling interest. All unrealized profit must be eliminated. In the case of upstream sales, however, the unrealized profit should be allocated between controlling and noncontrolling interests.

The elimination of intercompany sales and purchases does not affect consolidated net income. This is because equal amounts are deducted from sales and cost of sales and the net effect on consolidated net income is nil. The importance of the elimination lies in a correct statement of consolidated sales and cost of sales.

Consolidated working capital is not affected by the elimination of intercompany accounts receivable and accounts payable balances. Since equal amounts are deducted from current assets and current liabilities, the effect on the computation "current assets less current liabilities" is nil.

Upstream sales are sales from subsidiary to parent. Downstream sales are sales from parent to subsidiary. The importance of this designation lies in the fact that the profit or loss on such transactions is the selling affiliate's profit or loss. In the case of unrealized profit or loss on downstream sales, all the profit or loss is assigned to the parent-seller. But unrealized profit or loss on upstream sales is profit or loss of the subsidiary-seller and is assigned to the parent and noncontrolling interest in relation to their proportionate holdings.

Yes. If unrealized profits are not eliminated at year end, consolidated net income will be overstated in 2011. The ending inventory of one year becomes the beginning inventory of the next year, and unrealized profits in the beginning inventory will understate consolidated net income in 2012. The analysis of the effect of unrealized inventory profits on consolidated net income is basically the same as the analysis for inventory errors. Like inventory errors, errors in eliminating unrealized profits are self-correcting over any two accounting periods. Consolidated net income for 2013 is unaffected.

The noncontrolling interest share is affected by upstream sales if the merchandise has not been resold by the parent to outside parties by the end of the accounting period. This is because the noncontrolling interest share is based on the income of the subsidiary. If the subsidiary has unrealized profit from intercompany sales, its realized income will be less than its reported income. The noncontrolling interest share should be based on the realized income of the subsidiary.

Intercompany Profit Transactions — Inventories

5-2

A parent's investment income and investment accounts are adjusted for unrealized profits on intercompany sales to subsidiaries in accordance with the one-line consolidation concept. The parent reduces its investment and investment income accounts for the full amount of the unrealized profits in the year of intercompany sale. When the goods are sold to outside parties by the subsidiary, the profits of the parent are realized and the parent increases its investment and investment income accounts.

Combined cost of goods sold is overstated when there are unrealized profits in the beginning inventory and understated when there are unrealized profits in the ending inventory. The elimination of unrealized profits in the beginning inventory reduces (credits) cost of goods sold and the elimination of unrealized profits in the ending inventory increases (debits) cost of goods sold.

The effect of unrealized profits on consolidated cost of goods sold is not affected either by a noncontrolling interest or by the direction of the intercompany sales. All unrealized profit from both upstream and downstream sales is eliminated from consolidated cost of goods sold.

Unrealized profit in the beginning inventory is reflected in an overstatement of cost of sales and is eliminated by reducing (crediting) cost of sales and debiting the investment account if a correct equity method has been used and the intercompany sales are downstream. In the case of upstream sales, cost of sales is credited and the noncontrolling interest and the investment account are debited proportionately.

There are two equally good approaches for computing noncontrolling interest share when there are unrealized profits from upstream sales in both beginning and ending inventories. One approach is to compute realized income of the subsidiary by adding unrealized profits in the beginning inventory to reported subsidiary net income and deducting unrealized profits in the ending inventory. The noncontrolling interest share is then equal to the realized income of the subsidiary multiplied by the noncontrolling interest percentage. The other approach is to compute the noncontrolling interest percentage in reported subsidiary net income, in unrealized profits in beginning inventory, and in unrealized profits in ending inventory. Noncontrolling interest share is then computed by adding the noncontrolling interest percentage in unrealized profits in the beginning inventory to the noncontrolling interest share of reported income, and subtracting the noncontrolling interest percentage relating to the unrealized profits in the ending inventory.

The assumption that unrealized profits in an ending inventory are realized in the succeeding period is a convenience, but it does not result in incorrect measurements of consolidated net income as long as the unrealized profits at any statement date are correctly determined. This is because any unrealized profits in beginning inventory that are considered realized are credited to cost of sales. The same items will appear as unrealized profits in the ending inventory if they remain unsold, and the elimination of these items results in debiting cost of sales for the same amount. Thus, the workpaper effects are offsetting as illustrated in the following workpaper entries, which assume $5,000 unrealized profits from downstream sales. Investment in subsidiary Cost of sales To eliminate unrealized profit in beginning inventory.

5,000

Cost of sales

5,000

Inventory To eliminate unrealized profit in ending inventory.

5,000

Chapter 5

5-3

SOLUTIONS TO EXERCISES Solution E5-1 1 2 3 4

a d a c

5 6 7 8

c a a c

Solution E5-2 [AICPA adapted] 1

c Unrealized profits from intercompany sales with Ken are eliminated from the ending inventory: $960,000 combined current assets less $36,000 unrealized profit ($180,000  20%).

c Combined cost of sales of $2,250,0000 less $750,000 intercompany sales

Solution 5-3 1

d Pil's separate income (in thousands) Add: Share of Sil's income ($1,000  100%) Add: Realization of profit deferred in 2011 $3,000 - ($3,000/150%) Less: Unrealized profit in 2012 inventory $2,400 - ($2,400/150%) Controlling share of consolidated net income

$2,000 1,000 1,000 (800) $3,200

d Combined sales Less: Intercompany sales Consolidated sales

$2,800 (100) $2,700

c Combined cost of sales Less: Intercompany purchases

$1,360 (100)

Less: Unrealized profit in beginning inventory Add: Unrealized profit in ending inventory Consolidated cost of sales

(8) 20 $1,272

Intercompany Profit Transactions — Inventories

5-4

Solution E5-4 1

b Pid's share of Sed's income ($120,000  80%) Less: Unrealized profit in ending inventory ($40,000  50% unsold  80% owned) Income from Sed d Combined cost of sales Less: Intercompany sales Add: Unrealized profit in ending inventory Consolidated cost of sales b Reported income of Sed Unrealized profit Sed's realized income Noncontrolling interest percentage Noncontrolling interest share

96,000

(16,000) 80,000

900,000 (200,000) 20,000 $ 720,000 $

120,000 (20,000) 100,000 20% 20,000

Solution E5-5 1

c Combined sales Less: Intercompany sales Consolidated sales

$1,800,000 (400,000) $1,400,000

c Unrealized profit in beginning inventory $100,000 - ($100,000/125%)

20,000

Unrealized profit in ending inventory $125,000 - ($125,000/125%)

25,000

b Combined cost of goods sold Less: Intercompany sales Less: Unrealized profit in beginning inventory $100,000 - ($100,000/125%) Add: Unrealized profit in ending inventory $125,000 - ($125,000/125%) Consolidated cost of goods sold

$1,440,000 (400,000) (20,000) 25,000 $1,045,000

Chapter 5

5-5

Solution E5-6 1

a Pat's separate income Add: Income from Sue (below) Controlling share of consolidated net income

$200,000 144,550 $344,550

Sue's reported income Less: Patent amortization Add: Unrealized profit in beginning inventory [$112,500 - ($112,500/150%)] Less: Unrealized profit in ending inventory [$33,000 - ($33,000/150%)] Sue’s adjusted and realized income

$200,000 (20,000)

Pat’s 70% controlling share of Sue’s realized income Noncontrolling interest share (30%)

$144,550 $ 61,950

37,500 (11,000) $206,500

c Pac's share of Slo's reported net loss ($150,000 loss  60%) Add: Unrealized profit in ending inventory ($200,000  1/4 unsold) Income from Slo Pac's separate income Controlling share of consolidated net income

$(90,000) (50,000) (140,000) 300,000 $160,000

b San's reported net income Add: Realized profit in beginning inventory $150,000 - ($150,000/1.25) Less: Deferred profit in ending inventory $200,000 - ($200,000/1.25) Income from San Par’s 75% controlling share of San’s income Noncontrolling interest share (25%)

$300,000 30,000 (40,000) $290,000 $217,500 $ 72,500

Solution E5-7 (in thousands) Pam's separate income Add: 80% of Sam's reported income Add: Realization of profits in beginning inventory Less: Unrealized profits in ending Inventory Controlling share of consolidated NI Add: Noncontrolling interest share Consolidated net income

2011 $1,800 2,400

(180) $4,020 600 $4,620

2012 $2,400 2,640

2013 $2,100 2,280

180

240

(240) $4,980 660 $5,640

(120) $4,500 570 $5,070

Intercompany Profit Transactions — Inventories

5-6

Solution E5-8 Pac Corporation and Subsidiary Consolidated Income Statement for the year ended December 31, 2011 (in thousands) Sales ($1,600 + $400 - $160 intercompany sales) Cost of sales ($800 + $160 - $160 intercompany purchases + $40 unrealized profit in ending inventory) Gross profit Other expenses ($400 + $120) Cnsolidated net income Less: Noncontrolling interest share ($120  20%) Controlling share of consolidated net income

$1,840 (840) 1,000 (520) 480 (24) $ 456

Solution E5-9 1

Noncontrolling interest share Sev's reported net income Add: Intercompany profit from upstream sales in beginning inventory Less: Intercompany profit from upstream sales in ending inventory Sev’s adjusted and realized income Noncontrolling interest share (40%) Consolidated sales Combined sales Less: Intercompany sales Consolidated sales Consolidated cost of sales Combined cost of sales Less: Intercompany sales Add: Intercompany profit in ending inventory Less: Intercompany profit in beginning inventory Consolidated cost of sales Total Consolidated Income Combined income Less: Intercompany profit in ending inventory Add: Intercompany profit in beginning inventory Total Consolidated Income

$ 50,000 5,000 (10,000) $ 45,000 $ 18,000 $1,250,000 100,000 $1,150,000 $

650,000 (100,000) 10,000 (5,000) $ 555,000 $ $

300,000 (10,000) 5,000 295,000

Chapter 5

5-7

Solution E5-10 Pap Corporation and Subsidiary Consolidated Income Statement December 31, 2013 (in thousands) Sales ($4,000 + $2,000 - $360 intercompany) Cost of sales ($1,600 + $1,000 - $360 intercompany $40 unrealized profit in beginning inventory + $60 unrealized profit in ending inventory Gross profit Depreciation expense Other expenses ($360 + $240) Total consolidated income Less: Noncontrolling interest share ($600 + $40 profit in beginning inventory - $60 profit in end. inventory)  20% Controlling interest share of consolidated net income Supporting computations Cost of investment in Sak at January 1, 2012 Implied fair value of Sak ($2,400 / 80%) Book value of Sak Goodwill

$5,640 (2,260) 3,380 (680) (600) 2,100 (116) $1,984 $ 2,400 $ 3,000 (2,800) $ 200

Solution E5-11 1

b Income as reported Add: Realization of profits in beginning inventory $120,000 - ($120,000/1.2) Less: Unrealized profits in ending inventory $360,000 - ($360,000/1.2) Realized income Percent ownership Income from Sue

200,000 20,000

(60,000) 160,000 60% 96,000

c Sue's equity as reported ($3,400,000 + $2,100,000) Less: Unrealized profit in ending inventory Realized equity Noncontrolling share Noncontrolling interest December 31, 2011

$5,500,000 (60,000) 5,440,000 40% $2,176,000

b Realized equity Controlling share Investment balance December 31, 2011

$5,440,000 60% $3,264,000

Note: The excess fair value over book value is fully amortized. Therefore, the investment balance of $3,264,000 plus the noncontrolling interest of $2,176,000 is equal to the $5,440,000 realized equity at the balance sheet date.

Intercompany Profit Transactions — Inventories

5-8

Solution E5-12 Put Corporation and Subsidiary Consolidated Income Statement for the year ended December 31, 2011 Sales ($5,520,000 - $480,000 intercompany sales) Cost of sales ($3,680,000 - $480,000 - $20,000a + $48,000b) Gross profit Operating expenses Total consolidated income Less: Noncontrolling interest share [$160,000 - ($48,000  .2)] Controlling share of consolidated net income a b

$5,040,000 (3,228,000) 1,812,000 (640,000) 1,172,000 (150,400) $1,021,600

Unrealized profit in beginning inventory (downstream) ($720,000 - $640,000)  .25 = $20,000 Unrealized profit in ending inventory (upstream) ($480,000 - $360,000)  .4 = $48,000

Chapter 5

5-9

SOLUTIONS TO PROBLEMS Solution P5-1 Par Corporation and Subsidiary Consolidated Statement of Income and Retained Earnings for the year ended December 31, 2012 (in thousands) Sales ($13,000 + $6,500 - $800 intercompany sales) $18,700 Less: Cost of sales ($8,000 + $3,900 - $800 intercompany purchases - $120 unrealized profit in beginning inventory + $160 unrealized profit in ending inventory) (11,140) Gross profit 7,560 Other expenses ($3,400 + $1,600) (5,000) Consolidated net income 2,560 (96) Noncontrolling interest share($1,000,000+$120,000-$160,000)10% Controlling share of consolidated net income 2,464 Add: Beginning consolidated retained earnings 3,692 Less: Dividends for the year (1,000) Consolidated retained earnings December 31 $ 5,156

Intercompany Profit Transactions — Inventories

5-10

Solution P5-2 1

Consolidated cost of sales — 2013 Combined cost of sales ($1,250,000 + $600,000) Less: Intercompany purchases Add: Profit in ending inventory Less: Profit in beginning inventory Consolidated cost of sales Noncontrolling interest share — 2013 Sam's net income ($1,200,000 - $600,000 - $300,000) Add: Profit in beginning inventory Less: Profit in ending inventory Sam's realized income Noncontrolling interest percentage Noncontrolling interest share Consolidated Controlling share of NI— 2013 Consolidated sales ($1,800,000 + $1,200,000 - $600,000) Less: Consolidated cost of sales Less: Consolidated expenses ($450,000 + $300,000) Less: Noncontrolling interest share Controlling share of consolidated net income Alternatively, Put's separate income Add: Income from Sam Controlling share of consolidated net income Add: Noncontrolling interest share Consolidated net income

Noncontrolling interest at December 31, 2013 Equity of Sam December 31, 2013 Less: Unrealized profit in ending inventory Noncontrolling interest percentage Noncontrolling interest December 31

$1,850,000 (600,000) 48,000 (24,000) $1,274,000 $

300,000 24,000 (48,000) 276,000 10% 27,600

$2,400,000 (1,274,000) (750,000) (27,600) $ 348,400 $

100,000 248,400 $ 348,400 27,600 $376,000 1,0400,000 (48,000) 10% $ 99,200

Chapter 5

5-11

Solution P5-3 1 2012

Inventories appearing in consolidated balance sheet at December 31, Beginning inventory — Pot ($120,000 - $8,000a) Beginning inventory — San ($77,500 - $15,500b) Beginning inventory — Tay ($48,000 - 0) Inventories December 31

$112,000 62,000 48,000 $222,000

Intercompany profit: a

2 2013

Pot: Inventory acquired intercompany ($120,000  40%) Cost of intercompany inventory ($48,000/1.2) Unrealized profit in Pot's inventory San: Inventory acquired intercompany ($77,500  100%) Cost of intercompany inventory ($77,500/1.25) Unrealized profit in San's inventory

$ 48,000 (40,000) $ 8,000 $ 77,500 (62,000) $ 15,500

Inventories appearing in consolidated balance sheet at December 31, Ending inventory — Pot ($108,000 - $9,000c) Ending inventory — San ($62,500 - $12,500d) Ending inventory — Tay ($72,000 - 0) Inventories December 31

$ 99,000 50,000 72,000 $221,000

Intercompany profit: c

Pot: Inventory acquired intercompany ($108,000  50%) Cost of intercompany inventory ($54,000/1.2) Unrealized profit in Pot's inventory San: Inventory acquired intercompany ($62,500  100%) Cost of intercompany inventory ($62,500/1.25) Unrealized profit in San's inventory

$ 54,000 (45,000) $ 9,000 $ 62,500 (50,000) $ 12,500

Intercompany Profit Transactions — Inventories

5-12

Solution P5-4 (in thousands) 1

Pit's income from Stu 75% of Stu's net income Unrealized profit in December 31, 2011 inventory (downstream) ($1,200  1/2)  100% Unrealized profit in December 31, 2012 inventory (upstream) $600  75% Pit's income from Stu Pits net income Pit’s separate income Add: Income from Stu Pit's net income Consolidated net income Separate incomes of Pit and Stu combined Unrealized profit in December 31, 2011 inventory Unrealized profit in December 31, 2012 inventory Total consolidated income Less: Noncontrolling interest share 2011 $2,400  25% 2012 ($2,700 - $600)  25% 2011 ($2,100 + $600)  25% Controlling share of net income

2011 $1,800

2012 $2,025

2013 $1,575

(600)

600

$1,200

(450) $2,175

450 $2,025

$10,800 1,200 $12,000

$10,200 2,175 $12,375

$12,000 2,025 $14,025

$13,200

$12,900

$14,100

(600)

600

12,600

(600) 12,900

600 14,700

(600) (525) $12,000

$12,375

(675) $14,025

Chapter 5

5-13

Solution P5-5 Pan Corporation and Subsidiary Consolidation Workpapers for the year ended December 31, 2012 (in thousands) Adjustments and Pan 100% Sal Eliminations Income Statement Sales Income from Sal Cost of sales

800 102 400*

$ 400 200*

a 120 d 102 b 12

110* 192*

40* 60*

$ 100

Depreciation expense Other expenses Net income

200

Retained Earnings Retained earnings — Pan

600 200✓ 100*

700

$ 430

Balance Sheet Cash

54 90

Buildings — net Equipment — net Investment in Sal Patents

Accounts payable Other liabilities Common stock, $10 par Retained earnings

80 90 50 150

500

400

736 ______

_____

$1,800

$ 867

700✓ $1,800

472* 150* 258* $

200

e 380 200 d

37 60

100 70 50 200

160 340 600

a 120 c 20

100✓ 50*

Dividends Retained earnings December 31

Receivables — net Inventories Other assets Land

$1,080

600 $ 380

Retained earnings — Sal Net income

Consolidated Statements

47 90 300

430✓ $ 867

100* $

700

91 133 168 160 100 350 900

d 52 e 704 f 6

18 $1,920

e 300 _________

_________

981

190 430 600 700

$1,920

Supporting computations Unrealized profit in beginning inventory ($40,000  1/2) = $20,000 Unrealized profit in ending inventory ($48,000  1/4) = $12,000 Sal's income of $100,000 plus $20,000 profit in beginning inventory, less $12,000 profit in ending inventory, and less $6,000 patent amortization equals $102,000 income from Sal.

Intercompany Profit Transactions — Inventories

5-14

Solution P5-6 Pay Corporation and Subsidiary Consolidation Workpapers for the year ended December 31, 2012 (in thousands) Adjustments and Pay Sue 75% Eliminations Income Statement Sales Income from Sue Cost of sales Operating expenses Consolidated net income Noncontrolling int.share Controlling share of NI Retained Earnings Retained earnings — Pay Retained earnings — Sue Controlling share of NI Dividends Retained earnings December 31 Balance Sheet Cash Accounts receivable Dividends receivable Inventories Land

$2,400 410 1,080*

$1,600

580*

160*

______

$1,150✓

600✓

360

840*

a 520 d 410 b 80

$3,480 a c

520 40

f 150

1,150✓ 600*

760

120 400

1,150 d f

150 50

$ g h b

60 60 80

560

1,540

600* $1,280

320 200 400

800

Equipment — net Investment in Sue

730

e 360

600✓ 200*

$1,280

Buildings — net

1,440* 740* $1,300 150* $1,150

730

340 660 60 240 320 920

Consolidated Statements

460 1,000 480 520 1,320 1,360

d 260 e 1,320

Goodwill

______ $4,880

______ $2,000

e 800

800 $5,940

Accounts payable Dividends payable Other liabilities Common stock, $10 par Retained earnings

g h

$1,240 300 780 1,800 1,280

900 280 620 1,800

1,280✓ $4,880 Noncontrolling interest January 1 Noncontrolling interest December 31 *

400 80 160 600

60 60

e 600

760✓ $2,000 ______ 3,080

e f

440 100 3,080

540 $5,940

Deduct

Supporting computations Investment in Sue at January 1, 2011 Implied fair value of Sue ($1,200 / 75%) Book value of Sue Goodwill

$1,200 $1,600 800 $ 800

Chapter 5

5-15

Solution P5-7 Preliminary computations Investment cost Implied fair value of Sal Less: Book value of Sal Patents Patent amortization

$2,700,000 $3,000,000 2,500,000 $ 500,000

$500,000/10 years = $50,000 per year

Upstream sales Unrealized profit in December 31, 2011 inventory of Pal $280,000 - ($280,000  1.4) = $80,000 Unrealized profit in December 31, 2012 inventory of Pal $420,000 - ($420,000  1.4) = $120,000 Income from Sal Sal's reported net income Less: Patent amortization Less: Unrealized profit in ending inventory Add: Unrealized profit in beginning inventory Sal’s adjusted and realized income

$1,000,000 (50,000) (120,000) 80,000 $ 910,000

Pal’s 90% controlling share of Sal’s income 10% noncontrolling interest share of Sal’s income

$ 819,000 $ 91,000

Investment balance Initial investment cost Increase in Sal's net assets from December 31, 2010 to December 31, 2012 ($700,000  90%) Patent amortization for 2 years (90%) Unrealized profit in December 31, 2012 inventory Investment balance December 31, 2012

$2,700,000 630,000 ( 90,000) (108,000) $3,132,000

Intercompany Profit Transactions — Inventories

5-16

Solution P5-7 (continued) Pal Corporation and Subsidiary Consolidation Workpapers for the year ended December 31, 2012 (in thousands) Pal Income Statement Sales Income from Sal Cost of sales

$ 8,190 819 5,460*

$5,600 4,000*

Other expenses Consolidated net income Noncontrolling int.share Controlling share of NI

1,544*

600*

$ 2,005

$1,000

Retained Earnings Retained earnings — Pal

$ 1,200 2,005✓ 1,000*

Dividends Retained earnings December 31 Balance Sheet Cash Inventory Other current assets Plant assets — net Investment in Sal Patents

Current liabilities Capital stock Retained earnings

_______

______

$ 7,905

$4,500

$ 1,700 4,000

$1,300 2,000

Noncontrolling interest January 1 Noncontrolling interest December 31

$ 8,190 a 5,600 c 80

3,900* 2,194* $ 2,096 91* $ 2,005

700 2,005 d h

450 50

1,000* $ 2,205

500 800 200 3,000

3,132

2,205✓

1,000✓ 500*

$1,200

$ 7,905

700

$ 2,205

753 420 600 3,000

a 5,600 d 819 b 120

Consolidated Statements

$ 1,200 $

Retained earnings — Sal Controlling share of NI

Adjustments and Eliminations

Sal 90%

b g c

450

120 100

d 369 e 2,835 f 50

$ 1,253 1,100 700 6,000

400 $ 9,453

g 100 e 2,000

$ 2,900 4,000 2,205

1,200✓ $4,500 c 8 _______ 10,010

e h

315 41 10,010

Deduct

348 $ 9,453

Chapter 5

5-17

Solution P5-8 Pan Corporation and Subsidiary Consolidation Workpapers for the year ended December 31, 2012 (in thousands) 100% Sal

Pan Income Statement Sales Income from Sal Cost of sales

800 108 400*

Depreciation expense Other expenses Net income

206

Retained Earnings Retained earnings — Pan

606

200*

110* 192*

a 120 d 108 b 12

Consolidated Statements $1,080

a 120 c 20

472*

40* 60* $

150* 252*

100

206

606 $

Retained earnings — Sal Net income

400

Adjustments and Eliminations

206✓ 100*

380

e 380 206

100✓ 50*

Dividends Retained earnings December 31

712

430

712

Balance Sheet Cash

54 90

37 60

91 133

Receivables — net Inventories Other assets Land Buildings — net Equipment — net Investment in Sal Goodwill

Accounts payable Other liabilities Common stock, $10 par Retained earnings

100 70 50 200

80 90 50 150

500

400

748 ______

______

$1,812

867

47 90 300 430 867

160 340 600 712 $1,812

100*

168 160 100 350 900

d 58 e 710 30 $1,932

e 300 ______ 987

_______ 987

190 430 600 712 $1,932

Supporting computations Unrealized profit in beginning inventory ($40,000  1/2) = $20,000 Unrealized profit in ending inventory ($48,000  1/4) = $12,000 Sal's income of $100,000 plus $20,000 profit in beginning inventory less $12,000 profit in ending inventory. Copyright © 2015 Pearson Education, Inc.

Intercompany Profit Transactions — Inventories

5-18

Solution P5-9 (in thousands) Preliminary computations Investment cost Implied fair value of Sun ($5,400 / 90%) Less: Book value of Sun Goodwill

$5,400 $6,000 5,000 $1,000

Upstream sales Unrealized profit in December 31, 2013 inventory of Poe $560 - ($560  1.4) = $160 Unrealized profit in December 31, 2014 inventory of Poe $840 - ($840  1.4) = $240 Income from Sun San's reported net income Less: Unrealized profit in ending inventory Add: Unrealized profit in beginning inventory Sun’s adjusted and realized income

$2,000 (240) 160 $1,920

Poe’s 90% controlling interest share of Sun’s income 10% noncontrolling interest share of Sun’s income

$1,728 $ 192

Investment balance Initial investment cost Increase in Sun's net assets from December 31, 2011 to December 31, 2014 ($1,400  90%) Unrealized profit in December 31, 2014 inventory (90%) Investment balance December 31, 2014

$5,400 1,260 (216) $6,444

Chapter 5

5-19

Solution P5-9 (continued) Poe Corporation and Subsidiary Consolidation Workpapers for the year ended December 31, 2014 (in thousands) Poe Income Statement Sales Income from Sun Cost of sales

$16,380 1,728 10,920*

$11,200

3,088*

1,200*

Other expenses Consolidated net income Noncontrolling int.share Controlling share of NI

$ 4,100

Retained Earnings Retained earnings — Poe

$ 2,500

Retained earnings — Sun Controlling share of NI Dividends Retained earnings December 31 Balance Sheet Cash Inventory Other current assets Plant assets — net Investment in San Goodwill

Current liabilities Capital stock Retained earnings

8,000*

a 11,200 d 1,728 b 240

Consolidated Statements $16,380

a 11,200 c 160

7,800* 4,288* $ 4,292 192*

192

$ 2,000

$ 4,100

$ 2,500 $ 1,400

4,100✓ 2,000*

1,400 4,100

2,000✓ 1,000*

$ 4,600

$ 2,400

$ 1,516 840 1,200 6,000

$ 1,000 1,600 400 6,000

6,444 _______

_______

$16,000

$ 9,000

$ 3,400 8,000 4,600✓

$ 2,600 4,000 2,400✓

$16,000

$ 9,000

Noncontrolling interest January 1 Noncontrolling interest December 31 *

Adjustments and Eliminations

Sun 90%

d f

900 100

2,000*

$ 4,600

b g c

144

1,000

240 200

$ 2,516 2,200 1,400 12,000

d 828 e 5,760 1,000 $19,116

g e

200 4,000

c 16 ________ 20,120

$ 5,800 8,000 4,600

e f

640 92 20,120

Deduct

716 $19,116

Chapter 6 INTERCOMPANY PROFIT TRANSACTIONS — PLANT ASSETS Answers to Questions 1 The objective of eliminating the effects of intercompany sales of plant assets is to reflect plant assets and related depreciation amounts in the consolidated financial statements at cost to the consolidated entity. 2

Consolidation procedures for eliminating unrealized profit on plant assets are affected by the direction of the sale. The full amount of unrealized profit or loss on downstream sales (parent to subsidiary) is charged or credited to the controlling interest. In the case of upstream sales, however, unrealized profit or loss is allocated between controlling and noncontrolling interests. Because there is no allocation to noncontrolling interests in the case of a 100 percent owned subsidiary, consolidation procedures are the same for upstream sales as for downstream sales.

Unrealized gains and losses from intercompany sales of land are realized from the viewpoint of the selling affiliate when the purchasing affiliate resells the land to parties outside the consolidated entity. This is also the point at which the consolidated entity recognizes gain or loss on the difference between the selling price to outside parties and the cost to the consolidated entity.

Noncontrolling interest share is not affected by downstream sales of land because the realized income of the subsidiary is not affected by downstream sales. In the case of upstream sales of land, the reported income of the subsidiary is adjusted downward for unrealized profits and upward for unrealized losses to determine realized income. Since noncontrolling interest share is computed on the basis of realized subsidiary income, the computation of noncontrolling interest share is affected by upstream sales of land.

Consolidation procedures are designed to eliminate 100 percent of all unrealized profit or loss on all intercompany transactions. The issue is not whether 100 percent of the unrealized profit or loss is eliminated, but if the amount eliminated is allocated between controlling and noncontrolling interests. In the case of an upstream sale of land, 100 percent of the unrealized profit from the sale is eliminated, but the amount is allocated between controlling and noncontrolling interests in relation to their ownership holdings.

Unrealized gains and losses from intercompany sales of depreciable assets are realized through use if the assets are held within the consolidated entity and through sale if the assets are sold to outside parties. The process of recognizing previously unrealized gains and losses through use is a piecemeal recognition over the remaining useful life of the depreciable asset.

The computation of noncontrolling interest share in the year of an upstream sale of depreciable plant asset is as follows: Unrealized Unrealized Gain on Sale Loss on Sale Income of subsidiary as reported XXX XXX Deduct: Gain on sale of plant assets - XX Add: Loss on sale of plant assets + XX Add: Piecemeal recognition of gain on sale of plant assets + X Deduct: Piecemeal recognition of loss on sale of plant assets ____ - X Realized subsidiary income XXX XXX Noncontrolling interest percentage X% X% Noncontrolling interest share XXX XXX

Intercompany Profit Transactions — Plant Assets

6-2

The effects of unrealized gains on intercompany sales of plant assets are charged against the parent’s income from subsidiary account in the year of the intercompany sale, with equal amounts being deducted from the investment in subsidiary account. In subsequent years, the income from subsidiary and investment in subsidiary accounts are increased for depreciation on the unrealized gain that is recorded on the subsidiary books for downstream sales or for the parent’s proportionate share for upstream sales. If the unrealized gain relates to land, no entries are needed until the land is sold to entities outside of the affiliation structure.

Accounting procedures are designed to eliminate the effects of intercompany sales of plant assets on both parent income and consolidated net income until the gains and losses on such sales are realized through use or through sale to outside parties. In years subsequent to intercompany sales of depreciable plant assets, the effect on parent income is eliminated by adjusting depreciation expense to a cost basis for the consolidated entity.

Consolidation workpaper entries to eliminate the effect of a gain on sale of depreciable plant assets from a downstream sale are illustrated as follows: Year of sale Gain on sale Accumulated depreciation Depreciation expense Plant assets To reduce plant assets and related depreciation amounts to a cost basis to the consolidated entity and to eliminate unrealized gain on intercompany sale. Subsequent years Investment in subsidiary Accumulated depreciation Depreciation expense Plant assets To reduce plant assets and related depreciation amounts to a cost basis to the consolidated entity and to adjust the investment account for unrealized profits at the beginning of the current year.

SOLUTIONS TO EXERCISES Solution E6-1 1

Chapter 6

6-3

Solution E6-2 1

Par’s income from Sam will be decreased by $50,000 as a result of the following entry: Income from Sam 50,000 Investment in Sam 50,000 To eliminate unrealized gain on downstream sale of land. Par’s net income for 2014 will not be affected by the sale since the $50,000 gain will be offset by a $50,000 decrease in income from Sam. The investment in Sam account at December 31, 2014 will be $50,000 less as a result of the sale as indicated by the above entry. (The total balance sheet effect is to reduce land to its cost, reduce the investment account for the profit, and increase cash or other assets for the proceeds.)

The consolidated financial statements will not be affected because the gain on the sale is eliminated in the consolidated income statement and the land is reduced to its cost basis to the consolidated entity. A workpaper adjustment would show: Gain on sale of land Land

50,000 50,000

Neither Par’s income from Sam or net income for 2015 will be affected by the 2014 sale of land. The investment in Sam account, however, will still be $50,000 less than if the land had not been sold, even though there are no changes in the investment account during 2015.

The sale of the land will not affect Sam’s net income since it is being sold at Sam’s cost. However, the sale triggers recognition of the postponed gain on the original sale from Par to Sam. Investment in Sam Income from Sam To recognize the gain deferred in 2014.

50,000 50,000

Consolidated income will also feel the same impact of the recognition of the deferred gain. Investment in Sam Gain on sale of land

50,000

Intercompany Profit Transactions — Plant Assets

6-4

Solution E6-3 1a

Controlling Share of Consolidated net income Pit’s separate income Add: Equity in Sir’s income 2011 $40,000  90% 2012 $30,000  90% Gain on sale of land Controlling share of consolidated net income

2012 200,000

(5,000) 181,000 $

27,000 --227,000

4,000

3,000

150,000 $ 36,000 (4,500) 181,500 $

200,000 27,000 --227,000

4,000 $ (500) 3,500 $

3,000 --3,000

36,000

Controlling Share of Consolidated net income Pit’s separate income Add: Equity in Sir’s income Less: Gain on land  90% Controlling share of consolidated net income

2011 150,000

Noncontrolling interest share Sir’s net income  10%

Noncontrolling interest share Sir’s net income  10% Less: Gain on land  10% Noncontrolling interest share

$ $

Chapter 6

6-5

Solution E6-4 1. Entries for 2011 Cash

45,000 Investment in Sal To record dividends received from Sal.

Investment in Sal 54,000 Income from Sal To record income from Sal computed as follows: Share of Sal’s reported income ($75,000  90%) Less: Gain on building sold to Sal Add: Piecemeal recognition of gain on building ($15,000/10 years) Income from Sal 2

45,000

54,000 $

67,500 (15,000) 1,500 54,000

Pig Corporation and Subsidiary Consolidated Income Statement for the year ended December 31, 2011 Sales Cost of sales Gross profit Operating expenses Total consolidated income Noncontrolling interest share Controlling interest share

$1,100,000 (700,000) 400,000 (223,500) 176,500 (7,500) $ 169,000

Intercompany Profit Transactions — Plant Assets

6-6

Solution E6-5 [AICPA adapted] 1

d The equipment must be shown at its $1,400,000 book value to the consolidated entity and d is the only choice that provides a $1,400,000 book value. Ordinarily, the equipment would be shown at $1,500,000, its book value at the time of transfer, less the $100,000 depreciation after transfer.

c Reciprocal receivables and payables accounts and purchases and sales accounts must always be eliminated. But dividend income (parent) and dividends paid (subsidiary) accounts are reciprocals only when the cost method is used.

a Amount to be eliminated from consolidated net income in 2011: Intercompany gain on downstream sale of machinery $10,000 Less: Realized through depreciation of intercompany gain on machinery ($10,000/5 years) (2,000) Decrease in consolidated net income from $ 8,000 intercompany sale Amount to be added to consolidated net income in 2012 for realization through depreciation of intercompany gain on machinery $ 2,000

b One-third of the unrealized intercompany profit is recognized through depreciation for 2011.

Chapter 6

6-7

Solution E6-6 1

a Selling price in 2019 Cost to consolidated entity Gain on sale of land

$ $

55,000 15,000 40,000

b Gain on equipment $ 30,000 Less: Depreciation on gain (10,000) Net effect on investment account $ 20,000 The investment account will be $20,000 less than the underlying equity interest.

b Combined equipment — net Less: Unrealized gain Add: Piecemeal recognition of gain Consolidated equipment — net

$ $

b The workpaper entry to eliminate the unrealized profit is: Gain on sale of equipment 1,500 Equipment

1,500

c Investment income will be decreased by $12,000 gain less $3,000 piecemeal recognition of the gain.

c Sin’s net income Less: Unrealized gain Add: Piecemeal recognition Realized income Noncontrolling interest percentage Noncontrolling interest share

800,000 (20,000) 5,000 785,000

$1,000,000 (50,000) 5,000 955,000 40% $ 382,000

Intercompany Profit Transactions — Plant Assets

6-8

Solution E6-7 Pod Corporation and Subsidiary Consolidated Income Statement for the year ended December 31, 2011 Sales ($250,000 + $150,000) Gain on sale of machinerya Total revenue

$400,000 10,000 410,000

Cost of sales ($100,000 + $65,000) Depreciation expense ($25,000 + $15,000 - $2,500 from depreciation on intercompany profit for 2011) Other expenses ($40,000 + $20,000) Total expenses Consolidated net income Noncontrolling share ($50,000+$2,500 piecemeal recognition from depreciation + $5,000 remaining deferred gain)  25% noncontrolling interest Controlling interest share

165,000

37,500 60,000 262,500 $147,500

14,375 $133,125

Selling price of machinery at December 28, 2011 Book value on Pod’s books $32,500 – ($32,500/5 years  3 years) Gain on sale of machinery

$ 18,000 13,000 $ 5,000

Original intercompany profit Piecemeal recognition of gain $12,500/5 years  3 years Unamortized gain from intercompany sales

$ 12,500 7,500 $ 5,000

Gain on sale of machinery to outside entity

$ 10,000

Chapter 6

6-9

Solution E6-8 Preliminary computations: Investment in Sat (40%) at cost Implied total fair value of Sat ($100,000 / 40%) Book value Excess allocated to patents Annual amortization of patents ($50,000/5 years) 1

Income from Sat — 2011 Share of Sat’s net income ($40,000  1/2 year  40%) Amortization of patents ($10,000  1/2 year  40%) Unrealized inventory profit from upstream sale ($4,000  40%) Unrealized gain from downstream sale of land ($2,000  100%) Income from Sat

$100,000 $250,000 (200,000) $ 50,000 $ 10,000

8,000 (2,000) (1,600)

(2,000) 2,400

Income from Sat — 2012 Sat’s net income Amortization of patents Unrealized inventory profits from upstream sales: Recognition of profit in beginning inventory Deferral of profit in ending inventory Sat’s adjusted and realized income Income from Sat (40% share)

$ 60,000 (10,000) 4,000 (6,000) $ 48,000 $ 19,200

Intercompany Profit Transactions — Plant Assets

6-10

Solution E6-9 1

Income from Sip, net income and consolidated net income: Sip’s reported net income Less: Amortization of excess allocated to buildings ($1,000,000 - $800,000)/20 years Less: $40,000 unrealized profit on equipment Sip’s adjusted and realized income

$200,000 (10,000) (40,000) $150,000

Income from Sip (80% share) — 2013 Add: Separate income of Pan for 2013 Net income of Pan — 2013

120,000 1,000,000 $1,120,000

Sip’s reported net income Less: Amortization of excess allocated to buildings Add: Piecemeal recognition of unrealized gain on equipment ($40,000/4 years) Sip’s adjusted and realized income

$220,000 (10,000) 10,000 $220,000

$ 176,000 Income from Sip (80%) — 2014 Add: Separate income of Pan 1,200,000 $1,376,000 Net income of Pan — 2014 Controlling share of consolidated net income for 2013 and 2014 = Pan’s net income Alternatively, 2013 2014 Separate incomes combined $1,200,000 $1,420,000 Less: Amortization of excess (buildings) (10,000) (10,000) Less: Unrealized gain on equipment in 2013 (40,000) Add: Piecemeal recognition of gain in 2014 10,000 Consolidated net income $1,150,000 $1,420,000 Less: Noncontrolling interest share: (30,000) 2013 ($200,000 - $40,000 - $10,000)  20% (44,000) 2014 ($220,000 + $10,000 - $10,000)  20% Controlling interest share $1,120,000 $1,376,000 2

Investment in Sip Cost of investment July 1, 2011 $ Add: Pan’s share of Sip’s retained earnings increase from July 1, 2011 to December 31, 2012 ($300,000 - $200,000)  80% Less: 80% Amortization of excess ($8,000  1.5 years) Investment in Sip December 31, 2012 Add: 2013 income less dividends [$120,000-($100,000  80%)] Investment in Sip December 31, 2013 Add: 2014 income less dividends [$176,000-($120,000  80%)] Investment in Sip December 31, 2014 $

800,000 80,000 (12,000) 868,000 40,000 908,000 80,000 988,000

Chapter 6

6-11

Solution E6-9 (continued) Alternative solution for check at December 31, 2014: Share of Sip’s equity December 31, 2014 ($1,100,000  80%) Add: 80% Unamortized excess on buildings Original excess [$200,000 - ($10,000  3.5 years)]x 80% Less: Unrealized profit on equipment ($40,000 gain - $10,000 recognized)  80% Investment in Sip December 31, 2014

880,000 132,000

(24,000) 988,000

Intercompany Profit Transactions — Plant Assets

6-12

Solution E6-10 Preliminary computations Transfer price of inventory to Spa ($360,000  2) Cost to consolidated entity Unrealized profit on January 3 Amortization of unrealized profit from consolidated view: $360,000/6 years = $60,000 per year 1

$720,000 (360,000) $360,000

Consolidated balance sheet amounts: 2011 Equipment (at transfer price) $720,000 Less: Unrealized profit (360,000) Less: Depreciation taken by Spa ($720,000/6 years) (120,000) Add: Depreciation on unrealized profit ($360,000/6 years) 60,000 Equipment — net to be included on consolidated balance sheet $300,000 Alternatively: Equipment (at cost to the consolidated entity) Less: Depreciation based on cost ($360,000/6 years) Equipment — net

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

2012 Year after intercompany sale Equipment — net beginning of the period on cost basis Less: Depreciation (based on cost) Equipment — net

$300,000 (60,000) $240,000

Consolidation workpaper entries: 2011 Sales 720,000 Cost of goods sold 360,000 300,000 Equipment — net Depreciation expense 60,000 To eliminate intercompany inventory sale, return equipment to its cost to the consolidated entity, and eliminate depreciation on the intercompany profit. 2012 Investment in Spa 300,000 240,000 Equipment — net Depreciation expense 60,000 To eliminate unrealized profit from the equipment account and the current year’s depreciation on the unrealized profit and establish reciprocity between the investment account and beginning-of-the-period subsidiary equity accounts.

Chapter 6

6-13

Solution E6-11 Par Corporation and Subsidiary Schedule for Computation of Consolidated Net Income 2011 2012 2013 2014 Combined separate incomes $260,000 $220,000 $120,000 $210,000 Add: Amortization of negative differential assigned to plant assets ($50,000/10 years)* 5,000 5,000 5,000 5,000 Unrealized gain on land (Note that Par’s $5,000 gain is included in Par’s separate income) (5,000) 5,000 Unrealized gain on machinery (25,000) Piecemeal recognition of Gain on machinery 5,000 5,000 5,000 Unrealized inventory profits (8,000) 8,000 Consolidated net income 260,000 205,000 122,000 233,000 Less: Noncontrolling interest share (12,000) 2011 ($60,000-$5,000+$5,000)  20% ( 15,000) 2012 ($70,000+$5,000)  20% (15,400) 2013 ($80,000-$8,000+$5,000))  20% 2014 ($90,000 + $8,000 + (21,600) $5,000 + $5,000))  20% Controlling share of NI $248,000 $190,000 $106,600 $211,400 Alternative Solution: Par’s separate income Add: 80% of Sum’s income Amortize the negative differential assigned to plant asset  80% Unrealized profit on upstream Sale of land ($5,000  80%) Unrealized profit on downstream Sale of machinery Piecemeal recognition of gain ($25,000/5 years) Unrealized profit on upstream Sale of inventory items $8,000  80% Par’s net income and controlling share of consolidated net income

$200,000 48,000

$150,000 56,000

$ 40,000 64,000

$120,000 72,000

4,000

(4,000)

4,000 (25,000) 5,000

$248,000

$190,000

5,000

(6,400)

6,400

$106,600

$211,400

* Note: Since Par paid $40,000 less than book value for its 80% share, the implied total fair value minus book value of Sum is $50,000.

Intercompany Profit Transactions — Plant Assets

6-14

SOLUTIONS TO PROBLEMS Solution P6-1 Preliminary computations NOTE: Since Pal paid a price $45,000 in excess of book value for its 90% share, the implied total excess of fair value over book is $50,000 ($45,000 / 90%). Computation of income from Sim: Share of Sim’s reported income ($40,000  .9) Add: Realization of deferred profits in beginning inventory Less: Unrealized profits in ending inventory Less: Unrealized profit on intercompany sale of equipment ($30,000 - $21,000) Add: Piecemeal recognition of deferred profit in equipment ($9,000/3 years) Income from Sim

$36,000 5,000 (4,000) (9,000) 3,000 $31,000

Consolidation workpaper entries a

Cash

Sales

2,000 Accounts receivable To record cash in transit from Sim on account.

2,000

20,000 Cost of sales To eliminate intercompany purchases and sales.

20,000

Investment in Sim 5,000 Cost of sales 5,000 To recognize previously deferred profit from beginning inventory.

Cost of sales 4,000 Inventory To defer unrealized profit from ending inventory.

4,000

Investment in Sim 3,000 Land 3,000 To reduce land to its cost basis and adjust the investment account to establish reciprocity with Sim’s beginning of the period equity accounts.

Gain on sale of equipment 9,000 9,000 Equipment — net To eliminate gain on intercompany sale of equipment and reduce equipment to a cost basis.

Chapter 6

6-15

Solution P6-1 (continued) g

3,000 Equipment — net Operating expenses 3,000 To eliminate current year’s depreciation of unrealized gain.

Income from Sim 31,000 18,000 Dividends — Sim Investment in Sim 13,000 To eliminate income and dividends from Sim and return investment account to its beginning of the period balance.

70,000 Retained earnings — Sim 50,000 Capital stock — Sim Goodwill 50,000 Investment in Sim 153,000 17,000 Noncontrolling interest — January 1 To eliminate reciprocal investment and equity amounts, establish beginning noncontrolling interest, and enter beginning-of-theperiod fair value — book value differential (goodwill).

Noncontrolling Interest Share 4,000 2,000 Dividends — Sim Noncontrolling Interest 2,000 To record Noncontrolling interest share of subsidiary income and dividends.

Dividends payable 9,000 Dividends receivable To eliminate reciprocal receivables and payables.

9,000

Intercompany Profit Transactions — Plant Assets

6-16

Solution P6-1 (continued) Pal Corporation and Subsidiary Consolidation WorkPapers for the year ended December 31, 2012 (in thousands) Pal Income Statement Sales Income from Sim Gain on equipment Cost of sales

$ 300 31 9 140*

$ 100

60*

10*

Operating expenses Consolidated NI

50*

Controlling share of NI

$ 140✓

Retained Earnings Retained earnings — Pal

$ 157

Retained earnings — Sim Controlling share of NI Dividends

Balance Sheet Cash Accounts receivable Dividends receivable Inventories Land Buildings — net

Accounts payable Dividends payable Other liabilities Capital stock Retained earnings

40✓

$ 100 90 9 20 40 135

17 50

158 _____

_____

$ 717

$ 200

Noncontrolling interest January 1 Noncontrolling interest December 31

20 5 3

169* 67* 144 4*

i 70 140 h j

30 10 20 50 90✓

18 2

60* $ 237

c 5 e 3 i 50

a k d e

2 9 4 3

$ 119 138 24 52 185 219

h 13 i 153 50 $ 787

$ 128 16 87 300 237

i 50

$ 200

______ 260

b c g

$ 140

8 15 50

165

$ 717

$ 380

40 20*

$ 237

98 15 67 300 237✓

Consolidated Statements

$ 157

140 60*

Equipment — net Investment in Sim Goodwill

b 20 h 31 f 9 d 4

Noncontrolling share

Retained earnings December 31

Adjustments and Eliminations

Sim 90%

260

$ 787

Deduct

Chapter 6

6-17

Solution P6-2 Preliminary computations Cost January 1, 2011 Implied fair value of Sor ($540,000 / 90%) Book value of Sor Excess of fair value over book value - Goodwill

$540,000 $600,000 (480,000) $120,000

Cost January 1, 2011 Add: Income from Sor for 2011 $ 72,000 Equity in income ($80,000  90%) Less: Unrealized inventory profit (20,000) Less: Unrealized profit on machinery (selling price $70,000 - book value $56,000) (14,000) Add: Piecemeal recognition of profit on 2,000 machinery ($14,000/3.5 years  .5 year) Income from Sor for 2011 Less: Dividends $20,000  90%

$540,000

Investment balance January 1, 2012 Add: Income from Sor for 2012 Equity in income ($100,000  90%) Add: Unrealized profit in beginning inventory Less: Unrealized profit in ending inventory Add: Piecemeal recognition of profit on machinery ($14,000/3.5 years) Less: Gain on sale of land Income from Sor for 2012 Less: Dividends ($40,000  90%)

562,000

40,000 (18,000)

$ 90,000 20,000 (24,000) 4,000 (10,000)

Investment balance December 31, 2012

80,000 (36,000) $606,000

Intercompany Profit Transactions — Plant Assets

6-18

Solution P6-2 (continued) Pal Corporation and Subsidiary Consolidation WorkPapers for the Year Ended December 31, 2012 (in thousands) Pal Income Statement Sales Income from Sor Gain on land Cost of sales

Operating expense

Sor 90%

900 80 10 (400)

$ 380

(226)

(80)

(200)

Consolidated NI Noncontrolling share

Controlling share of NI

364

Retained Earnings Retained earnings — Pal

404

Balance Sheet Cash Accounts receivable Dividends receivable Inventories Land

364 (300)

468

$ 300

266 360 36 120 200 560

660

Machinery — net Investment in Sor

$1,136

a b d

144 20 4

(10)

_____ $ 800

Accounts payable Dividends payable Other liabilities Capital stock Retained earnings Total equities

400 60 280 1,600 468

$ 100 40 60 300 300

$2,808

$ 800

364

404 364

f h

280

______ $2,808

240

72 60 160

Goodwill Total assets

(460) (302) 374

28 200

606

Noncontrolling interest January 1 Noncontrolling interest December 31

144 80 10 24

100 (40)

Buildings — net

Consolidated Statements

$ 100

$ 240

Retained earnings — Sor Controlling share of NI Dividends Retained earnings December 31

a f e c

Adjustments and Eliminations

b d g

20 12 120

i j

20 36

300

36 4

i j c e

20 36 24 10

f g

44 594

(300) $

468

294 540 168 250 720 932

120 $3,024 $

480 64 340 1,600 468

______

1,016

$3,024

Chapter 6

6-19

Solution P6-3 Par Corporation and Subsidiary Consolidation WorkPapers for the year ended December 31, 2011 (in thousands) Par Income Statement Sales Income from Sag Gain on land Gain on equipment Cost of sales Depreciation expense Other expenses

700 70

$ 500 10

20 300* 90* 200*

300* 35* 65*

$ 110

Consolidated NI Noncontrolling share Controlling share of NI

200

Retained Earnings Retained earnings — Par

600 $ 200

Retained earnings — Sag Controlling share of NI

200✓ 100*

Dividends Retained earnings December 31 Balance Sheet Cash Accounts receivable Inventories Other current items Land

Consolidated Balance Sheet

a e c d b

50 70 10 20 5

$1,150

50 5

555* 120* 265* 210 10* $

200

600

f 200 200

110✓ 50*

e h

45 5

100*

700

$ 260

700

35 90 100 70 50 200

65 190 175 110 110 350

30 110 80 40 70 150

500

400

655

______

$1,700

$ 880

Equipment — net Investment in Sag

160 340 500

700✓ $1,700

Noncontrolling interest January 1 Noncontrolling interest December 31

50 70 500

g b

10 5

885

e 25 f 630 $1,885 g

f 500

260✓ $ 880

_____ 875

a d

Buildings — net

Accounts payable Other liabilities Capital stock Retained earnings

Adjustments and Eliminations

Sag 90%

200 410 500 700

875

$1,885

Deduct

Intercompany Profit Transactions — Plant Assets

6-20

Solution P6-4 Preliminary computations Cost January 1, 2011 Add: Income from Sto for 2011 $360,000 Equity in income ($400,000  90%) Less: Patent amortize. ($600,000/10 years)x 90% (54,000) Less: Unrealized inventory profit (100,000) Less: Unrealized profit on machinery (selling price $350,000 - book value (70,000) $280,000) Add: Piecemeal recognition of profit on 10,000 machinery ($70,000/3.5 years  .5 year) Income from Sto for 2011 Less: Dividends $100,000  90%

$2,700,000

Investment balance January 1, 2012 Add: Income from Sto for 2012 Equity in income ($500,000  90%) Less: Patent amortization (90%) Add: Unrealized profit in beginning inventory Less: Unrealized profit in ending inventory Add: Piecemeal recognition of profit on machinery ($70,000/3.5 years) Less: Gain on sale of land Income from Sto for 2012 Less: Dividends ($200,000  90%)

2,756,000 $450,000 (54,000) 100,000 (120,000) 20,000 (50,000) 346,000 (180,000)

Investment balance December 31, 2012 Noncontrolling interest share of Sto’s income (10%) Sto’s reported net income Less: Patent amortization Sto’s adjusted income 10% Noncontrollling interest share

146,000 (90,000)

$2,922,000 2011

2012

$400,000 (60,000) $340,000 $ 34,000

$500,000 (60,000) $440,000 $ 44,000

Chapter 6

6-21

Solution P6-4 (continued) Pal Corporation and Subsidiary Consolidation WorkPapers for the Year Ended December 31, 2012 (in thousands) Pal Income Statement Sales Income from Sto Gain on land Cost of sales

4,500 346 50 (2,000)

$ 1,900

(1,130)

Operating expense Consolidated NI Noncontrolling share Controlling share of NI

1,766

Retained Earnings Retained earnings — Pal

2,000

Retained earnings December 31 Balance Sheet Cash Accounts receivable Dividends receivable Inventories Land

Consolidated Statements $

a b d

720 100 20

500

5,680

(2,300) (1,570) 1,810 (44) $

1,766

2,000

g 1,200

500 (200)

1,766 f k

180 20

(1,500)

2,266

$ 1,500

2,266

1,364 1,800 180 600 1,000 2,800

1,504 2,700

140 1,000 360 300 800

3,300

1,400

2,922

_______

$ 13,966

$ 4,000

Machinery — net Investment in Sto

Accounts payable Dividends payable Other liabilities Capital stock Retained earnings Total equities

(400)

1,766 (1,500)

Buildings — net

Patents Total assets

720 346 50 120

(1,000)

a f e c

$ 1,200

Retained earnings — Sto Controlling share of NI Dividends

Adjustments and Eliminations

Sto 90%

2,000 300 1,400 8,000 2,266 $13,966

Noncontrolling interest January 1 Noncontrolling interest December 31

500 200 300 1,500 1,500 $ 4,000

b d g

100 60 540

i j c e

100 180 120 50

840 1,250 3,600 4,660

f 166 g 2,916 h 60

480 $ 15,034

i j

100 180

g 1,500

_______ 5,020

g k

324 24 5,020

2,400 320 1,700 8,000 2,266

348 $ 15,034

6-22

Intercompany Profit Transactions — Plant Assets

Solution P6-5 Preliminary computations Investment cost Implied fair value of San ($290,000 / 80%) Book value of San Excess fair value over book value - allocated 50% to Patents with a ten-year life ($31,250) - allocated 50% to Inventory sold in 2009 ($31,250) Reconciliation of income from San: Pil’s share of San’s net income ($50,000  80%) Less: 80% of Patent amortization ($31,250/10 years) Add: Depreciation on deferred gain on equipment ($15,000/5 years)  80% Less: Unrealized profit on upstream sale of land ($10,000  80%) Income from San Reconciliation of investment account: Share of San’s underlying equity ($400,000  80%) Add: 80% of Unamort. patent ($31,250 - ($3,125  3 years)) x 80% Less: Unrealized gain on equipment [$15,000 - ($3,000  2 years)]  80% Less: Share of unrealized gain on land Investment in San December 31, 2011 Noncontrolling interest share: San’s reported income Add: Piecemeal recognition of gain on sale of machinery Less: Patent amortization Less: Unrealized gain on upstream sale of land Realized income Noncontrolling percentage Noncontrolling interest share

$290,000 $362,500 (300,000) $ 62,500

$ 40,000 (2,500) 2,400 (8,000) $ 31,900 $320,000 17,500 (7,200) (8,000) $322,300 $ 50,000 3,000 ( 3,125) (10,000) 39,875 20% $ 7,975

Chapter 6

6-23

Solution P6-5 (continued) Pil Corporation and Subsidiary Consolidation WorkPapers for the year ended December 31, 2011 Pil Income Statement Sales Income from San Gain on land Depreciation expense Other expenses Consolidated NI Noncontrolling share Controlling share of NI Retained Earnings Retained earnings — Pil

$ 210,000 31,900

$ 130,000 10,000 30,000* 60,000*

40,000* 110,000*

91,900

50,000

$ 202,300

$ 100,000

Balance Sheet Current assets Plant assets

$ 200,000 550,000

$ 170,000 350,000

120,000* 322,300

70,000* _________

91,900✓ 30,000*

31,900 10,000

3,125

7,975

3,000

340,000

67,000* 173,125* 99,875 7,975* $

91,900

140,400

50,000 91,900 30,000*

a b a a

6,000 9,600

25,000

202,300

370,000 875,000

15,000 10,000

184,000* c 31,900 d 300,000 e 3,125

21,875

$ 952,300

$ 450,000

$1,082,875

$ 150,000 600,000

202,300✓ $ 952,300

Noncontrolling interest January 1 Noncontrolling interest December 31 *

c b

50,000✓ _________

Patent

Current liabilities Capital stock Retained earnings

Consolidated Statements $

$ 140,400

Retained earnings — San Controlling share of NI Dividends Retained earnings December 31

Accumulated depreciation Investment in San

Adjustments and Eliminations

San 80%

50,000 300,000

d 300,000

100,000✓

200,000 600,000 202,300

$ 450,000 a

2,400 _______ 446,000

d f

75,000 7,975 446,000

Deduct

80,575 $1,082,875

Intercompany Profit Transactions — Plant Assets

6-24

Solution 6-5 (continued) Consolidation workpaper entries a

Accumulated depreciation 6,000 Investment in San 9,600 Noncontrolling interest 2,400 Depreciation expense 3,000 Plant assets 15,000 To eliminate unrealized profit on 2010 sale of plant assets and reduce plant assets to cost.

Gain on land

Income from San 31,900 Investment in San 31,900 To eliminate income from San against the investment in San.

Capital stock—San 300,000 Retained earnings—San January 1 50,000 Patent 25,000 Investment in San 300,000 Noncontrolling interest January 1 75,000 To eliminate investment in San and stockholders’ equity of San and enter beginning of the period patent.

Other expenses Patent To provide for patent amortization.

10,000 Plant assets 10,000 To eliminate unrealized gain on 2011 upstream sale of land and reduce land to cost.

3,125 3,125

Noncontrolling Interest Share 7,975 Noncontrolling Interest 7,975 To enter noncontrolling interest share of subsidiary income.

Chapter 6

6-25

Solution P6-6 Preliminary computations (amounts in thousands) Investment cost for 100% of Ski, April 1, 2011 Book value acquired Excess fair value over book value Excess allocated: Undervalued inventory items (sold in 2011) Undervalued buildings (7-year remaining useful life) Goodwill Excess fair value over book value

$15,000 (7,000) $ 8,000 $

500 3,500 4,000 $ 8,000

Reconciliation of investment account balance: Investment cost April 1, 2011 Add: Increase in Ski’s retained earnings Less: Excess allocated to inventories sold in 2011 Less: Depreciation on excess allocated to buildings ($3,500/7 years)  4.75 years Less: Unrealized inventory profits December 31, 2015 Less: Unrealized profit on equipment ($800 intercompany profit - $200 recognized) Investment balance December 31, 2015

$15,000 3,000 (500) (2,375) (120) (600) $14,405

Reconciliation of investment income balance: Share of Ski’s income (100%) Add: Unrealized profit in beginning inventory Add: Realization of previously deferred profit on land Less: Unrealized profit in ending inventory Less: Depreciation on excess allocated to buildings Less: Unrealized profit on equipment Income from Ski

$ 2,000 100 500 (120) (500) (600) $ 1,380

Intercompany Profit Transactions — Plant Assets

6-26

Solution P6-6 (continued) Pot Corporation and Subsidiary Consolidation WorkPapers for the year ended December 31, 2015 (in thousands) Pot Income Statement Sales Gain on land Gain on equipment Income from Ski Cost of sales

$26,000 700

Retained Earnings Retained earnings — Pot Retained earnings — Ski Consolidated net income Dividends Retained earnings December 31

Balance Sheet Cash Accounts receivable Inventories Land Buildings — net Equipment — net Investment in Ski

$11,000 800

1,380 15,000*

Depreciation expense 3,700* Other expenses 4,280* Consolidated net income $ 5,100

5,000* 2,000* 2,800*

b 1,500 e 800 g 1,380 d 120 i

500

b c f

1,500 100 200

$ 2,000

Consolidated Statements $35,500 1,200

18,520* 6,000* 7,080* $ 5,100

$12,375

$12,375 $ 4,000

5,100✓ 3,000*

h 4,000 5,100

2,000✓ 1,000*

$14,475

$ 5,000

$ 1,170 2,000 5,000 4,000 15,000

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

10,000

4,000

14,405

_______

$51,575

$13,000

$ 4,100 7,000 26,000

$ 1,000 2,000 5,000

14,475✓ $51,575

5,000✓ $13,000

Goodwill

Accounts payable Other liabilities Capital stock Retained earnings

Adjustments and Eliminations

Ski

1,000

3,000* $14,475

j d

300 120

h 1,625

500

$ 1,670 3,200 6,880 5,000 20,125

800

13,400

200

a 500 c 100 h 4,000

g 380 h 14,625 4,000 $54,275

300

h 5,000 _______

________

$ 4,800 9,000 26,000 14,475

20,025

$54,275

Deduct

Chapter 6

6-27

Solution P6-7 Preliminary computations Investment cost January 1, 2011 Implied fair value of Sin ($108,000 / 80%) Book value of Sin Excess fair value over book value allocated to patent Patent amortization: $25,000/10 years

$108,000 $135,000 (110,000) $ 25,000 $ 2,500

Reconciliation of investment income: Sin’s reported income Less: Patent amortization Less: Unrealized profit in ending inventory Add: Unrealized profit in beginning inventory Add: Piecemeal recognition of deferred profit on plant assets ($20,000 / 5 years) Sin’s adjusted income

$ 50,000 (2,500) (1,000) 2,000

Par’s 80% controlling share

$ 42,000

20% Noncontrolling interest share

$ 10,500

4,000 $ 52,500

Intercompany Profit Transactions — Plant Assets

6-28

Solution P6-7 (continued) Par Corporation and Subsidiary Consolidation WorkPapers for the year ended December 31, 2014

Income Statement Sales Income from Sin Cost of sales Other expenses Consolidated NI Noncontrolling share Controlling share of NI Retained Earnings Retained earnings Par Retained earnings Sin Controlling share of NI

Balance Sheet Cash Accounts receivable Inventories Plant assets Accumulated depreciation Investment in Sin

Consolidated Statements

8,000 42,000 1,000

$ 762,000

40,000*

a e b

30,000*

2,500

10,500

Sin 80%

$ 650,000 42,000 390,000*

$ 120,000

170,000*

$ 132,000

50,000

20,000

58,000 40,000 60,000 290,000 70,000* 121,600

20,000 20,000 35,000 205,000 100,000* _________

$ 180,000

157,600✓

Noncontrolling interest January 1 Noncontrolling interest December 31

198,500* 142,500 10,500*

30,000 100,000

95,600

20,000 132,000 e i

16,000 4,000

50,000

$ 499,600 42,000 300,000

421,000*

$ 132,000

50,000✓ 20,000*

$ 157,600

$ 499,600

8,000 2,000 4,000

Patent

Accounts payable Capital stock Retained earnings

a c d

95,600 132,000✓ 70,000*

Dividends Retained earnings December 31

Adjustments and Eliminations

Par

70,000* $ 157,600

$ h b d d c d f

8,000 1,600 12,800 17,500

4,000 1,000 20,000

e 26,000 f 110,000 g 2,500

78,000 56,000 94,000 475,000 162,000*

15,000 $ 556,000

h 4,000 f 100,000

50,000✓

68,000 300,000 157,600

$ 180,000 c 400 d 3,200 _________ 231,500

27,500

6,500 231,500

Deduct

30,400 $ 556,000

Chapter 6

6-29

Solution P6-8 Preliminary computations Investment cost Implied fair value of Sun ($290,000 / 80%) Book value of Sun Excess fair value over book value Excess allocated: Inventories (50%)- Sold in 2009 Goodwill Excess fair value over book value Reconciliation of income from Sun: Sun’s reported net income Add: Depreciation on deferred gain on equipment ($15,000/5 years Less: Unrealized profit on upstream sale of land Sun’s adjusted and realized income

$290,000 $362,500 (300,000) $ 62,500 $ 31,250 31,250 $ 62,500 $ 50,000 3,000 (10,000) $ 43,000

Pal’s 80% controlling share

$ 34,400

20% Noncontrolling interest share

Reconciliation of investment account: Share of Sun’s underlying equity ($400,000  80%) Add: 80% of unamortized goodwill Less: Unrealized gain on equipment [$15,000 - ($3,000  2 years)]  80% Less: Share of unrealized gain on land Investment in Sun December 31, 2011

8,600

$320,000 25,000 (7,200) (8,000) $329,800

Intercompany Profit Transactions — Plant Assets

6-30

Solution P6-8 (continued) Pal Corporation and Subsidiary Consolidation WorkPaper for the year ended December 31, 2011

Income Statement Sales Income from Sun Gain on land Depreciation expense Other expenses Consolidated NI Noncontrolling share Controlling share of NI Retained Earnings Retained earnings — Pal Retained earnings — Sun Consolidated share of NI

Pal

Sun 80%

$ 210,000 34,400

$ 130,000 10,000 30,000* 60,000*

40,000* 110,000*

94,400

50,000

$ 100,000

Balance Sheet Current assets Plant assets

$ 200,000 550,000

$ 170,000 350,000

120,000* 329,800

70,000* _________

Goodwill

67,000* 170,000* 103,000 8,600*

8,600 $

94,400

145,400

50,000 94,400 30,000*

a b a a

6,000 9,600

31,250

209,800

370,000 875,000

15,000 10,000

184,000* c 34,400 d 305,000 31,250

$ 959,800

$ 450,000

$1,092,250

$ 150,000 600,000

209,800✓ $ 959,800

100,000✓ $ 450,000

Noncontrolling interest January 1 Noncontrolling interest December 31 *

3,000

50,000✓ _________

$ 209,800

Current liabilities Capital stock Retained earnings

340,000

34,400 10,000

$ 145,400 94,400✓ 30,000*

Consolidated Statements $

c b

e $

Dividends Retained earnings December 31

Accumulated depreciation Investment in Sun

Adjustments and Eliminations

50,000 300,000

d 300,000

2,400 _______ 452,250

d e

76,250 8,600 452,250

Deduct

200,000 600,000 209,800

82,450 $1,092,250

Chapter 6

6-31

Solution P6-8 (continued) Consolidation workpaper entries a

Accumulated depreciation 6,000 Investment in Sun 9,600 Noncontrolling interest 2,400 Depreciation expense 3,000 Plant assets 15,000 To eliminate unrealized profit on 2010 sale of plant assets.

Gain on land

Income from Sun 34,400 Investment in Sun 34,400 To eliminate income from Sun against the investment in Sun.

Capital stock—Sun 300,000 Retained earnings–Sun January 1 50,000 Goodwill 31,250 Investment in Sun 305,000 Noncontrolling interest January 1 76,250 To eliminate investment in Sun and stockholders’ equity of Sun and enter beginning of the period goodwill.

Noncontrolling Interest Share 8,600 Noncontrolling Interest 8,600 To enter noncontrolling interest share of subsidiary income.

10,000 Plant assets 10,000 To eliminate unrealized gain on 2011 upstream sale of land.

Intercompany Profit Transactions — Plant Assets

6-32

Solution P6-9 1

The 90 percent ownership interest can be determined in several ways. a.

$13,500 dividends received  $15,000 dividends paid = 90%

$37,200 noncontrolling interest  ($340,000 Sal’s stockholders’ equity + $32,000 unamortized patent) = 10%

($4,600 noncontrolling interest share  ($50,000 net income of Sal less $4,000 patent amortization) = 10%

Yes. Pop’s net income of $200,400 equals the controlling interest share consolidated net income of $200,400. Pop’s retained earnings of $350,400 equals consolidated retained earnings.

Yes. Combined sales Consolidated sales Intercompany sales

$800,000 716,000 $ 84,000

Yes. Combined inventories Consolidated inventories Unrealized inventory profits

$150,000 136,000 $ 14,000

Reconciliation of combined and consolidated cost of sales Combined cost of sales (given) Less: Intercompany sales (see 3 above) Add: Unrealized profits in ending inventory (see 4 above) Less: Unrealized profits in beginning inventory (solve for this)

$350,000 (84,000) 14,000

Consolidated cost of sales (given)

$275,000

(5,000)

Reconciliation of combined and consolidated equipment — net

Combined equipment — net of $565,000 less consolidated equipment — net of $550,000 shows a difference of $15,000. The workpaper entry to eliminate the effects of an intercompany sale of equipment must have been: Gain on equipment Depreciation expense Equipment — net 7

20,000 5,000 15,000

Yes. Intercompany receivables and payables are as follows: Accounts receivable Accounts payable Dividends receivable Dividends payable

Combined $ 80,000 110,000 13,500 15,000

Consolidated $ 70,000 100,000 --1,500

Intercompany $10,000 10,000 13,500 13,500

Chapter 6

6-33

Solution P6-9 (continued) 8

Reconciliation of noncontrolling interest: Noncontrolling interest January 1, 2012 ($320,000  10%) 10% of unamortized patent at January 1 Add: Noncontrolling interest share for 2012 Less: Noncontrolling interest dividends ($30,000  10%) Noncontrolling interest December 31, 2012

Patent at December 31, 2011 Patent December 31, 2012 Add: Patent amortization ($141,000 consolidated other expenses - $137,000 combined other expenses)

$ 32,000 3,600 4,600 (3,000) $ 37,200 $ 32,000 4,000

Patent December 31, 2011

$ 36,000

Analysis of investment in Sal account Book value (Sal’s stockholders’ equity $340,000  90%) Less: Unrealized profit in ending inventory Less: Unrealized profit in equipment Add: 90% of Unamortized patent

$306,000 (14,000) (15,000) 28,800

Investment in Sal December 31, 2012

$305,800

Chapter 7 INTERCOMPANY PROFIT TRANSACTIONS — BONDS Answers to Questions 1

Intercompany borrowing gives rise to notes or advances receivable from and payable to affiliates, as well as reciprocal interest receivable and payable accounts and interest income and expense accounts.

Direct lending and borrowing transactions do not give rise to unrealized gains and losses. Any income reported by the lender is precisely reciprocal to an expense reported by the borrower, and the transactions are complete on the date consummated. Similarly, direct lending and borrowing transactions do not give rise to unrecognized gains and losses since intercompany amounts received and paid are both realized and recognized from the viewpoint of the separate legal entities.

Constructive gains and losses are gains and losses from the viewpoint of the consolidated entity but not from the viewpoint of the separate affiliates involved. The purchase of a parent’s outstanding bonds by its subsidiary at a price below the book value of the bonds on the parent’s books results in a constructive gain. Although the bonds are not actually retired, they are constructively retired from the viewpoint of the consolidated entity because they are no longer liabilities of the consolidated entity to outside parties.

The book value of the liability is $1,004,700, computed as $1,000,000 plus $10,000 minus $5,300. If an affiliate purchases half of the bonds at 98, it will record a bond investment of $490,000. From the viewpoint of the consolidated entity, the purchase of the bonds results in a constructive retirement of $500,000 par of bonds payable. The constructive gain on the bonds is $12,350 [($1,004,700  50%) – $490,000].

A constructive gain on bonds is a gain for consolidated statement purposes that is not recorded on the books of the separate affiliates. The affiliates continue to carry the bonds as a liability (issuer) and investment (purchaser) on their separate books. Alternatively, an unrealized gain on the sale of land is recorded on the books of the selling affiliate, but it is not recognized as a gain for consolidated statement purposes because the land is still held within the consolidated entity. Thus, a constructive gain on bonds is realized and recognized from the viewpoint of the consolidated entity but it is not recognized on the books of the affiliates. An unrealized gain on the sale of land is recognized on the books of the selling affiliate but is not realized or recognized from the viewpoint of the consolidated entity.

Constructive gains on intercompany bonds are realized and recognized through the interest income and expense reported on the separate books of the affiliates. The difference between the interest income reported by the investor and the interest expense reported by the issuer on the intercompany bonds is the amount of constructive gain recognized in each period. Constructive gains and losses are recognized in the consolidated financial statements before they are recognized on the books of the affiliates.

If a subsidiary purchases parent bonds at a price in excess of book value, a constructive loss results. The loss is attributed to the parent since it is the parent bonds that are constructively retired. This approach of associating constructive gains and losses on intercompany bonds with the issuer is consistent with the procedures used in earlier chapters of associating gains and losses on intercompany sales transactions with the selling affiliates.

Intercompany Profit Transactions — Bonds

7-2

Assume bonds were purchased at the beginning of the current year 10% bonds payable 52,000 Interest income 5,250 Interest payable 2,500 Investment in S bonds 49,000 Interest expense 4,500 Interest receivable 2,500 Constructive gain on bonds 3,750 To eliminate reciprocal bond investment and liability amounts, reciprocal interest income and expense amounts, reciprocal interest receivable and payable amounts, and enter the constructive gain on bonds. The constructive gain is computed as the $52,500 book value of bonds that were retired for $48,750.

Assume bonds were purchased one year earlier 10% bonds payable 52,000 Interest income 5,250 Interest payable 2,500 Investment in S bonds 49,000 Interest expense 4,500 Interest receivable 2,500 Investment in S stock (90%) 3,375 Noncontrolling interest 375 To eliminate reciprocal bond investment and liability amounts, reciprocal interest income and expense amounts, reciprocal interest receivable and payable amounts, and adjust controlling and noncontrolling interest holdings for constructive gain less piecemeal recognition. The constructive gain is computed as: $53,000 book value - $48,500 cost = $4,500 of which $750 was recognized on the books of the affiliate in the prior year.

Separate entries are as follows: Investment in S Income from S To recognize income subsidiary income.

40,000 40,000 equal

80%

reported

Investment in S Income from S

4,000 4,000

To recognize gain on constructive retirement of bonds (parent’s books). The full amount of constructive gain on bonds is recognized as investment income because we assign the full amount to the parent issuer.

Chapter 7

7-3

Investment income from subsidiary 75% of subsidiary’s $100,000 reported income Less: 75% of $8,000 constructive loss on retirement of subsidiary bonds Investment income

$75,000 6,000 $69,000

11a

A constructive gain will result when interest income exceeds interest expense on the bonds that are constructively retired.

11b

The constructive gain is associated with the parent since the issuer reports interest expense.

11c

The $200 difference between interest income and expense represents a piecemeal recognition of the constructive gain on the books of the separate companies.

SOLUTIONS TO EXERCISES Solution E7-1 1 c 2 a

3 4

d a

Solution E7-2 1 a Book value of Pan bond’s acquired by Sow ($900,000 + $48,000)  2/3 Cost to Sow Constructive gain 2 d Nominal interest on Pan’s remaining outstanding bonds $300,000  8% Less: Amortization of premium ($48,000  1/3)/ 4 years Interest expense on consolidated income statement

$632,000 602,000 $ 30,000 $ 24,000 4,000 $ 20,000

Intercompany Profit Transactions — Bonds

7-4

Solution E7-3 1 c Cost of $80,000 par of Pal bonds January 1, 2011 Book value acquired ($400,000 par - $8,000 discount)  20% Constructive gain 2 d Par value of bonds payable Less: Unamortized discount ($8,000 - $2,000) Book value of bonds Percent outstanding Bonds payable 3 c Constructive gain $2,400/4 years  3 years 4 c Nominal interest Add: Amortization of discount Percent outstanding Interest expense 5

Piecemeal recognition of gain is $2,400  25% in 2011.

$ 76,000 78,400 $ 2,400 $400,000 (6,000) 394,000 80% $315,200 $

1,800

$ 40,000 2,000 42,000 80% $ 33,600

Chapter 7

7-5

Solution E7-4 1

Controlling Share of Consolidated net income (in thousands) Pat’s separate income Add: Income from Sal Share of Sal’s income ($1,000  80%) Less: Loss on bonds constructively retired Book value ($2,000 - $80)  40% Cost to Sal Add: Piecemeal recognition of loss ($32,000/4 years) Controlling Share of Consolidated net income

$1,600 $800

$768 800

(32) 8

776 $2,376

Noncontrolling interest share Sal’s reported income $1,000  20%

200

750 (435)

Solution E7-5 Pim Corporation and Subsidiary Consolidated Income Statement for the year ended December 31, 2019 (in thousands) Sales Less: Cost of sales Gross profit Add: Gain on constructive retirement of bondsb Less: Operating expenses

315 3 (125)

Operating profit Other Items: Bond interest expensea Consolidated net income

193

a b

(15) 178

Parent’s bond interest expense $25,000 less interest on bonds held intercompany $10,000 = $15,000. Book value of parent’s bonds purchased $100,000 less purchase price $97,000 = $3,000 gain on constructive retirement.

Intercompany Profit Transactions — Bonds

7-6

Solution E7-6 1

Constructive loss Cost paid to retire 1/2 of Son’s bonds Book value of bonds retired ($495,000  .5) Constructive loss on bond retirement

$251,500 247,500 $ 4,000

Income from Son Share of Son’s reported income $7,000  70% Less: Constructive loss $4,000  70% Add: Piecemeal recognition of constructive loss ($4,000/4 years)  70% Income from Son

4,900 (2,800) 700 2,800

Solution E7-7 1

a January 1, 2011 cost of $400,000 par bonds Book value acquired ($2,000,000 + $90,000 premium)  20% Constructive gain

$391,000 418,000 $ 27,000

b Constructive gain $27,000/5 years  4 years

$ 21,600

c Book value $2,072,000  80% outstanding

$1,657,600

Chapter 7

7-7

Solution E7-8 1a

Constructive gain Book value of bonds January 1, 2012 Amortization for 6 months ($15,000/4 years  1/2 year) Book value of bonds July 1, 2012

$485,000 1,875 486,875

Percent purchased by Say

60%

Book value of bonds purchased Purchase price

$292,125 287,400

Constructive gain

Consolidated bond interest expense for 2012 Bond interest expense January 1 to July 1 ($500,000  8%  1/2 year) + $1,875 amortization

$ 21,875

Bond interest expense July 1 to December 31 [($500,000  8%  1/2 year) + $1,875 amortization]  40% Consolidated bond interest expense 1c

8,750 $ 30,625

Bond liability of Par January 1, 2012 Amortization 2012 December 31, 2012

Par $500,000 $500,000

Discount $15,000 - 3,750 $11,250

Consolidated bond liability $488,750  40% outstanding 2

4,725

Book Value $485,000 + 3,750 $488,750 $195,500

The amounts would not be different if Say had been the issuer and Par the purchaser. However, the constructive retirement gains would ‘belong’ to Say and would have been allocated to both Par and the noncontrolling interests in Say.

Intercompany Profit Transactions — Bonds

7-8

Solution E7-9 (amounts in thousands) Subsidiary purchases parent company bonds: 1a Gain on constructive retirement of bonds Book value of Pin’s bonds constructively retired ($5,000 - $100 unamortized discount)  40% Purchase price of $1,000 par bonds Gain on constructive bond retirement 1b

$1,960 1,900 $ 60

Consolidated interest payable ($3,000 + $1,000)  10% interest  1/2 year

Bonds payable at par ($3,000 + $1,000)

$4,000

None But Sid’s investment in Pin bonds will be $1,920. Cost January 2 Add: Amortization ($100,000/5 years)

200

$1,900 20 $1,920

Parent purchases subsidiary bonds: Loss on constructive retirement of bonds Sid’s bonds payable ($1,000 + $20) Price paid by Pin Loss on constructive retirement of bonds

$1,020 1,030 $ (10)

Consolidated interest expense Pin bonds ($5,000  10% interest) + $20 amortization

None Interest receivable of $50 is eliminated in consolidation.

Book value of bonds payable Pin’s bonds December 31, 2011 Add: Amortization for 2012 ($100 / 5 years) Book value of bonds payable

520

$4,900 20 $4,920

Chapter 7

7-9

Solution E7-10 (in thousands) 1

Gain from constructive retirement of bonds Book value of bonds purchased by Sal ($4,000 + $120)  25% Price paid by Sal Gain from constructive retirement of bonds

Working paper entry to eliminate effect of intercompany bond holdings 12% bonds payable 1,024 Interest incomea 124 Interest payable 60 Investment in Pad bonds 984 Gain on retirement of bonds 50 Interest expenseb 114 Interest receivable 60 a b

($1,000  12% interest) + $4 amortization = $124 [($4,000  12%) - $24 amortization]  25% intercompany = $114

Consolidated income statement amounts — 2013 a Constructive gain

None

Noncontrolling interest share ($600  20%)

120

Bond interest expense [($4,000  12%) - $24]  75% outsiders

342

d 4

$1,030 980 $ 50

Bond interest income

None

Consolidated balance sheet amounts — December 31, 2013 a Investment in Pad bonds b

Book value of bonds payable ($4,000 + $72)  75% outsiders

Bond interest receivable

Bond interest payable $4,000  12%  75% outsiders  1/2 year

None $3,054 None $

180

Intercompany Profit Transactions — Bonds

7-10

Solution E7-11 Preliminary computations: Book value of Saw bonds on January 1, 2012 Purchase price paid by Par Gain on constructive retirement of Saw bonds Amortization of gain on bonds ($217,000/7 years) Computation of noncontrolling interest share: Share of Saw’s reported income ($140,000  20%) Add: Share of constructive gain ($217,000  20%) Less: Piecemeal recognition of constructive gain ($31,000  20%) Noncontrolling interest share

$1,000,000 783,000 $ 217,000 $

31,000

28,000 43,400 (6,200) 65,200

Par Corporation and Subsidiary Consolidated Income Statement for the year ended December 31, 2012 (in thousands) Sales Less: Cost of sales

$1,800 950

Gross profit Add: Gain from constructive retirement of Saw bonds Less: Operating expenses Consolidated net income Less: Noncontrolling interest share Controlling interest share of NI

$ $

850 217 400 667 65.2 601.8

Chapter 7

7-11

Solution E7-12 1

Pub Corporation and Subsidiary, December 31, 2011

Interest receivable Investment in Sap bonds Interest payable ($40,000  90%) 8% bonds payable (($1,000,000  90%)- 13,500 discount) Interest income Interest expense ($86,000/2) + .9(86,000/2) Loss on constructive retirement of bonds a

Amounts Appearing in Consolidated Financial Statements 0 0 36,000 886,500

Computation of loss on intercompany bonds Balance of investment in bonds at December 31, 2011 Add: Amount amortized for July 1 to December 31, 2011 ($5,000 balance at December 31  30/36 months = $6,000 unamortized at July 1) Investment cost July 1, 2011 Less: Book value acquired [$1,000,000 - ($15,000 unamortized discount at December 31  30/36 months)]  10% Loss on constructive retirement of bonds

0 81,700 7,800a $105,000

1,000 $106,000

98,200 7,800

Consolidation working paper entries at December 31, 2011 Interest income 3,000 8% bonds payable 98,500 Loss on retirement of bonds 7,800 Investment in Sap bonds 105,000 Interest expense 4,300 To eliminate intercompany bonds, record constructive loss on retirement, and eliminate intercompany interest income and expense. Interest payable 4,000 Interest receivable 4,000 To eliminate reciprocal interest payable and receivable amounts.

Consolidation working paper entries at December 31, 2012 Investment in Sap (80%) 5,200 Noncontrolling interest(20%) 1,300 Interest income 6,000 8% bonds payable 99,100 Investment in Sap bonds 103,000 Interest expense 8,600 To eliminate intercompany bonds, interest income and expense, and to charge the unrecognized portion of the constructive loss at the beginning of the period 80% to the investment in Sap and 20% to the noncontrolling interest. Interest payable 4,000 Interest receivable 4,000 To eliminate reciprocal interest payable and receivable amounts.

Intercompany Profit Transactions — Bonds

7-12

Solution E7-13 1

Gain on constructive retirement of bonds Purchase price of bonds Book value Gain on constructive retirement of bonds

$ 97,600 100,000 $ 2,400

Son accounts for its investment in Pap bonds January 2, 2013 Investment in Pap bonds 97,600 Cash To record investment in $100,000 par, 8% Pap bonds. July 1, 2013 Cash Investment in Pap bonds Interest income To record interest and amortization.

4,000 400 4,400

December 31, 2013 Interest receivable 4,000 Investment in Pap bonds 400 Interest income To accrue interest and record amortization. 3

4,400

Pap accounts for its bonds payable July 1, 2013 Interest expense Cash To record interest payment for 6 months. December 31, 2013 Interest expense Interest payable To accrue interest for 6 months.

97,600

8,000 8,000

Pap accounts for its investment in Son December 31, 2013 Investment in Son 81,600 Income from Son 81,600 To record income from Son (80%  $100,000) + $2,400 constructive gain - $800 piecemeal recognition of gain.

Noncontrolling interest share ($100,000  20%)

$ 20,000

Controlling share of NI ($400,000 + $81,600) Consolidated net income

$481,600 $501,600

Chapter 7

7-13

SOLUTIONS TO PROBLEMS Solution P7-1 1

Loss on constructive retirement of bonds Purchase price of $50,000 par bonds April 1, 2011 Book value of bonds acquired: Par value Less: Unamortized discount $1,800 for 27 of 36 months ($1,800  .75) Book value of bonds Intercompany bonds

$53,600 $100,000 2,400 97,600 50%

Loss on constructive retirement of bonds 2

$ 4,800

Interest income and expense Interest income in consolidated income statement — 2011 Interest expense in consolidated income statement — 2011 $8,800 - ($8,800  3/4 year  50%)

48,800

0 $ 5,500

Interest receivable and payable Interest receivable in consolidated balance sheet at December 31, 2011

Interest payable in consolidated balance sheet at December 31, 2011

$ 1,000

Consolidation working paper entries Loss on constructive retirement of bonds 4,800 8% bonds payable 49,100 Interest income 2,100 Investment in Pan bonds 52,700 Interest expense 3,300 To eliminate reciprocal interest income and expense amounts and reciprocal bond investment and liability amounts and enter unrecognized constructive loss. Interest payable 1,000 Interest receivable To eliminate reciprocal payables and receivables.

1,000

Intercompany Profit Transactions — Bonds

7-14

Solution P7-2 Pew Corporation and Sat Corporation Schedule to Determine Pew’s Net Income and Controlling Share of Consolidated Net Income Pew’s separate income

2011 $250,000

2012 $187,500

2013 $230,000

2014 $255,000

Total 922,500

80% of Sat’s net income

+ 40,000

+ 48,000

+ 44,000

+ 48,000

180,000

$2,500 unrealized profit in Sat’s December 31, 2011 Inventory

2,500

5,000

2,500

$5,000 unrealized profit in Sat’s December 31, 2012 Inventory

5,000

$7,500 unrealized profit in 2013 on sale of land upstream  80%

6,000

$15,000 unrealized profit on sale of equipment in 2013

- 15,000

15,000

$3,750 depreciation on unrealized profit on equipment in 2013 and 2014

3,750

7,500

$4,000 constructive loss on purchase of Pew’s bonds in 2014

4,000

$1,000 piecemeal recognition of constructive loss in 2014

1,000

Pew’s net income

$287,500

$233,000

3,750

$261,750

$303,750

$1,086,000

Chapter 7

7-15

Solution P7-3 Income from Sum for 2011: Share of reported income of Sum ($400,000  75%) Add: Unrealized profit in beginning inventory of Sum Less: Unrealized profit in ending inventory of Sum Add: Piecemeal recognition of gain on sale of equipment to Pad ($96,000/6 years)  75% Less: Unrealized gain on sale of land to Sum Less: Unrealized gain on sale of building to Sum less piecemeal recognition through depreciation ($80,000 - $4,000) Add: Gain on constructive retirement of Pad bonds ($400,000 - $376,000) Income from Sum

$ 300,000 48,000 (60,000) 12,000 (40,000) (76,000) 24,000 $ 208,000

Investment in Sum at December 31, 2011: Underlying equity in Sum ($2,080,000  75%) Less: Unrealized profit in Sum’s ending inventory Less: Unrealized gain on equipment sold to Pad ($96,000 - $48,000 recognized)  75% Less: Unrealized gain on sale of land to Sum Less: Unrealized gain on sale of building to Sum ($80,000 - $4,000 recognized) Add: Gain on constructive retirement of Pad’s bonds Investment in Sum December 31

$1,560,000 (60,000) (36,000) (40,000) (76,000) 24,000 $1,372,000

Noncontrolling interest share: Net income of Sum $400,000 Add: Piecemeal recognition of gain on equipment ($96,000/6 years) 16,000 Sum’s realized income 416,000 Noncontrolling interest percentage 25% Noncontrolling interest share $104,000

Intercompany Profit Transactions — Bonds

7-16

Solution P7-3 (continued) Pad Corporation and Subsidiary Consolidation Working Paper for the year ended December 31, 2011 (in thousands)

Pad Income Statement Sales Gain on land Gain on building Income from Sum Gain on bonds Cost of sales

Sum 75%

Adjustments and Eliminations

Consolidated Statements $4,320

$ 2,520 40 80 208

$ 2,000

b f f h

200 40 80 208

1,400*

1,200*

Depreciation expense

304*

160*

Interest expense Other expenses Consolidated NI Noncontrolling int. share Controlling share of NI

80* 184*

Retained Earnings Retained earnings — Pad Retained earnings — Sum Controlling share of NI Dividends

880

600

Balance Sheet Cash Bond interest receivable Other receivables Inventories Land Buildings — net Equipment — net Investment in Sum stock

Investment in Pad bonds

400

400 400✓ 320*

880✓ 640*

Retained earnings, Dec. 31 $ $

840

480

108

324 20 120 200 280 720 360

160 320 360 600 560 1,372

_______ $ 3,480 Accounts payable $ 200 Bond interest payable 40 10% bonds payable 800 Common stock 1,600 Retained earnings 840✓ $ 3,480 Noncontrolling interest January 1 Noncontrolling interest December 31

24 200 48 16 4

24 2,412*

444* 80* 424* 984 104* 880

600

240* k

g b c e f

104

400 880 h k

c e h

48 48 32

376 $ 2,400 $ 320

1,600 480✓ $ 2,400

240 80

j 20 a 40 d 60 f 40 f 76 e 48 i 1,500

376

i k

500 24 3,296

j 20 g 400 i 1,600

e 16 _______ 3,296

640* 840

472 240 460 600 1,244 872

______ $3,888 $ 520 20 400 1,600 840

508 $3,888

Chapter 7

7-17

Solution P7-4 Preliminary Computations: Acquisition price Implied fair value of She ($640,000 / 80%) She’s book value Excess allocated to plant & equipment with 8 year life

$ 640,000 $ 800,000 (600,000) $ 200,000

Annual depreciation of excess ($200,000 / 8 years)

25,000

Loss is from the constructive retirement of bonds Purchase price of bonds Book value of bonds ($200,000 + $6,000 premium) Loss on retirement of bonds

$212,000 206,000 $ 6,000

Consolidated sales Combined sales Less: Intercompany sales Consolidated sales

$560,000 100,000 $460,000

Consolidated cost of goods sold Combined cost of goods sold Less: Intercompany sales Less: Unrealized profits in beginning inventory Add: Unrealized profits in ending inventory Consolidated cost of goods sold

$ 340,000 (100,000) (40,000) 20,000 $ 220,000

Unrealized profit in beginning inventory Forced computations ($340,000 + $20,000) - ($100,000 + $220,000)

40,000

Unrealized profit in ending inventory Combined inventories ($200,000 + $100,000) Less: Consolidated inventories Unrealized profit in ending inventory

$300,000 280,000 $ 20,000

Consolidated accounts receivable Combined accounts receivable ($240,000 + $120,000) Less: Intercompany receivables Consolidated accounts receivable

$360,000 30,000 $330,000

Noncontrolling interest share She’s reported net income Less: Depreciation of excess Add: Unrealized profit in beginning inventory Less: Unrealized profit in ending inventory Sher’s realized income Noncontrolling interest percentage Noncontrolling interest share

$ 60,000 (25,000) 40,000 (20,000) 55,000 20% $ 11,000

Intercompany Profit Transactions — Bonds

7-18

Solution P7-4 (continued) 8

Noncontrolling interest December 31, 2013 Beginning noncontrolling interest (($670,000 + $150,000 unamortized excess)  20%) Less: Unrealized profit in beginning inventory ($40,000  20%) Less: Noncontrolling interest dividends ($30,000  20%) Add: Noncontrolling interest share Noncontrolling interest December 31

$164,000 (8,000) (6,000) 11,000 $161,000

Alternative computation: Ending equity of She ($700,000 + $125,000 unamortized $165,000 excess)(  20%) (4,000) Less: Unrealized profit in ending inventory ($20,000  20%) Noncontrolling interest December 31, 2013 $161,000 9

Investment in She stock at December 31, 2012 Investment in She stock at cost Add: Changes in retained earnings to December 31, 2012 ($270,000 - $200,000)  80% Less: 80% of Excess of ($200,000/8 years) = $20,000 per year  2 years Less: Unrealized profit in beginning inventory ($40,000  80%) Investment in She stock December 31, 2012 Alternative computation: Investment in She stock December 31, 2013 Less: Income from She for 2013 Add: Dividends from She ($30,000  80%) Investment in She stock December 31, 2012

Income from She Share of She’s reported net income Less: Depreciation on excess ($200,000/8 years) Add: Unrealized profit in beginning inventory Less: Unrealized profit in ending inventory She’s adjusted and realized income Pet’s 80% controlling share Less: Constructive loss on retirement of bonds ($6,000 - $2,000) Pet’s income from She

$640,000 56,000 (40,000) (32,000) $624,000 $640,000 (40,000) 24,000 $624,000 $ 60,000 (25,000) 40,000 (20,000) $ 55,000 $ 44,000 (4,000) $ 40,000

Chapter 7

7-19

Solution P7-5 [AICPA adapted] 1

Consolidated cash ($50,000 + $15,000)

$ 65,000

Equipment — net ($800,000 equipment - $320,000 accumulated depreciation - $21,000 unrealized profit + $7,000 profit realized through depreciation of excess)

$466,000

Investment in Saw does not appear in consolidated statements.

Bonds payable (Saw’s bonds payable of $200,000  1/2 held outside the consolidated entity)

$100,000

Common stock (Poe’s stock)

$100,000

Beginning retained earnings (Poe’s retained earnings)

$272,000

Dividends paid (Poe’s dividends)

$ 80,000

Gain on retirement of bonds (Book value of Saw’s bonds acquired by Poe $100,000 less acquisition cost of $91,000. Since bonds were acquired on December 31, 2011, none of the $9,000 gain has been amortized.)

Cost of goods sold ($860,000 combined - $60,000 intercompany sales + $10,000 unrealized profit in ending inventory)

$810,000

Interest expense (Saw paid interest for the entire year to outside entities so all of Saw’s interest is reported)

$ 16,000

Depreciation expense ($45,000 combined - depreciation on the unrealized gain $7,000)

$ 38,000

10 11

9,000

Intercompany Profit Transactions — Bonds

7-20

Solution P7-6 Income from Sal for 2012: Share of reported income of Sal ($100,000  75%) Add: Unrealized profit in beginning inventory of Sal Less: Unrealized profit in ending inventory of Sal Add: Piecemeal recognition of gain on sale of equipment to Par ($24,000/6 years)  75% Less: Unrealized gain on sale of land to Sal Less: Unrealized gain on sale of building to Sal less piecemeal recognition through depreciation ($20,000 - $1,000) Add: Gain on constructive retirement of Par bonds ($100,000 - $94,000) Income from Sal for 2012

$ 75,000 12,000 (15,000) 3,000 (10,000) (19,000) 6,000 $ 52,000

Investment in Sal at December 31, 2012: Underlying equity in Sal ($520,000  75%) Less: Unrealized profit in Sal’s ending inventory Less: Unrealized gain on equipment sold to Par ($24,000 - $12,000 recognized)  75% Less: Unrealized gain on sale of land to Sal Less: Unrealized gain on sale of building to Sal ($20,000 - $1,000 recognized) Add: Gain on constructive retirement of Par’s bonds Investment in Sal December 31

$390,000 (15,000) (9,000) (10,000) (19,000) 6,000 $343,000

Noncontrolling interest share: Net income of Sal Add: Piecemeal recognition of gain on equipment ($24,000/6 years) Sal’s realized income Noncontrolling interest percentage Noncontrolling interest share

$100,000 4,000 104,000 25% $ 26,000

Chapter 7

7-21

Solution P7-6 (continued) Par Corporation and Subsidiary Consolidation Working Papers for the year ended December 31, 2012 (in thousands) Par Income Statement Sales Gain on plant Income from Sal Gain on bonds Cost of sales

Consolidated Statements $1,080

b f h

50 30 52

350*

300*

Depreciation expense

76*

40*

Interest expense Operating expense Consolidated NI Noncontrolling int. share Controlling share of NI

20* 46*

Retained earnings December 31 Balance Sheet Cash Bond interest receivable Other receivables Inventories Land Buildings — net Equipment — net Investment in Sal stock

Adjustments and Eliminations

500

Retained Earnings Retained earnings — Par Retained earnings — Sal Controlling share of NI Dividends

630 30 52

Sal 75%

220

150

100

100 100✓ 80*

220✓ 160*

210

120

81 5 30 50 70 180 90

40 80 90 150 140 343

______ $ 870 Accounts payable $ 50 Bond interest payable 10 10% bonds payable 200 Common stock 400 Retained earnings 210✓ $ 870 Noncontrolling interest January 1 Noncontrolling interest December 31

6 50 12 4 1

6 603*

111* 20* 106* 246 26* 220

150

60* k

g b c e f

i 100 220 h k

c e h

Investment in Par bonds

$ $

12 12 8

94 600 80

400 120✓ 600

60 20 $

210

118

j 5 a 10 d 15 f 10 f 19 e 12 i 375

j 5 g 100 i 400

e 4 _____ 824

160*

i 125 k 6 824

60 115 150 311 218

______ $ 972 $ 130 5 100 400 210

127 972

Intercompany Profit Transactions — Bonds

7-22 *

Deduct

Chapter 8 CONSOLIDATIONS — CHANGES IN OWNERSHIP INTERESTS Answers to Questions 1

Preacquisition earnings and dividends are the earnings and dividends applicable to an investment interest prior to its acquisition during an accounting period. Assume that P purchases an 80 percent interest in S on July 1, 2011 and that S has earnings of $100,000 between January 1 and July 1, 2011 and pays $50,000 dividends on May 1, 2011. In this case, preacquisition earnings and dividends are $100,000and $40,000, respectively. Historically, preacquisition earnings purchased were shown as a deduction on the income statement to arrive at consolidated net income. Under current GAAP, this is no longer the case. Instead, the consolidated income statement should only report revenues, expenses, gains and losses subsequent to the acquisition. For example, in a March 31 acquisition, the consolidated income statement would only include income of the subsidiary from April 1 through December 31. GAAP reasons that acquirers purchase assets and assume liabilities, based on their fair values. Acquirers do not “purchase” preacquisition earnings, although fair values of net assets should reflect earning power of the acquired firm.

Preacquisition earnings are not recorded by a parent under the equity method because the investor only recognizes income subsequent to acquisition on the interest acquired. Historically, preacquisition earnings purchased were shown as a deduction on the income statement to arrive at consolidated net income. Under current GAAP, this is no longer the case. Instead, the consolidated income statement should only report revenues, expenses, gains and losses subsequent to the combination date. For example, in a March 31 acquisition, the consolidated income statement would only include income of the subsidiary from April 1 through December 31.

Noncontrolling stockholders of Sub Company held a 20 percent interest during the first half year and a 10 percent interest during the last half year and at year-end. Since we have a controlling interest all year, noncontrolling interest share for the year is computed as 20% of income for one-half of the year and 10% of income for one-half of the year. Noncontrolling interest at year-end is computed for the 10 percent interest held by noncontrolling stockholders at year end.

Preacquisition income is similar to noncontrolling interest share because it represents the income of a subsidiary attributable to stockholders outside the consolidated entity. But preacquisition income is not income of the noncontrolling stockholders at the date of the financial statements. In fact, preacquisition income relates to a previous controlling stockholder group when the interest acquired exceeds 50 percent. In such a case, it seems improper to report this as a deduction in the consolidated income statement. Rather, the fair value of net assets acquired should reflect the acquiree’s earnings history.

Under GAAP, a gain or loss is only recorded when the sold interest results in deconsolidation of the subsidiary, i.e., the parent no longer holds a controlling interest. The gain or loss on the sale of an equity interest is the difference between the proceeds from the sale (the fair value) and the recorded book value of the interest sold, provided that the investment is accounted for as a one-line consolidation. We must determine the aggregate of (1) the fair value of consideration received, (2) the fair value of any retained noncontrolling investment in the former subsidiary at the date the subsidiary is deconsolidated and (3) the carrying amount of the noncontrolling interest in the former subsidiary at the date the subsidiary is deconsolidated. The aggregate is compared to the carrying amount of the former subsidiary’s assets and liabilities. If another method of accounting has been used, the investment account must be converted to the equity method so that any gain or loss on sale is the same as if a one-line consolidation had been used previously.

When the parent maintains a controlling interest after the sale, the sale is treated as an equity transaction, with no gain or loss recognition. The parent debits cash or other consideration received in the sale, credits Copyright © 2015 Pearson Education, Inc. 8-1

Consolidations — Changes in Ownership Interests

8-2

the investment account based on percent of carrying value sold, and records the difference as an adjustment to other paid-in capital.

Conceptually, the income applicable to an equity interest sold during an accounting period should be included in investment income and consolidated net income. In this case, the gain or loss on sale is computed on the basis of the book value of the interest at the time of sale, and income is assigned to the increased noncontrolling interest only after the date of sale. As a practical expedient, a beginning-of-theperiod sale date can be used such that no income is recognized on the interest sold up to the time of sale, and the gain or loss is computed on the book value at the beginning of the period. When this expedient is used, income must be assigned to the increased noncontrolling interest for the entire year of sale. The combined investment income and gain or loss on sale are the same under both approaches provided that the assumptions (beginning of the year and time of sale) are followed consistently. As noted in question 5, gain or loss on the sale of the equity interest is only recognized when the subsidiary is deconsolidated. Other wise, the gain or loss is an adjustment to other paid-in capital.

Assuming that no gain or loss is recognized, no adjustment of the parent’s investment account is necessary when the subsidiary sells additional shares to outside parties at book value because the parent’s share of underlying book value does not change. If additional shares are sold above book values, the parent’s share of the underlying equity of the subsidiary increases. This increase is recorded by the parent as follows: Investment in subsidiary Additional paid-in capital

XX XX

If the subsidiary sells additional shares below book value, the parent’s interest is decreased and the parent records decreases in its investment and additional paid-in capital accounts. In all three cases (at book value, above book value, or below book value), the parent’s ownership percentage decreases from 80 percent (8,000 of 10,000 shares) to 66 23 percent (8,000 of 12,000 shares). No gain or loss is recognized, the change in underlying book value, adjusted for one-sixth [(80% –

66 23 %)  80%] of any unamortized cost book value differential is reported as adjustment to additional paid-in capital, since the parent maintains its controlling interest. An alternative computation is to assume that the parent sold one-sixth of its interest for 66 23 percent of the proceeds, the difference being the amount of adjustment to additional paid-in capital. 8

The acquisition of the 2,000 shares directly from the subsidiary increases the parent’s percentage interest from 80 percent (8,000 of 10,000 shares) to 5/6 (10,000 of 12,000 shares, or 83 1/3%). The change in the interest held does not affect the way in which the parent records its additional investment. The parent in all cases increases its investment account by the amount of cash paid or other consideration given for the additional investment. It makes no difference if the purchase price is above or below book value.

Treasury stock transactions by a subsidiary change the parent’s proportionate interest in the subsidiary. Any changes in the parent’s share of the underlying book value of the subsidiary require adjustments in the parent’s investment in subsidiary and additional paid-in capital accounts.

Gains and losses to a parent (or equity investor) do not result from the treasury stock transactions of its subsidiaries (or equity investees). Although the parent’s investment interest may increase or decrease from such transactions, the predominate view is that such changes are of a capital nature and should be accounted for by additional paid-in capital adjustments rather than by recorded gains and losses.

Stock splits and stock dividends by a subsidiary do not affect the amounts that appear in the consolidated financial statements. But stock dividends by a subsidiary result in capitalization of subsidiary retained earnings and the amounts involved in eliminations for the subsidiary’s stockholders’ equity accounts are affected. Copyright © 2015 Pearson Education, Inc.

Consolidations — Changes in Ownership Interests

8-4

SOLUTIONS TO EXERCISES Solution E8-1 Allocation of Set’s net income: Controlling share of income ($100,000  70%  1 year) + ($100,000  20%  1/2 year)

$80,000

Noncontrolling interest share ($100,000 x 30% x 6/12) + ($100,000 x 10% x 6/12)

$20,000

Preacquisition income

Allocation of Set’s dividends: Dividends to Pie ($30,000  70%) + ($30,000  90%)

$48,000

Noncontrolling interest ($30,000 x 30%) + ($30,000 x 10%) Preacquisition interest

$12,000 $0

Solution E8-2 1

Income from Sip for 2011: (60% interest  $240,000  1/3 year) + (40% x $240,000 x 2/3)

Preacquisition income: Under GAAP, no preacquisition income appears on the consolidated income statement.

Noncontrolling interest share for 2011: $80,000  40%

$112,000 $0

$ 32,000

Chapter 8

8-5

Solution E8-3 (amounts in thousands) Entry to record sale of 15% interest: Cash Investment in Sap Other paid-in capital To record sale of 15% interest in Sap. No gain or loss on sale is recognized since Pet maintains an 85% controlling interest. Entry to record investment income for 2011: Investment in Sap($600  85%) Income from Sap To record income from Sap.

750 660 90

510

Check: Investment balance January 1, 2011 Less: Book value of interest sold Add: Income from Sap Investment balance December 31, 2011 Underlying equity ($4,600  85%) Add: 85% of Goodwill* Investment balance December 31, 2011 *Note that implied total goodwill is $400 ($340 / 85%).

510

$4,400 (660) 510 $4,250 $3,910 340 $4,250

Consolidations — Changes in Ownership Interests

8-6

Solution E8-4 (amounts in thousands) 1

Gain on sale of 20% interest: No gain or loss is recognized since Pal maintains a 60% controlling interest. Beginning of the period sale assumption Selling price $130 Book value of interest ($436 investment 109 account balance  20%/80%) Adjustment to other paid-in capital $ 21 Actual sale date assumption Selling price Book value of interest sold: Beginning of the period balance Add: Income ($150  1/3 year  80%) Interest sold Adjustment to increase additional paid-in capital

$130 $436 40 476 25%

2 Income from Sag Beginning of the period sale assumption Income from Sag($150  60%) Actual sale date assumption January 1 to May 1: Share of Sag’s income ($150  80%  1/3 year) May 1 to December 31: Share of Sag’s income ($150  60%  2/3 year) Income from Sag 3

119 $ 11

$ 90

$ 40 60 $100

Investment in Sag December 31, 2011

Investment balance January 1 Book value of interest sold Income from Sag Dividends Investment balance December 31, 2011

Beginning of Period Sale Assumption $436 (109) 90 (48) $369

Actual Sale Date Assumption $436 (119) 100 (48) $369

Chapter 8

8-7

Solution E8-5 (amounts in thousands) 1a

Fair value — book value differential Cost Implied fair value of Set ($1,274 / 70%) Book value ($1,480 January 1 balance + $100 income for 5 months - $60 dividends in January and April) Goodwill

$1,274 $1,820 (1,520) $ 300

Income from Set (Note: Only include earnings subsequent to the acquisition date). $ Income from Set ($240,000  7/12 year  70%) Investment in Set at December 31 Investment cost Add: Income from Set Deduct: Dividends ($60,000  70%) Investment in Set December 31, 2011

$1,274 98 (42) $1,330

Consolidation working paper entries: a

Income from Set 98 Investment in Set 56 Dividends 42 To eliminate income and dividends from Set and adjust investment account to its cost on June 1.

1,000 Common stock, $10 par — Set 580 Retained earnings — Set Goodwill 300 Investment in Set 1,274 Noncontrolling interest 564 Dividends 42 To eliminate reciprocal investment and equity balances, record preacquisition income and beginning noncontrolling interest, and eliminate preacquisition dividends.

Noncontrolling interest share($240,000 x 7/12 x 30%) Dividends($120,000 x 30%) Noncontrolling interest

42,000

36,000 6,000

Consolidations — Changes in Ownership Interests

8-8

Solution E8-6 1

Investment in Sow (in thousands) Investment balance December 31, 2011 ($9,000  80%) Cost of new shares ($25  60,000 shares) Investment in Sow after new investment

$ 7,200 1,500 $ 8,700

Goodwill from new investment Sow’s stockholders’ equity after issuance ($9,000 + $1,500) Pal’s ownership percentage (480,000 + 60,000 shares)/660,000 shares Pal’s book value after issuance Less: Pal’s book value before issuance Increase in book value from purchase (book value acquired) Cost of 60,000 shares Book value acquired Goodwill from acquisition of new shares* *

$10,500 .8182 8,591.1 (7,200) $ 1,391.1 $ 1,500 (1,391.1) $ 108.9

This implies total goodwill is equal to $133,097.

Solution E8-7 1

Sod issues 30,000 shares to Pod at $20 per share Pod’s ownership interest before issuance: 176,000/220,000 shares = 80% Pod’s ownership interest after issuance: 206,000/250,000 shares = 82.4%

Sod sells 30,000 shares to the public at $20 per share Pod’s ownership interest after issuance: 176,000/250,000 shares = 70.4%

Sod sells 30,000 shares to the public; no gain or loss recognized: Investment in Sod 115,200 Additional paid-in capital 115,200 To record increase in investment in Sod computed as follows: Book value before issuance ($3,200,000  80%) Book value after issuance ($3,800,000  70.4%) Additional paid-in capital

$2,560,000 2,675,200 $ 115,200

Chapter 8

8-9

Solution E8-8 Pam buys shares 1a

Percentage ownership after additional investment: 700,000/1,000,000 = 70%

Goodwill from additional investment (in thousands): Book value of interest after sale $2,600  70% Book value of interest before sale $2,100  2/3 Book value of interest acquired Cost of interest Goodwill from additional investment * *

$1,820 1,400 420 500 $ 80

This implies total goodwill is now equal to $114,286.

Outsiders buy shares 2a

Percentage ownership after sale: 600,000/1,000,000 = 60%

Change in underlying book value of investment in Sat: Sat’s underlying equity after sale Pam’s interest Book value of Pam’s investment in Sat after the sale Less: Book value before the sale Increase in book value of investment

$2,600,000 60% 1,560,000 1,400,000 $ 160,000

Entry to adjust investment account: Investment in Sat Additional paid-in capital

160,000

Consolidations — Changes in Ownership Interests

8-10

Solution E8-9 Preliminary computations of fair value — book value differentials: April 1, 2011 acquisition Cost of 4,000 shares (20% interest) $ 64,000 Implied total fair value of Sum ($64,000 / 20%) $320,000 Book value of Sum on april 1 acquisition date: Beginning stockholders’ equity $280,000 20,000 Add: Income for 3 months ($80,000  ¼ year) Stockholders’ equity April 1 300,000 Goodwill $ 20,000 July 1, 2012 acquisition Cost of 8,000 shares (40% interest) Implied total fair value of Sum ($164,000 / 40%) Book value on July 1 acquisition date: Beginning stockholders’ equity Add: Income for 6 months ($80,000  1/2 year) Less: Dividends May 1 Stockholders’ equity July 1 Goodwill (amount is unchanged by this transaction) 1

$164,000 $410,000 $360,000 40,000 (10,000) 390,000 $ 20,000

Income from Sum 2011 Income from Sum for 2011 ($80,000  20%  3/4 year)

$ 12,000

2012 Income from Sum 20% share of reported income ($80,000  20%) 40% share of reported income ($80,000  40%  1/2 year) Income from Sum

$ 16,000 16,000 $ 32,000

Noncontrolling interest December 31, 2012 (($420,000 book value + $20,000 goodwill) 40%)

$176,000

Preacquisition income (does not appear in income statement)

Investment balance at December 31, 2012 Cost of 20% investment Income from Sum for 2011 Cost of 40% investment Income from Sum for 2012 Less: Dividends ($2,000 + $6,000) Investment in Sum

$ 64,000 12,000 164,000 32,000 (8,000) $264,000

Check: Share of Sum’s December 31, 2012 equity ($420,000  60%) Add: 60% of $20,000 Goodwill Investment in Sum

$252,000 12,000 $264,000

Chapter 8

8-11

Solution E8-10 Preliminary computations Investment cost July 1, 2012

$675,000

Implied total fair value of Sad ($675,000 / 90%) Less: Book value of Sad at acquisition: Equity of Sad December 31, 2011 Add: Income for 1/2 year Equity of Sad July 1, 2012 Excess (book value = underlying equity)

$750,000

$700,000 50,000 750,000 0

Investment income from Sad Income from Sad — 2012 ($100,000  1/2 year  90%) Income from Sad — 2013: January 1 to July 1 ($80,000  1/2 year  90%) July 1 to December 31 ($80,000  1/2 year  80%)

$ 45,000

$ 36,000 32,000 $ 68,000

Investment in Sad Cost July 1, 2012 Add: Income from Sad — 2012 Less: Dividends paid in December ($50,000  90%)

$675,000 45,000 (45,000)

Investment balance December 31, 2012

675,000

Less: Book value of 1/9 interest sold on July 1, 2013a Add: Income from Sad — 2013 Less: Dividends paid in December ($30,000  80%) Investment balance December 31, 2013

(79,000) 68,000 (24,000) $640,000

a Sale of 10% interest July 1, 2013: Equity of Sad December 31, 2011 Add: Income less dividends — 2012 Add: Income for 1/2 year — 2013 Equity of Sad July 1, 2013 Interest sold

$700,000 50,000 40,000 790,000 10%

Underlying equity of interest sold

$ 79,000

Gain on sale of 1/9 interest ($85,000 proceeds - $79,000) Since Pit maintains a controlling interest, the gain is not recorded, but shown as an adjustment to additional paid-in capital.

6,000

Consolidations — Changes in Ownership Interests

8-12

Solution E8-10 (continued) 2

Noncontrolling interest share Noncontrolling interest share — 2012: ($100,000 income  10% interest x 1/2)

$ 5,000

Noncontrolling interest share — 2013: ($80,000  1/2 year  10%) + ($80,000  1/2 year  20%)

$ 12,000

Noncontrolling interest December 31, 2012 Equity of Sad January 1 Add: Income less dividends for 2012 Equity of Sad December 31 Noncontrolling interest percentage

$700,000 50,000 750,000 10%

Noncontrolling interest December 31

$ 75,000

Noncontrolling interest December 31, 2013 Equity of Sad January 1 Add: Income less dividends for 2013 Equity of Sad December 31 Noncontrolling interest percentage

$750,000 50,000 800,000 20%

Noncontrolling interest December 31

$160,000

Chapter 8

8-13

Solution E8-11 Preliminary computations: Investment cost January 1, 2012

Implied total fair value of Soy ($690,000 / 75%) Book value of Soy Excess fair value over book value = Goodwill 1

920,000 (800,000) $ 120,000

Underlying book value December 31, 2012 $1,000,000 equity  75%

690,000

750,000

690,000

Percentage ownership before purchase of additional shares 30,000 shares owned/40,000 shares outstanding = 75% interest Percentage ownership after purchase of additional shares 40,000 shares owned/50,000 shares outstanding = 80% interest

Investment in Soy balance January 3, 2013 Investment cost January 1, 2012 Add: Share of Soy’s income less dividends for 2012 ($200,000  75%) Investment in Soy December 31, 2012 Add: Additional investment — January 3, 2013 (10,000 shares  $30) Investment in Soy balance January 3, 2013

150,000 840,000 300,000 $1,140,000

Percentage ownership if shares sold to outside entities 30,000 shares owned/50,000 shares outstanding = 60% interest

Investment in Soy balance January 3, 2013 Investment in Soy December 31, 2012 (see 3 above) Add: Increase in book value from change in ownership interest: Book value after additional 10,000 shares were issued ($1,300,000 equity  60%) Book value before additional 10,000 shares were issued ($1,000,000 equity  75%) Investment in Soy balance - January 3, 2013

840,000

30,000 870,000

$780,000 (750,000)

Consolidations — Changes in Ownership Interests

8-14

Solution E8-12 Preliminary computations: Cost of additional investment (2,000 shares  $80)

$160,000

Implied total fair value of Son $160,000 / (2,000/12,000) Less: Book value of Son after issuance Excess fair value over book value

$960,000 710,000 $250,000

January 2, 2012 Investment in Son 160,000 Cash To record purchase of additional 2,000 shares of Son.

160,000

December 2012 Cash 50,000 Investment in Son 50,000 To record receipt of dividends ($60,000  10,000/12,000 shares). December 31, 2012 Investment in Son 75,000 Income from Son To record income from Son($90,000  10,000/12,000).

75,000

Chapter 8

8-15

Solution E8-13 1

Investment in Sir (in thousands) Cost Add: 90% of $300 increase in equity since 2011 Investment in Sir January 1, 2013

$1,800 270 $2,070

Entry on Pat’s books (no gain or loss recognized) Investment in Sir 180 Additional paid-in capital 180 To recognize change in book value of investment from Sir’s sale of additional shares, computed as follows: $1,800 Underlying equity after issuance ($2,400  75%) (1,620) Underlying equity before issuance ($1,800  90%) $ 180

Consolidations — Changes in Ownership Interests

8-16

SOLUTIONS TO PROBLEMS Solution P8-1 Preliminary computations (in thousands): Cost of 40,000 shares July 1, 2011

$620

Implied total fair value of Sin ($620 / 80%) Book value of Sin ($550 + $50 income) Excess fair value over book value

$775 (600) $175

Cost of 10,000 shares January 1, 2012 Book value after issuance ($762  5/6) Book value before issuance ($600  80%) Excess fair value over book value of 10,000 shares acquired 1

$162 $635 (480)

(155) $ 7

Investment in Sin — December 31, 2011 Investment cost Add: Income from Sin- $100  1/2 year  80% Less: Dividends ($50  80%) Investment in Sin December 31, 2011

$620 40 (40) $620

Income from Sin — 2012 Share of Sin’s income ($150  5/6)

$125

Investment in Sin — December 31, 2012 Investment balance December 31, 2011 Add: Additional investment Add: Income from Sin — 2012 Less: Dividends for 2012 ($60  5/6) Investment in Sin December 31, 2012

$620 162 125 (50) $857

Check: Share of Sin’s equity ($852  5/6) Goodwill [ ($175 x 80%) + ($210 x (5/6 – 80%) ] Investment in Sin December 31, 2012

$710 147 $857

Chapter 8

8-17

Solution P8-2 1

Investment in Sit (in thousands) Underlying equity $26,000  80% Goodwill (80%) Investment in Sit January 1, 2013

$20,800 2,000 $22,800

Percentage interest after stock issuance Shares owned 960,000/1,600,000 outstanding shares = 60% interest

No gain or loss recognized on issuance of additional shares Investment in Sit 2,000 Other paid-in capital 2,000 To recognize change in ownership interest computed as: Underlying equity after sale ($38,000  60%) less underlying equity before sale of additional shares ($26,000  80%).

Consolidations — Changes in Ownership Interests

8-18

Solution P8-3 1

Journal entry to record sale as of actual sale date Cash 120,000 Additional paid-in capital 1,500 Investment in Saw 121,500 To record sale of 1/9 of investment in Saw. Book value of interest sold is computed as follows: Investment balance December 31, 2010 Add: Income from Saw for one-half year ($280,000  1/2 year  90%) Less: Dividends ($80,000  90%) Book value of investment on July 1, 2011 Book value of interest sold ($1,093,500/9)

126,000 (72,000) $1,093,500 $ 121,500

Journal entry to record sale as of January 1, 2011 Cash 120,000 Additional paid-in capital 12,500 Investment in Saw 107,500 To record sale of 1/9 of investment in Saw. Book value of interest sold is computed as follows: Investment balance December 31, 2010 Less: Dividends Book value adjusted for dividends Book value of interest sold ($967,500/9)

$1,039,500

$1,039,500 (72,000) $ 967,500 $ 107,500

Reconciliation

Balance January 1, 2011 Add: Income from Saw January 1 — July 1 July 1 — December 31 Less: Dividends First half-year Last half-year Less: Book value of interest sold Balance December 31, 2011

Investment in Saw Actual Sale Date $1,039,500

Investment in Saw Beginning of Year Sale Date $1,039,500

126,000 112,000

112,000 1l2,000

(72,000) (64,000) (121,500) $1,020,000

(72,000) (64,000) (107,500) $1,020,000

Chapter 8

8-19

Solution P8-4 (in thousands) Entries on Pan’s books to reflect the change in ownership interest: Option 1 Pan sells 30,000 shares of Son Cash

1,500 Investment in Son 870 Additional paid-in capital 630 To record sale of 30,000 shares at $50 per share. No gain or loss is recognized since Pan maintains a controlling interest.

Option 2 Son issues and sells 40,000 shares to the public Investment in Son Additional paid-in capital

630 630

To record adjustment in ownership computed as follows: Book value after sale of 40,000 shares ($12,440  75%) Book value before sale of 40,000 shares ($10,440  5/6) Increase in book value of investment from sale

$9,330 (8,700) $ 630

Option 3 Son reissues 40,000 shares of treasury stock Investment in Son 630 Additional paid-in capital 630 To record adjustment in ownership computed the same as 2 above.

Consolidated Stockholders’ Equity at January 1, 2012

Common stock Additional paid-in capital Retained earnings Noncontrolling interesta Total stockholders’ equity a

Option 1

Option 2

Option 3

$10,000 3,630 7,000 2,610 $23,240

$10,000 3,630 7,000 3,110 $23,740

Noncontrolling interest under option 1: $10,440  25% Noncontrolling interest under options 2 and 3: $12,440  25%

Consolidations — Changes in Ownership Interests

8-20

Solution P8-5 Preliminary computations: Cost of 9,000 shares (90% interest) January 1, 2011

Implied total fair value of Sal ($810,000 / 90%) Book value of Sal ($500,000 + $300,000) Excess fair value over book value = Goodwill 1

900,000 (800,000) $ 100,000

Investment balance December 31, 2011 $

Cost January 1, 2011 (9,000 shares  $90) Add: Share of Sal’s 2011 income ($50,000  90%) Investment in Sal December 31 2

100,000

$ 850,000 (1,350,000) (500,000) 500,000 $ 0

Additional paid-in capital (outsider purchased additional shares) Book value after issuance ($1,350,000  60%) Book value before issuance ($850,000  90%) Additional paid-in capital (gain is not recognized)

810,000 45,000 855,000

Goodwill at December 31, 2012(Pal purchased additional shares) Goodwill from January 1, 2011 purchase Goodwill from January 1, 2012 purchase: Book value before purchase Book value after purchase Book value acquired Cost of additional 5,000 shares Goodwill from January 1, 2012 Goodwill at December 31, 2012

810,000

810,000 (765,000) $ 45,000

Noncontrolling interest December 31, 2012 (outsider purchased shares)

Subsidiary equity January 1, 2011 Increase for 2011 Increase for 2012 Sale of additional shares Book value Goodwill Fair value of Sal equity December 31, 2012 Noncontrolling interest percentage 6,000/15,000 shares Noncontrolling interest December 31, 2012

800,000 50,000 70,000 500,000 $1,420,000 100,000 $1,520,000 $

40% 608,000

Chapter 8

8-21

Solution P8-6 1

Investment in Sod December 31, 2012 Investment in Sod January 2, 2011 $ 98,000 Increase for 2011 ($30,000 retained earnings increase  70%) 21,000 Purchase of additional 20% interest June 30, 2012 37,000 Increase 2012: 24,000 ($30,000  1/2 year  70%) + ($30,000  1/2 year  90%) (9,000) Dividends 2012: ($10,000  90%) Investment in Sod December 31, 2012 $171,000

Goodwill December 31, 2012 January 2, 2011 purchase: Cost of 70% interest Implied fair value of Sod ($98,000 / 70%) Less: Book value of Sod Goodwill June 30, 2012 purchase: Cost of 20% interest Implied fair value of Sod ($37,000 / 20%) Less: Book value of Sod Goodwill - December 31, 2012

$ 98,000 $140,000 120,000 $ 20,000 $ 37,000 $185,000 165,000

Consolidated net income Sales Cost of sales Expenses Consolidated net income Noncontrolling interest share* Controlling share of net income * Noncontrolling share is 10% for full year plus 20% for ½ year. Alternative: Pot’s reported income = Controlling share of net income

Consolidated retained earnings December 31, 2012 Beginning retained earnings Add: Controlling share of Consolidated net income — 2012 Less: Dividends Consolidated retained earnings — ending Alternative solution: Pot’s reported ending retained earnings = Consolidated retained earnings — ending

$ 20,000 $600,000 (400,000) (70,000) 130,000 6,000 $124,000

$124,000 $200,000 124,000 (64,000) $260,000 $260,000

Consolidations — Changes in Ownership Interests

8-22

Solution P8-6 (continued) 5

Noncontrolling interest December 31, 2012

Equity of Sod December 31, 2012 Goodwill Fair value of Sod Noncontrolling interest percentage Noncontrolling interest December 31, 2012

$170,000 20,000 $190,000 10% $ 19,000

Chapter 8

Solution P8-7 1

8-23

Pod Corporation and Subsidiary Consolidated Income Statement for the year ended December 31, 2012 (in thousands)

Sales Cost of sales Gross profit Depreciation expense Other expenses Consolidated net income Noncontrolling interest share ($150,000  20%) + ($150,000  1/4 year  10%) Controlling share of Consolidated net income 2

Schedule to allocate Saw’s income and dividends Control. $150,000 $116,250

416.25

Noncontrol.

Total

$33,750

$60,000

Saw’s income $150,000 x 70% x 3/12 $150,000 x 80% x 9/12 Allocation

90,000 $116,250

$33,750

90,000 $150,000

Dividends

$40,000 x 70%

$ 28,000 $40,000 x 30%

$12,000

$40,000

$40,000 x 80%

32,000 $40,000 x 20% $ 60,000

8,000 $20,000

40,000 $80,000

Allocation

$26,250

$3,200 (1,900) 1,300 (700) (150) 450 (33.75)

Consolidations — Changes in Ownership Interests

8-24

Solution P8-8 Preliminary computations Cost October 1, 2011 Implied fair value of Sat ($82,400 / 80%) Book value on October 1 acquisition date: Book value on January 1, 2011 Add: Income January 1 to October 1 ($24,000  3/4 year) Deduct: Dividends March 15 Book value October 1 Goodwill

$ 82,400 $103,000 $70,000 18,000 (5,000) 83,000 $ 20,000

Income from Sat for 2011 Share of Sat’s net income ($24,000  1/4 year  80%) Less: Unrealized profit in Sat’s ending inventory Income from Sat

$ 4,800 (1,000) $ 3,800

* Preacquisition income ($24,000  3/4 year  100%)

$18,000

* Preacquisition dividends ($5,000  80%)

$ 4,000

* Noncontrolling interest share ($6,000  20%)

$ 1,200

* Under GAAP, preacquisition earnings are not shown as a reduction of consolidated net income. Rather, we only include earnings and dividends subsequent to the acquisition date. Preacquistion amounts are disclosed in required pro-forma disclosures for acquisitions. The worksheet on the following page reflects these adjustments.

Chapter 8

8-25

Solution P8-8 (continued) Pop Corporation and Subsidiary Consolidation Working Papers for the year ended December 31, 2011 Pop Income Statement Sales

Income from Sat Cost of sales

3,800 60,000*

a 12,000 c 37,500 b 3,800 20,000* d 1,000

Operating expenses Consolidated net income Noncontrolling int. share

25,100*

6,000*

Controlling share of NI $

30,700

Retained Earnings Retained earnings — Pop

30,000

$ 30,700✓ 20,000*

Dividends

Balance Sheet Cash Accounts receivable Note receivable Inventories

50,000

Retained earnings — Sat Net income

Retained earnings December 31

112,000

Adjustments and Eliminations

Sat 80%

a 12,000 c 15,000 c 4,500

40,700

34,000

5,100 10,400 5,000 30,000 88,000

7,000 17,000 10,000 16,000 60,000

82,200

112,500

54,000* 26,600* 31,900 1,200*

1,200 $

30,700

30,000

c 20,000 30,700

24,000✓ 10,000*

Plant assets — net Investment in Sat

24,000

20,000

Consolidated Statements

b c f

4,000 4,000 2,000

6,000

1,000

20,000* $

40,700

12,100 21,400 15,000 45,000 148,000

261,500

25,000 35,000 140,000 40,700

200 c 82,400

Goodwill

Accounts payable Notes payable Capital stock Retained earnings

__________

220,700

110,000

15,000 25,000 140,000

16,000 10,000 50,000

40,700✓ $

220,700

c 20,000

6,000

c 50,000

34,000✓ $

110,000 c 21,600

Noncontrolling interest — beginning Noncontrolling interest December 31

20,000

800

__________ __________ 152,500 152,500 $ *

Deduct

20,800

261,500

Consolidations — Changes in Ownership Interests

8-26

Solution P8-9 Supporting computations: Fair value — book value differential Investment cost

$175,000

Implied total fair value of Sid ($175,000 / 70%) Less: Book value of Sid ($250,000 equity on January 1 plus $10,000 net income (1/4 year) less $10,000 dividends) Fair value — book value differential

$250,000 250,000 0

Allocation of Sid’s reported net income Pal company ($40,000  3/4 year  70%) Preacquisition income ($40,000  1/4 year  100%) Noncontrolling interest share ($40,000  1 year  30% x 3/4)

$ 21,000 10,000 9,000

Sid’s net income

$ 40,000

Pal’s income from Sid Equity in Sid’s income

$ 21,000

Constructive gain on Pal’s bonds Note that bonds payable has a book value of $105,400 on December 31, 2011. A half-year of premium amortization ($300) yields a book value of $105,700 at July 1, 2011 ( $105,700 book value on July 1 less $102,850 on December 31)

2,850

Recognition of constructive gain on separate books ($2,850  6/114 months)

(150)

Gain on intercompany sale of equipment — downstream [$30,000 - ($36,000/2)]

(12,000)

Piecemeal recognition of gain on equipment — downstream ($12,000/3 years  1/2 year) Gain on intercompany sale of land — upstream ($10,000 - $8,000 cost)  70% Income from Sid

2,000

(1,400) $ 12,300

Chapter 8

8-27

Solution P8-9 (continued) Worksheet entries in journal form a

Income from Sid 12,300 Dividends - Sid Investment in Sid common Eliminate intercompany post-acquisition earnings and dividends and return Investment to beginning balance. Sales* 37,500 Retained earnings - Sid 50,000 Common stock - Sid 200,000 Expenses* Dividends – Sid* Investment in Sid - common Noncontrolling interest Eliminate preacquisition earnings and dividends. Eliminate Sid’s equity accounts, the investment account and establish beginning noncontrolling interest. Gain on plant assets 12,000 Plant assets Eliminate intercompany gain on sale of equipment. Gain on plant assets 2,000 Plant assets Eliminate intercompany gain on sale of land. Interest income 5,850 Bonds payable 105,400 Interest expense Gain on bond retirement Investment in Pal bonds Record constructive retirement of bonds payable. Interest payable 6,000 Interest receivable Eliminate reciprocal interest accounts. Other current liabilities 7,000 Other current assets Eliminate reciprocal for unpaid intercompany dividends. Noncontrolling interest share 8,400 Dividends - Sid Noncontrolling interest Record noncontrolling interest share of earnings and post-acquisition dividends. Plant assets | 2,000 Expenses | Eliminate excess depreciation on equipment.

*Sales 37,500 = $150,000 x 3/12 *Expenses 27,500 = $110,000 x 3/12 *Dividends 7,000 = $10,000 x 0.70

7,000 5,300

27,500 7,000 175,000 78,000

12,000

2,000

5,700 2,850 102,700

6,000

7,000

6,000 2,400

2,000

Consolidations — Changes in Ownership Interests

8-28

Solution P8-9 (continued) Pal Corporation and Subsidiary Consolidation Working Papers for the year ended December 31, 2011 Pal Income Statement Sales Income from Sid Gain on bonds Gain on plant assets

287,100 12,300

12,000

Interest income Interest expense Expenses — includes cost of goods sold

200,000*

Consolidated NI Noncontrolling int. share Controlling share of Net Inc. $

100,000

Retained Earnings Retained earnings — Pal

250,000

b a

37,500 12,300

2,000

c d e

12,000 2,000 5,850

5,850

Retained earnings — Sid Controlling share of Net Inc.

117,850* h $

40,000

50,000

100,000✓ 50,000*

Dividends

Balance Sheet Cash Interest receivable Inventories Other current assets

150,000

11,400*

Retained earnings December 31

Adjustments and Eliminations

Sid 70%

300,000

70,000

17,000

4,000 6,000 60,000 20,000 107,300

Plant assets — net Investment — Sid common

180,300

Investment — Pal bonds Interest payable Other current liabilities 12% bonds payable Common stock Retained earnings

950,000

6,000 38,600 105,400 500,000

$ $

200,000

300,000✓ $

950,000

2,850

e b i

5,700 27,500 2,000

5,700* 288,350* 108,400 8,400* $

100,000

250,000 100,000

a b h

2,000

7,000 7,000 6,000

50,000* $

300,000

21,000

6,000

g 7,000 c 12,000 d 2,000 a 5,300 b 175,000 e 102,700

f 6,000 g 7,000 e 105,400 b 200,000

200,000 123,000 598,000

__________ $

942,000

61,600 500,000 300,000

70,000✓ $

300,000

Noncontrolling interest Noncontrolling interest December 31 ($268,000  30%)

300,000 30,000

399,600

50,000

102,700 $

8,400

40,000✓ 20,000*

140,000 110,000 502,700

Consolidated Statements

b _________ 448,450

78,000 2,400 448,450

80,400 $

942,000

Chapter 8

8-29

Solution P8-10 Supporting computations: Investment cost of 70% interest

$420,000

Implied total fair value of Sam ($420,000 / 70%) Book value of Sam Goodwill

$600,000 500,000 $100,000

Investment cost of 10% interest

$ 67,500

Implied total fair value of Sam ($67,500 / 10%) Book value of Sam: Beginning equity January 1, 2012 Add: Income for 1/2 year Less: June dividends Book value at July 1, 2012 Goodwill (unchanged)

$675,000 $550,000 50,000 (25,000) 575,000 $100,000

Investment in Sam account: Investment cost January 1, 2011 Add: 2011 share of retained earnings increase ($50,000  70%) Less: Unrealized profit in ending inventory Less: Unrealized gain on land Investment balance December 31, 2011 Add: Investment cost of 10% interest Add: Income from Sam for 2012 $100,000  70% interest  1 year $100,000  10% interest  1/2 year Add: Beginning inventory profits Less: Ending inventory profits Less: Gain: intercompany sale machinery Add: Piecemeal recognition of gain ($40,000/5  1/2 year) Less: Dividends from Sam ($25,000  70%) + ($25,000  80%) Investment balance December 31, 2012

$420,000 $ 35,000 (5,000) (8,000)

22,000 $442,000 67,500

$ 70,000 5,000 5,000 (6,000) (40,000) 4,000

38,000 (37,500) $510,000

Consolidations — Changes in Ownership Interests

8-30

Solution P8-10 (continued) Pam Corporation and Subsidiary Consolidation Working Papers for the year ended December 31, 2012 (in thousands) 80% Sam

Pam Income Statement Sales Income from Sam Gain on machinery Cost of sales

900 38 40 400*

Depreciation expense Other expenses Consolidated net income Noncontrolling int. share Controlling share of NI

328

Retained Earnings Retained earnings — Pam

155

Accounts payable Dividends payable Other liabilities Capital stock, $10 par Retained earnings

100

250

300

20 130 20 90 20 50 60

80 30

______

1,000

725

40 25 60 300

177 100 140 300 283✓

Noncontrolling interest, January 1 Noncontrolling interest, December 31

a b d

48 5 4

328

155

b 5 e 8 g 100

37.5 12.5

i j c

25 20 6

200* $

283

100 135 154 100 82 165 384

g 522.5 f .5 100 $1,220

i j

25 20

g 300

300✓ $

653* 146* 200* 353 25*

328 f h

320

510

$1,352

g 250

70 80 40 105

100

Consolidated Statements

100✓ 50*

283

$1,000

Machinery — net Investment in Sam

48 38 40 6

60* 40*

328✓ 200*

Buildings — net

Goodwill

a f d c

Dividends

Balance Sheet Cash Accounts receivable Dividends receivable Inventories Other current items Land

500

300*

90* 160*

Retained earnings — Sam Controlling share of NI

Retained earnings December 31

Adjustments and Eliminations

192 105 200 300 283

725 ______ 865

g 127.5 h 12.5 865

Deduct

140 $1,220

Chapter 8

8-31

Solution P8-11 Preliminary computations: Investment cost of 85% of Sly August 1, 2011

$522,750

Implied fair value of Sly ($522,750 / 85%) Book value August 1, 2011: Capital stock Retained earnings Add: Income for 7 months Less: Dividends for 1/2 year Stockholders’ equity August 1, 2011 Fair value – book value differential

$615,000 $500,000 100,000 35,000 (20,000) $

Investment cost August 1, 2011 Equity in income $60,000  5/12 year  85% Less: Deferred inventory profit from upstream sale $5,000  85% Less: Deferred profit from sale of equipment $10,000 profit - ($2,000  1/4 year) Income from Sly 2011 Less: Dividends from Sly $20,000  85% Investment in Sly December 31, 2011

615,000 0

$522,750 $ 21,250 (4,250) (9,500) 7,500 (17,000) $513,250

Noncontrolling interest share of post-acquisition income, adjusted for the

inventory profit: ($25,000 - $5,000)  15% = $3,000 Preacquisition earnings ($35,000  100%) = $35,000 Under GAAP, pre-acquisition earnings and dividends are closed to retained earnings, and the consolidated income statement reports only post-acquisition earnings. Working paper entries: a

Sales

60,000 Cost of sales To eliminate intercompany sales.

Cost of sales Inventories To defer unrealized inventory profits.

60,000 5,000 5,000

Sales

50,000 Cost of sales 40,000 10,000 Plant assets — net To eliminate intercompany sale of inventory item to be used as equipment.

500 Plant assets — net Operating expense 500 To record depreciation for 1/4 year on intercompany gain on plant asset.

Consolidations — Changes in Ownership Interests

8-32

Solution P8-11 (continued) e

Income from Sly 7,500 Investment in Sly 9,500 Dividends 17,000 To eliminate income and dividends and return investment account to its beginning-of-the-period balance.

Capital stock 500,000 Retained earnings 100,000 Sales 233,333 Investment in Sly 522,750 Noncontrolling interest 95,250 Cost of sales 145,833 Operating expenses 52,500 Dividends 17,000 To eliminate reciprocal equity and investment balances, and enter beginning noncontrolling interest (* adjusted for preacquisition earnings and dividends).

Dividends payable 17,000 Dividends receivable 17,000 To eliminate reciprocal dividends receivable and payable amounts.

Noncontrolling Interest Share 3,000 Noncontrolling interest 3,000 Dividends 6,000 To enter Noncontrolling Interest share of subsidiary postacquisition income and dividends.

Alternative to entry c: Sales Cost of sales Cost of sales Plant assets — net

50,000 50,000 10,000

10,000

Chapter 8

8-33

Solution P8-11 (continued) Pan Corporation and Subsidiary Consolidation Working Papers for the year ended December 31, 2011 Pan Income Statement Sales

910,000

Adjustments and Eliminations

Sly 85%

Income from Sly Cost of sales

7,500 500,000*

a 60,000 c 50,000 f 233,333 e 7,500 250,000* b 5,000

Operating expense

200,000*

90,000*

Consolidated net income Noncontrolling int. share Controlling share of NI

217,500

Retained Earnings Retained earnings — Pan

192,500

60,000

100,000

$ a 60,000 c 40,000 f 145,833 d 500 f 52,500

966,667

509,167* 237,000* 220,500 3,000*

3,000 $

217,500

192,500

f 100,000 217,500

60,000✓ 40,000*

e f h

310,000

120,000

33,750 17,000 120,000 300,000 880,000

10,000 70,000 150,000 500,000

500

513,250

__________

9,500

Plant assets — net Investment in Sly

Accounts payable Dividends payable Capital stock Retained earnings

217,500✓ 100,000*

Dividends

Balance Sheet Cash Dividends receivable Accounts receivable Inventories

400,000

Retained earnings — Sly Net income

Retained earnings December 31

Consolidated Statements

17,000 17,000 6,000

100,000* $

310,000

43,750

17,000

b c

5,000 10,000

190,000 445,000 1,370,500

f 522,750

__________

$1,864,000

730,000

$2,049,250

90,000 20,000 500,000

154,000

1,400,000 310,000✓ $1,864,000

Noncontrolling interest January 1 Noncontrolling interest December 31

g 17,000 f 500,000

120,000✓ $

244,000 3,000 1,400,000 310,000

730,000

3,000 988,833

f 95,250 _________ 988,833

92,250 $2,049,250

Consolidations — Changes in Ownership Interests

8-34

Solution P8-12 Indirect Method Pop Corporation and Subsidiary Consolidated Statement of Cash Flows for the year ended December 31, 2012 Cash Flows from Operating Activities Controlling share of consolidated net income Adjustments to reconcile controlling share of consolidated net income to net cash provided by operating activities: Noncontrolling interest share Depreciation expense Decrease in accounts receivable Decrease in prepaid expenses Decrease in accounts payable Increase in inventories Gain on sale of 10% interest *

$300,000

22,000 528,000 2,500 20,000 (203,500) (130,000) (5,700)

Net cash flows from operating activities Cash Flows from Investing Activities Purchase of equipment Sale of 10% interest in subsidiary

533,300 $(100,000) 72,700

Net cash flows from investing activities Cash Flows from Financing Activities Cash paid on long-term note Payment of cash dividends — controlling Payment of cash dividends — noncontrolling

233,300

(27,300) $(300,000) (200,000) (10,000)

Net cash flows from financing activities Decrease in cash for 2012 Cash on hand January 1, 2012 Cash on hand December 31, 2012

(510,000) (4,000) 50,500 $ 46,500

* Note: Since Pop maintains a controlling interest in Sat, no gain or loss should have been recognized on sale of the 10% interest. Rather, this amount should appear as an increase in other paid-in capital. The net effect on the statement of cash flows is the same.

Chapter 8

8-35

Solution P8-12 (continued) Pop Corporation and Subsidiary Working Paper for the Statement of Cash Flows (Indirect Method) for the year ended December 31, 2012 Reconciling Items Year’s Change Asset Changes Cash Accounts receivable — net Inventories Prepaid expenses Equipment Accumulated depreciation Land and buildings Accum. depreciation Total asset changes

Debit

Credit

Cash Flows from Operations

Cash Flows Investing Activities

Cash Flows Financing Activities

(4,000) (2,500) e 2,500 130,000 k 130,000 (20,000) l 20,000 90,000 h 10,000 g 100,000 (498,000) f 500,000 h 2,000 0 (28,000) f (332,500)

28,000

Changes in Equities Accounts payable (203,500) i 203,500 Dividends payable 0 Long-term note (300,000) j 300,000 payable Common stock 0 Retained earnings 100,000 a 300,000 c 200,000 71,000 b 22,000 d 10,000 Noncontrol. int. 20% h 59,000 Changes in equities (332,500) Controlling Share of a 300,000 Consolidated net income b 22,000 Noncontrolling int. share Purchase of equipment g 100,000

300,000 22,000 (100,000)

Depreciation — equipment and buildings f 528,000 528,000 Gain - sale of 10% subsidiary Interest h 5,700 (5,700) Decrease in accounts receivable e 2,500 2,500 Increase in inventories k 130,000 (130,000) Decrease in prepaid expenses l 20,000 20,000 Decrease in accounts payable i 203,500 (203,500) Cash paid on long-term note j 300,000 c 200,000 Paid dividends — controlling Paid dividends —noncontrol. Sale of 10% interest in Subsidiary

(300,000) (200,000)

10,000

(10,000)

h 72,700 1,890,700 1,890,700

72,700 533,300

(27,300)

(510,000)

8-36

Consolidations — Changes in Ownership Interests

Chapter 9 INDIRECT AND MUTUAL HOLDINGS Answers to Questions 1

An indirect holding of the stock of an affiliate gives the investor an ability to control or significantly influence the decisions of an investee not directly owned through an investee that is directly owned. Two primary types of indirect ownership situations are the father-son-grandson relationship and the connecting affiliates relationship.

No. Only 40 percent of T’s stock is held within the affiliation structure and P owns indirectly only 24 percent (60%  40%) of T. T should be included as an equity investment in the consolidated statements of P Company and Subsidiaries.

An indirect holding involves the ability of one corporation to control another by virtue of its control over one or more other corporations. A mutual holding affiliation structure is a special type of indirect holding where affiliates indirectly own themselves.

The parent’s direct and indirect ownership of Subsidiary B is 49 percent (70%  70%). However, consolidation of Subsidiary B is still appropriate because 70 percent of B’s stock is held within the affiliation structure and only 30 percent is held by the noncontrolling stockholders of B.

Approach A Pat Sam Stan

Combined separate earnings of Pat, Sam, and Stan ($200,000 + $160,000 + $100,000) $460,000 Less: Noncontrolling interest share computed as follows: Direct noncontrolling interest in Stan’s income (30,000) ($100,000  30%) Indirect noncontrolling interest in Stan’s income (14,000) ($100,000  70%  20%) Direct noncontrolling interest in Sam’s income (32,000) ($160,000  20%) Pat’s net income and controlling share of consolidated net income $384,000 Approach B Separate earnings Allocate Stan’s income to Sam ($100,000  70%) Allocate Sam’s income to Pat ($230,000  80%) Controlling share Noncontrolling interest share

Pat $200,000

+184,000 $384,000

Sam $160,000

Stan $100,000

+ 70,000

-70,000

-184,000

$ 46,000

$30,000

9-2

Indirect and Mutual Holdings

When the schedule approach for allocating income is used, investment income from the lowest subsidiary must be added to the separate income of the next subsidiary to determine that subsidiary’s net income before it can be allocated to the next subsidiary, and so on. Separate earnings Deduct: Unrealized profit Separate realized earnings Allocate S2’s income Allocate S1’s income P’s net income Noncontrolling int. share

P $20,000

S1 80% $10,000 - 1,000

S2 70% $5,000

20,000

9,000 + 3,500 -10,000

5,000 -3,500 0

$ 2,500

$1,500

+10,000 $30,000

S1’s investment in S2 account was not adjusted for the unrealized profits because this would create a disparity between S1’s investment in S2 account and S1’s share of S2’s equity. 8

A mutual holding situation exists because two affiliates hold ownership interests in each other.

The treasury stock approach considers parent stock held by a subsidiary to be treasury stock of the consolidated entity. Accordingly, the subsidiary investment account is maintained on a cost basis and is deducted at cost from stockholders’ equity in the consolidated balance sheet.

In situations in which a subsidiary holds stock in the parent, both the conventional and treasury stock approaches are acceptable, but they do not result in equivalent consolidated financial statements. The consolidated retained earnings and noncontrolling interest amounts will usually be different because of different amounts of investment income. The treasury stock approach is not applicable when the mutually held stock involves subsidiaries holding the stock of each other.

No. Parent dividends paid to the subsidiary are eliminated.

The theory is that parent stock purchased by a subsidiary is, in effect, returned to the parent and constructively retired. By recording the constructive retirement of the parent stock on parent books, parent equity will reflect the equity of stockholders outside the consolidated entity. Also, recording the constructive retirement, by reducing parent stock and retained earnings to reflect amounts applicable to controlling stockholders outside the consolidated entity, will establish consistency between capital stock and retained earnings for the parent’s outside stockholders and parent net income, dividends, and earnings per share which also relate to the outside stockholders of the parent.

Controlling Share of Consolidated net income is computed as follows: P = $100,000 + .8S S = $40,000 + .1P P = $100,000 + .8($40,000 + .1P) P = $143,478 Controlling Share of Consolidated net income = $143,478  90% = $129,130

For eliminating the effect of mutually held parent stock, two generally accepted approaches are used—the treasury stock approach and the conventional approach. But when the mutually held stock involves subsidiaries holding stock of each other, the treasury stock approach is not applicable.

By adding beginning noncontrolling interest and noncontrolling interest share (determined by multiplying the company’s net income by the noncontrolling interest percentage) and subtracting the noncontrolling

Chapter 9

9-3

interest’s percentage of dividends, the noncontrolling interest can be determined without use of simultaneous equations. SOLUTIONS TO EXERCISES Solution E9-1 Pen

Sal

Tip

$1,600

$1,000

$400

30 240 (762)

(240) ______

$508

$160

Separate earnings of the three affiliates (in thousands) Add: Dividend income from Sal’s investment in Win accounted for by the cost method ($200,000  15%) Allocate 60% of Tip’s earnings Allocate 60% of Sal’s earnings Controlling Share Noncontrolling interest share

762 $2,362

Solution E9-2 Pub Corporation and Subsidiaries Income Allocation Schedule for the year 2011 (in thousands) Pub Separate earnings or loss $400 Allocate Sam’s income: 90 to Pub ($150,000  60%) to Tim ($150,000  20%) Allocate Tim’s loss: (136) to Pub $(170,000)  80% Controlling Share $354 Noncontrolling interest share

Sam $150

Tim $ (200)

(90) (30)

30 136

$ 30

$ (34)

Solution E9-3 Place Corporation and Subsidiaries Income Allocation Schedule for the year 2011 Place Lake Separate incomes $400,000 $160,000 Less: Unrealized profit on land ________ ( 40,000) Separate realized incomes 400,000 120,000 Allocate Lake’s income 60% to Place 72,000 ( 72,000) 20% to Marsh ( 24,000) Allocate Marsh’s income 70% to Place 114,800 Controlling Share $586,800 _________ Noncontrolling interest share $ 24,000

Marsh $140,000 _________ 140,000 24,000 (114,800) _________ $ 49,200

9-4

Indirect and Mutual Holdings

Solution E9-4 1

c Income from Son is equal to: 70% of Son’s $160,000 income 70% of Son’s 80% interest in Tan’s $100,000 income Income from Son d Noncontrolling interest share is equal to: 30% direct noncontrolling interest in Son’s $160,000 income 20% direct noncontrolling interest in Tan’s $100,000 income 30%  80% indirect noncontrolling interest in Tan’s $100,000 income Total noncontrolling interest share

$112,000 56,000 $168,000

$ 48,000 20,000 24,000 $ 92,000

d Consolidated net income is equal to: Combined separate incomes of $360,000 + $160,000 + $100,000 Less: Noncontrolling interest share Controlling interest share of Consolidated net income

$620,000 92,000 $528,000

Alternative computation: Pin’s separate income Add: 70% of Son’s $160,000 income Add: (70%  80%) of Tan’s $100,000 income Controlling interest share of Consolidated net income

$360,000 112,000 56,000 $528,000

Chapter 9

9-5

Solution E9-5 Separate earnings Less: Unrealized profit Separate realized earnings Allocate Val’s income 70% to Tea Allocate Won’s income 10% to Tea 60% to Sal Allocate Tea’s income 80% to Pal 10% to Sal Allocate Sal’s income 80% to Pal Pal’s net income (or Controlling share of consolidated net income) Noncontrolling interest share

Pal $ 50,000

Sal $30,000

Tea $35,000 - 5,000

Won $(20,000) _________

Val $40,000 ________

50,000

30,000

(20,000)

40,000

+28,000 (2,000) (12,000) + 44,800 + 5,600 + 18,880

(28,000) + 2,000 + 12,000

(44,800) (5,600)

(18,880)

$113,680 $ 4,720

_______

________

_______

$ 5,600

$ (6,000)

$12,000

9-6

Indirect and Mutual Holdings

Solution E9-6

Separate earnings Unrealized profit Separate realized earnings Allocate Oak’s income 20% to Nun 70% to Man Allocate Nun’s income 70% to Pet 10% to Man Allocate Man’s income 90% to Pet Pet’s net income (or Controlling share of NI) Noncontrolling interest share

Pet $130,000 130,000

Man $36,000 - 8,000 28,000

Nun $56,000 + 4,000 60,000

Oak $18,000 -8,000 10,000

+ 2,000

(2,000) (7,000)

+ 7,000 + 43,400

(43,400) (6,200)

+ 6,200 + 37,080

(37,080)

$210,480 $ 4,120

_______ $12,400

______ $1,000

Alternative solution Consolidated Net Income $130,000

Noncontrolling Interest = Share 0

28,000a

25,200

$ 2,800

4,000

60,000b

47,400

12,600

8,000

10,000c

7,880

2,120

$228,000

$210,480

$17,520

+ -

Pet

Reported Income $130,000

Man

36,000

$8,000

Nun

56,000

Oak

18,000

a b c

Adjusted Adjustments = Income $130,000

$28,000 divided 90% to consolidated net income (CNI) 10% to noncontrolling interest share (NIS) $60,000 divided 70% + (90%  10%) to CNI and 20% + (10%  10%) to NIS $10,000 divided (90%  70%) + (70%  20%) + (90%  10%  20%) to CNI [78.8%] and 10% + (10%  10%  20%) + (20%  20%) + (10%  70%) to NIS [21.2%]

Chapter 9

9-7

Solution E9-7 1

a Separate income of Tar Direct noncontrolling interest

$400,000 X 30% $120,000

a Separate income = net income of Van Noncontrolling interest (direct) c Total separate incomes Less: Controlling Share of Consolidated net income Pan $1,240,000  100% Sin $350,000  90% Tar $400,000  90%  70% Win $(100,000)  90%  60% Van $240,000  90%  80%

$240,000 X 20% $ 48,000 $2,130,000 $1,240,000 315,000 252,000 (54,000) 172,800

Total noncontrolling interest share Alternative solution Sin $350,000  10% Tar $400,000  37% Won $(100,000)  46% Van $240,000  28% Total noncontrolling interest share 4

a [See computations for question 3]

d Net income of Sin Separate income Add: 70% of Tar’s $400,000 Deduct: 60% of Won’s $(100,000) Add: 80% of Van’s $240,000 Net income of Sin Pan’s interest Investment increase Less: Dividends received from Sin ($200,000  90%) Net increase

(1,925,800) $ 204,200 $

35,000 148,000 (46,000) 67,200 204,200

350,000 280,000 (60,000) 192,000 $ 762,000 90% 685,800 (180,000) $ 505,800

9-8

Indirect and Mutual Holdings

Solution E9-8 1

b Separate income of Sam (net income) Separate income of Ten $40,000 - ($80,000  10%) Separate income of Pat $240,000 - ($40,000  70%) - ($80,000  80%) Total separate income

$ 80,000 32,000 148,000 $260,000

d Separate income Unrealized profit on inventory Unrealized profit on land Separate realized income

Pat $148,000 _________ $148,000

Sam $80,000 (10,000) ________ $70,000

Ten $32,000 (15,000) $17,000

a Pat’s separate income $148,000 56,000 Add: Investment income from Sam ($70,000  80%) Add: Investment income from Ten 16,800 [$17,000 + ($70,000  10%)]  70% Pat’s income (controlling share of consolidated net income) $220,800

d Total separate realized income Less: Controlling share of consolidated net income Noncontrolling interest share Alternative solution Direct noncontrolling interest in Sam ($70,000  .1) Indirect noncontrolling interest in Sam ($70,000  .3  .1) Direct noncontrolling interest in Ten ($17,000  .3) Noncontrolling interest share

$235,000 220,800 $ 14,200 $

7,000

2,100 5,100 $ 14,200

Chapter 9

9-9

Solution E9-9 Controlling Share of Consolidated net income P = Income of Pan on a consolidated basis (including mutual income) S = Income of Sol on a consolidated basis (including mutual income) P = Separate income of $6,000,000 + 80% of S S = Separate income of $3,000,000 + 30% of P P = $6,000,000 + .8($3,000,000 + .3P) = $6,000,000 + $2,400,000 + .24P .76P = $8,400,000 P = $11,052,632 Controlling Share of Consolidated net income = $11,052,632  70% = $7,736,842

9-10

Indirect and Mutual Holdings

Solution E9-10 P = Pad’s income on a consolidated basis S = Sad’s income on a consolidated basis T = Two’s income on a consolidated basis P = $400,000 + .7S S = $240,000 + .8T T = $160,000 + .1S Solve for S S = $240,000 + .8($160,000 + .1S) S = $368,000 + .08S S = $400,000 Compute P and T P = $400,000 + .7($400,000) P = $680,000 T = $160,000 + .1($400,000) T = $200,000 Income Allocation Controlling Share of Consolidated net income (equal to P) Noncontrolling interest share in Sad ($400,000  20%) Noncontrolling interest share in Two ($200,000  20%) Total consolidated income

$680,000 80,000 40,000 $800,000

Chapter 9

9-11

Solution E9-11 [AICPA adapted] 1

Supporting computations A = Pin’s income on a consolidated basis B = Son’s income on a consolidated basis C = Tin’s income on a consolidated basis A = $190,000 + .8B + .7C B = $170,000 + .15C C = $230,000 + .25A Solve for A A = $190,000 + .8[$170,000 + .15($230,000 + .25A)] + .7($230,000 + .25A) A = $190,000 + $136,000 + $27,600 + .03A + $161,000 + .175A A = $514,600 + .205A .795A = $514,600 A = $647,295.59 Determine C C = $230,000 + .25($647,295.59) C = $391,823.90 Determine B B = $170,000 + .15($391,823.90) B = $228,773.58 Allocate income to controlling share of consolidated net income and noncontrolling interest Controlling Share of Consolidated net income ($647,295.59  75%) Noncontrolling interest — Son ($228,773.58  20%) Noncontrolling interest — Tin ($391,823.90  15%) Total consolidated income

$485,471.69 45,754.72 58,773.59 $590,000.00

9-12

Indirect and Mutual Holdings

Solution E9-12 1

d Combined separate income Less: Noncontrolling interest share Controlling Share of Consolidated net income

$160,000 6,750 $153,250

Alternatively: Pet’s separate income Add: Sod’s net income of $67,500  90% Less: Dividends received from Pet ($50,000  15%) Controlling interest share of Consolidated net income

$100,000 60,750 (7,500) $153,250

b P = $100,000 + .9($60,000 + .15P) .865P = $154,000 P = $178,035 S = $60,000 + $26,705 = $86,705 Controlling Share of Consolidated net income = $178,035  .85 = Noncontrolling interest share = $86,705  .10 = Total consolidated income

$151,330 8,670 $160,000

Chapter 9

9-13

Solution E9-13 1 Treasury stock approach Investment in Sat balance December 31, 2011 Investment balance December 31, 2010 Add: Income from Sat Less: Dividends received from Sat(70% x $30,000) Add: Dividends paid to Sat Investment in Sat December 31, 2011

$245,700 26,900 (21,000) 6,000 $257,600

Supporting computations Computation of income from Sat: Sat’s separate income Add: Sat’s dividend income from Pug Sat’s net income Pug’s ownership interest Pug’s equity in Sat’s income Less: Dividends paid to Sat ($60,000  10%) Less: Excess amortization ($9,000 x 70%) Income from Sat

$ 50,000 6,000 56,000 70% 39,200 (6,000) (6,300) $ 26,900

2 Conventional approach Pug’s net income and consolidated net income P = ($120,000 + .7S) - $6,300 S = $50,000 + .1P P = $120,000 + .7($50,000 + .1P) - $6,300 P = $120,000 + $35,000 + .07P - $6,300 .93P = $148,700 P = $159,892 S = $50,000 + .1($159,892) S = $65,989 Pug’s net income and controlling share ($159,892  90%) Noncontrolling interest share ($65,989  30%) Total income

$143,903 19,797 $163,700

Income from Sat Controlling Share of Consolidated net income Less: Pug’s separate income Income from Sat

$143,903 120,000 $ 23,903

Or alternatively, ($65,989  70%) - ($159,892  10%) - $6,300 excess

$ 23,903

Investment in Sat December 31, 2011 Investment in Sat December 31, 2010 Add: Income from Sat Less: Dividends from Sat Investment in Sat December 31, 2011

$245,700 23,903 (21,000) $248,603

9-14

Indirect and Mutual Holdings

SOLUTIONS TO PROBLEMS Solution P9-1 Pad Corporation and Subsidiaries Schedule to Compute Controlling Share of Consolidated Net Income and Noncontrolling Interest Share for the year 2011 Separate income (loss)

Pad $500,000

Sal $300,000

Less: Unrealized profit Separate realized income (loss) Allocate Ban’s loss 70% to Sal

500,000

Ban $(20,000)

(20,000)

_________

130,000

(20,000)

(14,000)

Allocate Axe’s income 60% to Sal Patent Allocate Sal’s income 90% to Pad Patent

300,000

Axe $150,000

78,000 (12,000) 352,000 316,800 (40,000)

14,000 (78,000)

(316,800)

Controlling share of net income $776,800 Noncontrolling interest income

$ 35,200

$ 52,000

$ (6,000)

Check: Income allocated: $776,800 consolidated net income + $35,200 noncontrolling interest share in Sal + $52,000 noncontrolling interest share in Axe - $6,000 noncontrolling interest share (loss) in Ban = $858,000 Income to allocate: $500,000 Pad income + $300,000 Sal income + $130,000 realized income of Axe - $20,000 loss of Ban - $52,000 patent = $858,000 Controlling share of consolidated net income: $500,000 - $40,000 + 90%($300,000 - $12,000) + (90%  60%  $130,000) - (90%  70%  $20,000) = $776,800

Chapter 9

9-15

Solution P9-2 1

Sea’s books Investment in Toy (70%) 588,000 Cash 588,000 To record purchase of a 70% interest in Toy Corporation. Cash

28,000 Investment in Toy (70%) To record dividends received from Toy ($40,000  70%).

Investment in Toy (70%) 70,000 Income from Toy To record investment income computed as follows: Share of Toy’s net income ($120,000  70%) Less: Unrealized profit from upstream sale of inventory items ($20,000  70%)

28,000

70,000 $ 84,000 (14,000) $ 70,000

Pot’s books Cash

96,000 Investment in Sea (80%) 96,000 To record dividends received from Sea ($120,000  80%).

Investment in Sea (80%) 176,000 Income from Sea To record investment income computed as follows: Share of Toy’s net income ($200,000 + $70,000)  80% Less: Unrealized gain on land sold to Toy

176,000

$216,000 (40,000) $176,000

9-16

Indirect and Mutual Holdings

Solution P9-2 (Continued) 2

Schedule of income allocation Separate earnings Less: Unrealized profits

Pot $600,000 (40,000)

Sea $200,000

Toy $120,000 (20,000)

560,000

200,000

100,000

70,000

(70,000)

Separate realized earnings Allocate Toy’s realized earnings to Sea ($100,000  70%) Sea’s net income Allocate Sea’s net income to Pot ($270,000  80%) Pot’s net income and Controlling share of net income Noncontrolling interest share Check:

270,000 216,000

(216,000)

$776,000 $ 54,000

_________ $ 30,000

Realized earnings ($560,000 + $200,000 + $100,000) $860,000 Less: Noncontrolling interest share (84,000) (54,000+30,000) Controlling share of net income $776,000

Schedule of assets and equities at December 31, 2012 Pot

Sea

Toy

Assets Investment in Sea (80%) Investment in Toy (70%) Total assets

$ 3,696,000 $ 920,000 880,000 ___________ 630,000 $ 4,576,000 $1,550,000

$1,080,000

Liabilities Capital stock Retained earnings Total liabilities and equity

600,000 $ 400,000 2,400,000 800,000 1,576,000 350,000 $ 4,576,000 $1,550,000

__________ $1,080,000 200,000 600,000 280,000 $1,080,000

Note: Pot’s assets other than investments consist of $3,200,000 assets at the beginning of the year, plus separate earnings of $600,000 and dividend income of $96,000, less dividends paid of $200,000. Sea’s assets other than investments consist of $1,400,000 assets at the beginning of the period, plus separate earnings of $200,000 and dividend income of $28,000, less investment cost of $588,000 and dividends paid of $120,000.

Chapter 9

9-17

Solution P9-3 Preliminary computations Check on consolidated net income Net income as stated Less: Investment income Separate income Add: Unrealized profit in beginning inventory Less: Unrealized profit in ending inventory Separate realized incomes Allocate Tip’s income 50% to Pen 40% to Sir Sir’s net income Allocate Sir’s income 80% to Pen Less: Depreciation on excess allocated to plant and Equipment Total income of consolidated Entity Controlling share of NI Noncontrolling int. share

Pen $184,500 (84,500) 100,000

Sir $90,000 (10,000) 80,000

Tip $25,000

Total $299,500 (94,500) 205,000

25,000

8,000 _________ 108,000

8,000 ________ 80,000

2,500 2,000 82,000 65,600

(65,600)

(5,000)

( 1,250)

_________ $171,100

_________ $ 15,150

(20,000) 5,000

(20,000) 193,000

(2,500) (2,000)

(6,250) ________ $ 500

$186,750 171,100 15,650 $186,750

Investment in Sir (80%)

$ 420,000

Implied total fair value of Sir ($420,000 / 80%) Book value of Sir Excess of fair value over book value

$ 525,000 (500,000) $ 25,000

Excess allocated to equipment with a four year lfe Amortization ($25,000 / 4 yrs)

6,250

Investment in Tip (50%)

75,000

Implied total fair value of Tip ($75,000 / 50%) Book value of Sir Excess of fair value over book value – Goodwill

$ 150,000 (120,000) $ 30,000

9-18

Indirect and Mutual Holdings

Solution P9-3 (continued) Pen Corporation and Subsidiaries Consolidation Working Papers for the year ended December 31, 2011 Pen

Sir

Tip

Income Statement Sales

$500,000

$300,000

$100,000

Income from Sir

72,000

Adjustments and Eliminations h

50,000

72,000

Consolidated Statements $

850,000

Income from Tip

12,500

10,000

22,500

Cost of sales

240,000*

150,000*

60,000*

20,000

Other expenses

160,000*

70,000*

15,000*

6,250

251,250*

Noncont.int.share — Sir

15,150

15,150*

Noncont.int.share — Tip

500

500*

Cont. share of net inc.

$184,500

$ 90,000

g h

8,000 50,000

$ 25,000

412,000*

171,100

95,000

Retained Earnings Retained earnings — Pen

$115,500

160,000

Retained earnings — Sir

12,500

8,000

e 160,000 45,000

Retained earnings — Tip

Cont. share of net inc.

184,500✓

90,000✓

25,000✓

Dividends

80,000*

40,000*

10,000*

Retained earnings December 31

$220,000

$210,000

$ 60,000

Balance Sheet Cash

45,000 171,100 a c d

9,000 9,000 32,000

80,000* $

186,100

113,000

$ 67,000

$ 36,000

$ 10,000

Accounts receivable

70,000

50,000

20,000

10,000

130,000

Inventories

110,000

75,000

35,000

20,000

200,000

140,000

425,000

115,000

18,750

686,250

Plant and equipment — net Investment in Sir 80% Investment in Tip 50%

25,000

d 40,000 e 468,000

508,000 95,000

Investment in Tip 40% Goodwill

74,000 ________

________

$990,000

$660,000

$180,000

Accounts payable

$ 70,000

$ 40,000

$ 15,000

Other liabilities

100,000

10,000

5,000

Capital stock

600,000

400,000

100,000

Retained earnings

220,000✓

210,000✓

60,000✓

$990,000

$660,000

a b

6,000 68,000 30,000 $1,159,250

10,000

115,000 115,000

b 100,000 e 400,000

600,000 186,100

$180,000 e 117,000 b

Noncontrolling interest — Tip (beginning) _________ 976,900 *

7,500 87,500

30,000

Noncontrolling interest — Sir (beginning) Noncontrolling interest December 31

a b

19,500

6,650

143,150

976,900

$1,159,250

Deduct

Chapter 9

9-19

Solution P9-4 Income allocation Definitions P = Par’s income on a consolidated basis S = Sit’s income on a consolidated basis T = Tot’s income on a consolidated basis Equations P = $400,000 + .8S + .5T S = $200,000 + .2T T = $100,000 + .1S Solve for S S = $200,000 + .2($100,000 + .1S) S = $220,000 + .02S .98S = $220,000 S = $224,489.80 or $224,490 Compute T T = $100,000 + .1($224,489.80) T = $100,000 + $22,448.98 T = $122,448.98 or $122,449 Compute P P = $400,000 + .8($224,489.80) + .5($122,448.98) P = $640,816.33 or $640,816 Income allocation Controlling share of consolidated net income = P = Noncontrolling interest share in Sit ($224,490  .1) Noncontrolling interest share in Tot ($122,449  .3)

$640,816 22,449 36,735 $700,000

9-20

Indirect and Mutual Holdings

Solution P9-4 (continued) 3

P, S, and T are as defined in part 2. Equation P = ($400,000 - $40,000) + .8S + .5T S = $200,000 + .2T T = ($100,000 - $20,000) + .1S Solve for S S = $200,000 + .2($80,000 + .1S) S = $216,000 + .02S S = $220,408.16 Compute T T = $80,000 + .1($220,408.16) T = $102,040.82 Compute P P = $360,000 + .8($220,408.16) + .5($102,040.82) P = $587,346.94 Income allocation Controlling share of consolidated net income = P = Noncontrolling interest share in Sit ($220,408.16  10%) Noncontrolling interest share in Tot ($102,040.82  30%)

$587,346.94 22,040.82 30,612.24 $640,000.00

Chapter 9

9-21

Solution P9-5 Working paper entries a Income from Sun 27,000 Dividend income 10,000 Dividends 28,000 Investment in Sun 9,000 To eliminate income from Sun, dividend income, and 90% of Sun’s dividends, and return the investment in Sun account to the beginning-of-the-period balance under the equity method. b

200,000 Capital stock — Sun 200,000 Retained earnings — Sun Goodwill 50,000 Investment in Sun 405,000 45,000 Noncontrolling interest — beginning To eliminate reciprocal investment and equity accounts, and enter beginning-of-the-period goodwill and noncontrolling interest.

Treasury stock 80,000 Investment in Pin To reclassify investment in Pin to treasury stock.

80,000

Noncontrolling Interest Share 3,000 Dividends 2,000 Noncontrolling Interest 1,000 To record noncontrolling interest share of subsidiary income and dividends.

9-22

Indirect and Mutual Holdings

Solution P9-5 (continued) Treasury Stock approach Pin Company and Subsidiary Consolidation Working Papers for the year ended December 31, 2013 Pin Income Statement Sales Income from Sun Dividend income Cost of sales Expenses

400,000 27,000

177,000

Retained Earnings Retained earnings — Pin

300,000

Dividends

100,000*

Investment in Pin 10% Goodwill

Liabilities Capital stock Retained earnings

10,000 50,000* 30,000*

$ 177,000✓

Balance Sheet Other assets Investment in Sun 90%

100,000

250,000* 80,000* 170,000 3,000 $

167,000

300,000

b 200,000

30,000✓ 20,000*

377,000

210,000

486,000 414,000

420,000

__________

80,000 __________

900,000

500,000

123,000 400,000

90,000 200,000

377,000✓ 900,000 $

a d

28,000 2,000

90,000* $

377,000

906,000

956,000

213,000 400,000 377,000

a 9,000 b 405,000 c 80,000 b

50,000

b 200,000

210,000✓ 500,000

Noncontrolling interest January 1 Noncontrolling interest December 31

3,000*

167,000

Treasury stock

500,000

27,000 10,000

30,000

200,000

Consolidated Statements $

a a

Retained earnings — Sun Net income (Controlling share in Consol. Column)

Retained earnings December 31

200,000* 50,000*

Consolidated NI Noncontrolling share Controlling share of NI

Adjustments and Eliminations

Sun 90%

80,000 570,000

45,000

1,000

_________ 570,000

Deduct

46,000 $

80,000* 956,000

Chapter 9

9-23

Solution P9-6 Calculations Income from Sip Par separate income (140,000 - 80,000) Sip separate income (100,000 + 3,000 - 60,000)

$ 60,000 $ 43,000

Formula: P income = Adjusted Par income + % interest  S income Adjusted Par income = $60,000 + $2,000 delayed gain on land - $4,000 patent amortization (80%) S income = Sip income + % interest  P income P income = $58,000 + 80%  ($43,000 + 20%  P income) P income = $92,400 + .16  P income P income = $110,000 S income = $43,000 + 20%  $110,000 S income = $65,000 Controlling share of consolidated net income = P income  % outstanding Controlling share = $88,000 Noncontrolling share = S income  % outstanding Noncontrolling share = $12,000 [($65,000 - $5,000 amortiz.) x 20%] Income from Sip = consolidated income less P separate income Income from Sip = $28,000 ($88,000-$60,000)

9-24

Indirect and Mutual Holdings

Solution P9-6 (continued) Working paper entries a Investment in Sip 2,000 Gain on sale of land To recognize previously deferred gain on sale of land. b

Dividend income 4,000 Investment in Sip To eliminate intercompany dividends paid to Sip

2,000

4,000

Income from Sip 28,000 Dividends 16,000 Investment in Sip 12,000 To eliminate income from Sip and 80% of Sip’s dividends, and return the investment in Sip account to the beginning-of-theperiod balance under the equity method.

Investment in Sip Investment in Par To eliminate reciprocal investments.

100,000 100,000

50,000 Capital stock — Sip 180,000 Retained earnings — Sip Patent 20,000 Investment in Sip 195,710 54,290 Noncontrolling interest — beginning To eliminate reciprocal investment and equity accounts, and enter beginning-of-the-period patent and noncontrolling interest.

Expenses 5,000 Patent To record current year’s amortization of patent.

5,000

Noncontrolling Interest Share 12,000 Dividends 4,000 Noncontrolling Interest 8,000 To record the noncontrolling interest share of subsidiary income and dividends.

Chapter 9

9-25

Solution P9-6 (continued) Par Company and Subsidiary Consolidation Working Papers for the year ended December 31, 2010 Par Income Statement Sales Income from Sip

Dividend income Gain on sale of land Expenses Consolidated net income Noncontrolling share

Controlling share of NI

140,000 28,000

80,000*

88,000

405,710

Adjustments and Eliminations

Sip 90%

100,000

Consolidated Statements $

28,000

4,000 b 3,000 60,000* f

4,000

12,000

2,000

5,000 145,000* 100,000 12,000*

5,000

47,000

240,000

88,000

405,710

Retained Earnings Retained earnings — Par

Retained earnings — Sip

Controlling share of NI

88,000✓ 16,000*

Dividends Retained earnings December 31 Balance Sheet Other assets Investment in Sip

Investment in Par Patent

477,710

207,000

448,000 109,710

157,000

88,000 c g

a 2,000 d 100,000

__________

100,000 __________

557,710

80,000

50,000

477,710✓ 557,710 $

207,000✓ 257,000

Noncontrolling interest January 1 Noncontrolling interest December 31

e 180,000

47,000✓ 20,000*

Capital stock Retained earnings

180,000

20,000

16,000 4,000

16,000* $

477,710

605,000

b 4,000 c 12,000 e 195,710 d 100,000 f 5,000

257,000

15,000 $

50,000

_________ 401,000

620,000 80,000 477,710

e g

54,290 8,000 401,000

Deduct

62,290 620,000

9-26

Indirect and Mutual Holdings

Solution P9-7 Preliminary Computations Pan’s investment cost

$170,000

Implied total fair value of Set ($170,000 / 80%) Book value of Set Excess of fair value over book value - Goodwill

$212,500 (200,000) $ 12,500

Consolidated net income and noncontrolling interest share (conventional approach) Definitions P = Pan’s income on a consolidated basis S = Set’s income on a consolidated basis P = $100,000 separate earnings + .8S S = $40,000 separate earnings + .1P Solve for P P = $100,000 + .8($40,000 + .1P) P = $100,000 + $32,000 + .08P P = $143,478 Compute S S = $40,000 + .1($143,478) S = $54,348 Income allocation Controlling Share of Consolidated net income ($143,478  90% $129,130 outside ownership) 10,870 Noncontrolling interest share ($54,348  20%) Total (separate incomes)

$140,000

Chapter 9

9-27

Solution P9-7 (continued) 2

Entries to account for investments on an equity basis Pan’s books Capital stock 60,000 Retained earnings 20,000 Investment in Set 80,000 To record constructive retirement of 10% of Pan’s stock. Investment in Set (80%) 29,130 Income from Set 29,130 To record income from Set computed as follows: 80%($54,348) 10%($143,478) = $29,130. Alternatively $129,130 - $100,000 separate income = $29,130. Cash

16,000 Investment in Set To record receipt of 80% of Set’s dividends.

16,000

Investment in Set (80%) 5,000 Dividends 5,000 To eliminate dividends on stock that was constructively retired and to adjust the investment in Set account for the transfer equal to 10% of Pan’s dividends.

9-28

Indirect and Mutual Holdings

Solution P9-7 (continued) 3

Journal entries on Set’s books Investment in Pan (10%) 80,000 Assets 80,000 To record acquisition of a 10% interest in Pan at book value. Investment in Pan 14,348 Income from Pan 14,348 To record 10% of Pan’s $143,478 income on a consolidated basis. Cash

5,000 Investment in Pan (10%) 5,000 To record receipt of dividends from Pan ($50,000  10%).

Net income for 2013 Separate incomes Investment income Net income

Pan $100,000 29,130 $129,130

Set $ 40,000 14,348 $ 54,348

Investment balance December 31, 2013 Investments beginning of 2013 Less: Constructive retirement of Pan’s stock Add: Investment income Add: Dividends paid to Set Less: Dividends received Investment balances December 31, 2013

Pan $208,000 (80,000) 29,130 5,000 (16,000) $146,130

Set $ 80,000

Stockholders’ equity December 31, 2013 Stockholders’ equity January 1, 2013 Add: Net income Less: Dividends Stockholders’ equity December 31, 2013

Pan $720,000 129,130 (45,000) $804,130

Set $250,000 54,348 (20,000) $284,348

Noncontrolling interest at December 31, 2013 Set’s equity on a consolidated basis Noncontrolling interest percentage Noncontrolling interest at December 31, 2013

$284,348 20% $ 56,870

Alternative solution Noncontrolling interest January 1, 2013 ($250,000  20%) Noncontrolling interest share ($54,348  20%) Noncontrolling interest dividends Noncontrolling interest at December 31, 2013

$ 50,000 10,870 (4,000) $ 56,870

14,348 (5,000) $ 89,348

Chapter 9

9-29

Solution P9-7 (continued) 8

Adjustment and elimination entries a

Income from Pan 14,348 Dividends 5,000 Investment in Pan 9,348 To eliminate investment income and dividends from Pan and return the investment account to its beginning-of-theperiod balance.

Investment in Set 80,000 Investment in Pan 80,000 To eliminate investment in Pan balance and increase the investment in Set for the constructive retirement of Pan’s stock that was charged to the investment in Set account.

Dividends Investment in Set To eliminate dividends.

5,000 5,000

Income from Set 29,130 Dividends 16,000 Investment in Set 13,130 To eliminate income and dividends from Set and return the investment in Set to its beginning-of-the-period balance.

150,000 Capital stock — Set 100,000 Retained earnings — Set Goodwill 12,500 Investment in Set 208,000 Noncontrolling interest 54,500 To eliminate Set’s equity account balances and the investment in Set, enter beginning-of-the-period goodwill and noncontrolling interest.

Noncontrolling interest share 10,870 Dividends 4,000 Noncontrolling Interest 6,870 To record the noncontrolling interest share of subsidiary income and dividends.

Chapter 10 SUBSIDIARY PREFERRED STOCK, CONSOLIDATED EARNINGS PER SHARE, AND CONSOLIDATED INCOME TAXATION Answers to Questions 1

Par’s investment income Sam’s net income Less: Preferred income ($500,000  10%) Income to common stockholders Par’s percentage owned Investment income Par’s investment account balance (equal to book value): Sam’s stockholders’ equity Less: Preferred equity (no arrearages or call premiums) Common equity Par’s percentage ownership Investment account balance

300,000 (50,000) 250,000 60% 150,000

$2,500,000 (500,000) 2,000,000 60% $1,200,000

The payment of two years preferred dividend requirements would not have affected Par’s investment income. Since the preferred stock is cumulative, the preferred dividend requirements are deducted from net income each year regardless of whether preferred dividends are declared.

The preferred stock of a subsidiary does not appear in a consolidated balance sheet. If there is a noncontrolling interest in the preferred stock, it is reported as a noncontrolling interest in the consolidated balance sheet. In part a, the investment in preferred is eliminated against the preferred equity and there is no noncontrolling interest in preferred. When 50 percent of the stock is held by the parent (part b), the investment in preferred is eliminated against 50 percent of the preferred equity and the other 50 percent is reported as a noncontrolling interest. In part c, all of the preferred stock is reported as a noncontrolling interest.

Assuming that the parent does not hold any of the subsidiary’s preferred stock, the computation of noncontrolling interest share for an 80 percent owned subsidiary is 100 percent of the income allocated to preferred plus 20 percent of the income allocated to common.

There is no difference between the controlling share of consolidated EPS and parent company EPS.

An investor company’s EPS computations must reflect the potential dilution of an equity investee’s common stock equivalents and other potentially dilutive securities if the effect is material.

Procedures applied in computing a parent company’s EPS computations are the same as those for a corporation without equity investments except when the subsidiary has outstanding common stock equivalents or other potentially dilutive securities.

Subsidiary EPS computations are only needed when computing diluted EPS, never for basic EPS, and then it is only needed when the subsidiary has potentially dilutive securities convertible into subsidiary common stock.

10-2

Subsidiary Preferred Stock, Consolidated Earnings per Share, and Consolidated Income Taxation

If a subsidiary has dilutive securities convertible into subsidiary common stock, the parent’s diluted earnings are adjusted by replacing the parent’s equity in subsidiary realized income with its equity in subsidiary diluted EPS. Alternatively, when subsidiary securities are convertible into the parent’s common stock, the parent’s diluted earnings and common shares are adjusted as if the dilutive securities had been issued by the parent.

The replacement computation does not involve unrealized profits from downstream sales because these items relate solely to parent operations and do not affect the noncontrolling interest. In the case of unrealized profits from upstream sales, however, unrealized profits are deducted in the replacement computation which involves subtracting the parent’s equity in subsidiary realized income and adding back the parent’s equity in subsidiary diluted EPS (also based on subsidiary realized income).

Consolidated tax returns are not required for a consolidated entity, but a consolidated entity that qualifies as an “affiliated group” may elect to file consolidated tax returns. Once consolidated returns are elected, it may be difficult to obtain IRS permission to file separate returns.

Yes. Consolidated entities that meet the requirements of an affiliated group can and often do elect to file separate income tax returns.

The primary advantages of filing consolidated tax returns are (1) losses of affiliates are offset against gains of other members of the affiliated group, (2) intercompany profits between group members are eliminated from taxable income until realized, and (3) intercorporate dividends are fully excluded from taxable income. (But note that 3 is not a unique advantage of filing a consolidated return.)

Dividends received by a member of an affiliated group from other group members are excluded from federal income taxation regardless of whether the affiliated group elects to file consolidated tax returns.

Temporary differences result because investors that are not members of an affiliated group record income from equity investments as it is earned, but pay taxes only when dividends are actually received.

In providing for income taxes on undistributed earnings of equity investees, the parent/investor debits income tax expense and credits deferred tax liability as part of the determination of all income taxes for the period. The investment and investment income accounts are not affected.

Unrealized and constructive gains and losses give rise to temporary differences unless the consolidated entity is a member of an affiliated group and elects to file consolidated tax returns.

Chapter 10

10-3

SOLUTIONS TO EXERCISES Solution E10-1 1

2 3 4

[AICPA adapted]

a Sob income to preferred $ 4,000 $20,000  20% owned Sob income to common 80,000 $100,000  80% owned Income from Sob $ 84,000 a $150,000  20% taxable  30% tax rate d All dividend income is excluded from a consolidated group. d Intercompany profit is deferred in the consolidated tax return until realized through sale to an outside entity.

10-4

Subsidiary Preferred Stock, Consolidated Earnings per Share, and Consolidated Income Taxation

Solution E10-2

[Preferred stock](in thousands)

Cost/fair value differential Total stockholders’ equity January 1, 2012 Less: Preferred equity (20,000 shares  $115) Common equity

$16,000 2,300 $13,700

Cost

$16,200

Implied total fair ($16,200 / 90%) Book value of investment Excess fair over book value – Goodwill

$18,000 13,700 $ 4,300

Income from Sir for 2012 Sir’s net income Less: Preferred dividends for 2012 Income to common Income from Sir ($2,200  90%)

$2,400 200 $2,200 $1,980

Investment in Sir at December 31, 2012 Investment cost January 1, 2012 Add: Income from Sir Less: Dividends ($1,200 - $400 preferred)  90% Investment in Sir

$16,200 1,980 (720) $17,460

Noncontrolling interest for 2012 Beginning stockholders’ equity Add: Net income Less: Dividends Stockholders’ equity December 31, 2012

$16,000 2,400 (1,200) $17,200

Preferred equity ($105  20,000) Common noncontrolling interest ($17,200,000 + $4,300,000 (Goodwill)-$2,100,000)  10% Noncontrolling interest December 31, 2012

$2,100 1,940 $4,040

Chapter 10

Solution E10-3 1

10-5

[Preferred stock]

Fair value — book value differential Cost of 80% interest

$3,072,000

Implied total fair value ($3,072,000 / 80%) Less: Book value ($5,000,000 total equity $1,260,000 preferred equity) Excess fair value over book value - Goodwill

$3,840,000

Loss from Sol — 2011 Sol’s net loss Add: Income to preferred stockholders Loss to common stockholders Percent owned Loss on investment in Sol

200,000 144,000 344,000 80% 275,200

Income from Sol — 2012 Net income Less: Income to preferred stockholders Income to common stockholders Percent owned Income from investment in Sol

(3,740,000) $ 100,000

$1,000,000 (144,000) 856,000 80% $ 684,800

Par’s investment in Sol account Total stockholders’ equity at December 31, 2012 ($5,000,000 - $200,000 loss in 2011 + $1,000,000 income in 2012 - $688,000 dividends in 2012) Less: Preferred equity

$5,112,000

Common equity Percent owned Underlying equity Add: 80% of Goodwill Investment in Sol at December 31, 2012

(1,260,000) 3,852,000 80% 3,081,600 80,000 $3,161,600

Check: Cost of investment Loss — 2011 Income — 2012 Dividends 2012 ($688,000 - $288,000)  80% Investment in Sol at December 31, 2012

$3,072,000 (275,200) 684,800 (320,000) $3,161,600

10-6

Subsidiary Preferred Stock, Consolidated Earnings per Share, and Consolidated Income Taxation

Solution E10-4

[Preferred stock]

Investment cost (fair value equals book value) Total stockholders’ equity of San Less: Preferred equity 20,000 shares  ($200 + $10 + $24) Common equity Percent owned Investment cost (fair value and book value)

$8,000,000 2,340,000 5,660,000 80% $4,528,000

Consolidated net income and noncontrolling interest share Pen separate income Add: Income from San ($1,000,000 - $240,000)  80% Controlling Share of Consolidated net income

$6,000,000 608,000 $6,608,000

Noncontrolling interest share ($760,000 common income  20%) + $240,000 preferred income

392,000

Underlying book value Total stockholders’ equity Less: Preferred equity (20,000 shares  $105 call price) Common equity Percent owned Underlying book value December 31, 2012

$8,400,000 2,100,000 6,300,000 80% $5,040,000

Chapter 10

10-7

Solution E10-5 Preliminary computations Total equity of Son at December 31, 2011 Less: Preferred equity (10,000 shares  $115) Common equity December 31, 2011 1

$3,500,000 (1,150,000) $2,350,000

Entries to record preferred stock investment 600,000 Investment in Son — preferred Cash To record purchase of 50% of Son’s preferred stock.

600,000

Additional paid-in capital 25,000 25,000 Investment in Son — preferred To adjust investment in preferred account to underlying equity: $600,000 cost - ($1,150,000 underlying equity  50%) = $25,000. 2

Excess of fair value over book value from common stock investment Cost of 80% investment in common stock $2,000,000 Implied total fair value ($2,000,000 / 80%) Book value Excess fair value over book value

$2,500,000 (2,350,000) $ 150,000

Pam’s income from Son preferred — 2012 $1,000,000 par  15%  50% owned

75,000

Pam’s income from Son common — 2012 Equity in Son’s common income ($400,000 income $150,000 preferred dividends)  80% owned

200,000

Noncontrolling interest at December 31, 2012 Total equity at December 31 ($3,500,000 + $400,000 income - $300,000 dividends) Less: Preferred equity Common equity Plus: Goodwill Common equity plus excess fair value

$3,600,000 (1,000,000) $2,600,000 150,000 $2,750,000

Noncontrol. Int. — preferred ($1,000,000  50%) $500,000 Noncontrol. interest — common ($2,750,000  20%) 550,000 Total noncontrolling interest December 31

$1,050,000

10-8

Subsidiary Preferred Stock, Consolidated Earnings per Share, and Consolidated Income Taxation

Solution E10-6

[Preferred stock] (in thousands)

Fair value — book value differentials Cost of preferred stock Book value of preferred 60,000 shares  ($100 par + $5 call premium + $10 dividend arrearage) Excess book value of preferred stock over cost

$ 6,500

Cost of common stock

$35,000

Implied total fair value ($35,000 / 70%) Book value of common ($60,000 total equity $11,500 preferred equity) Excess fair value over book value of common

$50,000

(6,900) (400)

48,500 $ 1,500

The $400,000 negative differential should be treated as an increase in the preferred investment and other paid-in capital accounts on Pay’s books. Pay will record its investment in Set preferred as follows: Investment in Set preferred 6,500 Cash To record purchase of 60% of Set’s preferred stock.

6,500

Investment in Set preferred 400 Other paid-in capital 400 To adjust other paid-in capital for the constructive retirement of 60% of Set’s preferred shares. Solution E10-7 1 2 3

[EPS]

d c d

Chapter 10

10-9

Solution E10-8 [EPS] 1 a Sod’s diluted earnings for consolidated EPS purposes Pal’s equity in Sod’s income $176,000/.8 2

c Sod’s outstanding shares Add: Incremental shares 10,000 shares - ($100,000 assumed proceeds/$20 average market price) Sod’s common shares and common share equivalents b Pal’s net income Less: Equity in Sod’s income Add: Equity in Sod’s diluted earnings (40,000 shares  Sod’s $4 diluted EPS) Pal’s diluted earnings

220,000

50,000 shares 5,000 shares 55,000 shares $

316,000 (176,000) 160,000 300,000

d Pal’s diluted earnings $300,000/300,000 Pal outstanding common shares = $1

10-10

Subsidiary Preferred Stock, Consolidated Earnings per Share, and Consolidated Income Taxation

Solution E10-9

[EPS]

San’s basic and diluted EPS Income to common (equal to San’s net income) = a Common shares and common share equivalents: Outstanding shares Additional shares using treasury stock method: 1,000 - (1,000  $9)/$15 Common shares and common share equivalents = b San’s EPS = a/b

Basic $18,000

Diluted $18,000

5,000

________ 5,000 $ 3.60

400 5,400 $ 3.33

$20,000

Put’s basic and diluted EPS Income to common (equal to Put’s net income) Replacement of Put’s equity in San’s realized income with Put’s equity in San’s diluted earnings: Equity in San’s income to common ($18,000  80%) Equity in San’s diluted earnings (4,000 shares  $3.33) Put’s basic and diluted earnings = a Outstanding common shares = b Put’s EPS = a/b

(14,400)

$20,000 8,000 $ 2.50

13,320 $18,920 8,000 $ 2.37

Chapter 10

Solution E10-10

10-11

[EPS] Basic

Sal’s earnings per share Net income Sal’s common shares outstanding Incremental shares from warrants Diluted: 5,000 — ($120,000 assumed proceeds/$30 average price) Common shares and equivalents Earnings per share Pin’s basic and diluted EPS Pin’s income to common ($80,467 - $12,000 to preferred) Replacement computation: Equity in Sal’s realized income Equity in Sal’s diluted EPS 16,000 shares  $1.26

$26,400 20,000

Diluted $26,400 20,000 1,000

20,000 1.32

$68,467

21,000 1.26

(21,120) 20,160

a b

Earnings Pin’s common shares outstanding

$68,467 10,000

$67,507 10,000

a/b

Earnings per share

6.85

6.75

10-12

Subsidiary Preferred Stock, Consolidated Earnings per Share, and Consolidated Income Taxation

Solution E10-11

[EPS] Diluted

1 a

Soy’s earnings per share Soy’s earnings: Income to Soy common (equals net income) Soy’s outstanding shares Incremental shares from warrants Diluted: 10,000 — ($240,000 assumed proceeds/$40 average price)

Common and equivalent shares

a/b

Soy’s earnings per share

Consolidated earnings per share Pow’s income to common (equals net income) Replacement: 80% of Soy’s income Equity in diluted earnings 40,000 shares  $11.67 diluted EPS Pow’s earnings

Pow’s outstanding shares

a/b

Consolidated earnings per share

Solution E10-12

[Tax]

$630,000 50,000 4,000 54,000 $

11.67

Basic

Diluted

$1,480,000

$1,480,000 (504,000)

__________ $1,480,000

466,800 $1,442,800

1,000,000

1.48

1.44

Chapter 10

Solution E10-13 1

10-13

[Tax]

c Assigned value of equipment Related deferred tax liability ($6,000,000 - $4,000,000 tax basis)  34% tax rate

$6,000,000 $

680,000

c Income tax expense = $500,000 investment income  20% taxable  34% tax rate

c Income taxes currently payable: $30,000 dividends  20% taxable  34% tax rate = $2,040 Income tax expense: $60,000 income from Sap  20% taxable  34% tax rate = $4,080 Deferred tax liability: $30,000 undistributed earnings  20% taxable  34% tax rate = $2,040

d Income taxes currently payable: $17,500 dividends  20% taxable  34% tax rate = $1,190 Deferred income taxes: $17,500 share of undistributed earnings  20% taxable  34% tax rate = $1,190

a No income tax is assessed on dividends received from a 100% owned domestic subsidiary

10-14

Subsidiary Preferred Stock, Consolidated Earnings per Share, and Consolidated Income Taxation

Solution E10-14

[Tax]

Separate company tax returns Pit’s income taxes currently payable: Pretax accounting income $600,000  34% tax rate = Sol’s income taxes currently payable: Pretax accounting income $200,000  34% tax rate = Income taxes currently payable Less: Increase in deferred tax asset ($400,000  34%) Consolidated income tax expense Consolidated tax return Combined pretax accounting income Less: Unrealized gain on downstream sale of land Taxable income Tax rate Consolidated income tax expense Separate tax returns Pit’s income taxes currently payable: Pretax accounting income $600,000  34% tax rate = Sol’s income taxes currently payable: Pretax accounting income $200,000  34% tax rate = Income taxes currently payable Consolidated tax return Combined pretax accounting income Less: Unrealized gain on downstream sale of land Taxable income Tax rate Income taxes currently payable

$204,000 68,000 272,000 (136,000) $136,000 $800,000 (400,000) 400,000 34% $136,000

$204,000 68,000 272,000 $800,000 (400,000) 400,000 34% $136,000

Note: No tax is paid on intercompany profits when consolidated returns are filed.

Chapter 10

Solution E10-15

10-15

[Tax]

Preliminary computations — Because there is only one tax rate, a schedule approach to this solution is not necessary. Sales Gain on equipment Cost of sales Other expenses(includes $50,000 patent amortization) Pretax operating income Income taxes payable on operating income at 34% income tax rate Income taxes payable on dividends ($400,000 paid  70% interest  20% taxable  34%) Income taxes currently payable Increase in deferred tax asset* Income tax expense Separate incomes Add: Income from Sum ($528,000  70% owned - $160,000 unrealized gain) Net income *

Pan Sum $8,000,000 $4,000,000 200,000 (5,000,000) (2,000,000) (1,850,000) (1,200,000) 1,350,000 800,000 (459,000)

(272,000)

(19,040) ___________ (478,040) (272,000) 48,307 ___________ (429,733) (272,000) 920,267 528,000 209,600 $1,129,867

__________ $

528,000

Deferred tax asset ($160,000 unrealized gain  34%) - ($128,000 future dividends  70% owned  20% taxable  34% enacted tax rate) = $48,307

Pan Corporation and Subsidiary Consolidated Income Statement for the year 2011 Consolidated sales Less: Cost of sales Less: Other expenses ($3,000,000 + $50,000 - $40,000) Income before income taxes and noncontrolling interest share Income tax expense** Total consolidated income Noncontrolling interest share Controlling share of consolidated net income

$12,000,000 (7,000,000) (3,010,000) 1,990,000 (701,733) 1,288,267 (158,400) $ 1,129,867

** Taxes currently payable of $478,040 for Pan + $272,000 for Sum - $48,307 increase in deferred tax asset = $701,733

10-16

Subsidiary Preferred Stock, Consolidated Earnings per Share, and Consolidated Income Taxation

Solution E10-16

[Tax]

One-line consolidation entries Separate tax returns are filed Income from Sun 80,000 Investment in Sun 80,000 To eliminate unrealized profit on downstream sale of merchandise. Computation: $100,000 gross profit  80% unrealized. Note: that the tax effect of the unrealized profit is $27,200, but that amount is a deferred tax asset to be included in the computation of Ped’s income tax expense. The deferred tax asset may be reduced by a valuation allowance. Consolidated income tax returns are filed Income from Sun 80,000 Investment in Sun 80,000 To eliminate unrealized profit on downstream sale of merchandise. Computation: $100,000 gross profit  80% unrealized. Note: since no tax is paid on the inventory profit, no income tax adjustment is necessary.

Consolidation working paper entries Separate Income Tax Consolidated Income Returns Filed Tax Returns Filed Sales 200,000 200,000 Cost of goods sold 200,000 200,000 To eliminate reciprocal sales and cost of goods sold. Cost of goods sold 80,000 80,000 Inventory 80,000 To eliminate unrealized profits in ending inventory.

80,000

Note: No adjustments for tax effects are needed because consolidated income tax is equal to combined separate company income taxes under GAAP.

Chapter 10

Solution E10-17 1

10-17

[Tax]

One-line consolidation entry Income from Son 160,000 Investment in Son 160,000 To eliminate unrealized profit on upstream sale. Computation: $200,000 unrealized profit  80% owned.

Consolidation working paper entries Gain on sale of equipment 200,000 Equipment 200,000 To eliminate unrealized gain and reduce equipment to its cost basis.

Noncontrolling interest share Net income of Son (includes the tax effect of the gain) Less: Unrealized profit Realized income of Son Noncontrolling interest percentage Noncontrolling interest share

$1,600,000 (200,000) 1,400,000 20% $ 280,000

10-18

Subsidiary Preferred Stock, Consolidated Earnings per Share, and Consolidated Income Taxation

Solution E10-18 Possible Estimated Outcome

Individual Probability of Occurring (%)

Cumulative Probability of Occurring (%)

$500,000

400,000

300,000

200,000

100,000

100

Because $300,000 is the largest amount of benefit that is greater than 50 percent likely of being realized, Pax would recognize a tax benefit of $300,000 in the financial statements (Deferred tax asset of $500,000 less a valuation allowance of $200,000). Solution E10-19 Possible Estimated Outcome

Individual Probability of Occurring (%)

Cumulative Probability of Occurring (%)

$150,000

125,000

100,000

50,000

100

Because $125,000 is the largest amount of benefit that is greater than 50 percent likely of being realized, Pun would recognize a tax benefit of $125,000 in the financial statements (Deferred tax asset of $150,000 less a valuation allowance of $25,000).

Chapter 10

10-19

SOLUTIONS TO PROBLEMS Solution P10-1 1

[Preferred stock] (amounts in thousands)

Goodwill from Par’s investment in Sun Cost of 360,000 shares of common stock

$7,200

Implied total fair value ($7,200 / 90%) Less: Book value Stockholders equity $8,300 2,300 Less: Preferred equity (20,000  $115)* Common equity Excess fair value = Goodwill * Preferred equity at liq. Pref. (20,000  $105) + Div. in arrears ($200,000)

$8,000

Income from Sun Sun’s reported income Less: Preferred dividend for 2011 Sun’s adjusted income to common 90% of Sun’s adjusted income Noncontrolling interest share for 2011 Income allocable to preferred Sun’s adjusted income Noncontrol. common interest share (10%) Noncontrolling interest share

6,000 $2,000

$1,000 ( 200) $ 800 $

720

200

$ $

80 280

$800

Noncontrolling interest December 31, 2011 Total stockholders’ equity ($8,300 + $1,000 net income $800 dividends) $8,500 Less: Preferred equity (No div. in 2,100  100% arrears) Common equity – book value $6,400 Plus Unamortized goodwill at 12/31 2,000 Common equity at fair value $8,400  10% Noncontrolling interest December 31 Investment in Sun December 31, 2011 Investment cost Add: Income from Sun Less: Dividends ($800 - $200 preferred dividends in arrears - $200 current preferred dividends)  90% Investment in Sun December 31 Check: Equity of common ($6,400  90%) Undepreciated excess ($2,000  90%) Investment in Sun December 31

$2,100

840 $2,940 $7,200 720 (360) $7,560 $5,760 1,800 $7,560

10-20

Subsidiary Preferred Stock, Consolidated Earnings per Share, and Consolidated Income Taxation

Solution P10-2

[Preferred stock]

Preliminary computations Stockholders’ equity July 1, 2011 $900,000 - ($46,000 income  1/2 year) Less: Preferred equity July 1, 2011 Par value with call premium Dividend arrearage — 2010 ($200,000  9%) Dividend arrearage — 2011 ($200,000  9%  1/2 year) Common equity July 1, 2011

$877,000 $210,000 18,000 9,000

237,000 $640,000

Cost of 90% interest in Set’s common stock

$630,000

Implied total fair value ($630,000 / 90%) Book value of common equity Goodwill

$700,000 (640,000) $ 60,000

Cost of 80% interest in Set’s preferred stock Book value acquired ($237,000  80%) Book value over cost of preferred

$175,000 (189,600) $(14,600)

Investment account balances at December 31, 2011 Common Investment cost $630,000 Adjust preferred to book value and recognize a constructive retirement Income to preferred ($18,000  1/2 year  80%) 12,600 Income to common ($28,000  1/2 year  90%) Investment balances December 31 $642,600

Preferred $175,000 14,600 7,200 ________ $196,800

Consolidated balance sheet working paper entries 9% preferred stock, $100 par 200,000 46,000 Retained earnings — Set 196,800 Investment in Set — preferred 49,200 Noncontrolling interest — preferred To eliminate reciprocal preferred equity and investment balances and enter noncontrolling interest. The preferred stockholders’ claim on Set’s retained earnings consists of $18 per share preferred dividends in arrears plus a $5 per share call premium. Computations: Investment in Set preferred = $123  1,600 shares. Noncontrolling interest — preferred = $123  400 shares. 500,000 Common stock, $10 par — Set 40,000 Paid-in capital in excess of par — Set 114,000 Retained earnings — Set Goodwill 60,000 642,600 Investment in Set — common 71,400 Noncontrolling interest — common To eliminate reciprocal common equity and investment amounts and enter goodwill and noncontrolling interest in common. NOTE: Noncontrolling interest includes 10% of Goodwill.

Chapter 10

10-21

Problem 10-2 (continued) Income from Set, Preferred (9,000 x 80%) Investment in Set – Preferred To eliminate preferred dividend from Set and return investment account to beginning of period balance.

7,200

Income from Set, Common (28,000 x 90% x ½) Investment in Set – Common To eliminate income from Set and return investment account to beginning of period balance.

12,600

Noncontrolling interest share – preferred Noncontrolling interest - preferred (9,000 x 20%) To enter noncontrolling interest share of preferred dividend.

1,800

Noncontrolling interest share - common Noncontrolling interest - common (28,000 x 10% x ½)To enter noncontrolling interest share of Set income.

1,400

7,200

12,600

1,800

1,400

10-22

Subsidiary Preferred Stock, Consolidated Earnings per Share, and Consolidated Income Taxation

Solution P10-3 [Preferred stock](in thousands) Preliminary computations Cost of 70% interest in Sal January 1, 2010 Implied total fair value of Sal ($490 / 70%) Book value acquired of common equity Excess of fair value over book value

$490 $700 700 $ 0

Cost of 20% interest in Sal April 1, 2011

$152

Implied total fair value of Sal ($152 / 20%) Book value of Sal($850 + $22.5 - $12.5 - $100) Excess of fair value over book value

$760 760 $ 0

Pat’s investment income from Sal for 2011 Sal’s net income Less: Preferred income ($100  10%) Income to common Income from Sal($80  70%  1 year)+($80  20%  3/4 year)

$ 90 10 $ 80 $ 68

Chapter 10

10-23

Solution P10-3 (continued) Pat Corporation and Subsidiary Consolidation Working Papers for the year ended December 31, 2011 (in thousands) Pat Income Statement Sales Income from Sal Cost of sales Other expenses Noncon. int. share—common Noncon. int. share—pref. Controlling share of NI

$1,233 68 610* 390*

Adjustments and Eliminations

Sal $

700

$1,933 a

301

501

400* 210* d e

200

Consolidated Statements

1,010* 600* 12* 10* $ 301

12 10

Retained Earnings Retained earnings — Pat Retained earnings — Sal Net income

301✓ 200*

Dividends

Retained earnings December 31 Balance Sheet Cash Other current assets Plant assets Investment in Sal**

Current liabilities $10 preferred stock Common stock Other paid-in capital Retained earnings

602

191 200 900 711

$2,002

950

60 100 500 50

200

a d e

34 6 10 $

602

50 300 600 ______

241 500 1,500

602✓

a 34 b 677

260 1,200 602

240✓ $

______ $2,241 $

c 100 b 500 b 50

950

Noncontrolling interest — common

Noncontrolling interest — preferred Noncontrolling interest December 31

c 100

200*

240

1,200

$2,002

301

90✓ 50*

501

b 200

______ 940

73 6 940

Deduct

** Common equity of Sal = $790 x 90% = $711

179 $2,241

10-24

Subsidiary Preferred Stock, Consolidated Earnings per Share, and Consolidated Income Taxation

Solution P10-4 [Preferred stock] Preliminary computations Fair value — book value differential Investment cost Implied total fair value of Sam ($240,000 / 80%) Less: Book value acquired Sam’s stockholders’ equity January 1, 2010 Less: Preferred equity Sam’s common equity Excess fair value over book value = Goodwill

$240,000 $300,000 $325,000 100,000

Income from Sam for 2011 Equity in Sam’s income ($60,000 - $10,000 pf)  80% Add: Intercompany profits beginning inventory ($50,000  40%  3/5) Less: Intercompany profits ending inventory ($60,000  40%  4/6) Add: Realization of 80% of $10,000 profit deferred on land from 2010 Add: Constructive gain on bonds ($9,000  80%) Less: Piecemeal recognition of gain ($9,000/3 years  1/2 year  80%) Income from Sam Investment in Sam December 31, 2011 Underlying book value ($390,000 - $100,000)  80% Add: 80% of Goodwill Less: Unrealized inventory profit Add: Constructive gain less 1/2 year piecemeal recognition ($9,000 - $1,500)  80% Investment in Sam December 31 Noncontrolling interest share — common Sam’s reported income less income to preferred ($60,000 - $10,000) Recognition of previously deferred gain on land Constructive gain on bonds less 1/2 year piecemeal recognition of gain ($9,000 - $1,500) Sam’s realized income to common Noncontrolling interest percentage Noncontrolling interest share — common

225,000 $ 75,000 $ 40,000 12,000 (16,000) 8,000 7,200 (1,200) $ 50,000 $232,000 60,000 (16,000) 6,000 $282,000

$ 50,000 10,000 7,500 67,500 20% $ 13,500

Chapter 10

10-25

Solution P10-4 (continued) Par Corporation and Subsidiary Consolidation Working Papers for the year ended December 31, 2011 Par Income Statement Sales Gain on land Interest income Gain on bonds Income from Sam Cost of sales

900,000 10,000 6,500

50,000 600,000*

Operating expenses Interest expense Consolidated net income Noncontrolling share Preferred

300,000

140,000*

208,500*

Noncontrol. Share — common Controlling share of NI

Adjustments and Eliminations

Sam 80% a e

6,500

f c

50,000 16,000

90,000* 10,000*

i i $

158,000

132,000

60,000

Consolidated Statements

10,000

$1,140,000 20,000

9,000

a b

60,000 12,000

5,000

684,000* 298,500* 5,000* 181,500

10,000 13,500

10,000* 13,500*

60,000

158,000

132,000

Retained Earnings Retained earnings — Par

Retained earnings — Sam Controlling share of NI

158,000✓ 100,000*

Dividends Retained earnings December 31

50,000

190,000

90,000

15,000 20,000 60,000 5,000 30,000 420,000

Investment — Sam bonds

5,500 26,000 80,000 100,000 160,000 268,000 92,500

Investment — Sam stock

282,000

Goodwill Accounts payable 10% bonds payable Other liabilities Common stock 10% preferred stock Retained earnings

__________

$1,014,000

550,000

15,000 100,000 45,000 200,000 100,000

24,000 100,000 700,000 190,000✓

$1,014,000

50,000 158,000

60,000✓ 20,000*

Balance Sheet Cash Accounts receivable Inventories Other current assets Land Plant and equipment

f i

b d h

12,000 8,000 75,000

8,000 12,000

j c

5,000 16,000

92,500

Noncontrolling interest — preferred (beginning)

190,000

20,500 41,000 124,000 105,000 190,000 688,000

75,000 $1,243,500

j 5,000 e 100,000

34,000 145,000 700,000

h 200,000 g 100,000

190,000

550,000

Noncontrolling interest — common (beginning)

f 42,000 h 260,000

90,000✓ $

100,000*

2,000

65,000

g 100,000

10-26

Subsidiary Preferred Stock, Consolidated Earnings per Share, and Consolidated Income Taxation

Noncontrolling interest December 31

_________ 708,000

11,500 708,000

174,500 $1,243,500

Chapter 10

10-27

Solution P10-5 [EPS](in thousands) Requirement 1 Requirement 2 Diluted Diluted Sir’s EPS Sir’s net income (equal to income to common stockholders) Add: Net-of-tax interest on convertible bonds Sir’s earnings = a

$ 60 6 $ 66

$ 60 NA $ 60

Sir’s outstanding common shares Add: Shares from assumed conversion of bonds Common shares and common share equivalents = b Sir’s EPS = a/b

50 10 60 $1.10

50 NA 50 $1.20

$150

Pal’s EPS Pal’s net income (equal to income to common stockholders) Add: Net-of-tax interest on convertible bonds of Sir Replacement of Pal’s equity in Sir’s income with Pal’s equity in Sir’s diluted EPS (35,000 shares  $1.10) and convertible to Pal securities (35,000 shares  $1.20) Pal’s earnings = a Pal’s outstanding common shares Add: Shares from assumed conversion of bonds Common shares and common share equivalents = b Pal’s EPS = a/b a

6 (42) 38.5 ______ $146.5

(42)a

100

100 10 110 $1.42

100 $1.47

42a $156

When subsidiary securities are convertible into parent common stock, the replacement calculation is not needed. The replacement is included in this solution only to show that it has no effect on the calculation.

10-28

Subsidiary Preferred Stock, Consolidated Earnings per Share, and Consolidated Income Taxation

Solution P10-6 [EPS] Basic

a b a

She’s earnings per share Income to common Income to preferred assumed converted Earnings Common shares and common share equivalents: Common shares outstanding Add: Common shares issuable on preferred Add: Incremental shares issuable on options 2,000 - [($2,000  $15)/$30] Common and common equivalent shares EPS a/b Pen’s earnings per share Income to common Replacement calculation Equity in She’s income to common ($45,000  80%) Equity in She’s EPS 8,000  $4.50 basic EPS 8,000  $3.93 diluted EPS Earnings Common shares EPS a/b

Diluted

$ 45,000 ________ $ 45,000

$ 45,000 10,000 $ 55,000

10,000

10,000 3,000

________ 1,000 10,000 14,000 $ 4.50 $ 3.93 $150,000

$150,000

(36,000)a

(36,000)

36,000a 31,440 $150,000 $145,440 20,000 20,000 $ 7.50 $ 7.27

A replacement calculation is never needed when calculating basic earnings per share. It is only included here to illustrate the point that the replacement will have no impact on the earnings per share calculation.

Chapter 10

10-29

Solution P10-7 [EPS] 1

Basic

Sit’s earnings per share Income to common $50,000 - $14,000 Add: Income to preferred assumed converted Earnings Common shares outstanding Common shares from conversion of preferred

a b 2

$ 36,000

_______ $36,000 6,000 _______

14,000 $ 50,000 6,000 4,000

6,000

10,000

Consolidated earnings per share Net income to Pro Replacement calculation for diluted EPS $36,000  80% share of realized income $5.00 diluted EPS  4,800 shares Earnings Outstanding common shares EPS a/b Net income of Pro Add: Income to preferred

$36,000

Common and common equivalent shares EPS a/b

Earnings Common stock of Pro Common shares from conversion of Preferred Common and common share equivalents EPS a/b

Solution P10-8

Diluted

6.00

5.00

$93,800

$ 93,800

_______ $93,800 20,000 $ 4.69

(28,800) 24,000 $ 89,000 20,000 $ 4.45

$93,800

$ 93,800

_______ $93,800 20,000

11,200 $105,000 20,000

_______ 20,000 $ 4.69

5,000 25,000 $ 4.20

[EPS]

Pin’s net income Replacement calculation: Pin’s equity in Sum’s realized income ($500,000 - $60,000)  80% Pin’s equity in Sum’s diluted EPS (40,000 shares  $7.44) Consolidated diluted earnings = a Pin’s outstanding common shares = b Consolidated diluted EPS = a/b

$1,262,000 $352,000 297,600

54,400 $1,207,600 100,000 $ 12.08

10-30

Subsidiary Preferred Stock, Consolidated Earnings per Share, and Consolidated Income Taxation

Solution P10-9 [EPS](in thousands)

a b

Basic

Diluted

$200 (20)

$200 (20) 100 $280 50 30

Sim’s earnings per share Income to common Less: Unrealized profit — upstream sale Add: Income to preferred Earnings Common shares outstanding Add: Shares from conversion of preferred Add: Incremental shares from warrants 10,000 - ($150,000/$20) Common and common equivalent shares EPS a/b

$180 50

2.5 82.5 $3.3939

$450

$450 100 $4.50

(144) 135.6 $441.6 100 $4.42

Consolidated (and Pit’s) earnings per share Pit’s income to common Replacement calculation Equity in Sim’s realized income ($200,000 - $20,000)  80% Equity in Sim’s diluted EPS 40,000  $3.39 Earnings Outstanding common shares EPS a/b

50 $3.60

Solution P10-10 [Tax] Par Corporation Income Statement for the current year (in thousands) (a) Assuming Separate Tax Returns Sales $4,800 Gain on sale of land 200 Income from Sama 196 Cost of sales (2,400) Operating expenses (1,400) Income before income taxes 1,396 Income tax expenseb (340) Net income $1,056

(b) Assuming Consolidated Tax Return $4,800 200 196 (2,400) 1,400) 1,396 (340) $1,056

Supporting computations a

Income from Sam Equity in Sam’s income ($600 - $204 income taxes)  100% Less: Unrealized profit Income from Sam Income tax expense Income tax currently payable: Par’s $1,200 taxable income  34% Consolidated taxable income of $1,600  34%  $1,000/$1,600 Deferred income taxes: Deferred tax asset ($200  34%) Income tax expense

$ 396 (200) $ 196

$396 (200) $196

$408 $340 (68) $340

____ $340

Chapter 10

10-31

Note: There is no tax on undistributed income because Par and Sam are an affiliated group.

10-32

Subsidiary Preferred Stock, Consolidated Earnings per Share, and Consolidated Income Taxation

Solution P10-11 [Tax] Preliminary computations Investment cost

$1,155,000

Implied total fair value of Sir($1,155,000 / 70%) Less: Book value of Sir Excess fair value over book value = Goodwill

$1,650,000 1,600,000 $ 50,000

Income tax expense (separate tax returns required) Pan Tax on operating income ($1,000,000  34%) ($400,000  34%) Tax on dividends received ($100,000  70%)  20% taxable  34% tax rate Income taxes currently payable Deferred tax on undistributed income ($98,000*  70%)  20% taxable  34% tax rate Deferred tax asset on unrealized inventory profit ($100,000  34%) Income tax expense *

Sir

$340,000 $136,000 4,760 344,760

_________ 136,000

(4,664) ________

(34,000)

$340,096

$102,000

Undistributed income (Sir’s operating income of $400,000 - $102,000 tax $100,000 unrealized profit - $100,000 dividends paid) = $98,000

Income from Sir $208,600 (70,000) $138,600

Equity in Sir’s net income ($400,000 - $102,000 tax)  70% Unrealized inventory profit ($100,000  70%) Income from Sir 3

Pan Corporation and Subsidiary Consolidated Income Statement for the year ended December 31, 2011 Sales ($10,000,000 - $240,000) Cost of sales ($5,100,000 + $100,000 - $240,000) Gross profit Operating expenses Income before income taxes and noncontrolling interest Less: Income taxes ($340,096 + $102,000) Total consolidated income Less: Noncontrolling interest share ($298,000 net income - $100,000 unrealized)  30%

$9,760,000 4,960,000 4,800,000 3,500,000 1,300,000 442,096 857,904

Controlling share of NI

798,504

659,904 138,600 798,504

59,400

10-34

Subsidiary Preferred Stock, Consolidated Earnings per Share, and Consolidated Income Taxation

Solution P10-12 [Tax] Pub Corporation and Subsidiary Partial Consolidation Working Papers for the year ended December 31, 2011 Pub Income Statement Sales $500,000 Dividends received from Sew 28,000 Cost of sales 250,000* Operating expenses 78,000* Income tax expense 58,222* Noncont. Share** Control. Share - NI $141,778

70% Sew $300,000

120,000* 80,000* 34,000*

Adjustments and Eliminations

Noncont. Interest

a 90,000 c 28,000 b 10,000

Consolidated Statements $

710,000

290,000* 158,000* 92,222* 19,800* 149,978

a 90,000

$19,800 $ 66,000

Note: The offsetting credits to entries b and c are to inventory and dividend accounts, respectively. * **

Deduct Noncontrolling interest share = $66,000  30%

Supporting computations Pub Income taxes currently payable Taxes on operating income ($172,000  34%) ($100,000  34%) Tax on dividends received ($40,000  70%)  20% taxable  34% tax rate Tax on undistributed income ($26,000  70%)  20% taxable  34% tax rate Less: Deferred tax on inventory profit $10,000  34% tax rate Income tax expense

Sew

$58,480 $ 34,000 1,904 60,384

________ 34,000

1,238 (3,400) $58,222

Consolidated net income check Sew’s net income of $66,000  70% Less: Unrealized inventory profit Income from Sew — equity basis Less: Sew’s income — cost basis Cost — equity method difference Add: Pub’s reported net income Controlling share of NI

________ $ 34,000 $ 46,200 (10,000) 36,200 (28,000) 8,200 141,778 $149,978

Chapter 10

Solution P10-13

10-35

[Tax]

Preliminary computations Investment cost

$900,000

Implied total fair value of Soo($900,000 / 90%) Less: Book value of Soo Excess fair value over book value = Goodwill

$1,000,000 900,000 $ 100,000

Soo $200,000

$221,430

$ 62,700

(475,000) (180,000) (117,300) (6,270) $ 221,430

Pen’s income tax expense is calculated: Sales Cost of Sales Expenses Pretax income Tax rate Income tax expense

800,000 (400,000) (150,000) 250,000 .34 85,000

Sales Gain on land sale Income from Soo Cost of sales Expenses Income tax expense Noncontrolling share Controlling share of NI

Adjustments and Eliminations

Pen $800,000 20,000 36,430 (400,000) (150,000) (85,000)a

a 20,000 b 36,430 (75,000) (30,000) (32,300)

Preliminary computations Income from Soo for 2011 Share of Soo’s net income ($62,700  90%) Less: Unrealized profit on intercompany sale of land Income from Soo Investment in Soo account December 31, 2011 Cost of 90% interest in Soo January 1 Add: Income from Soo Less: Dividends from Soo Investment December 31 a

Consolidated $1,000,000

$ 56,430 (20,000) $ 36,430 $900,000 36,430 (45,000) $891,430

Gain on sale of land 20,000 Land 20,000 To eliminate unrealized intercompany profit from downstream sale of land. Income from Soo 36,430 Investment in Soo 8,570 Dividends from Soo 45,000 To eliminate investment income and dividends and return the investment in Soo account to its beginning of the period balance. Capital stock — Soo Retained earnings — Soo Goodwill Investment in Soo Noncontrolling interest January 1

500,000 400,000 100,000

900,000 100,000

10-36

Subsidiary Preferred Stock, Consolidated Earnings per Share, and Consolidated Income Taxation

To eliminate reciprocal beginning of the period investment and equity balances, establish beginning noncontrolling interest, and enter goodwill. Noncontrolling interest share 6,270 Dividends 50,000 x 10% 5,000 Noncontrolling interest 1,270

Chapter 10

10-37

Solution P10-14 [Tax] 1

Allocation schedule Cost of investment = Fair value (100% purchase) Book value Excess fair value over book value Excess allocated Land Buildings — net Equipment — net Goodwill for the remainder Excess fair value over book value

$280,000 170,000 $110,000 $ 40,000 30,000 10,000 30,000 $110,000

(10 year life) (2 year life)

Note: In a taxable combination transaction there are no deferred tax liabilities since the tax basis and book basis are the same. A current tax deduction will affect the future recognized income from Sad Corporation. 2

Allocation schedule Cost (fair value) of investment Book value Excess fair value over book value Excess allocated: Land Buildings — net Equipment — net Deferred tax liability ($80,000  35%) Goodwill for the remainder Excess fair value over book value a

$280,000 170,000 $110,000 $ 40,000 30,000 10,000

(10 year life) (2 year life)

(28,000)a 58,000 $110,000

On a tax-free reorganization a deferred tax liability must be set up for all the tax basis/book basis differentials, other than goodwill. Since the transaction is recorded at purchase price on the books but has no change in tax basis from the original books, differences in basis occur and are equal to any fair value write-ups of the assets.

Par’s income from Sad for 2011 Taxable Sad’s reported income Less: Depreciation on excess allocated to buildings — net ($30,000/10 years) Less: Depreciation on excess allocated to equipment — net ($10,000/2 years) Add: Income tax reductions due to the prior adjustments Income from Sad a

$ 50,000 (3,000) (5,000) 2,800a $ 44,800

Since all two items are currently deductible for tax purposes they will reduce the income taxes Par will have to pay.

10-38

Subsidiary Preferred Stock, Consolidated Earnings per Share, and Consolidated Income Taxation

Solution P10-14 (continued) Tax free Sad’s reported income Less: Depreciation on excess allocated to buildings — net ($30,000/10 years) Add: Amortization of deferred tax liability allocated to buildings ($3,000  .35) Less: Depreciation on excess allocated to equipment — net ($10,000/2 years) Add: Amortization of deferred tax liability allocated to equipment ($5,000  .35) Income from Sad

$50,000 (3,000) 1,050 (5,000) 1,750 $44,800

Solution P10-15 1

Income tax expense Pop Income taxes currently payable: Taxes on operating income $1,400,000  34% $800,000  34% Tax on dividends received: $280,000  20% taxable  34% tax rate Income taxes currently payable Tax on undistributed income: $128,000  70%  20% taxable  34% tax rate Less: Deferred tax on gain on equipment $400,000  34% tax rate Income tax expense

$476,000 $272,000 19,040 495,040

________ 272,000

6,093 (136,000) $365,133

________ $272,000

Loss from Son Income from Son on an equity basis Son’s net income of $528,000  70% Less: Unrealized gain ($500,000 - $100,000) Income from Son — equity basis (loss)

Son

$ $

369,600 (400,000) (30,400)

Pop Corporation and Subsidiary Consolidated Income Statement for the year ended December 31, 2011 Sales Cost of sales Gross profit Other expenses ($2,100,000 + $1,200,000 - $100,000) Income before income taxes Income tax expense ($365,133 + $272,000) Total consolidated income Less: Noncontrolling interest share ($528,000  30%) Controlling share of NI

$12,000,000 (7,000,000) 5,000,000 (3,200,000) 1,800,000 (637,133) 1,162,867 (158,400) $ 1,004,467

Check: Pop’s pretax income of $1,400,000 - $30,400 loss from Son $365,133 income taxes = $1,004,467 Controlling share of NI

Chapter 10

10-39

Solution P10-16 1

[Tax]

Sal’s net income Pretax income Less: Income tax expense: Taxes currently payable ($430,000  34%) Less: Deferred tax asset — land ($30,000  34%) Sal’s net income

$ $146,200 (10,200)

(136,000) $ 294,000

Pix’s income from Sal Share of Sal’s net income ($294,000  90%) Less: Unrealized gain on upstream sale of land ($30,000  90%) Less: Unrealized inventory profit Income from Sal on an equity basis

430,000

264,600

(27,000) (15,000) 222,600

Pix’s net income Sales Income from Sal Less: Cost of sales and expenses Income before income taxes Income tax expense ($209,100 currently payable less $5,100a deferred tax asset) Net income a

$3,815,000 222,600 (2,200,000) 1,837,600 (204,000) $1,633,600

The deferred tax asset is $5,100 deferral for the inventory profit.

Chapter 11 CONSOLIDATION THEORIES, PUSH-DOWN ACCOUNTING, AND CORPORATE JOINT VENTURES Answers to Questions 1

Parent company theory views consolidated financial statements from the viewpoint of the parent and entity theory views consolidated financial statements from the viewpoint of the business entity under which all resources are controlled by a single management team. By contrast, traditional theory sometimes reflects the parent viewpoint and at other times it reflects the viewpoint of the business entity. A detailed comparison of these theories is presented in Exhibit 11–1 of the text.

Only contemporary theory is changed by current pronouncements of the Financial Accounting Standards Board. While such pronouncements can and do change the current accounting and reporting practices, they do not change the logic or the consistency of either parent company or entity theory.

The valuation of subsidiary assets on the basis of the price paid for the controlling interest seems justified conceptually when substantially all of the subsidiary stock is acquired by the parent. But the conceptual support for this approach is less when only a slim majority of subsidiary stock is acquired. In addition, the valuation of the noncontrolling interest based on the price paid by the parent has practical limitations because noncontrolling interest does not represent equity ownership in the usual sense. The ability of noncontrolling stockholders to participate in management is limited and noncontrolling shares do not possess the usual marketability of equity securities.

Consolidated assets are equal to their fair values under entity theory only when the book values of parent assets are equal to their fair values. Otherwise, consolidated assets are not equal to their fair values under either parent company or entity theories.

The valuation of the noncontrolling interest at book value might overstate the equity of noncontrolling shareholders because of the limited marketability of shares held by noncontrolling stockholders and because of the limited ability of noncontrolling stockholders to share in management through their voting rights. Valuation of the noncontrolling interest at book value also overstates or understates the noncontrolling interest unless the subsidiary assets are recorded at fair values.

Consolidated net income under parent company theory and income to the controlling stockholders under entity theory should be the same. This is illustrated in Exhibit 11–5, which shows different income statement amounts for cost of sales, operating expenses, and income allocated to noncontrolling stockholders, but the same income to controlling stockholders. Note that consolidated net income under parent company and traditional theories reflects income to controlling stockholders.

Income to the parent stockholders under the equity method of accounting is the same as income to the controlling stockholders under entity theory. But income to controlling stockholders is not identified as consolidated net income as it would be under parent company or traditional theories.

Consolidated income statement amounts under entity theory are the same as under traditional theory when subsidiary investments are made at book value because traditional theory follows entity theory in eliminating the effects of intercompany transactions from consolidated financial statements.

11-2

Consolidation Theories, Push-down Accounting, and Corporate Joint Ventures

Traditional theory corresponds to entity theory in matters relating to unrealized and constructive gains and losses from intercompany transactions. In other words, unrealized and constructive gains and losses are allocated between controlling and noncontrolling interests in the same manner under these two theories.

Push-down accounting simplifies the consolidation process. The push-down adjustments are recorded in the subsidiary’s separate books at the time of the business combination; thus, it is not necessary to allocate the unamortized fair values in the consolidation working papers.

A joint venture is an entity that is owned, operated, and jointly controlled by a small group of investorventurers to operate a business for the mutual benefit of the venturers. Some joint ventures are organized as corporations, while others are organized as partnerships or undivided interests. Each venturer typically participates in important decisions of a joint venture irrespective of ownership percentage.

Investors in corporate joint ventures use the equity method of accounting and reporting for their investment earnings and investment balances as required by GAAP. The cost method would be used only if the investor could not exercise significant influence over the corporate joint venture. Alternatively, investors in unincorporated joint ventures use the equity method of accounting and reporting or proportional consolidation for undivided interests specified as a special industry practice.

SOLUTIONS TO EXERCISES Solution E11-1 1 2 3 4

A A C A

5 6 7

B C D

4 5

D C

Solution E11-2 1 2 3

B B D

Chapter 11

11-3

Solution E11-3 1

c Total value of Sit implied by purchase price ($1,440,000/.8) Noncontrolling interest percentage Noncontrolling interest

$1,800,000 20% $360,000

a Only the parent’s percentage of unrealized profits from upstream sales is eliminated under parent company theory.

b Subsidiary’s income of $400,000  10% noncontrolling interest Less: Patent amortization ($140,000/10 years  10%) Noncontrolling interest share

a Implied fair value — $1,680,000 = patents at acquisition Book value of 100% of identifiable net assets Add: Patents at acquisition ($108,000/90%) Total implied value Percent acquired Purchase price under entity theory

$ 40,000 (1,400) $ 38,600

$1,680,000 120,000 1,800,000 80% $1,440,000

b Purchase price — ($1,680,000  80%) = patents at acquisition $1,344,000 Book value $1,680,000  80% = underlying equity Add: Patents at acquisition ($108,000/90%) 120,000 Purchase price (traditional theory) $1,464,000

11-4

Consolidation Theories, Push-down Accounting, and Corporate Joint Ventures

Solution E11-4 1

Goodwill Parent company theory Cost of investment in Sad Fair value acquired ($400,000  80%) Goodwill Entity theory Implied value based on purchase price ($500,000/.8) Fair value of Sad’s net assets Goodwill Noncontrolling interest Parent company theory Book value of Sad’s net assets Noncontrolling interest percentage Noncontrolling interest Entity theory Total valuation of Sad Noncontrolling interest percentage Noncontrolling interest Total assets Parent company theory Pod Current assets $ 20,000 Plant assets — net 480,000 Goodwill $500,000 Entity theory Current assets $ 20,000 Plant assets — net 480,000 Goodwill $500,000

Sad $ 50,000 250,000

$ $ $

$ $ $ $

Adjustment $ 40,000  80% 110,000  80%

$300,000 $ 50,000 250,000

$ 40,000  100% 110,000  100%

$300,000

500,000 320,000 180,000 625,000 400,000 225,000

260,000 20% 52,000 625,000 20% 125,000

Total 102,000 818,000 180,000 $1,100,000 $

110,000 840,000 225,000 $1,175,000

Chapter 11

11-5

Solution E11-5 Preliminary computations Parent company theory Cost of 80% interest Fair value acquired ($700,000  80%) Goodwill

$600,000 560,000 $ 40,000

Entity theory Implied total value ($600,000 cost ÷ 80%) Fair value of Sal’s net identifiable assets Goodwill

$750,000 700,000 $ 50,000

Consolidated net income and noncontrolling interest share for 2012: Parent Entity Company Theory Theory Combined separate incomes Depreciation on excess allocated to equipment: $150,000 excess  80% acquired ÷ 5 years $150,000 excess ÷ 5 years Total consolidated income Less: Noncontrolling interest share $100,000  20% ($100,000 - 30,000)  20% Controlling interest share of NI Consolidated net income Goodwill at December 31, 2012:

$1,100,000

(24,000) (30,000) 1,070,000 (20,000) ___________ $1,056,000 $ 40,000

(14,000) $1,056,000 $

50,000

11-6

Consolidation Theories, Push-down Accounting, and Corporate Joint Ventures

Solution E11-6 Preliminary computation Interest acquired in Sal: 36,000 shares  40,000 shares = 90% 1

Sal’s net assets under entity theory Implied value from purchase price: $900,000/90% interest

Goodwill a

c 3

Entity theory Implied value Less: Fair value and book value of net assets Goodwill Parent company theory Cost of 90% interest Fair values of net assets acquired ($855,000  90%) Goodwill Traditional theory (same as parent theory)

$1,000,000 855,000 $ 145,000 $ $

900,000 769,500 130,500

130,500

18,000

Investment income from Sal Income from Sal ($40,000  1/2 year  90% interest)

$1,000,000

Noncontrolling interest under entity theory Imputed value of Sal at July 1, 2012 Add: Income for 1/2 year Noncontrolling percentage Noncontrolling interest

$1,000,000 20,000 1,020,000 10% $ 102,000

Alternatively, $100,000 noncontrolling interest at July 1, plus $2,000 share of reported income = $102,000

Chapter 11

11-7

Solution E11-7 1

Parent company theory Combined separate incomes of Pal and Sal Less: Pal’s share of unrealized profits from upstream inventory sales ($30,000  80%) Less: Noncontrolling interest share ($300,000  20%) Consolidated net income

$800,000 (24,000) (60,000) $716,000

Entity theory Combined separate incomes Less: Unrealized profits from upstream sales Total consolidated income

$800,000 (30,000) $770,000

Income allocated to controlling stockholders ($500,000 + [$270,000  80%])

$716,000

Income allocated to noncontrolling stockholders ($300,000 - $30,000)  20%

$ 54,000

Solution E11-8

Combined separate incomes Less: Unrealized inventory profits from downstream sales ($60,000 - $30,000)  50% Less: Unrealized profit on upstream sale of land ($96,000 - $70,000)  100% ($96,000 - $70,000)  80% Less: Noncontrolling interest share ($60,000 - $26,000)  20% $60,000  20% Consolidated net income

Traditional Theory $180,000

Parent Company Theory $180,000

Entity Theory $180,000

(15,000)

(26,000)

(26,000) (20,800)

(6,800) $132,200

(12,000) $132,200

Total consolidated income Allocated to controlling stockholders Allocated to noncontrolling Stockholders ($60,000 - $26,000)  20%

$139,000 $132,200

6,800

11-8

Consolidation Theories, Push-down Accounting, and Corporate Joint Ventures

Solution E11-9

[Push-down accounting]

Push down under parent company theory Retained earnings 800,000 Inventories 90,000 Land 450,000 270,000 Buildings — net Goodwill 360,000 Equipment 180,000 Other liabilities 90,000 Push down equity 1,700,000 To record revaluation of 90% of the net assets and elimination of retained earnings as a result of a business combination with Pin Corporation. Push down equity = ($600,000 fair value -- book value differential  90%) + $360,000 goodwill + $800,000 retained earnings.

Push down under entity theory Retained earnings 800,000 Inventories 100,000 Land 500,000 300,000 Buildings — net Goodwill 400,000 200,000 Equipment — net Other liabilities 100,000 Push down equity 1,800,000 To record revaluation of 100% of the net assets and elimination of retained earnings as a result of a business combination with Pin. Push down equity = $600,000 fair value -- book value differential + $400,000 goodwill + $800,000 retained earnings.

Solution E11-10 Each of the investments should be accounted for by the equity method as a one-line consolidation because the joint venture agreement requires consent of each venturer for important decisions. Thus, each venturer is able to exercise significant influence over its joint venture investment irrespective of ownership interest. The 40 percent venturer: Income from Sun ($500,000  40%) Investment in Sun ($8,500,000  40%)

$ 200,000 $3,400,000

The 15 percent venturer Income from Sun ($500,000  15%) Investment in Sun ($8,500,000  15%)

$ 75,000 $1,275,000

Chapter 11

11-9

Solution E11-11 In general, VIE accounting follows normal consolidation principles. Under that approach, the noncontrolling interest share would be 90% of VIE earnings, or $900,000. However, the intercompany fees must be allocated to the primary beneficiary, not to noncontrolling interests. Therefore, in this case, noncontrolling interest share would be 90% of $920,000, or $828,000. Solution E11-12 As primary beneficiary, Pal must include Pot in its consolidated financial staements. Additionally, Pal must make the following disclosures: (a) the nature, purpose, size, and activities of the variable interest entity, (b) the carrying amount and classification of consolidated assets that are collateral for the variable interest entity’s obligations, and (c) lack of recourse if creditors (or beneficial interest holders) of a consolidated variable interest entity have no recourse to the general credit of the primary beneficiary. Den will not consolidate Pot, since they are not the primary beneficiary. As in traditional consolidations, only one firm consolidates a subsidiary. However, since Den has a significant interest in Pot, they must disclose: (a) the nature of its involvement with the variable interest entity and when that involvement began, (b) the nature, purpose, size, and activities of the variable interest entity, and (c) the enterprise’s maximum exposure to loss as a result of its involvement with the variable interest entity. Den accounts for the investment using the equity method. Solution E11-13 According to GAAP, if an enterprise absorbs a majority of a variable interest entity’s expected losses and another receives a majority of expected residual returns, the enterprise absorbing the losses is the primary beneficiary and if condition one is also met. Laura meets condition one, since as CEO, she had the power over economic decisions. Laura must consolidate the variable interest entity. The contractual arrangement makes Laura the primary beneficiary.

11-10

Consolidation Theories, Push-down Accounting, and Corporate Joint Ventures

SOLUTION TO PROBLEMS Solution P11-1 Pin Corporation and Subsidiary Comparative Consolidated Balance Sheets at December 31, 2012 (in thousands) Parent Company Theory Assets Cash Receivables — net Inventories Plant assets — neta Patentsb Total assets Liabilities Accounts payable Other liabilities Noncontrolling interestc Total liabilities Capital stock Retained earnings Noncontrolling interestd Total stockholders’ equity Total liabilities and stockholders’ equity a

b c d

Entity Theory

52 300 450 1,998 64 $2,864

52 300 450 2,010 80 $2,892

304 500 160 964 1,000 900 0 1,900

$2,864

$2,892

304 500 804 1,000 900 188 2,088

Parent company theory: Combined plant assets of $1,950 + ($80  3/5 undepreciated excess) Entity theory: Combined plant assets of $1,950 + ($100  3/5 undepreciated excess) Parent company theory: $80 patents - $16 amortization Entity theory: $100 patents - $20 amortization Parent company theory: Noncontrolling interest equals Son’s equity of $800  20% Entity theory: [Son’s equity of $800 + ($60 undepreciated plant assets + $80 unamortized patents)]  20%

Chapter 11

11-11

Solution P11-2 Preliminary computation Implied value of Sip based on purchase price ($320,000/.8) Book value Excess to undervalued equipment 1

$400,000 340,000 $ 60,000

Par Corporation and Subsidiary Consolidated Income Statement for the year ended December 31, 2011 Sales Less: Cost of sales Gross profit Other expenses Depreciationa

$1,200,000 760,000 440,000 $ 160,000 159,000

Total consolidated net income Allocation of income to: Noncontrolling interestb Controlling interest a b

319,000 $

121,000

$ $

8,200 112,800

$150,000 depreciation - $1,000 piecemeal recognition of gain on equipment through depreciation + ($60,000 excess  6 years) excess depreciation ($60,000 reported income - $10,000 unrealized gain on equipment + $1,000 piecemeal recognition of gain on equipment - $10,000 excess depreciation)  20% interest

Par Corporation and Subsidiary Consolidated Balance Sheet at December 31, 2011 Assets Current assets Plant and equipment — net ($1,190,000 - $399,000 + 50,000) Total assets Liabilities and equity Liabilities Capital stock Retained earningsa Noncontrolling interestb Total liabilities and stockholders’ equity a b

483,200

841,000 $1,324,200 $

300,000 600,000 340,000 84,200 $1,324,200

Par beginning retained earnings $327,200 + Par net income $112,800 - Par dividends of $100,000 ($380,000 stockholders’ equity + $50,000 excess - $9,000 unrealized gain on equipment)  20%

Check: $80,000 beginning noncontrolling interest + $8,200 noncontrolling interest share - $4,000 noncontrolling interest dividends = $84,200

11-12

Consolidation Theories, Push-down Accounting, and Corporate Joint Ventures

Solution P11-3 Parent company theory 1a Income from Sin for 2012 ($180,000  70%)

$126,000

Goodwill at December 31, 2012 ($1,190,000 cost - $1,050,000 fair value)

$140,000

Consolidated net income for 2012 Pal’s separate income Add: Income from Sin

$600,000 126,000

Noncontrolling interest share for 2012 Net income of Sin of $180,000  30%

$726,000

$ 54,000

Noncontrolling interest December 31, 2012 Sin’s stockholders’ equity $1,580,000  30%

$474,000

Entity theory 2a

Income from Sin for 2012 ($180,000  70%)

Goodwill at December 31, 2012 Imputed value ($1,190,000/70%) Fair value of Sin’s net assets Goodwill

$126,000

$1,700,000 1,500,000 $ 200,000

Total consolidated income for 2012 Income to controlling stockholders ($600,000 + $126,000) Add: Noncontrolling interest share ($180,000  30%) Total consolidated income

$726,000 54,000 $780,000

Noncontrolling interest share (computed in 2c above)

$ 54,000

Noncontrolling interest at December 31, 2012 (Book equity $1,580,000 + $200,000 goodwill)  30%

$534,000

Chapter 11

11-13

Solution P11-4 Preliminary computations Parent company theory Investment in Sam Fair value of 80% interest acquired ($2,400,000  80%) Goodwill

$2,240,000 1,920,000 $ 320,000

Entity Theory Implied value of Sam ($2,240,000/.8) Fair value of identifiable net assets Goodwill

$2,800,000 2,400,000 $ 400,000

Pit used an incomplete equity method in accounting for its investment in Sam. It ignored the intercompany upstream sales of inventory. Income from Sam on an equity basis would be: $ 400,000 Share of Sam’s income ($500,000  .8) Less: Unrealized profits in ending inventory from (32,000) upstream sale ($80,000  50%  80%) Income from Sam $ 368,000 Pit Corporation and Subsidiary Comparative Consolidated Income Statements for the year ended December 31, 2012 (in thousands) Parent Traditional Company Theory Theory Sales($10,000 - $230) $9,770 $9,770 Less: Cost of sales ($5,750 - $230 + $32) (5,552) ($5,750 - $230 + $40) (5,560) Gross profit 4,210 4,218 Expenses

(2,000)

Noncontrolling interest share $500  20% ($500 - $40) x 20% Consolidated net income Total consolidated income Allocated to controlling Stockholders Allocated to noncontrolling Stockholders ($500 - $40)  20%

Entity Theory $9,770 (5,560) 4,210

(2,000)

(100) (92) $2,118

2,118

________ $ 2,210 $

2,118

11-14

Consolidation Theories, Push-down Accounting, and Corporate Joint Ventures

Solution P11-4 (continued) Pit Corporation and Subsidiary Comparative Statements of Retained Earnings for the year ended December 31, 2012 (in thousands) Parent Company Retained earnings December 31, 2011 Add: Consolidated net income Add: Net income to controlling stockholders Less: Dividends to controlling stockholders Retained earnings December 31, 2012

Traditional Theory Theory $ 3,600 $ 3,600 2,118 2,118

Entity $

Theory 3,600 2,118

5,718 (1,200) $

4,518

5,718 (1,200) $

4,518

5,718 (1,200) $

4,518

Pit Corporation and Subsidiary Comparative Consolidated Balance Sheets at December 31, 2012 (in thousands)

Traditional Theory Assets Cash Accounts receivable Inventory Land Buildings — net Goodwill Total assets

Liabilities Accounts payable Noncontrolling interest Total liabilities Stockholders’ equity Capital stock Retained earnings Noncontrolling interest Total stockholders’ equity Total equities

Parent Company

Entity

Theory

1,108 1,200 1,960 2,800 8,400 320 $ 15,788

1,108 1,200 1,968 2,800 8,400 320 $ 15,796

2,758 520 3,278

8,000 4,518

8,000 4,518 592 13,110 $ 15,868

2,758 2,758

8,000 4,518 512 13,030 $ 15,788

12,518 $ 15,796

1,108 1,200 1,960 2,800 8,400 400 $ 15,868 2,758 2,758

Chapter 11

11-15

Solution P11-5 Pad Corporation and Subsidiary Comparative Balance Sheets at December 31, 2012 Traditional Theory

Entity Theory

Assets Cash Receivables — net Inventories Plant assets — net Goodwill Total assets

$ 70,000 110,000 120,000 300,000 40,000 $640,000

$ 70,000 110,000 120,000 300,000 50,000 $650,000

Liabilities Accounts payable Other liabilities Total liabilities

$ 95,000 25,000 120,000

300,000 194,000

Stockholders’ equity Capital stock Retained earnings Noncontrolling interest ($150,000 - $20,000)  20% ($150,000 + $50,000 - $20,000)  20% Total stockholders’ equity Total equities Supporting computations Cost or imputed value Book value of 80% Book value of 100% Goodwill Investment cost Add: 80% of retained earnings increase ($50,000 - $10,000)  80% Less: 80% of $20,000 unrealized profits Investment balance

26,000 520,000 $640,000 Traditional Theory $128,000 88,000 $ 40,000 $128,000 32,000 (16,000) $144,000

36,000 530,000 $650,000 Entity Theory $160,000 110,000 $ 50,000

11-16

Consolidation Theories, Push-down Accounting, and Corporate Joint Ventures

Solution P11-6 [AICPA adapted] 1

P carries its investment in S on a cost basis. This is evidenced by the appearance of dividend revenue in P Company’s income statement and by the absence of income from subsidiary.

P holds 1,400 shares of S. P Company’s percentage ownership is 70%, as determined by the relationship of P Company’s dividend revenues and S Company’s dividends paid ($11,200/$16,000). S has 2,000 outstanding shares ($200,000/$100) and P holds 70% of these, or 1,400 shares.

S Company’s retained earnings at acquisition were $100,000. Imputed value of S ($245,000 cost/70%) Less: Patents (applicable to 100%) Book value and fair value of S’s identifiable net assets Less: Capital stock Retained earnings

350,000 (50,000) 300,000 (200,000) $ 100,000

The nonrecurring loss is a constructive loss on the purchase of P bonds by S Company. Working paper entry: Mortgage bonds payable (5%) 100,000 Loss on retirement of P bonds 3,000 P bonds owned 103,000 To eliminate intercompany bond investment and bonds payable and to recognize a loss on the constructive retirement of P bonds.

Intercompany sales P to S are $240,000 computed as follows: Combined sales ($600,000 + $400,000) Less: Consolidated sales Intercompany sales

$1,000,000 760,000 $ 240,000

Yes, there are other intercompany debts: Cash and receivables Current payables Dividends payable

Combined $143,000 93,000 18,000

Consolidated $97,400 53,000 12,400

Intercompany Balances $ 45,600 40,000 5,600

S Company owes P Company $40,000 on intercompany purchases and P Company owes S Company $5,600 dividends.

Chapter 11

11-17

Solution P11-6 (continued) 7

Adjustment to determine consolidated cost of goods sold: Consolidated Cost of Goods Sold Combined cost of goods $640,000 $240,000 Intercompany purchases Sold Unrealized profit in Unrealized profit in ending inventory 8,000 5,000 beginning inventory To balance 403,000✓ $648,000 $648,000 Consolidated cost of goods sold $403,000 Unrealized profit in ending inventory is equal to the combined less consolidated inventories ($130,000 - $122,000). Unrealized profit in beginning inventory is plugged as follows: ($640,000 + $8,000) - ($240,000 + $403,000) = $5,000

Noncontrolling interest share of $8,700 is computed as follows: Net income of S Less: Patent amortization ($50,000/10 years) Adjusted income of S Noncontrolling interest percentage Noncontrolling interest share

Noncontrolling interest of $117,000 at the balance sheet date is computed: Stockholders’ equity of S Company Add: Unamortized patents Equity of S plus unamortized patents Noncontrolling interest percentage Noncontrolling interest on balance sheet date

$ 34,000 5,000 29,000 30% $ 8,700

$360,000 30,000 390,000 30% $117,000

Consolidated retained earnings Retained earnings of P at end of year Add: P’s share of increase in S’s retained earnings since acquisition ($160,000 - $100,000)  70% Less: Unrealized profit in S’s ending inventory Less: S’s patent amortization since acquisition $20,000  70% Less: Loss on constructive retirement of P’s bonds Consolidated retained earnings — end of year

$200,000 42,000 (8,000) (14,000) (3,000) $217,000

11-18

Consolidation Theories, Push-down Accounting, and Corporate Joint Ventures

Solution P11-7 1

Entry on Sap’s books at acquisition Inventories 20,000 Land 25,000 90,000 Buildings — net Other liabilities 10,000 Goodwill 70,000 Retained earnings 80,000 Equipment — net Push-down capital To push down fair value — book value differentials.

Sap Corporation Balance Sheet at January 1, 2012 Assets Cash Accounts receivable — net Inventories Total current assets Land Buildings — net Equipment — net Total plant assets Goodwill Total assets Liabilities And Stockholders’ Equity Accounts payable Other liabilities Total liabilities Capital stock Push-down capital Total stockholders’ equity Total liabilities and stockholders’ equity

15,000 280,000

$ 30,000 70,000 80,000 $180,000 $ 75,000 190,000 75,000 340,000 70,000 $590,000 $ 50,000 60,000 $110,000 $200,000 280,000 480,000 $590,000

If Sap reports net income of $90,000 under the new push-down system for the calendar year 2012, Pay’s income from Sap will also be $90,000 under a one-line consolidation.

Chapter 11

11-19

Solution P11-8 1

Parent company theory Preliminary computation: Cost of 80% interest in Son Book value acquired ($2,000,000  80%) Excess cost over book value acquired Excess allocated to: Inventories $1,600,000  80% Equipment — net $(500,000)  80% Goodwill for the remainder Excess fair value over book value acquired Entry on Son’s books to reflect 80% push down: Inventories Goodwill Retained earnings Equipment — net Push-down capital

$1,280,000 (400,000) 520,000 $1,400,000 1,280,000 520,000 1,200,000 400,000 2,600,000

Entity theory Preliminary computation: Implied value of net assets ($3,000,000/.8) Book value of net assets Total excess Excess allocated to: Inventories Equipment — net Goodwill for remainder Total excess Entry on Son’s books to reflect 100% push down: Inventories Goodwill Retained earnings Equipment Push-down capital

$3,000,000 1,600,000 $1,400,000

$3,750,000 2,000,000 $1,750,000 $1,600,000 (500,000) 650,000 $1,750,000 1,600,000 650,000 1,200,000

Noncontrolling interest (Parent company theory) Son’s stockholders’ equity $2,000,000  20%

500,000 2,950,000

400,000

Noncontrolling interest (Entity theory) Capital stock Push-down capital Stockholders’ equity Noncontrolling interest percentage Noncontrolling interest

800,000 2,950,000 3,750,000 20% $ 750,000

11-20

Consolidation Theories, Push-down Accounting, and Corporate Joint Ventures

Solution P11-9 1

Push down under parent company theory 18,000 Buildings — net 27,000 Equipment — net Goodwill 36,000 Retained earnings 20,000 Inventories 9,000 Push-down capital 92,000 To record revaluation of 90% of net assets and elimination of retained earnings as a result of a business combination with Paw Corporation.

Push down under entity theory 20,000 Buildings — net 30,000 Equipment — net Goodwill 40,000 Retained earnings 20,000 Inventories 10,000 Push-down capital 100,000 To record revaluation of net assets imputed from purchase price of 90% interest acquired by Paw Corporation.

Sun Corporation Comparative Balance Sheets at January 1, 2012 Parent Company Theory

Entity Theory

Assets Cash Accounts receivable — net Inventories Land Buildings — net Equipment — net Goodwill Total assets

$ 20,000 50,000 31,000 15,000 48,000 97,000 36,000 $297,000

$ 20,000 50,000 30,000 15,000 50,000 100,000 40,000 $305,000

Liabilities and stockholders’ equity Accounts payable Other liabilities Capital stock Push-down capital Retained earnings Total equities

$ 45,000 60,000 100,000 92,000 0 $297,000

$ 45,000 60,000 100,000 100,000 0 $305,000

Chapter 11

11-21

Solution P11-10—Push down 90%--parent company theory a Paw Corporation and Subsidiary Consolidation Working Papers for the year ended December 31, 2012 90% Sun

Power

Adjustments and Eliminations

Income Statement Sales $ 310,800 $ 110,000 Income from Sun 37,800 b Cost of sales 140,000* 33,000* Depreciation expense 29,000* 24,200* Other operating exp. 45,000* 11,000* Consolidated NI Noncontrolling share e Controlling share of NI $ 134,600 $ 41,800

Consolidated Statements $

420,800

37,800

173,000* 53,200* 56,000* 138,600 4,000* 134,600

147,000

$ 4,000

Retained Earnings Retained earnings — Paw

$ 147,000 $

Retained earnings — Sun Controlling share of NI

134,600✓ 60,000*

Dividends

Retained earnings December 31

$ 221,600

31,800

Balance Sheet Cash

27,000 40,000

Accounts receivable — net Dividends receivable Inventories Land Buildings — net Equipment — net Investment in Sun

63,800 90,000

b e

9,000 1,000

8,000 a

8,000

9,000

60,000* $

221,600

98,800 122,000

9,000 20,000 40,000 140,000

35,000 15,000 43,200

55,000 55,000 183,200

165,000

77,600

242,600

208,800

b 28,800 c 180,000

Goodwill

36,000

Accounts payable Dividends payable Other liabilities Capital stock Push-down capital Retained earnings

36,000

$ 736,600

$ 273,800

792,600

$ 125,000 15,000 75,000 300,000

145,000 16,000 95,000 300,000

221,600✓ $ 736,600

Noncontrolling interest January 1 Noncontrolling interest December 31 *

134,600

41,800✓ 10,000*

20,000 10,000 20,000 100,000 92,000

9,000

c 100,000 c 92,000

221,600

31,800✓ $ 273,800 c 12,000 _________ e 3,000 250,800 250,800 $

Deduct

15,000 792,600

11-22

Consolidation Theories, Push-down Accounting, and Corporate Joint Ventures

Solution P11-10 (continued)—Push down 100%--entity theory b Paw Corporation and Subsidiary Consolidation Working Papers for the year ended December 31, 2012 90% Sun

Paw

Adjustments and Eliminations

Income Statement Sales $ 310,800 $ 110,000 Income from Sun 37,800 b Cost of sales 140,000* 32,000* Depreciation expense 29,000* 25,000* Other operating exp. 45,000* 11,000* Consolidated NI Noncontrolling share e Controlling share of NI $ 134,600 $ 42,000

Consolidated Statements $

420,800

37,800

172,000* 54,000* 56,000* 138,800 4,200* 134,600

147,000

$ 4,200

Retained Earnings Retained earnings — Paw

$ 147,000 $

Retained earnings — Sun Controlling share of NI

134,600✓ 60,000*

Dividends

Retained earnings December 31

$ 221,600

32,000

Balance Sheet Cash

27,000 40,000

Accounts receivable — net Dividends receivable Inventories Land Buildings — net Equipment — net Investment in Sun

63,800 90,000

b e

9,000 1,000

8,000 a

8,000

9,000

60,000* $

221,600

98,800 122,000

9,000 20,000 40,000 140,000

35,000 15,000 45,000

55,000 55,000 185,000

165,000

80,000

245,000

208,800

b 28,800 c 180,000

Goodwill

40,000

Accounts payable Dividends payable Other liabilities Capital stock Push-down capital Retained earnings

40,000

$ 736,600

$ 282,000

800,800

$ 125,000 15,000 75,000 300,000

145,000 16,000 95,000 300,000

221,600✓ $ 736,600

Noncontrolling interest January 1 Noncontrolling interest December 31 *

134,600

42,000✓ 10,000*

20,000 10,000 20,000 100,000 100,000

9,000

c 100,000 c 100,000

221,600

32,000✓ $ 282,000 c 20,000 _________ e 3,200 259,000 259,000 $

Deduct

23,200 800,800

Chapter 11

11-23

Solution P11-11 Pep Corporation and Subsidiary Proportionate Consolidation Working Papers for the year ended December 31, 2011

Income Statement Sales Income from Jay Cost of sales Depreciation expense Other expenses Net income

Pep

Jay 40%

800,000 $ 20,000 400,000* 100,000* 120,000*

300,000

200,000

50,000

300,000 $

250,000

Adjustments and Eliminations b 180,000 a 20,000

150,000* 40,000* 60,000*

Consolidated Statements $

b b b

90,000 24,000 36,000

920,000 460,000* 116,000* 144,000*

200,000

300,000

Retained Earnings Retained earnings — Pep Venture equity — Jay Net income

200,000✓ 100,000*

b 250,000 200,000

50,000✓

Dividends Retained earnings/ Venture equity

400,000

300,000

Balance Sheet Cash

100,000 130,000

50,000 30,000

b b

30,000 18,000

110,000 140,000 200,000

40,000 60,000 100,000

b b b

24,000 36,000 60,000

126,000 164,000 240,000

300,000

180,000

b 108,000

372,000

Receivables — net Inventories Land Buildings — net Equipment — net Investment in Jay

100,000*

120,000 $1,100,000

Accounts payable Other liabilities Common stock, $10 par Retained earnings

400,000

120,000 142,000

a 20,000 b 100,000 $

460,000

120,000 $ 80,000 500,000 400,000✓

100,000 60,000

$1,164,000 b b

60,000 36,000

160,000 104,000 500,000 400,000

300,000✓ __________ __________

Venture equity — Jay $1,100,000 *

460,000

546,000

Deduct

$1,164,000

Chapter 12 Derivatives and Foreign Currency: Concepts and Common Transactions Answers to Questions

Derivative is the name given to a broad range of financial securities. Their common characteristic is that the derivative contract’s value to the investor is directly related to fluctuations in price, rate, or some other variable that underlies it. Interest rate, foreign currency exchange rate, commodity prices and stock prices are common types of prices and rate risks that companies hedge.

A forward is negotiated directly with a counterparty, while a future is a standard contract traded on an exchange. The exchange traded instrument has less risk of non-performance, and is commonly cheaper to transact. But standard contracts might not fit all companies’ needs. The forward carries the risk of counterparty default, but each contract can be tailored to exact needs.

An option gives the holder the right to buy or sell the underlying at a set price. The writer of an option has the obligation to either buy or sell. Options are often traded on exchanges and have low transaction costs. Because an option is an agreement on a single transaction, they are not helpful in managing the risk of a stream of future transactions. A swap is an agreement to exchange a series of future cash flows. These are often negotiated, but there are some standardized exchange-traded swaps.

Net settlement means the instrument can be settled in cash for the net value. The parties in a net settlement do not have to buy or sell physical products and then realize the cash flows. Only one payment needs to be made, either from the holder or the writer of the instrument.

A transaction is measured in a particular currency if its magnitude is expressed in that currency. A transaction is measured in a particular currency when it is recorded in the financial records in that currency. Assets and liabilities are denominated in a currency if their amounts are fixed in terms of that currency, and they are settled with that currency.

Direct quotation: 1.20/1 = $1.20 Indirect quotation: 1/1.20 = .83 euros per dollar

Official or fixed rates are set by a government and do not change as a result of changes in world currency markets. Free or floating exchange rates are those that reflect fluctuating market prices for currency based on supply and demand factors in world currency markets. The United States changed from fixed to floating (free) exchange rates in 1971. But the U.S. dollar is sometimes described as a “filthy float” because the United States has frequently engaged in currency transactions to support or weaken the dollar against other currencies. Such action is taken for economic reasons, such as to make U.S. goods more competitive in world markets. Both Japan and Germany have engaged in currency transactions in an attempt to support the U.S. dollar. In February 1987, the United States and six other industrial nations (the Group of 7 or G-7) entered the Louvre accord to cooperate on economic and monetary policies in support of agreed upon exchange rate levels.

Spot rates are the exchange rates for immediate delivery of currencies exchanged. The current rate for foreign currency transactions is the spot rate in effect for immediate settlement of the amounts denominated in foreign currency at the balance sheet date. Historical rates are the rates that were in effect on the date that a particular event or transaction occurred. Spot rates could be fixed rates if the currency was a fixed rate currency as determined by the government issuing the currency.

The transaction is a foreign transaction because it involves import activities, but it is not a foreign currency transaction for the U.S. firm because it is denominated in local currency. It is a foreign currency transaction for the Japanese company. Copyright © 2015 Pearson Education, Inc. 12-1

12-2

Derivatives and Foreign Currency: Concepts and Common Transactions

At the transaction date, assets and liabilities denominated in foreign currency are translated into dollars by use of the exchange rate in effect at that date, and they are recorded at that amount. At the balance sheet date, cash and amounts owed by or to the enterprise that are denominated in foreign currency are adjusted to reflect the current rate. Assets carried at market whose current market price is stated in a foreign currency are adjusted to the equivalent dollar market price at the balance sheet date.

Exchange gains and losses occur because of changes in the exchange rates between the transaction date and the date of settlement. Both exchange gains and exchange losses can occur in either foreign import activities or foreign export activities. The statement is erroneous.

Exchange gains and losses on foreign currency transactions are reflected in income in the period in which the exchange rate changes except for hedges of an identifiable foreign currency commitment where deferral is possible if certain requirements are met. Also hedges of a net investment in a foreign entity are treated as equity adjustments from translation. Intercompany foreign currency transactions of a long-term nature are also treated as equity adjustments.

There will be a $20 exchange loss in the period of purchase and a $10 exchange gain in the period of settlement: Billing date Inventory Accounts payable (fc) Year-end adjustment Exchange loss Accounts payable (fc) Settlement date Accounts payable (fc) Cash Exchange gain

$1,450 $1,450 $

20 $

$1,470 $1,460 10

Chapter 12

12-3

SOLUTIONS TO EXERCISES Solution E12-1 1 2 3 4

b c d a

Solution E12-2 1 2 3 4

c a d b

Solution E12-3 1 2 3

b d d

Solution E12-4 1

The dollar has weakened against the yen because it now costs more dollars to buy one yen.

10,000,000 yen  $.0075 = $75,000

Accounts payable(yen) Exchange loss Cash

$75,000 1,000 $76,000

Zimmer would have entered a contract to purchase yen for future receipt. This would assure that Zimmer had the yen available at that date to pay their obligation, and would have ‘locked in’ the amount of US dollars needed to satisfy that obligation.

12-4

Derivatives and Foreign Currency: Concepts and Common Transactions

Solution E12-5 December 16, 2011 Inventory

$36,000 Accounts payable (euros) $36,000 To record purchase of merchandise from Wing Corporation for 30,000 euros at $1.20 spot rate.

December 31, 2011 Exchange loss $ 1,500 Accounts payable (euros) $ 1,500 To adjust accounts payable to Wing: ($1.25 - $1.20)  30,000 euros. January 15, 2012 Accounts payable (euros) $37,500 Exchange gain $ 300 Cash 37,200 To record payment of 30,000 euros at $1.24 spot rate in settlement of account payable and to recognize gain. Solution E12-6 Adjustment in value of account receivable for 2011: ($.84 - $.80)  90,000 C$ = $3,600 exchange gain Adjustment in value of account receivable at settlement in 2012: ($.83 - $.84)  90,000 C$ = $900 exchange loss Solution E12-7 May 1, 2011 Accounts receivable (fc) $333,333 Sales $333,333 To record sale of inventory items to Royal for 200,000 pounds: 200,000 pounds/.6000 pounds (indirect quotation). May 30, 2011 Cash (fc) $330,579 Exchange loss 2,754 Accounts receivable (fc) $333,333 To record receipt of 200,000 pounds from Royal in settlement of accounts receivable: 200,000 pounds/.6050 pounds.

Chapter 12

12-5

Solution E12-8 [Based on AICPA] 1 Receivable at 10/15/11 Euros received and sold for U.S. dollars on 11/16/11 Foreign exchange loss 2011 2

$420,000 415,000 5,000

On December 31, 2011 Yumi Corp. adjusts its account payable denominated in euros from $12,000 (10,000 x $1.20) to $12,400 (10,000  $1.24) and recognizes a loss of $400 [10,000 LCU  ($1.24 - $1.20)]

3 December 31, 2011 note payable July 1, 2012 note payable 2012 exchange loss

$240,000 280,000 $(40,000)

Note receivable December 31, 2011 Amount collected July 1, 2012 (840,000 LCU  8) 2012 exchange loss

$140,000

4 105,000 $ 35,000

Solution E12-9 1

Exchange gain or loss in 2011: Account receivable December 16 December 31 adjusted balance 150,000 C$  $0.68 Account payable December 2 December 31 adjusted balance 275,000 C$  $0.68 Net exchange gain for 2011 Exchange gain or loss in 2012: Account receivable adjusted 12/31 Account receivable 1/15/12 150,000 C$ x $0.675 Account payable adjusted 12/31 Account payable 1/30/12 275,000 C$ x $0.685 Net exchange loss for 2012

Gain or (Loss) $103,500 102,000 $195,250

$(1,500)

187,000

8,250 $ 6,750 Gain or (Loss)

$102,000 101,250 $187,000

188,375

(1,375) $(2,125)

(750)

12-6

Derivatives and Foreign Currency: Concepts and Common Transactions

Solution E12-10 1

December 12, 2011 Inventory Accounts payable (yen)

$375,000 $375,000

Purchase from Toko Company (50,000,000 yen  $.00750). December 15, 2011 Accounts receivable (pounds) Sales

$ 66,000 $ 66,000

Sale to British Products Company (40,000 pounds  $1.65). 2

December 31, 2011 Exchange loss $ 5,000 Accounts payable (yen) $ 5,000 To adjust accounts payable denominated in yen for exchange rate change: 50,000,000 yen  ($.00760 - $.00750). Exchange loss $ 2,000 Accounts receivable (pounds) $ 2,000 To adjust accounts receivable denominated in pounds for exchange rate change: 40,000 pounds  ($1.65 - $1.60).

January 11, 2012 Accounts payable (yen) Exchange loss Cash

$380,000 2,500 $382,500

To record payment to Toko Company (50,000,000 yen  $.00765). January 14, 2012 Cash $ 65,200 Accounts receivable (pounds) $ 64,000 Exchange gain 1,200 To record receipt from British Products Company: 40,000 pounds  $1.63.

Chapter 12

12-7

Solution E12-11 Comment: The contract receivable and payable are both recorded instead of recording the contract net because Martin must deliver the euros to the exchange broker, net settlement is not allowed. October 2, 2011 Contract receivable $653,000 Contract payable (fc) $653,000 To record contract to sell 1,000,000 euros to exchange broker in 180 days for the forward rate of $.6530. December 31, 2011 Contract payable (fc) $ 12,000 Exchange gain $ 12,000 To adjust contract payable in euros to the 90-day forward rate of $.6410. March 31, 2012 Contract payable (fc) $641,000 Exchange loss 14,000 Cash (fc) $655,000 To record payment of 1,000,000 euros to exchange broker when spot rate is $.6550. Cash

$653,000 Contract receivable $653,000 To record receipt of U.S. dollars from exchange broker in settlement of account.

12-8

Derivatives and Foreign Currency: Concepts and Common Transactions

SOLUTIONS TO PROBLEMS Solution P12-1 TCO would receive $8,000 from XYZ = 100,000 x (2.48-2.40) Solution P12-2 The expected profit for Sue is 300,000 x ($6.20 - $5.90) = $90,000

Market Price per Bushel

Forward Price per Bushel

Unhedged Gain/(Loss)

Economic Gain/(Loss) on Forward

$6.40

$6.20

$150,000

$(60,000)

$90,000

$6.30

$6.20

120,000

(30,000)

90,000

$6.20

90,000

—

90,000

$6.10

$6.20

60,000

30,000

90,000

$6.00

$6.20

30,000

60,000

90,000

Economic Income with Hedge

Chapter 12

12-9

Solution P12-3 The expected profit for Sue is 300,000($6.20 - $5.90 - $0.05) = $75,000

Market Price per Bushel

Option Price per Bushel

Unhedged Gain/(Loss)

Economic Gain/(Loss) on Option Exercise

Economic Income (Loss) with Cost of Option

$6.40

$6.20

$150,000

---

$135,000

$6.30

$6.20

120,000

---

105,000

$6.20

90,000

—

75,000

$6.10

$6.20

60,000

30,000

75,000

$6.00

$6.20

30,000

60,000

75,000

12-10

Derivatives and Foreign Currency: Concepts and Common Transactions

Solution P12-4 1, 2 Accounts receivable U.S. dollars Swedish Krona (20,000  $.66) British pounds(25,000  $1.65) Accounts payable U.S. dollars Canadian dollars (10,000  $.70) British pounds (15,000  $1.65)

Per Books

Balance Sheet

Exchange Gain or (Loss)

$28,500 11,800 41,000 $81,300

$28,500 13,200 41,250 $82,950

$1,400 250 1,650

$ 6,850 7,600 24,450 $38,900

$ 6,850 7,000 24,750 $38,600

Net exchange gain 3

600 (300) 300 $1,950

Collect receivables: Cash

$28,500 Accounts receivable To record collection of accounts receivable.

Cash

$28,500

$13,400 Accounts receivable (Krona) Exchange gain To collect 20,000 Krona at $.67 spot rate.

Cash $40,750 Exchange loss 500 Accounts receivable (pounds) To collect 25,000 pounds at $1.63 spot rate. 4

$13,200 200

$41,250

Settlement of accounts payable: Accounts payable $ 6,850 Cash $ 6,850 To record payment of accounts denominated in dollars. Accounts payable (Canadian $) $ 7,000 Exchange loss 100 Cash $ 7,100 To record payment of account denominated in Canadian dollars at $.71 spot rate. Accounts payable (pounds) $24,750 Cash $24,300 Exchange gain 450 To record payment of 15,000 pounds at $1.62 spot rate.

Chapter 12

12-11

Solution P12-5 1, 2 Accounts receivable British pounds (100,000  1.660) Euros (250,000  $.670) Swedish krona (160,000  $.640) Japanese yen (2,000,000  $.0076) Accounts payable Canadian dollars(150,000  $.69) Swedish krona (220,000  $.135) Japanese yen (4,500,000  $.0076)

Per Books

Balance Sheet

Exchange Gain or (Loss)

$165,000 165,000 105,600 15,000 $450,600

$166,000 167,500 102,400 15,200 $451,100

$1,000 2,500 (3,200) 200 500

$105,000 28,600 33,300 $166,900

$103,500 29,700 34,200 $167,400

$1,500 (1,100) (900) (500)

Net exchange gain 3

The company would need to enter into a contract to deliver 250,000 euros (sell them) since it would be receiving euros and would need to convert them into US dollars.

Chapter 13 Accounting for Derivatives and Hedging Activities Answers to Questions 1

Hedge accounting refers to accounting designed to record changes in the value of the hedged item and the hedging instrument in the same accounting period. This enhances transparency because the hedged item and hedging instrument accounting are linked. Prior to hedge accounting, the financial statement effect of the hedged item and hedging instrument were not linked. Since companies enter into hedges to mitigate risks, the accounting should reflect the effect of this strategy and should clearly communicate the strategy. The accounting and footnote disclosures required for derivatives attempt to do this.

An option is a contract that allows the holder to buy or sell a security at a particular date. The holder is not obligated to buy or sell the security. They may allow the contract to expire. Typically, the holder must pay an upfront fee to the writer of the option. The writer of the option collects a fee, or premium for the option, and in exchange they are obligated to perform under the option contract. A forward contract or a futures contract is similar because both sides of the contract are obligated to perform. A forward contract is negotiated between two parties, they agree upon delivering a certain quantity of goods or currency at a specific date in the future. Many allow net settlement which means the “winner” of the contract receives cash consideration for the difference between the market price of the commodity and the contracted amount on the date the contract expires. The initial amount exchanged at the date the contract is entered into is negligible; however, as noted in Chapter 12, forward contracts hold the risk that the opposing party will not be able to perform. A futures contract is traded on a market. The amount of commodity to be exchanged and the date of delivery are standardized. The futures rate is determined by the market at the date the contract is entered into. These contracts are settled daily. As noted in Chapter 12, a potential cost of this type of contract is that the contract is defined by the market, so it cannot be tailored to hedge a specific risk.

Hedge effectiveness involves assessing how well the hedge mitigates the gains or losses of the asset, liability and/or anticipated transaction that it is entered into to mitigate. The most common approaches to determining hedge effectiveness are critical term analysis and statistical analysis. Under critical term analysis, the nature of the underlying variable, the notional amount of the derivative and the item being hedged, the delivery date of the derivative and the settlement date for the item being hedged are examined. If the critical terms of the derivative and the hedged item are identical, then an effective hedge is assumed. A statistical approach is used if critical terms don’t match. One such approach involves comparing the correlation between changes in the price of the item being hedged and the derivative. While the FASB does not specify a specific benchmark correlation coefficient, cash flow offsets of between 80% and 125% are considered to be highly effective. Outside of these ranges, the hedge would not be considered highly effective.

13-2

Accounting for Derivatives and Hedging Activities

Under a firm purchase or sales commitment, if the hedge is considered to be effective, then it would qualify as a fair value hedge. The item being hedged (regardless of whether it is an asset or liability position) and the offsetting derivative are both marked to fair value at the financial statement date. If the hedge relationship is not considered to be effective, then the derivative is marked to market at the balance sheet date, regardless of when the gain or loss on the item that is being hedged is recognized. No offsetting changes in the fair value of the item being hedged are recorded until they are realized.

A company that has an existing loan that involves a variable or floating interest rate enters into a pay-fixed, receive variable swap. The company is swapping its variable interest rate payments for fixed ones. These contracts are typically settled net. For example, if the fixed rate agreed upon is 10% for the term of the swap agreement and in one year the variable rate is 9%, then the company with the variable rate loan must pay the difference in rates multiplied by the notional amount of the loan to the other party. If the variable rate is 12%, then the company will receive the difference in rates multiplied by the notional amount of the loan. Regardless of the movement in interest rates over the term of the swap, the company will pay the fixed rate, net. This type of swap is aimed at reducing the variability in cash flows related to the debt; therefore it is designated as a cash flow hedge.

A receive fixed, pay variable swap is entered into if a company has an existing loan that involves a fixed interest rate and desires to swap those fixed payments for variable payments. For example, a company has a loan with an 8% fixed rate and enters into a swap arrangement so that it will pay LIBOR + 1%. If the variable rate for a year is 9%, then the company will pay 1% multiplied by the notional amount as well as the 8% for the loan. Thus, the company has paid 9%, the floating rate. If the variable rate is 6% (5% LIBOR + 1%), then the company will pay 8% on the loan, but will receive 2% related to the swap. Thus, the company will pay 6%, the floating rate. This type of swap is aimed at reducing the variability in the fair value of the underlying loan therefore it is designated as a fair value hedge.

Fair value hedge accounting is used when the company is attempting to reduce the price risk of an existing asset/liability or firm purchase/sale commitment. Cash flow hedge accounting is appropriate when the company is attempting to reduce the variability in cash flows thus it is appropriate when hedging anticipated purchases and sales. Under certain circumstances, hedges of existing foreign currency denominated receivables and payables are accounted for as cash flow hedges instead of fair value hedges. See question 8’s solution for these cases.

Cash flow hedge accounting can be used when hedging recognized foreign-currency denominated assets and liabilities if the variability of cash flows is completely eliminated by the hedge. This criterion is generally met if all of the critical terms of the hedged item and the hedge match such as the settlement date, currency type and currency amounts. If these don’t match, then it must be accounted for as a fair value hedge. The key difference between this situation and the more general cash flow hedge case is that an existing asset or liability is being accounted for here. Under the more general case, the recognition of gains and losses is deferred because an anticipated transaction is being hedged. The foreign currency asset or liability is marked to fair value at year-end and the resulting gain or loss account is recognized, however, the gain or loss is offset by reclassifying an equal amount from other comprehensive income. Thus, the asset and liability are marked to fair value, but no gain or loss related to that adjustment is included in current period income.

Chapter 13

13-3

The premium or discount related to the hedge contract is amortized to income over the length of the contract using the effective interest method. For example, if a 100,000 euro foreign currency receivable due in 60 days is recorded at the spot rate of $1.20/euro or $120,000 and at the same date, a forward contract is entered into to deliver 100,000 euros in 60 days at a forward rate of $1.18, the company knows that it will lose $2,000. This $2,000 must be amortized to income over the 60 day period. 9

International Accounting Standards No. 32 and 39 prescribe the accounting for derivatives. Their requirements are similar to SFAS No. 133 and 138 in terms of determining when hedge accounting can be used. The requirements for determining hedge effectiveness are very similar. Both fair value and cash flow hedge definitions and general requirements are similar. However, under IAS 39, firm sale or purchase commitments can be accounted for as either fair value or cash flow hedges which differs from the FASB requirement that they must be accounted for as fair value hedges.

A forward contract of an anticipated foreign currency transaction is accounted for as a cash flow hedge. The contract is marked to fair value at each financial date and the corresponding gain or loss is included in other comprehensive income. Any premium or discount must be amortized to income over the contract term using an effective interest rate method. The gain (loss) credit (debit) is offset by a debit (credit) from other comprehensive income. When the anticipated transaction occurs and the forward contract is settled, the resulting other comprehensive income balance is amortized to income in the same period as the underlying transaction is recognized in income.

13-4

Accounting for Derivatives and Hedging Activities

SOLUTIONS TO EXERCISES Solution E13-1 1

December 1, 2011

No entry is necessary

December 31, 2011 Other Comprehensive Income (-OCI,-SE) 9,901 Forward Contract (+L) 9,901 Forward contract value at 12/31/11($1,000 - $980) x 500 = $10,000/(1.005)2 = $9,901 liability

Settlement date February 28, 2012 Forward Contract (-L) 9,901 Forward Contract (+A) 2,500 Other Comprehensive Income (+OCI,+SE) 12,401 Forward contract value at 2/28/12($1,000 - $1,005) x 500 = $2,500 asset. The forward contract liability at 12/31/11 is eliminated and the asset established. Accordingly, the corresponding credit to other comprehensive income, $12,401, will result in an ending balance of $2,500 credit in other comprehensive income. Rice Inventory (+A)($1,005 x 500) 502,500 Cash (-A) To record the rice purchase at market price

502,500

Cash (+A) 2,500 Forward Contract (-A) To record the forward contract settlement

2,500

Settlement date June 1, 2012 Cash (+A) Sales (+R)

600,000

Cost of Goods Sold (+E) Other Comprehensive Income (-OCI,-SE) Rice Inventory (-A)

500,000 2,500

600,000

502,500

Chapter 13

13-5

Solution E13-2 1

December 1, 2011 No entry is necessary

b. December 31, 2011 Loss on forward contract (+Lo,-SE) 9,901 Forward Contract (+L) 9,901 Forward contract value at 12/31/11($1,000 - $980) x 500 = $10,000/(1.005)2 = $9,901 liability Firm Purchase Commitment (+A) Gain on firm purchase commitment (+Ga, +SE)

9,901 9,901

c. Settlement date February 28, 2012 Forward Contract (-L) 9,901 Forward Contract (+A) 2,500 Gain on forward contract (+G,+SE) 12,401 Forward contract value at 2/28/12($1,000 - $1,005) x 500 = $2,500 asset. Loss on firm purchase commitment (+Lo,-SE) Firm purchase commitment (-A) Firm purchase commitment (+L)

12,401 9,901 2,500

Rice Inventory (+A) 500,000 Firm purchase commitment (-L) 2,500 Cash (-A) To record the rice purchase at market price Cash (+A) 2,500 Forward Contract (-A) To record the forward contract settlement

502,500

2,500

2. Cash (+A) Sales (+R,+SE)

600,000

Cost of Goods Sold (+E,-SE) Rice Inventory (-A)

500,000

600,000

500,000

13-6

Accounting for Derivatives and Hedging Activities

Solution E13-3 1

November 1, 2011 Memorandum entry only December 31, 2011 Forward Contract (+A) 49,751 Unrealized Gain on Forward Contract (+Ga, +SE) (100,000 x .50)/1.005 To record the change in fair value of the forward contract attributable to the discounted change in the forward price Unrealized Loss on Firm Sales Commitment (+Lo, -SE) Firm Sales Commitment (+L) To record the change in fair value of the firm commitment

49,751 49,751

January 31, 2012 Unrealized Loss on Forward Contract (+Lo,-SE) 149,751 Forward Contract (+L) Forward Contract (-A) ($6-$5= 1.00 x 100,000) (To record the change in fair value of the forward contract attributable to the discounted change in the forward price Firm Sales Commitment (+A) 100,000 Firm Sales Commitment (-L) 49,751 Unrealized Gain on Firm Sales Commitment (+G,+SE) (To record the change in fair value of the firm commitment to sell) Forward Contract (-L) Cash To record the settlement of the forward contract.

100,000

Cash

600,000

100,000 49,751

149,751

100,000

Sales To record cash sales. Sales

49,751

600,000 100,000

Firm Sales Commitment (-A) To record termination of firm sales commitment.

100,000

Chapter 13

13-7

Solution E13-4 1

October 1, 2011 Forward contract(+A) 49,012 Gain on forward contract (100,000 x ($2.00 - $1.50))/(1.005)4 To record the change in fair value of the forward contract attributable to the discounted change in the forward price Inventory (+A) Gain on inventory (+SE) To record inventory gain because the

49,012

50,000 50,000

December 31, 2011 Loss on forward contract 98,763 Forward contract(-A) Forward contract(+L) (100,000 x ($2.00 - $2.50))/(1.005)= 49,751 To record the change in fair value of the forward contract attributable to the discounted change in the forward price

49,012 49,751

The inventory will not be marked to market because the market value ($1.50) does not equal the cost ($1.00) when the derivative is signed on October 1, 2011.

January 31, 2012 Forward contract(-L) Cash Gain on forward contract To record settlement of forward contract.

49,751

30,000 19,751

13-8

Accounting for Derivatives and Hedging Activities

Solution E13-5 [Based on AICPA] 1

Assuming that this is a fair value hedge: At 12/31/11, $3,000 is the forward contract fair value [100,000 x ($.90 forward rate contracted $.93 Forward contract rate at 12/31/11) = $3,000]. Since this contract will not be settled for 72 days, the present value of the contract is $2,931 using .03288% [i=12%/365 days], n=72 and future value of $3,000. The exchange gain related to this contract is recorded at 12/31/11 and the forward contract asset account is debited. December 31, 2011 Forward Contract (+A) Exchange Gain (+Ga,+SE) To record forward contract at market

2,931 2,931

Exchange Loss (+L,-SE) 10,000 Accounts Payable(fc) (+L) 10,000 To mark accounts payable to fair value at 12/31/11 (this assumes that the accounts payable was marked to market on 12/12/11, the date the forward contract was entered into) 2

This firm purchase commitment would be accounted for as a fair value hedge. December 31, 2011 Forward Contract (+A) 2,931 Exchange Gain (+Ga,+SE) 2,931 Exchange Loss (+Lo,-SE) Firm purchase commitment (+L)

2,931 2,931

The forward contract would again be recorded at fair value throughout the life of the contract. Therefore, a $3,000 gain would be reported at 12/31/11.

Chapter 13

13-9

Solution E13-6 April 1, 2011 Contract receivable (+A) 35,250 Contract payable (fc)(+L) 35,250 To record forward contract to sell 50,000 Canadian dollars to the exchange broker at the forward rate of .705 for delivery on May 31 for $35,250. May 31, 2011 Cash (fc) (+A) 36,250 Sales (+R,+SE) 36,250 To record sale of fittings to Win for 50,000 Canadian dollars: ($.725  50,000 Canadian) Contract payable (fc) (-L) 35,250 Exchange loss on forward contract (+Lo,-SE) 1,000 Cash (fc) (-A) 36,250 To record payment of the contract denominated in Canadian dollars to the exchange broker. Cash (+A) 35,250 Contract receivable (-A) 35,250 To record receipt of the $35,250 from the exchange broker to settle the account receivable denominated in U.S. dollars. Change in value of firm sales commitment Exchange gain (+Ga, +SE) To record gain on sales commitment.

1,000 1,000

Alternative solution: On April 1, 2011, no entry is necessary if the forward contract allowed net settlement. If this is the case, the May 31, 2011 entries would be: May 31, 2011 Cash (+A) 36,250 Sales (+R,+SE) 36,250 To record sale of fittings to Windsor for 50,000 Canadian dollars: ($.725  50,000 Canadian). Assuming immediate conversion of the Canadian dollars to U.S. dollars at the current exchange rate. Exchange loss on forward contract (+Lo,-SE) 1,000 Cash (-A) To record net settlement of the exchange contract.

$1,000

Change in value of firm sales commitment Exchange gain (+Ga, +SE) To record gain on sales commitment.

1,000

13-10

Accounting for Derivatives and Hedging Activities

Solution E13-7 1

Entry on November 2 for contract with the exchange broker: Contract receivable (fc) (+A) 7,800 Contract payable (+L) 7,800 To record contract to purchase 1,000,000 yen in 90 days at the future rate. If this contract allowed for net settlement, then no entry would be necessary on November 2.

No journal entry needed as the 30-day future rate at the end of the year is at $.0078 which was the same rate as the 90-day rate on November 2.

Chapter 13

13-11

SOLUTIONS TO PROBLEMS Solution P13-1 1.

This hedge is designed to mitigate the impact of price changes on natural gas. Since one would expect that natural gas price changes and futures market prices of natural gas to be highly correlated, this is likely to be a highly effective hedge.

This would be accounted for as a cash flow hedge since this is a hedge of an anticipated transaction.

November 2, 2011 Futures contract (+A) 100,000 Cash (-A) Deposit is $5,000 x 20 contracts = $100,000

100,000

December 31, 2011 Other Comprehensive Income (-OCI,-SE) 50,000 Futures Contract (-A) 50,000 At 12/31/11, the futures contract price for delivery on the same date as our contract is $6.75 - $7.00 = $.25 loss per MMBtu x 10,000 x 20 contracts = $50,000 loss. February 2, 2012 Futures contract (+A) 20,000 Other Comprehensive Income (+OCI,+SE) 20,000 $6.85 - $6.75 = $.10 x 10,000 x 20 contract = $20,000 gain Cash (+A) 70,000 Futures contract (-A) To record final settlement of futures contract.

70,000

Gas Inventory (+A) 1,370,000 Cash (-A) To record the purchase of natural gas at market rates.

1,370,000

February 3, 2012 Cash (+A) Gas Revenue (+R,+SE) To record gas sale at $8.00 per MMBtu Cost of Goods Sold (+E,-SE) Gas Inventory (-A)

1,600,000 1,600,000

1,370,000 1,370,000

Cost of Goods Sold (+E,-SE) 30,000 Other Comprehensive Income (+OCI,+SE) 30,000 To record cost of goods sold so that it reflects the futures contract rate per the hedging contract, $7.00 per MMBtu.

13-12

Accounting for Derivatives and Hedging Activities

Solution P13-2 1.

Because the terms of the purchase commitment and the hedge instrument match.

This is a fair value hedge because a firm purchase commitment is being hedged instead of an anticipated purchase.

3. Silver options (+A) Cash (-A) 4.

December 31, 2011 Loss on firm purchase commitment (+Lo,-SE) Change in value of firm purchase commitment (+OCI,+SE)

1,000 1,000 1,194,030 1,194,030

Silver options (+A) 1,193,030 Gain (+Ga,+SE) 1,193,030 1,200,000 x $1 change ($10-$9) = $1,200,000 which will occur in 1 month (purchase and option expiration). $1,200,000/1.005 = $1,194,030. This is the present value of the firm purchase commitment and the option at 12/31/11 assuming 6% annual interest. Since the option already has a $1,000 balance, $1,193,030 will need to be recorded. 5. Change in value of firm purchase commitment (-OCI,-SE) 594,030 Gain on firm purchase commitment 594,030 (+Ga,+SE) To record the change in the firm purchase commitment. ($9 - $9.50) x 1,200,000. The ending balance is $600,000 after this adjustment. Loss (+Lo,-SE) Silver option (-A) The silver options value has also declined. still exercise the option.

594,030 594,030 However, the company will

Cash (+A) Silver option (-A) To record exercise of option.

600,000

Silver inventory (+A) Change in value of firm purchase commitment (-OCI,-SE) Cash (-A) Unrealized gain To record purchase of silver inventory.

11,400,000

600,000

11,400,000 600,000

Chapter 13

13-13

Solution P13-3 1

The purpose of this hedge is to reduce variability in cash flows in the future since the firm entered into a variable interest loan and is swapping that for a fixed interest rate. This is therefore a cash flow hedge.

One would expect that this is a highly effective hedge if the notional amount, $400,000 and the length of the term of the swap agreement agree.

a. The LIBOR rate at 12/31/11 is 5%, thus 2012’s interest rate on the variable loan will be 5% + 2% = 7%. The swap fixed rate is 8%. Cam will pay .01 percent more than the variable rate. The fair value of the swap is the present value of the estimated future net payments. Date of payment 12/31/12 12/31/13 12/31/14 12/31/15 Total

Estimated payment based on 12/31/11 LIBOR rate .01 x $400,000 .01 x $400,000 .01 x $400,000 .01 x $400,000

Factor

Present Value

1/(1.07) 1/(1.07)2 1/(1.07)3 1/(1.07)4

$ 3,738 3,493 3,265 3,051 $13,547

b. December 31, 2011 Other Comprehensive Income (-OCI,-SE) 13,547 Interest Rate Swap (+L) 13,547 To record the fair value of interest rate swap, cash flow hedge at 12/31/11. Interest Expense (+E,-SE) Cash (-A) To record interest payment.

32,000 32,000

4. December 31, 2012 Interest Expense (+E,-SE) 28,000 Cash (-A) 28,000 To record payment to Ven Bank of the interest expense for the year under the variable rate loan. The rate set on the loan at 1/1/12 was 7%. Interest Expense (+E,-SE) 4,000 Cash (-A) 4,000 To record the payment due on the interest rate swap because the fixed rate is 8%. This represents the net settlement amount. Interest rate swap (-L) 8,346 Other Comprehensive Income (-OCI,+SE) 8,346 To record the change in fair value of the interest rate swap.

13-14

Accounting for Derivatives and Hedging Activities

P13-3 (continued) The new variable rate for 2013 which is set at 12/31/12 is 5.5% + 2%. As a result, the estimated amount that Cam would pay is reduced from 1% to .5%. Date of payment 12/31/13 12/31/14 12/31/15 Total

Estimated payment based on 12/31/12 LIBOR rate .005 x $400,000 .005 x $400,000 .005 x $400,000

Factor

Present Value

1/(1.075) 1/(1.075)2 1/(1.075)3

$ 1,860 1,731 1,610 $ 5,201

The unadjusted Interest Rate Swap liability is $13,547 credit, but the adjusted is $5,201 credit. The Interest Rate Swap Liability must be reduced by $8,346.

Chapter 13

13-15

Solution P13-4 1.

This is a fair value hedge because the fixed rate loan’s fair value fluctuates over time as market interest rates change. By entering into this swap agreement that fluctuation is eliminated. So while the interest rate fluctuates, the loan’s fair value remains constant, reflecting the fixed rate in the swap.

Like P13-3, the terms match, thus this is considered to be a highly effective hedge.

a. Date of payment 12/31/12 12/31/13 12/31/14 12/31/15 Total

Estimated payment based on 12/31/11 LIBOR rate .01 x $400,000 .01 x $400,000 .01 x $400,000 .01 x $400,000

Factor

Present Value

1/(1.09) 1/(1.09)2 1/(1.09)3 1/(1.09)4

$ 3,670 3,367 3,089 2,834 $12,960

b. December 31, 2011 Interest Expense (+E,-SE) 32,000 Cash (-A) 32,000 To record interest due on fixed rate loan at 12/31/11 Loan Payable (-L) 12,960 Interest Rate Swap (+L) 12,960 To record the interest rate swap at fair value, computations above. Notice that the carrying value of the loan is now $387,040 ($400,000 $12,960). This agrees with the present value of the loan at the market rate of 9%. Proof: $400,000/(1.09)4 = $283,370 <= the present value of the maturity value. The present value of the interest payments is $32,000 x PVIFA(i=9,n=4)= $103,670. The total market value of the loan is $283,370 + $103,670 = $387,040.

13-16

Accounting for Derivatives and Hedging Activities

Solution P13-4 (continued) 4. Date of payment 12/31/13 12/31/14 12/31/15 Total

Estimated payment based on 12/31/12 LIBOR rate .005 x $400,000 .005 x $400,000 .005 x $400,000

Factor

Present Value

1/(1.085) 1/(1.085)2 1/(1.085)3

$1,843 1,699 1,566 $ 5,108

December 31, 2012 Interest Expense (+E,-SE) 32,000 Cash (-A) To record interest due on fixed rate mortgage Interest Expense (+E,-SE) Cash (-A) To record swap payment

32,000

4,000

Interest Rate Swap (-L) 7,852 Loan Payable (+L) To adjust interest rate swap to fair value, $5,108.

4,000

7,852

Notice that now the loan payable carrying value is: $400,000 – 12,960 + 7,852 = $394,892. This amount agrees with the present value of the loan at the market rate on this date, 8.5%. Proof: $400,000/(1.085)3 = $313,163—Present value of the maturity value of the loan. The present value of the interest payments = $32,000 x PVIFA(i=8.5,n=3)= $81,729. The present value of the loan at a market rate of 8.5% is therefore $313,163 + $81,729 = $394,892.

Chapter 13

13-17

Solution P13-5 1

Entries on April 1 Accounts receivable (pesos) (+A) 33,060 Sales (+R,+SE) 33,060 To record sales on account denominated in pesos: 200,000 pesos / 6.0496 LCUs Contract Receivable 33,228 Contract Payable 33,228 To record forward contract.

Entries on May 31 Cash (pesos) (+A) 33,378 Accounts receivable (pesos) (-A) 33,060 Exchange gain (+G,+SE) 318 To record collection of receivable in LCUs: 200,000 LCUs / 5.992 LCUs Contract payable Exchange loss Cash To record delivery of 200,000 pesos to the exchange broker.

33,228 150

Cash

33,228

33,378

Contract receivable To record receipt of cash from exchange broker.

33,228

13-18

Accounting for Derivatives and Hedging Activities

Solution P13-6 1

Entry on October 2, 2011 Contract receivable (euros) (+A) 31,750 Contract payable (+L) 31,750 To record forward contract to purchase 50,000 euros at $.6350 as a hedge of a firm commitment.

December 31, 2011 adjustment Contract receivable (euros) (+A) 350 Exchange gain (+G,+SE) 350 To adjust the contract receivable for 50,000 euros to the $.6420 future exchange rate at December 31, 2011: 50,000 euros  ($.6420 - $.6350). Exchange loss (+Lo,-SE) 350 Change in value of firm commitment 350 To record the change in the value of the underlying firm commitment hedged.

Entries on March 31, 2012 Contract payable (+L) 31,750 Cash (-A) 31,750 To pay exchange broker for 50,000 euros at the forward rate of $.6350 established on October 2, 2011. Cash (euros) (+A) 32,800 Contract receivable (euros) (-A) 32,100 Exchange gain (+G,+SE) 700 To record receipt of 50,000 euros from exchange broker when spot rate is $.6560. Exchange Loss (+Lo,-SE) 700 Change in value of firm commitment 700 To record the change in the value of the underlying firm commitment hedged. Inventory 32,800 Cash (euros) (+A) 32,800 To record purchase and payment in euros at $.6560 spot rate. Change in value of firm commitment (-OCI,-SE) 1,050 Inventory 1,050 To record the adjustment of inventory for the change in the value of the firm commitment. This effectively fixes the purchase at the original forward rate.

Chapter 13

13-19

Solution P13-7 We will assume that the hedge contract is to be settled net. December 2, 2011 No entry December 31, 2011 Other comprehensive income: exchange loss (-OCI, -SE) 4,950 Forward contract (+L) 4,950 Forward contract, 12/31/11, $1.69 – contract rate $1.68 = $.01 x 500,000 = $5,000. This is to be paid in two months so the present value assuming 6% annual interest rate is: $5,000/(1.005)2 = $4,950. Exchange Loss (+Lo,-SE) 3,346 Other comprehensive income (+OCI,+SE) To record discount amortization. See table below

3,346

March 1, 2012 Cash (fc) (+A) 855,000 Sales (+R,+SE) 855,000 To record delivery of equipment to Ram and collection of 500,000 pounds at the $1.71 spot rate. Other comprehensive income: exchange loss (+Lo, 10,050 -SE) Forward contract (+L) 10,050 To increase the forward contract to the final liability amount: $1.71-$1.68 = $.03 x 500,000 = $15,000 - $4,950 = $10,050 adjustment. Exchange Loss (+Lo,-SE) 6,654 Other comprehensive income (+OCI,+SE) To record discount amortization. (See table below)

6,654

Forward contract (-L) Cash (–A) To record forward contract payment.

15,000 15,000

Sales (-R,-SE) Other comprehensive income (+OCI,+SE)

5,000

13-20

Accounting for Derivatives and Hedging Activities

Solution P13-7 (continued) Discount amortization: The spot rate at the date the forward contract was entered into $1.70 x 500,000 = $850,000. $1.68 x 500,000 = $840,000. The discount of $10,000 must be amortized over the contract period. The effective interest rate equates these two amounts using a 3 month time period, that rate is .3937%. Date

Discount amortization

December 31, 2011 January 31, 2012 March 1, 2012

3,346 3,333 3,320

Balance $ 850,000 846,654 843,320 840,000

Chapter 13

13-21

Solution P13-8 1

December 16, 2011 Equipment (+A) 668,000 Accounts payable (fc) (+L) 668,000 To record purchase of equipment (400,000 pounds  $1.67).

December 31, 2011 Accounts payable (fc) (-L) 8,000 Exchange gain (+G,+SE) 8,000 To adjust accounts payable for currency exchange rate change: 400,000 pounds  ($1.67 - $1.65). Other Comprehensive Income (-OCI,-SE) 7,980 Forward Contract (+L) To record the forward contract loss at 12/31/11

7,980

Exchange loss (+Lo,-SE) 8,000 Other Comprehensive Income (+OCI,+SE) 8,000 To reclassify an amount from Other Comprehensive Income to offset the gain on the accounts payable Exchange Loss (+Lo,-SE) 1,994 Other Comprehensive Income (+OCI,+SE) 1,994 To amortize the premium. The premium is the difference between the $668,000 spot price for pounds at the date the contract was entered into and $672,000, the contracted amount. This difference must be amortized to income over the 30 day period. The effective interest rate is computed as follows: $672,000 = $668,000 x (1+r)30, solving for r (the daily interest rate) = .0199025%. $668,000 x .000199025 x 15= $1,994. December 31, 2011 account balances: Accounts Payable $660,000 Forward Contract 7,980 credit Other comprehensive income 2,014 credit Exchange loss (net) 1,994

13-22

Accounting for Derivatives and Hedging Activities

P13-8 (continued) 3

January 15, 2012 Accounts payable (fc) (-L) 4,000 Exchange gain (+G,+SE) To mark the accounts payable to fair value.

4,000

Other comprehensive income (-OCI,-SE) 8,020 Forward contract (+L) To mark the forward contract to fair value.

8,020

Exchange loss (+Lo,-SE) 4,000 Other Comprehensive Income (+OCI,+SE) 4,000 To record the reclassification from OCI to offset the exchange gain on the accounts payable Exchange loss (+Lo,-SE) 2,006 Other Comprehensive Income (+OCI,+SE) 2,006 To record the amortization of the premium The total premium is $4,000 ($672,000 - $668,000), the portion left to be amortized is $4,000 - $1,994 = $2,006. Forward contract 16,000 Cash To record the settlement of the forward contract.

16,000

Accounts payable (fc) (-L) 656,000 Cash (fc) (-A) To record payment of accounts payable in pounds.

656,000

January 15, 2012 account balances: Accounts Payable: $0 Forward Contract:$7,980 credit + $8,020 – $16,000 = $0 Other Comprehensive Income:$2,014 credit - $8,020 dr + $4,000 cr + $2,006 cr = $0 Exchange Loss (net): $2,006

Chapter 14 FOREIGN CURRENCY FINANCIAL STATEMENTS Answers to Questions 1

A company’s functional currency is the currency of the primary economic environment in which it operates. It is normally the currency in which it receives most of its payments from customers and in which it pays most of its liabilities. Other factors that are considered in determining the functional currency include whether its sales prices are determined primarily by local competition or local government regulation instead of short-run exchange rate changes or worldwide markets. The functional currency determination (local currency or parent currency or some other currency) is critical in determining what approach to converting financial statements to the ultimate reporting currency is used: the current rate or the temporal method. If the functional currency is the local currency, the current rate method is used. If it is the parent currency, the temporal method is used. If it is some other currency, then both approaches may need to be used.

A highly inflationary economy under GAAP is one that has cumulative inflation of approximately 100 percent or more over a three-year period. The functional currency is assumed to be the reporting currency (for U.S. companies, the dollar) which means that the foreign currency financial statements must be remeasured into the dollar using the temporal method. The effect of the hyperinflation is then reflected in the current year’s consolidated income statement which would not be the case if the current rate method were used. Judgment must be exercised in applying this rule to avoid changing functional currencies frequently due to minor differences in the inflation rate.

The functional currency of a foreign subsidiary does not affect the original recording of the business combination. This is because all assets, liabilities, and equities of the foreign subsidiary are converted into U.S. dollars at the current exchange rate in effect on the date of consummation of the business combination. As a result, no special procedure must be applied at the date of original recording of a foreign subsidiary.

The current rate method is used when the foreign subsidiary’s local currency is determined to be the subsidiary’s functional currency. The subsidiary’s financial statements must be translated using the current rate method into the reporting entity’s currency (typically the parent’s currency).

The temporal method is used when the foreign subsidiary’s currency is determined to be the reporting entity’s currency (typically the parent’s currency). The temporal method is used when the functional currency of the foreign subsidiary is the U.S. dollar. The subsidiary’s financial statements must be remeasured using the temporal method into the reporting entity’s currency.

Since the functional currency is not the parent’s currency, no direct impact on the reporting entity’s (parent’s) cash flows is expected due to exchange rate changes. The effects of exchange rate changes are reflected in the consolidated statement’s accumulated comprehensive income account instead of being included in the income statement.

Since the functional currency is assumed to be the reporting entity’s (or parent’s) currency, a direct impact on the parent’s cash flows is expected due to exchange rate changes. The effects of exchange rate changes are reflected in the consolidated income statement.

14-2

Foreign Currency Financial Statements

A foreign subsidiary’s financial statements could be both translated and remeasured if the entity’s books are maintained in a different currency than the functional currency and the functional currency is not the reporting entity’s local currency. In this case, the entity’s financial statements must be remeasured into the functional currency using the temporal method. The gain or loss on remeasurement is included in income. The functional currency financial statements are then translated into the reporting entity’s currency using the current rate method. The gain or loss on the translation is included in accumulated other comprehensive income. In this situation, the consolidated financial statements would include both a remeasurement gain or loss in income and the a translation adjustment included in accumulated other comprehensive income.

No, it would not be appropriate to use the annual average exchange rate. Theoretically, the exchange rate at the date each transaction occurs should be used. Given that this is not practical, reasonable assumptions are made concerning what exchange rate to use. The use of an average exchange rate is appropriate when sales are earned evenly during the year and expenses are incurred evenly during the year. A reasonable assumption for a holiday tree grower would be to use the average exchange rate during the quarter from October through December since those are the month’s that trees are typically sold. For expenses, examining the months that are the most labor intensive (such as planting, fertilizing and harvesting) and using a reasonable weighting of those months exchange rates would be a reasonable way of determining the rate for those costs.

The parent purchased the subsidiary for an amount in excess of book value. This excess was attributable to an unrecorded patent. Recall that the excess amount would not be included on the subsidiary’s books. The consolidated financial statements, however, would include both the amortization of the patent and the patent. Since the current rate method is being used, the impact of the change in exchange rates on the patent and the amortization is included in the translation adjustment to be included in consolidated comprehensive income. The subsidiary’s translation adjustment would not include this because the patent was not included in the books. Thus, the consolidated translation adjustment is larger than the subsidiary’s translation adjustment.

The temporal method requires remeasuring expenses of a foreign subsidiary. Expenses related to monetary items are remeasured at appropriately weighted average exchange rates for the period. Those types of expenses are either paid in cash or recorded as liabilities which will require the eventual payment of cash. Those that relate to nonmonetary items are remeasured at historical exchange rates. Expenses related to nonmonetary items would be those related to inventory and plant assets. Under the current rate method, all accounts are translated at the weighted average rate.

If the functional currency is a subsidiary’s local currency, the current rate method is used, and the gain or loss on the hedge of a net investment in a foreign subsidiary is reported in other comprehensive income. If the functional currency is the parent’s currency, the temporal method is used, and the gain or loss is included in current period income.

Chapter 14

14-3

SOLUTIONS TO EXERCISES Solution E14-1 1 2 3 4 5 6

c a c a b b

7 8 9

c b a

4 5

b a

Solution E14-2 [Based on AICPA] 1 2 3

c d d

Solution E14-3 Pai Company and Subsidiary Consolidated Balance Sheet at January 1, 2011 Current assets [$3,000,000 - $990,000 + (100,000£  $1.65)]

$2,175,000

Land [$800,000 + (200,000£  $1.65)]

1,130,000

Buildings — net [$1,200,000 + (250,000£  $1.65)]

1,612,500

Equipment — net [$1,000,000 + (100,000£  $1.65)]

1,165,000 247,500

Goodwill [$990,000 cost - (450,000£ fair value  $1.65)]

$6,330,000 Current liabilities [$600,000 + (50,000£  $1.65)]

682,500

Notes payable [$1,000,000 + (150,000£  $1.65)]

1,247,500

Capital stock

3,000,000

Retained earnings

1,400,000 $6,330,000

14-4

Foreign Currency Financial Statements

Solution E14-4 Foreign currency statements Inventory will be carried at the 10,000 euros historical cost. Remeasured statements (Temporal Method) Inventory will be carried at historical cost of $5,300. ($0.53 x 10,000) Under translated statements (Current Rate Method) The inventory will be carried at the year-end rate of $0.60, so the inventory is reported at $6,000. ($0.60 x 10,000) Solution E14-5 1

Patent at acquisition of Sim Cost of Sim Book value acquired: (35,000,000 Euros  $.030) Patent in dollars

$1,200,000 1,050,000 $ 150,000

Patent in Euros ($150,000/$.030)

5,000,000 Eu

Patent amortization in dollars Patent amortization in Euros (5,000,000/10 years) = 500,000 Euros Patent amortization in $ (500,000 Euros  $.032 average rate)

16,000

Entry to record patent amortization Income from Sim Investment in Sim Equity adjustment from translation of patent

$16,000 7,500 23,500

To record patent amortization and the equity adjustment from translation of patent computed as follows: Beginning patent 5,000,000 Euros $.030 $ 150,000 Amortization (500,000) .032 (16,000) 4,500,000 134,000 Equity adjustment _________ 23,500 Ending patent 4,500,000 .035 $ 157,500

Chapter 14

14-5

Solution E14-6 Preliminary computations Cost of investment in Sta Book value acquired (90,000 £  $1.66) Excess in dollars

$163,800 149,400 $ 14,400

Excess allocated to equipment (6,000 £  $1.66)

Patent

$ 4,440 $ 14,400

Equity adjustment from excess allocated to equipment on December 31, 2011 Depreciation of excess based on £ (6,000/3 years) Undepreciated excess balance at year-end based on £ (4,000 £  $1.64 current rate) Add: Depreciation on excess based on £ — 2011 2,000 £  $1.65 average rate

2,000 £ $

Equity adjustment from translation of excess allocated to equipment (loss)

6,560 3,300 9,860 9,960

Less: Beginning excess based on U.S. dollars

9,960

100

Equity adjustment from excess allocated to patent on December 31, 2011. Patent (must be carried in £) $4,440/$1.66 = 2,675 £ patent Patent amortization is 2,675 £ / 10 years = Unamortized excess balance at year-end based on £ (2,408 £  $1.64 current rate) Add: Amortization of patent based on £ (267 £  $1.65 average rate) Less: Beginning patent based on U.S. dollars Equity adjustment from translation of patent (loss)

267 £ $

3,949

$ $ $

441 4,390 4,440 50

Not required: The entry to record the decrease in the equity adjustment related to equipment and patent would be as follows: Income from Sta $3,741 Equity adjustment from translation (equipment) 100 Equity adjustment from translation of patent 50 Investment in Sta $ 3,891 To adjust the income from Sta for depreciation on the excess allocated to equipment ($3,300) and amortization of patent ($441), and to record a decrease in the equity adjustment from translation for the foreign exchange rate changes.

14-6

Foreign Currency Financial Statements

Solution E14-7 Preliminary computations Investment cost Book value acquired (1,400,000 Eu  $.75 exchange rate) Excess cost over book value acquired

$1,350,000 1,050,000 $ 300,000

Excess allocated to undervalued land (400,000 Eu  $.75)

300,000

308,000 8,000

Equity adjustment from translation on excess allocated to land Excess on land at January 1, 2011 Less: Excess on land at December 31, 2011 (400,000 Eu  $.77 current rate at year-end) Equity adjustment from translation - gain (credit) Solution E14-8 [Based on AICPA] 1

a Exchange loss of $15,000 less an exchange gain on the account payable of $4,000 ($64,000 original payable - $60,000 year-end adjusted balance) = $11,000 loss.

b Translated at historical rate: 25,000/2.2 = $11,364

d Depreciation on the property, plant, and equipment is computed as follows: Property, Plant Exchange Property, Plant Amortization Annual and Equipment Rate and Equipment Period Depreciation 2011 2,400,000 LCU  1.6 = $1,500,000 10 years = $150,000  2012 1,200,000 LCU  1.8 = 666,667 10 years = 66,667  3,600,000 LCU $2,166,667 $216,667

a 5.7 LCU to $1, the rate in effect when the dividend was paid.

d Long-term receivables 1,500,000 LCU  1.5 = Long-term debt 2,400,000 LCU  1.5 =

c All three accounts are translated at current rates.

c Cumulative inflation rate = (330 - 150)/150 = 120%

$1,000,000 $1,600,000

Chapter 14

14-7

SOLUTIONS TO PROBLEMS Solution P14-1 1

Pak’s income from Sco for 2011 Investment cost of 40% interest in Sco Less: Book value acquired ($2,400,000  40%) Patent in dollars at acquisition

$1,080,000 (960,000) $ 120,000

Patent in euros at acquisition $120,000/$.60 exchange rate = Equity in Sco’s income ($310,000  40%) Patent amortization for 2011 200,000 euros/10 years  $.62 average rate Income from Sco for 2011 2

200,000 euros $

124,000

(12,400) 111,600

Investment in Sco at December 31, 2011 Investment cost Add: Income from Sco Less: Dividends ($192,000  40%) Add: Equity adjustment from translation ($212,000  40%) Add: Equity adjustment from patent computed as: Beginning balance $120,000 Less: Patent amortization 12,400 Less: Unamortized patent at year end 117,000 Investment in Sco December 31, 2011

$1,080,000 111,600 (76,800) 84,800

9,400 $1,209,000

Proof of investment balance Net assets at December 31, 2011 of $2,730,000  40% Add: Unamortized patent (180,000 euros  $.65) Investment balance

$1,092,000 117,000 $1,209,000

14-8

Foreign Currency Financial Statements

Solution P14-2 1

Excess Patent at January 1, 2011: Cost Book value of interest acquired (4,000,000 LCUs  $.15)  40% Excess Patent Excess Patent in LCUs $102,000/$.15 = 680,000 LCUs

Alternatively, 68,000 LCUs  ($.15 - $.14) = 612,000 LCUs  ($.15 - $.13) =

$ 79,560

$102,000 (9,520) (79,560) $ 12,920 $

680 12,240 $12,920

Income from Sor — 2011: Equity in income ($112,000  40%) Less: Excess Patent amortization Income from Sor — 2011

9,520

Equity adjustment from Excess Patent: Beginning balance in U.S. dollars Less: Amortization for 2011 Less: Ending balance Equity adjustment from Excess Patent

Unamortized Excess Patent at December 31, 2011: (680,000 - 68,000 LCUs amortization)  $.13 current rate

(240,000) $102,000

Excess Patent amortization — 2011: Excess Patent in LCUs 680,000/10 years  $.14 average rate =

$342,000

$ 44,800 (9,520) $ 35,280

Investment in Sor balance at December 31, 2011: Cost January 1 Add: Income 2011 Less: Dividends ($56,000  40%) Less: Equity adjustment ($84,000  40%) Less: Equity adjustment from Excess Patent Investment in Sor December 31, 2011

$342,000 35,280 (22,400) (33,600) (12,920) $308,360

Check: Net assets $228,800 ($572,000  40%) plus $79,560 unamortized Excess Patent = $308,360 investment in Sor at December 31, 2011.

Chapter 14

14-9

Solution P14-3 1

Soo Company, Ltd. Translation Worksheet for 2011

Debits Cash Accounts receivable — net Inventories Equipment Cost of sales Depreciation expense Operating expenses Dividends Credits Accumulated depreciation Accounts payable Capital stock Retained earnings Sales Equity adjustment from translation

British Pounds

Exchange Rate

20,000 70,000 50,000 800,000 350,000 80,000 100,000 30,000 1,500,000

$1.65 C 1.65 C 1.65 C 1.65 C 1.63 A 1.63 A 1.63 A 1.62 R

330,000 70,000 400,000 100,000 600,000

$1.65 C 1.65 C 1.60 H measured 1.63

1,500,000 2

US Dollars 33,000 115,500 82,500 1,320,000 570,500 130,400 163,000 48,600 $2,463,500 544,500 115,500 640,000 160,000 978,000 25,500 $2,463,500

Journal entries — 2011 January 1, 2011 Investment in Soo Cash To record purchase of Soo at book value. During 2011 Cash Investment in Soo To record dividends from Soo.

$800,000 $800,000

$ 48,600 $ 48,600

December 31, 2011 Investment in Soo $139,600 Income from Soo $114,100 Equity adjustment from translation 25,500 To record income from Soo and enter equity adjustment for currency fluctuations. Check: Investment in Soo 1/1 Dividends Income from Soo Equity adjustment Investment in Soo 12/31

$800,000 (48,600) 114,100 25,500 $891,000

Capital stock Retained earnings 1/1 Add: Income Less: Dividends Stockholders’ equity Current rate

400,000 £ 100,000 £ 70,000 £ (30,000)£ 540,000 £ $ 1.65 $891,000 $25,000

14-10

Foreign Currency Financial Statements

Add: Net income 70,000 pounds x ($1.65 - $1.63) Less: Dividends 30,000 pounds x ($1.65 - $1.62) Effect of exchange rate changes on net assets

1,400 (900) $25,500

Chapter 14

14-11

Solution P14-4 Preliminary computations Investment cost $4,000,000 Less: Book value of interest acquired 2,800,000 (7,000,000 euros  $.50 exchange rate  80% interest) Patent $1,200,000 Patent in euros ($1,200,000/$.50 exchange rate) = 2,400,000 euros Patent amortization based on euros 2,400,000 euros/10 years = 240,000 euros 1

Sul Corporation Translation Worksheet at and for the year ended December 31, 2011

Debits Cash Accounts receivable Inventories Equipment Cost of sales Depreciation expense Operating expenses Dividends

Euros

Exchange Rate U.S. Dollars

1,000,000 2,000,000 4,000,000 8,000,000 4,000,000 800,000 2,700,000 500,000 23,000,000

$.6000 C $ 600,000 .6000 C 1,200,000 .6000 C 2,400,000 .6000 C 4,800,000 .5500 A 2,200,000 .5500 A 440,000 .5500 A 1,485,000 .5400 H 270,000 $13,395,000

Credits 2,400,000 Accumulated depreciation — equipment Accounts payable 3,600,000 Capital stock 5,000,000 Retained earnings, January 1 2,000,000 Sales 10,000,000 Equity adjustment from translation 23,000,000 2

.6000 C $ 1,440,000 .6000 C .5000 H .5000 H .5500 A

2,160,000 2,500,000 1,000,000 5,500,000 795,000 $13,395,000

Pet’s income from Sul — 2011 Share of Sul’s net income ($5,500,000 sales $2,200,000 cost of sales - $440,000 depreciation $1,485,000 operating expenses) Percentage owned

$ 1,375,000 80%

Equity in Sul’s net income Less: Patent amortization (240,000 euros  $.55 average rate) Income from Sul

1,100,000 (132,000) $

968,000

14-12

Foreign Currency Financial Statements

Solution P14-4 3

(continued)

Investment in Sul December 31, 2011 Investment January 1, 2011 Add: Income from Sul Add: Equity adjustment from translation ($795,000  80%) Add: Equity adjustment from Patent [$1,200,000 Patent at beginning of the period - $132,000 Patent amortization — (2,160,000 euros unamortized Patent x $.60 current rate)] Less: Dividends ($270,000  80%) Investment in Sul December 31, 2011

$4,000,000 968,000 636,000

228,000 (216,000) $5,616,000

Solution P14-5 Sar Company Remeasurement Worksheet at December 31, 2011

Cash Accounts receivable Short-term note receivable Inventories Land Buildings — net Equipment — net Cost of sales Depreciation expense Other expenses Dividends Exchange loss on remeasurement

British £

Exchange Rate

50,000 200,000 50,000 150,000 300,000 400,000 500,000 650,000 200,000 400,000 100,000

$1.70 C 1.70 C 1.70 C 1.68 H 1.60 H 1.60 H 1.60 H * H 1.60 H 1.65 A 1.64

$1.70 C 1.70 C 1.70 C 1.60 H M 1.65 A

3,000,000 Accounts payable Bonds payable — 10% Bond interest payable Capital stock Retained earnings Sales *

180,000 500,000 20,000 500,000 300,000 1,500,000 3,000,000

U.S. Dollars 85,000 340,000 85,000 252,000 480,000 640,000 800,000 1,058,000 320,000 660,000 164,000 61,000 $4,945,000 306,000 850,000 34,000 800,000 480,000 2,475,000 $4,945,000

Cost of sales = Beginning inventory (200,000 £  $1.60) + purchases (600,000 £  $1.65) - ending inventory (150,000 £  $1.68) = $1,058,000

Chapter 14

14-13

Solution P14-6 Stu Corporation Remeasurement Worksheet December 31, 2011 New Zealand Dollars Debits Cash Accounts receivable — net Inventories Prepaid expenses Land Equipment Cost of sales Depreciation expense Other operating expenses Dividends Remeasurement loss Credits Accumulated depreciation Accounts payable Capital stock Retained earnings Sales

Exchange Rate

U.S. Dollars

15,000 60,000 30,000 10,000 45,000 60,000 120,000 12,000 28,000 20,000 _______ 400,000

$ 0.65 C 0.65 C 0.66 H 0.70 H 0.70 H Note 1 M Note 2 M Note 3 M Note 4 M 0.66 H

9,750 39,000 19,800 7,000 31,500 41,800 82,200 8,360 19,000 13,200 1,450 $273,060

22,000 18,000 150,000 10,000 200,000 400,000

Note 5 M $ 0.65 C 0.70 H M 0.67 A

$ 15,360 11,700 105,000 7,000 134,000 $273,060

Note 1

Original equipment (50,000 NZ$  $.70) + equipment purchased in 2011 (10,000 NZ$  $.68)

Note 2

Beginning inventory (50,000 NZ$  $.70) + purchases (100,000 NZ$  $.67) - ending inventory (30,000 NZ$  $.66)

Note 3

Depreciation on original equipment (50,000 NZ$  20%  $.70) + depreciation on new equipment (10,000 NZ$  20%  $.68)

Note 4

Other operating expenses consist of the prepaid supplies used (8,000 NZ$  $.70) + current year outlays (20,000 NZ$  $.67)

Note 5

Accumulated depreciation on the original equipment (20,000 NZ$  $.70) + accumulated depreciation on the equipment purchased (2,000 NZ$  $.68)

14-14

Foreign Currency Financial Statements

Solution P14-7 1

Sar Company Translation Worksheet at and for the year ended December 31, 2011

Debits Cash Trade receivables Inventories Land Equipment — net Buildings — net Expenses Exchange loss (advance)* Dividends Equity adjustment Total Credits Accounts payable Other liabilities Advance from Pel Common stock Retained earnings January 1 Sales Total *

Sheqels

Translation Rate

40,000 50,000 150,000 160,000 300,000 500,000 400,000 20,000 100,000

$.30 C .30 C .30 C .30 C .30 C .30 C .32 A .32 A .33 R

$ 12,000 15,000 45,000 48,000 90,000 150,000 128,000 6,400 33,000 40,600 $568,000

$.30 C .30 C .30 C .35 H .35 H .32 A

$ 36,000 18,000 42,000 175,000 105,000 192,000 $568,000

1,720,000 120,000 60,000 140,000 500,000 300,000 600,000 1,720,000

U.S. $

Sar increased its advance by 20,000 sheqels and recognized a 20,000 sheqel loss.

Journal entries to account for the investment in Sar: January 1, 2011 Investment in Sar $308,000 Cash To record the investment in Sar Co. January 2, 2011 Advance to Sar $ 42,000 Cash To record advance to Sar denominated in U.S. dollars.

$308,000

$ 42,000

June 2011 Cash $ 33,000 Investment in Sar $ 33,000 To record receipt of dividends (100,000 sheqels  $.33). December 31, 2011 Investment in Sar $ 17,000 Equity adjustment from translation 40,600 Income from Sar $ 57,600 To record equity in Sar. Income from Sar $ 2,560 Equity adjustment from translation 3,840 Investment in Sar $ 6,400 To record equity adjustment from Patent amortization computed as follows: Copyright © 2015 Pearson Education, Inc.

Chapter 14

14-15

Patent amortization 80,000 sheqels/10 years  $.32 rate = $2,560 Ending balance 72,000 sheqels  $.30 rate = $21,600 $28,000 beginning balance - $21,600 ending balance = $6,400

14-16

Foreign Currency Financial Statements

Solution P14-8 Preliminary computations Investment cost of SAA Book value acquired (8,000,000 LCU  $.190) Patent

$1,710,000 (1,520,000) $ 190,000

Patent based on LCU ($190,000/$.190) Amortization of Patent (1,000,000 LCU/10 years)

1,000,000 LCU 100,000 LCU

Patent amortization for 2011 (100,000 LCU  $.185)

18,500

Unamortized Patent at December 31, 2011 (900,000 LCU  $.180)

162,000

9,500

Equity adjustment for Patent for 2011: Beginning balance Less: Amortization Less: Ending balance

$190,000 (18,500) (162,000)

Reconciliation of investment account: Investment in SAA January 1, 2011 Add: Income from SAA for 2011 ($360,750 - $18,500 Patent amortization) Equity adjustment from translation ($84,750  100%) Equity adjustment from Patent Dividends from SAA Investment in SAA December 31, 2011

$1,710,000 342,250 (84,750) (9,500) (185,000) $1,773,000

Chapter 14

14-17

Solution P14-8 (continued) 1

Journal entries to account for the investment in SAA January 1, 2011 Investment in SAA $1,710,000 Cash To record purchase of SAA stock for cash.

$1,710,000

July 1, 2011 Advance to SAA $ 333,000 Cash $ 333,000 To record short-term advance to SAA denominated in dollars. September 1, 2011 Cash $ 185,000 Investment in SAA $ 185,000 To record receipt of dividends when exchange rate is $.185. December 31, 2011 Investment in SAA Equity adjustment from translation Income from SAA To record equity in income of SAA.

276,000 84,750 $

360,750

Income from SAA $ 18,500 Equity adjustment from translation 9,500 Investment in SAA $ 28,000 To record Patent amortization and equity adjustment from Patent computed as follows: Patent amortization: 100,000 LCU  $.185 average rate = $18,500 Equity adjustment: $190,000 beginning Patent balance - $18,500 amortization - (900,000 LCU unamortized Patent at year end  $.180 current rate) = $9,500

14-18

Foreign Currency Financial Statements

Solution P14-8 (continued) PWA Corporation and Subsidiary Consolidation Working Papers for the year ended December 31, 2011 PWA Income Statement Sales Income from SAA Expenses Exchange loss Net income

Adjustments and Eliminations

SAA

Consolidated Statements

569,500 $1,110,000 342,250 a 342,250 (400,000) (740,000) c 18,500 (9,250)

$1,679,500

511,750

856,500

(1,158,500) (9,250)

360,750

Retained Earnings Retained earnings — PWA

Retained earnings — SAA Net income Dividends Retained earnings December 31, 2011 Balance Sheet Cash Accounts receivable Advance to SAA Inventories Land

511,750✓ (300,000)

570,000

b 570,000

360,750✓ (185,000)

$1,068,250

745,750

$1,068,250

99,000 90,000

90,720 128,500 333,000 120,000 100,000 600,000

333,000 390,000 388,000 1,140,000

300,000

900,000

1,200,000

1,773,000

__________

Buildings — net Investment in SAA Patent

94,250

b 190,000

a 157,250 b 1,710,000 c e

18,500 9,500

162,000

$3,445,220

$2,187,000

$3,688,220

162,720 308,500 2,000,000

Equity adjustment — PWA

189,720 218,500

270,000 288,000 540,000

Equipment — net

Accounts payable Advance from PWA Other liabilities Capital stock Retained earnings

511,750 (300,000)

185,000

1,068,250✓ (94,250)

135,000 333,000 108,000 950,000

d 333,000

$3,445,220

416,500 2,000,000 1,068,250

b 950,000

745,750✓

(94,250) (84,750) _________

Equity adjustment — SAA

297,720

$2,187,000

2,498,000

84,750 2,498,000 $3,688,220

Chapter 14

14-19

Solution P14-9 1

San Corporation Adjusted Trial Balance Translation Worksheet at December 31, 2011 Debits Cash Accounts receivable Inventories Land Buildings Equipment Cost of sales Depreciation expense Other expenses Exchange loss Dividends Equity adjustment Credits Accumulated depreciation — buildings Accumulated depreciation — equipment Accounts payable Short-term loan from Par Capital stock Retained earnings January 1 Sales

LCUs

Rate

U.S. Dollars

150,000 180,000 230,000 250,000 600,000 800,000 200,000 100,000 120,000 30,000 100,000 --2,760,000

$.20 C .20 C .20 C .20 C .20 C .20 C .22 A .22 A .22 A .22 A .21 R

$ 30,000 36,000 46,000 50,000 120,000 160,000 44,000 22,000 26,400 6,600 21,000 44,000 $606,000

300,000 400,000 130,000 230,000 800,000 200,000 700,000 2,760,000

$.20 C .20 C .20 C .20 C .24 H .24 H .22 A

$ 60,000 80,000 26,000 46,000 192,000 48,000 154,000 $606,000

Journal entries for 2011 [Par’s books] January 1, 2011 Investment in San $216,000 Cash $216,000 To record purchase of 90% interest in San: 1,000,000 LCU  $.24 exchange rate  90% interest. May 1, 2010 Advance to San $ 46,000 Cash $ 46,000 To record short-term loan to San denominated in U.S. dollars: 200,000 LCU  $.23 exchange rate.

14-20

Foreign Currency Financial Statements

Solution P14-9 (continued) September 2011 Cash $ 18,900 Investment in San $ 18,900 To record receipt of dividends from San (100,000 LCU  $.21 exchange rate  90% interest) December 31, 2011 Investment in San $ 9,900 Equity adjustment from translation 39,600 Income from San $ 49,500 To record investment income from San of $49,500 computed as [$154,000 revenue – ($44,000 cost of sales + $22,000 depreciation expense + $26,400 other expenses + $6,600 exchange loss)]  90% and to record equity adjustment from translation of $39,600 computed as $44,000  90%.

Supporting computations Investment balance January 1, 2011 Less: Dividends Add: Income from San Less: Equity adjustment from translation Investment balance December 31, 2011 Noncontrolling interest at January 1, 2011 date of acquisition 1,000,000 LCU  $.24  10% Less: Noncontrolling interest’s share of the equity adjustment from translation for 2011 ($44,000  10%) Beginning Noncontrolling interest in consolidation working papers

$216,000 (18,900) 49,500 (39,600) $207,000

$ 24,000

(4,400) $ 19,600

Chapter 14

14-21

Solution P14-9 (continued) 3 Par Corporation and Subsidiary Consolidation Working Papers for the year ended December 31, 2011 Par Income Statement Sales Income from San Cost of sales Depreciation expense Other expenses Exchange loss Noncontrolling interest share Net income

$ 800,000 $ 154,000 49,500 a (400,000) (44,000) (81,000) (22,000) (200,000) (26,400) (6,600) d $ 168,500

Retained Earnings Retained earnings — Par Retained earnings — San Net income Dividends Retained earnings December 31, 2011 Balance Sheet Cash Accounts receivable Loan to San Inventories Land Buildings — net Equipment — net Investment in San

Accounts payable Loan from Par Capital stock Retained earnings Equity adjustment — Par Equity adjustment — San

Adjustments and Eliminations

San 90%

(444,000) (103,000) (226,400) (6,600) 5,500

(5,500)

55,000

168,500✓ (100,000)

48,000

954,000

49,500

$ 220,000 $

Consolidated Statements

168,500

220,000

48,000 168,500

55,000✓ (21,000)

a d

18,900 2,100

(100,000)

$ 288,500

82,000

288,500

30,000 36,000

77,000 126,000

47,000 90,000 46,000 110,000 150,000 180,000

160,000

80,000

207,000

_________

$ 990,000

$ 302,000

$ 241,100

500,000 288,500

46,000

46,000 50,000 60,000

26,000 46,000 192,000 82,000

156,000 200,000 240,000 240,000 e

39,600

a 30,600 b 216,000 __________ $1,039,000 $

c 46,000 b 192,000

500,000 288,500

(39,600)

(39,600) (44,000)

$ 990,000

267,100

44,000

b d

24,000 3,400 385,000

$ 302,000

Noncontrolling interest January 1, 2011 Noncontrolling interest December 31, 2011

4,400 385,000

23,000 $1,039,000

14-22

Foreign Currency Financial Statements

Chapter 15 SEGMENT AND INTERIM FINANCIAL REPORTING Answers to Questions 1

An operating segment is a component of an enterprise: (1) that engages in business activities from which it may earn revenues and incur expenses, either internal or external; (2) whose operating results are regularly reviewed by the enterprise’s chief operating decision maker and (3) for which discrete financial information is available.

A reportable segment is an operating segment, either single or aggregated, for which information has to be reported under FASB ASC Topic 280. An operating segment is a reportable segment if (a) its revenue is 10 percent or more of the combined revenue of all operating segments, (b) its absolute profit or loss is 10 percent or more of the greater of combined profit of all segments that have profit or combined losses of all segments that have losses, or (c) its assets are 10 percent or more of the combined assets of all operating segments.

Segments not meeting one of these tests are subject to a reevaluation, and possible aggregation, if the combined revenue from sales to external customers of all reportable segments is less than 75 percent of consolidated revenue. Segments that are not reportable segments are combined with other business activities and reported under an “all other” category.

The 10 percent revenue test applies to the $480,000. Revenue for purposes of FASB ASC Topic 280 includes revenue from both external and intersegment customers.

An industry segment is a reportable segment under the 10 percent operating profit test if its operating profit or loss, in absolute amount, equals or is greater than the greater of combined operating profits for all operating segments having operating profits or the absolute value of the combined operating losses for all operating segments having operating losses.

A segment is a reportable segment under the 10 percent asset test if its assets are 10 percent or more of the combined assets of all operating segments. The allocation of general corporate assets depends on the internal operations of the enterprise. The key is the asset figure given to the chief operating decision maker on which he or she evaluates performance. If corporate assets are allocated, they become part of the reconciliation between the reportable segments’ assets and consolidated assets.

A segment is a reportable segment under the 10 percent revenue test if its intersegment and external sales is 10 percent or more of the combined intersegment and external sales of all the operating segments.

No. If the combined revenue from sales to external customers is less than 75 percent of total consolidated revenues, additional operating segments must be identified as reportable segments until the 75 percent test is met. Either some of the remaining segments must be aggregated, if they meet the aggregation criteria, so that the combined segment meets the materiality criteria of 10%, or one or more of the five operating segments that were not reportable segments under the 10 percent tests must be identified as reportable segments.

15-2

Segment and Interim Financial Reporting

The following information must be disclosed for reportable segments and for the remainder of the enterprise’s operating segments and other business activities in the aggregate: a Revenue, with separate amounts to unaffiliated and affiliated customers, and disclosure of the basis of accounting for intersegment sales. b A measure of profit or loss, based on the information reviewed by the chief operating officer. c Assets for each reportable segment. d Interest revenue e Interest expense f Aggregate amount of depreciation, depletion, and amortization expense. g Unusual items as described in paragraph 26 of APB Opinion No. 30. h Equity in the net income of investees accounted for by the equity method. i Income tax expense or benefit. j Extraordinary items. k Significant noncash items other than depreciation, depletion, and amortization.

If the enterprise is segmented on a geographic basis, complete segment information would be supplied by country of operation. If a different criteria is used for segmentation, more limited geographic information is supplied. Revenues and long lived assets attributed to the country of domicile and all foreign operations are disclosed. Any single country with material operations must also be disclosed separately.

The fact of and the amount of revenue from each customer must be disclosed if 10 percent or more of an enterprise’s revenue is derived from that customer. If 10 percent or more of an enterprise’s revenue is derived from sales to the federal government, or to a state, local, or foreign governmental unit, that fact and the amount of revenue must be disclosed. The identity of the segment making such sales must be disclosed, but the customer need not be identified by name.

The requirements of FASB ASC Topic 280 do apply to interim financial statements. Like other aspects of interim reporting, segment disclosure is more limited in the interim reports than in the annual reports. Required disclosure for each reportable segment in the interim reports include: (1) revenues from external customers, (2) intersegment revenues, (3) a measure of segment profit or loss, (4) total assets for which there has been a material change since the amount disclosed in the annual report, (5) a description of any changes in the basis for segmentation or the basis of measurement of segment profit or loss, (6) a reconciliation of total reportable segment profit or loss and consolidated income before income taxes.

An annual effective tax rate is computed as the sum of estimated income taxes for each quarter of the year, divided by the estimated income for the year. This approach spreads any progression in tax rates over the entire year in accordance with the integral theory of interim reporting.

The discrete theory assumes that each quarter is a separate and independent accounting period that stands alone. By contrast, the integral theory treats each interim period as an essential part of each annual period. The integral theory is required under GAAP reporting for interim reports.

FASB ASC Topic 270 specifies that minimum disclosures for interim reports should include gross revenues, provision for income taxes, extraordinary items, comprehensive income, net income and related EPS amounts as basic reporting items. In addition, disclosures are required of seasonal cost and revenue, significant changes in income tax estimates, or changes in financial position, and material contingencies, extraordinary and unusual or infrequently occurring items. Also, disclosures are required for the disposal of a component of an entity, change in accounting principles, change in estimate, reportable operating segments, pension plans, derivatives, permanent impairments, certain types of investments, use of fair value to measure assets and liabilities, and the fair value of financial instruments. Copyright © 2015 Pearson Education, Inc.

Chapter 15

15-3

SOLUTIONS TO EXERCISES Solution E15-1 1 2 3

d a d

4 5 6

b d b

Solution E15-2 1

Revenue tests

10% revenue test: Revenue from Affiliated and Unaffiliated Customers Concrete and stone products $ 400,000 Construction 1,000,000 Lumber and wood products 1,800,000 Building materials 1,000,000 Other 100,000 $4,300,000

Reportable Segment Test Value $430,000 No Yes Yes Yes No

75% revenue test: Combined Revenue from Reportable Segments to Unaffiliated Customers Concrete and stone products Construction Lumber and wood products Building materials Other

$ 1,000,000 1,000,000 600,000 $

2,600,000

Combined Revenue from All Segments to Unaffiliated Customers $ 400,000 1,000,000 1,000,000 600,000 100,000 $ 3,100,000

Since the $2,600,000 combined revenue from reportable segments to unaffiliated customers is greater than 75% of $3,100,000 revenue for all unaffiliated customers, no additional segments have to be reported. 2

Schedule for disclosing revenue by segment: Lumber Construction and Wood

Unaffiliated sales Affiliated sales Total Sales 3

Building Materials

Other

Totals

$1,000,000 $1,000,000 $600,000 $500,000 $3,100,000 __________ $800,000 $400,000 ________ 1,200,000 $1,000,000 $1,800,000 $1,000,000 $500,000 $4,300,000

Reconciliation of segment revenue to consolidated revenue

Total revenue of reportable segments Revenue of other segments Eliminations of intersegment revenue Total consolidated revenue

$3,800,000 500,000 (1,200,000) $3,100,000

15-4

Segment and Interim Financial Reporting

Solution E15-3 Revenue test: 10% of combined revenues (total sales) = $34,400 The food service industry, copper mine, and chemical industry are reportable segments under the revenue test because they each have revenue in excess of $34,400. Operating profit test: 10% of the greater of the combined operating profit of all industries having operating profit ($44,250) or the combined operating loss of all industries having operating losses ($12,750). The food service industry, copper mine, chemical industry, and agricultural products industry are reportable segments because they each have operating profit or loss in excess of $4,425. Asset test: 10% of combined assets ($319,000 total assets less $16,500 corporate assets) = $30,250. The food service industry and chemical industry are reportable segments because they have assets in excess of $30,250. Reportable segments (those that meet at least one of the tests): food service industry, copper mine, chemical industry, and agricultural products industry.

Chapter 15

15-5

Solution E15-4 Wow Corporation Segment Revenue for 2011 (in thousands)

Sales to unaffiliated customers Intersegment sales Total

United States $100,000 30,000 $130,000

Canada $36,000 16,000 $52,000

Other Foreign $42,000 8,000 $50,000

Since revenue from reportable operating segments of $136,000 is greater than 75% of consolidated revenue ($178,000), no additional segments need be reported. Revenue Reconciliation: Reportable Segments Other segments Intersegment revenue Consolidated revenue

$182,000 50,000 (54,000) $178,000

Segment and Interim Financial Reporting

15-6

Solution E15-5 1

[AICPA adapted]

c Revenue test value = $3,275

Industries A, B, C, and E

Operating profit test value = $580

Industries A, B, C, and E

Identifiable assets test value = $6,750 and E

Industries A, B, C, D,

d Ten percent of combined revenues of all industry segments.

b Revenue test value: 10% of sales to unaffiliated ($4,000) and affiliated ($1,200) customers = $520

b Only Beck and DG have total revenues  10% of $166,000 combined revenues: Beck $24,000 total revenue > $16,600 DG $118,000 total revenue > $16,600

d If sales to a single customer total 10% or more of Gum’s reported revenues ($50,000,000  10%), major customer data should be disclosed.

a If revenues generated by foreign operations in one country are material (10% or more) of consolidated revenue, Gum should report information about that country’s foreign operations.

c The materiality criteria for reporting a segment based on revenue is 10 percent of total (both external and intersegment, eliminating answer b) revenue (not income, eliminating answer a) of all operating segments (not just those reporting a profit, eliminating answer d).

b Sales to other segments are always included in segment income. The other three options generally would not be included but any of them could be included. Inclusion would depend on whether it was included in the performance report evaluated by the chief operating decision maker.

Chapter 15

15-7

Solution E15-6 1

c Japan is the only foreign segment that has segmental revenues (including intersegment revenues) of over 10% of total segment revenues of $63,000.

c United States Canada Germany Japan Mexico Other foreign Total foreign

Assets $50,000 7,500 8,500 9,000 2,000 1,500 $78,500

> < > > <

Test Value $7,850 $7,850 7,850 7,850 7,850

Reportable Geographic Area yes no yes yes no

The test value to determine reportability is 10 percent of consolidated segment assets of $78,500. 3

b United States on all three tests, Japan on the revenue and asset tests, and Germany on the operating profit and asset tests.

Segment and Interim Financial Reporting

15-8

Solution E15-7 1

1st Quarter $240,000 34% 81,600 Less: Tax in prior return periods 0 Quarterly period tax expense $ 81,600 Income year to date Tax rate

2nd Quarter $420,000 30% 126,000 81,600 $ 44,400

a Estimated total taxes of $26,150  $110,000 estimated pretax income = 23.77%

Solution E15-8 Ent Corporation Schedule of Income by Quarter for 2011 1st Quarter Income year-to-date $30,000 Quarterly period income $30,000 Income tax expense* (8,350) Net income $21,650 *

2nd Quarter $70,000

3rd Quarter $110,000

4th Quarter $150,000

Year 2011 $150,000

$40,000 $ 40,000 $ 40,000 $150,000 (11,133) (11,133) (11,134) (41,750) $28,867 $ 28,867 $ 28,866 $108,250

Income tax expense computations: 1st Quarter 2nd Quarter 3rd Quarter 4th Quarter

$30,000  .278333 = $8,350 $70,000  .278333 = $19,483 - $8,350 = $11,133 $110,000  .278333 = $30,616 - $19,483 = $11,133 $150,000  .278333 = $41,750 - $30,616 = $11,134

Chapter 15

15-9

Solution E15-9 [Based on AICPA] 1

a The inventory loss was not expected to be temporary, and therefore, the decline was recognized in the first period. The subsequent recovery to the original cost is recognized in the third period.

b The annual insurance premium has to be allocated $25,000 per quarter.

d The full $360,000 loss is included in the second quarter interim report because the loss is permanent.

a An extraordinary loss is allocated to the quarter to which it relates. In this case the $300,000 extraordinary loss is assigned to the third quarter.

a Under the integral theory each quarterly period is an integral part of each annual period. Thus, property taxes of $20,000 ($80,000  25%) and executive bonuses of $80,000 ($320,000  25%) should be allocated to each of the four quarters.

Solution E15-10 Current cost to replace 4,000 units at $7 $ 28,000 Historical cost of inventory liquidated 4,000 units at $5 20,000 Adjustment to cost of sales [4,000 units  ($7 - $5)] Cost of sales

8,000 550,000

Adjusted cost of sales for the first quarter

$558,000

Segment and Interim Financial Reporting

15-10

SOLUTIONS TO PROBLEMS Solution P15-1 1

Reportable segments under the 10% revenue test: Test value is 10% of $1,158,000 total sales, or $115,800. Reportable industry segments include the apparel, furniture, lumber and wood products, and textiles segments.

Test value for 75% revenue test is the combined revenue from sales to unaffiliated customers by all industry $669,000 segments of $892,000  75% = Reportable segments: Apparel Furniture Lumber and wood products Textiles Total

$164,000 208,000 175,000 50,000 $597,000

Sales to unaffiliated customers by the reportable industry segments of $597,000 is less than the $669,000 test value. Therefore, additional segments must be identified as reportable segments. The construction industry, as closest to the 10% criteria, should be included as a reportable segment. 3

Under the assumption that tobacco and paper share the majority of their operating characteristics they would be combined into one segment that now meets the 10% test and complies with the 75% criteria. Construction would no longer need to be reported. Note to disclose information about segment data:

Apparel Tobacco and paper Furniture Lumber and wood products Textiles Other segments Total revenue

Sales to Unaffiliated Customers $ 164,000 183,000 208,000 175,000 50,000 112,000 $ 892,000

Sales to Affiliated Customers --$

6,000 90,000 170,000 --$266,000

Total Sales $ 164,000 183,000 214,000 265,000 220,000 112,000 $1,158,000

Reconciliation of Segment Revenue to Consolidated Revenue: Reportable segment revenue Revenue of other segments Intersegment revenue Consolidated revenue

$1,046,000 112,000 (266,000) $ 892,000

Chapter 15

15-11

Solution P15-2 1

Reportable segments

Revenue test ($600,000 + $105,000)  10% = $70,500 Reportable segments: Food $350,000 Chemical $150,000 Beverages $ 72,000 Operating profit test ($85,000 + $10,000)  10% = $9,500 Reportable segments: Food $ 45,000 Chemical $ 23,000 Beverages $ 18,000 Asset test $645,000  10% = $64,500 Reportable segments: Food Chemical 2

$310,000 $150,000

Reportable segments test Test value $600,000 consolidated sales  75% = $450,000

Unaffiliated sales:

Food Chemical Beverages Total

$300,000 110,000 62,000 $472,000

Sales by reportable segments ($472,000) are greater than the $450,000 test value and no additional reportable segments are required.

Segment and Interim Financial Reporting

15-12

Solution P15-3 1

Operating segments (foreign geographic areas): Revenue test

Canada Mexico Brazil South Africa United States Total

Revenue $ 24,000 20,000 22,000 25,000 149,000 $240,000

 < <  

Test Value ($240,000 x 10%) $24,000 24,000 24,000 24,000 24,000

Reportable Geographic Area yes no no yes yes

 < <  

Test Value ($250,000 x 10%) $25,000 25,000 25,000 25,000 25,000

Reportable yes no no yes yes

    

Test Value ($50,000 x 10%) $5,000 5,000 5,000 5,000 5,000

Reportable yes yes yes yes yes

Asset test Canada Mexico Brazil South Africa United States Total

Assets $ 30,000 19,000 20,000 31,000 150,000 250,000

Profit test Canada Mexico Brazil South Africa United States Total 2

Profit $ 6,000 8,000 5,000 7,000 24,000 $50,000

All five geographic segments (Canada, Mexico, Brazil, South Africa, and the United States) are reportable segments.

Chapter 15

15-13

Solution P15-3 (continued) 3

DaP Corporation Schedule of Operations in Different Geographic Segments for the year ended December 31, 2011 United States

Mexico

Brazil

South Africa

Canada

$120,000

$20,000

$22,000

$15,000

$13,000 $190,000

29,000 $149,000

$20,000

$22,000

10,000 $25,000

11,000 50,000 $24,000 $240,000

Operating profit

$ 24,000

$ 8,000

$ 5,000

$ 7,000

$ 6,000 $ 50,000

Identifiable assets

$150,000

$19,000

$20,000

$31,000

$30,000 $250,000

Sales to unaffiliated customers Intersegment transfers Total revenue

Reconciliations: Revenue: Total revenue of reportable segments Other revenues Elimination of intersegment revenues Total consolidated revenues

$240,000 0 (50,000) $190,000

Operating Profit: Total operating profit for reportable segments $ 50,000 Other operating profit or loss 0 Elimination of intersegment operating profit 0 Unallocated amounts 0 Consolidated operating profit $ 50,000 Assets: Total assets for reportable segments Other assets Consolidated total

$250,000 0 $250,000

Total

Segment and Interim Financial Reporting

15-14

Solution P15-4 1

Reportable segments: Revenue test Sales to Affiliated and Unaffiliated Customers Test Value Foods $ 210 < $240 Soft drinks 1,060 240  Distilled spirits 570 240  Cosmetics 200 < 240 Packaging 120 < 240 Other (4 minor segments) 240 Total revenue $2,400

Reportable Segment no yes yes no no

75% revenue test

Foods Soft drinks Distilled spirits Cosmetics Packaging Other (4 minor segments)

Sales to Unaffiliated Customers Reportable All Segments Segments $ 180 $ 900 900 550 550 200 110 240 $1,450 $2,180

Since $1,450 < (75%  $2,180), other reportable segments must be identified to bring the total revenue from unaffiliated customers for reportable segments up to $1,635. If no further aggregation is possible, a logical approach is to include cosmetics, the next largest segment in terms of sales to unaffiliated customers. If further aggregation of some of the otherwise nonreportable segments were possible (they met the majority of the aggregation criteria), a combined segment may then meet the reportability criteria and would be reported instead of cosmetics. The test: $900 + $550 + $200 = $1,650 Since $1,650 > $1,635, the reportable segments are soft drinks, distilled spirits, and cosmetics.

Chapter 15

15-15

Solution P15-4 (continued) 2

Mer Corporation Schedule of Sales to Affiliated and Unaffiliated Customers by Segments for the year ended December 31, 2011 Soft Drinks

Sales to unaffiliated customers Sales to affiliated customers Total revenue

Distilled Other Spirits Cosmetics Segments

900

$550

160

$1,060

$570

$200

Totals

$530

$2,180

220

$570

$2,400

Reconciliation: Revenue from reportable segments Other revenue Elimination of intercompany revenue Consolidated revenue 3

$1,830 570 (220) $2,180

Mer Corporation Disclosure of Revenue from Domestic and Foreign Operations for the year ended December 31, 2011

Sales to unaffiliated customers Interarea sales Total revenue

United States $1,850 200 $2,050

Total Foreign $330 20 $350

Japan $250 ____ $250

Segment and Interim Financial Reporting

15-16

Solution P15-5 1

Reportable segments: Revenue test

Food Tobacco Lumber Textiles Furniture

Identified Segment Revenues $17,000 17,000 7,000 26,000 7,000 $74,000

  <  <

Test Value $7,400 7,400 7,400 7,400 7,400

Reportable Segment yes yes no yes no

  <  

Test Value $1,450 1,450 1,450 1,450 1,450

Reportable Segment yes yes no yes yes

  <  <

Test Value $7,200 7,200 7,200 7,200 7,200

Reportable Segment yes yes no yes no

Operating profit test

Food Tobacco Lumber Textiles Furniture

Operating Profit $ 4,000 4,000

Operating Loss

$(500) 5,000 1,500 $14,500

$(500)

Asset test

Food Tobacco Lumber Textiles Furniture

Identifiable Assets $18,000 19,000 6,000 22,000 7,000 $72,000

2 Food, tobacco, textile, and furniture segments are reportable segments.

Chapter 15

15-17

Solution P15-5 (continued) 3

Sales to Unaffiliated Customers Reportable All Segments Segments $12,000 $12,000 10,000 10,000 7,000 18,000 18,000 7,000 7,000 $47,000 $54,000

Food Tobacco Lumber Textiles Furniture

Since the $47,000 revenue from unaffiliated customers of previously identified reportable operating segments is greater than 75% of consolidated revenue (75%  $54,000 = $40,500), no additional reportable segments have to be identified. 4 Rad Company Schedule of Operations in Different Segments for the year ended December 31, 2011 Food

Tobacco

Textiles

Furniture

Other

Total

$12,000

$10,000

$18,000

$7,000

$54,000

5,000 $17,000

7,000 $17,000

8,000 $26,000

$7,000

20,000 $74,000

Operating profit Segment operating profit

$ 4,000

$ 5,000

$1,500

$ (500)

$14,000

Assets Identifiable assets Depreciation

$18,000 $ 1,000

$19,000 $ 2,000

$22,000 $ 3,000

$7,000 $ 500

$6,000 $2,500

$72,000 $ 9,000

Revenues Sales to unaffiliated customers Sales to affiliated Customers Segment revenue

Reconciliation of revenue: Revenue from reportable segments Revenue from equity investees Other revenue Intersegment eliminations Consolidated revenue

$ 67,000 9,000 7,000 (20,000) $ 63,000

Reconciliation of operating profit: Reportable segment operating profit Income from equity investees Other income Interest expense Consolidated operating profit

$ 14,500 9,000 (500) (7,000) $ 16,000

Reconciliation of assets: Reportable segment assets Other segment assets Investment in equity affiliates Corporate assets Consolidated assets

$ 66,000 6,000 60,000 4,000 $136,000

Segment and Interim Financial Reporting

15-18

Solution P15-6 Tut Corporation Schedule of Disclosures for Industry Segments for the year ended December 31, 2011

Revenue Sales to unaffiliated customers Intersegment sales Total sales Expenses Cost of sales General expenses Selling expenses Total expenses Segment operating profit Assets

Chemical Segment

Food Segment

Drug Segment

Totals

$125,000 35,000 160,000

$115,000 25,000 140,000

$120,000 ________ 120,000

$360,000 60,000 420,000

$ 80,000 15,000 20,000 115,000 $ 45,000

$ 70,000 10,000 15,000 95,000 $ 45,000

$ 60,000 10,000 15,000 85,000 $ 35,000

125,000

$200,000

$180,000

$150,000

$530,000

Reconciliation of revenue: Revenue from reportable segments Revenue from equity investees Interest revenue Intersegment eliminations Consolidated revenue Reconciliation of operating profit: Reportable segments operating profit Income from equity investees Interest income Corporate expense Interest expense Noncontrolling interest share Intersegment eliminations Consolidated operating profit Reconciliation of assets: Reportable segment assets Investment in equity affiliates Corporate assets Elimination of intersegment balances Consolidated assets

$ $

420,000 30,000 10,000 (60,000) 400,000 125,000 30,000 10,000 (5,000) (10,000) (15,000) (30,000) 105,000

530,000 300,000 200,000 (30,000) $1,000,000

Chapter 15

15-19

Solution P15-7 1

Reportable segments Revenue test

Segment Food Packing Textile All other Foreign

Industry Segment Revenue $1,010,000 560,000 330,000 400,000 300,000 $2,600,000

   > >

Test Value (10%  $2,600,000)

Operating Reportable Segment

$260,000 260,000 260,000 260,000 260,000

yes yes yes yes yes

Test Value (10%  $325,000)

Reportable Segment

$32,500 32,500 32,500 32,500 32,500

yes yes no yes no

Segment Test Value (10%  $2,125,000)

Reportable Segment

$212,500 212,500 212,500 212,500 212,500

yes yes yes yes no

Operating profit test Segment

Operating Profit

Food Packing Textile All other Foreign

$110,000 110,000 5,000 75,000 25,000 $325,000

  < > <

Asset test

Segment Food Packing Textile All other Foreign

Identifiable Assets $

700,000 500,000 325,000 400,000 200,000 $2,125,000

   > <

Reportable segments are Food, Packing, Textile and Foreign.

Segment and Interim Financial Reporting

15-20

Solution P15-7 (continued) 2

Cob Company Operations in Different Segments at or for the year ended December 31, 2011 (Data in Thousands of Dollars) Food Industry

Packing Industry

Textile Segments

Foreign Operation

All Other

Totals

950

$500

$300

$250

$400

$2,400

Revenues Sales to unaffiliated customers Intersegment sales at market

Total Segment Sales

$1,010

$560

$330

$300

$400

$2,600

Operating profit Segment operating profit

110

$110

$ 25

$ 75

$325

Assets Identifiable assets

700

$500

$325

$200

$400

$2,125

Reconciliation of revenue: Revenue from reportable segments Other segment revenue Intersegment eliminations Income from equity investees Consolidated revenue Reconciliation of operating profit: Reportable segment operating profit Other segment operating profit Income from equity investees Interest expense Corporate expense Noncontrolling interest share Consolidated operating profit Reconciliation of assets: Reportable segment assets Other segment assets Investment in equity affiliates Corporate assets Consolidated assets

200

$2,200 400 (200) 100 $2,500 $

250 75 100 (20) (25) (30) 350

$1,725 400 1,000 50 $3,175

Chapter 15

15-21

Solution P15-8 Tor Corporation Schedule of Income by Quarter for 2011 1

First $50,000  20% Remainder ($160,000 – 50,000)  34% Less amount subject to dividends received deduction ($20,000  80%  34%)

$ 10,000 37,400

Total tax for the year Total Income Effective tax rate

$ 41,960 $160,000 26.225%

(5,440)

1st 2nd 3rd 4th Year Quarter Quarter Quarter Quarter 2011 Income year-to-date $20,000 $50,000 $110,000 $160,000 $160,000 Quarterly period income $20,000 $30,000 $ 60,000 $ 50,000 $160,000 Income tax expense* (5,245) (7,868) (15,734) (13,113) (41,960) Net income $14,755 $22,132 $ 44,266 $ 36,887 $118,040 *

Income tax expense computations: 1st Quarter 2nd Quarter 3rd Quarter 4th Quarter

$20,000  .26225 = $5,245 $50,000  .26225 = $13,113 - $5,245 = $7,868 $110,000  .26225 = $28,847 - $13,113 = $15,734 $160,000  .26225 = $41,960 - $28,847 = $13,113

Chapter 16 PARTNERSHIPS — FORMATION, OPERATIONS, AND CHANGES IN OWNERSHIP INTERESTS Answers to Questions 1

Noncash investments of partners should be recorded at their fair values in order to provide equitable treatment to the individual partners. The recording of noncash assets at less than fair value will result in allocating the amount of understatement between the partners in their relative profit and loss sharing ratios as the undervalued assets are used for partnership business or when they are sold by the partnership.

Conceptually, there is no difference between the drawings and the withdrawals of partners since both represent disinvestments of resources from the partnership entity. From a practical viewpoint, the distinction between withdrawals and drawings may be important because allowable drawings are not usually deducted in determining the amount of partnership capital to be used for purposes of dividing profits among the partners. Since withdrawals are deducted, the distinction can affect the division of profits and losses.

In the absence of an agreement for dividing profits, an equal division among the partners is required by the Uniform Partnership Act. The agreement also applies to losses. And it applies irrespective of the relative investments by the partners.

Salary and interest allowances are included in some partnership agreements in order to reward partners for the time and effort that they devote to partnership business (salary allowances) and for capital investments (interest allowances) that they make in the business.

Salary allowances to partners are not expenses of a partnership. Rather, they are a means of recognizing the efforts of individual partners in the division of partnership income.

When profits are divided in the ratio of capital balances, capital balances should be computed on the basis of weighted average capital balances in the absence of evidence that another interpretation of capital balances is intended by the partners.

An individual partner may have a loss from his share of partnership operating activities even though the partnership has income. This situation results if priority allocations to other partners exceed partnership net income. For example, if net income for the A and B Partnership is $5,000 and profits are divided equally after a salary allowance of $8,000 to A, A will have partnership income of $6,500 and B will have a partnership loss of $1,500.

Partnership dissociation under the Uniform Partnership Act is the change in the relation of the partners caused by any partner ceasing to be associated in the carrying on of the business, as distinguished from the winding up of the business. Thus, the assignment of a partnership interest to a third party by one of the partners does not, by itself, dissolve the partnership because the assignee does not become a partner unless accepted as a partner by the continuing partners.

The sale of a partnership interest to a third party dissolves the old partnership if the continuing partners accept the third party purchaser as their partner. In this case, the relation among the partners is changed and a new partnership agreement is necessary.

When a new partner acquires an interest by purchase from existing partners, the partnership receives no new assets because the payment for the new partner’s interest is distributed to the old partners. Alternatively, an investment in a partnership increases the net assets of the partnership. This difference is important in accounting for the admission of a new partner. Copyright © 2015 Pearson Education, Inc. 16-1

16-2

Partnerships—Formation, Operations and Changes in Ownership Interests

The admission of a new partner may be recorded by the goodwill approach (or revaluation approach) or by the bonus approach (or nonrevaluation approach).

The goodwill procedure for recording the admission of a new partner is best described as a revaluation approach because identifiable assets and liabilities that are over or undervalued are adjusted to their fair values before the unidentifiable asset goodwill is recorded. For example, if a new partner’s investment reflects the fact that land owned by the old partnership is undervalued, it would be misleading to record the amount of revaluation as goodwill, rather than as a revaluation of the land account.

A bonus procedure for recording an investment in a partnership involves adjusting the partnership capital account to the extent necessary to meet the new partnership agreement without a revaluation of the assets and liabilities of the old partnership. If a new partner receives a capital credit in excess of his or her investment, the excess is a bonus to the new partner. A bonus to a new partner is charged against the old partners’ capital balances in relation to their old profit sharing ratios. If a new partner’s investment exceeds his or her capital credit, the excess is a bonus to the old partners. A bonus to the old partners is credited to the old partners’ capital balances in accordance with the old partners’ profit sharing ratios.

The amounts received by the individual partners in final liquidation will be the same under the bonus and goodwill procedures provided that the relative profit and loss sharing ratios of the old partners remain unchanged in the new partnership and that the new partners’ capital interest and profit and loss sharing ratio are aligned.

Parts a and b assume that the partnership assets are to be revalued upon the admission of Bob into the partnership. Goodwill would be recorded if identifiable assets and liabilities are equal to their fair values and 1. $10,000  25% > $10,000 + old capital; or 2. Old capital  75% > $10,000 + old capital; or 3. An independent assessment of earning power or other factors indicate goodwill. Old partnership assets would be written down if 1. $10,000  25% < $10,000 + old capital; or 2. Old capital  75% < $10,000 + old capital; or 3. An independent assessment of earning power or other factors indicate that partnership assets are overvalued. Parts c and d assume that partnership assets are not to be revalued upon the admission of Bob into the partnership. A bonus to the old partners would be recorded if 25%  ($10,000 + old capital) is less than $10,000. A bonus to Bob would be recorded if 25%  ($10,000 + old capital) is greater than $10,000.

Chapter 16

16-3

SOLUTIONS TO EXERCISES Solution E16-1 The partners’ contributions can be valued at anything the partnership agrees on. In this case they are forming an equal partnership in equity and recording the assets at fair value. If they feel that the combined partnership assets are worth $280,000, then they would select the bonus method. If it was agreed that Lam was bringing an additional $40,000 in added intangible benefits they would select the goodwill method. Cost

Car fair value

Cash Delivery equipment Furniture inventory

$60,000 80,000 120,000

$160,000

Lam Fair value $60,000 60,000 ________

Total

$260,000

$160,000

$120,000

If using the bonus method: Bonus adjustment Bonus capital balances

(20,000) 20,000 $140,000 $140,000

If using the goodwill method: Goodwill adjustment Goodwill capital balances

$160,000

40,000 $160,000

Partnerships—Formation, Operations and Changes in Ownership Interests

16-4

Solution E16-2 Computation of Bev’s bonus: Let B = bonus B = 10%  ($198,000 - B) B = $19,800 - .1B 1.1B = $19,800 B = $18,000 Schedule to Allocate Partnership Income Arn Net income to distribute Bonus to Bev Remainder to divide Divided 40:40:20 Income allocation

$198,000 (18,000) 180,000 (180,000) 0

Bev

Car

$18,000 $72,000 $72,000

72,000 $90,000

$ 36,000 $ 36,000

Chapter 16

16-5

Solution E16-3 Mel 2012 income to divide ($25,000 - $4,000) Salary to Mel Remainder to divide Divided equally 2011 income understatement Divided in the 2011 60:40 ratio Income allocation

$21,000 (18,000) 3,000 (3,000) 0 $ 4,000 (4,000) 0

Dav

$18,000 1,500

$ 1,500

2,400 $21,900

1,600 $ 3,100

Partnerships—Formation, Operations and Changes in Ownership Interests

16-6

Solution E16-4 Schedule to Allocate Partnership Income for 2011 Income to distribute Salary allocation Interest on capital* Loss to divide Divided equally Income to partners *

Balance $28,000 (42,000) (52,000) (66,000) 66,000 0

Dan

Hen

Bai

--21,000

$ 18,000 16,000

$24,000 15,000

(22,000) $(1,000)

(22,000) $12,000

(22,000) $17,000

Interest on average capital:

Dan

January 1, 2011 Balances $200,000 240,000 200,000

 1/2 year =  1/4 year =  1/4 year =

Average Interest Capital on Capital $100,000 60,000 50,000 $21,000 $210,000  10% =

Hen

$ 160,000

 1 year =

$160,000  10% =

16,000

Bai

$ 150,000

 1 year =

$150,000  10% =

15,000 $52,000

Chapter 16

16-7

Solution E16-5 Bir, Cag, and Den Partnership Statement of Partnership Capital for the year ended December 31, 2011

Balance January 1 Add: Investments Less: Withdrawals Less: Drawings Net contributed capital Add: Net incomea Balance December 31 a

Bir Capital

Cag Capital

Den Capital

Total Capital

$ 60,000

$ 45,000 10,000

$175,000 20,000 (30,000) (15,000)

(15,000) ( 5,000)

( 5,000)

$ 70,000 10,000 (15,000) (5,000)

40,000 12,000

50,000 12,000

60,000 12,000

150,000 36,000

$ 52,000

$ 62,000

$ 72,000

$186,000

Net income = $186,000 - $150,000 = $36,000

Solution E16-6 1

Ben capital

$350,000 Pet capital $350,000 To record assignment of half of Ben’s capital account to Pet.

The total capital of BIG Entertainment Galley remains at $1,480,000. The amount paid by Pet to Ben does not affect the partnership and Pet does not become a partner with the assignment of half of Ben’s interest.

Partnerships—Formation, Operations and Changes in Ownership Interests

16-8

Solution E16-7 1. Capital balances after Rob is admitted when assets are not revalued: Old Capital Fax capital Bel capital Rob capital Total capital

$140,000 60,000

x 40% x 40%

Capital Transfer

New Capital

$(56,000) (24,000) 80,000

$ 84,000 36,000 80,000

$200,000

2. If the existing partners are selling 40% of a business that is valued at $300,000 then they first divide $100,000 of goodwill by their capital ratio. Capital adjusted for FMV Fax capital* Bel capital** Rob capital

$215,000 85,000

x 40% x 40%

Capital Transfer

New Capital

$(86,000) (34,000) 120,000

$129,000 51,000 120,000

$300,000

Total capital $300,000 *$140,000 + (75% x $100,000) = $215,000 **$60,000 + (25% x $100,000) = $85,000

Chapter 16

16-9

Solution E16-8 Journal entries to admit Joh to the Bow/Mon partnership: Goodwill

$ 45,000 Bow capital $ 27,000 Mon capital 18,000 To record goodwill computed as follows: New capital = $75,000  1/3 = $225,000 Goodwill = $225,000 new capital - $180,000 old capital = $45,000

Bow capital Mon capital

$ 39,000 36,000

Joh capital $75,000 To record capital transfer to Joh: ($90,000 + $27,000)/3 from Bow and ($90,000 + $18,000)/3 from Mon.

Partnerships—Formation, Operations and Changes in Ownership Interests

16-10

Solution E16-9 1

Investment of $100,000 in partnership with revaluation: Cash Goodwill

$100,000 20,000

Wal capital $120,000 The new partnership valuation is computed as: old capital of $480,000/80% retained interest = $600,000 new capital. Goodwill is computed as: new capital of $600,000 - $580,000 (the old capital plus investment) = $20,000 goodwill. 2

Investment of $140,000 in partnership with revaluation: Goodwill

$80,000 Sip capital $24,000 Jog capital 40,000 Run capital 16,000 New partnership capital is computed on the basis of new investment of $140,000/20% interest = $700,000 new capital. New capital of $700,000 - ($480,000 old capital + $140,000 investment) = $80,000 goodwill.

Cash

$140,000 Wal capital To record Wal’s investment in the partnership.

$140,000

Chapter 16

16-11

Solution E16-10 1

Investment of $120,000 in the partnership with no revaluation: $400,000 old capital + $120,000 additional investment = $520,000 Box’s interest = $520,000  25% = $130,000 Therefore, the old partners are giving a bonus to Box of $10,000. Cash Man capital Eme capital Fot capital

$120,000 3,600 2,400 4,000

Box capital $130,000 To record Box’s admission to a 25% interest in the partnership capital and earnings. Capital accounts after Box’s admission to the partnership: Man capital ($140,000 - $3,600) Eme capital ($100,000 - $2,400) Fot capital ($160,000 - $4,000) Box capital 2

$136,400 97,600 156,000 130,000 $520,000

The profit and loss sharing ratios of the new partnership will depend on the provisions of the new partnership agreement. If the old partners wish to maintain their old partnership relationship, one possible division would be to reduce each of the old partners ratio by 25% (in other words, a new ratio of 27:18:30:25). However, if the issue is not addressed in the new partnership agreement, the partners will share profits equally, 25:25:25:25, in accordance with the Uniform Partnership Act.

Partnerships—Formation, Operations and Changes in Ownership Interests

16-12

Solution E16-11 Retirement of Nix with revaluation: Goodwill

$140,000 Nix capital (30%) $42,000 Man capital (30%) 42,000 Per capital (40%) 56,000 To record goodwill implied by the excess payment to Nix computed as: ($170,000 - $128,000)/30% = $140,000. Nix capital

$170,000

Cash To record payment to Nix upon his retirement.

$170,000

Solution E16-12 Entry to write-up assets to fair value Assets Bec capital Dee capital Lyn capital Entry to record settlement with Dee Dee capital Bec capital (5/6  $30,000 excess payment) Lyn capital (1/6  $30,000 excess payment) Loan to Dee Cash

$200,000 $100,000 80,000 20,000 $380,000 25,000 5,000 $100,000 310,000

Bec capital ($300,000 + $100,000 - $25,000)

$375,000

Lyn capital ($100,000 + $20,000 - $5,000)

$115,000

Chapter 16

16-13

Solution E16-13 1

Income Allocation Schedule Kat Net income Bonus to Kat Remainder Salary allowance Remainder 50/50 split Remainder

$30,000 (1,500) 28,500 (25,000) 3,500 (3,500) -0-

Edd

1,500

10,000

15,000

25,000

1,750 $13,250

1,750 $16,750

3,500 $30,000

Revenue and Expense Summary $30,000 Kat Capital $13,250 Edd Capital $16,750 Allocate partnership net income for the year to the partners. Kat Capital

$15,000 Kat Drawing

Edd Capital

$15,000 $10,000

Edd Drawing Close the drawing accounts to the capital accounts. 3

Total

$10,000

Capital Accounts K & E Partnership Statement of Partners’ Capital For the year ended December 31 2011 Capital balances January 1, 2011 Add: Additional investments Deduct: Withdrawals Deduct: Drawings Add: Net income Capital balances December 31, 2011

Kat $496,750 5,000 0 (15,000) 13,250 $500,000

Edd $268,250 5,000 0 (10,000) 16,750 $280,000

Partnerships—Formation, Operations and Changes in Ownership Interests

16-14

Solution E16-14 1

Valuation of assets and liabilities as implied by excess payment to Box: Building $10,000 Goodwill 40,000 Byd capital $ 15,000 Box capital 10,000 Dar capital 20,000 Fus capital 5,000 To record revaluation of building and goodwill implied by the excess payment to Box on his retirement ($10,000  20% = $50,000 revaluation). Box capital

$35,000 Cash $ 35,000 To record cash payment to Box on his retirement from the business.

No revaluation; bonus to retiring partner: Box capital $25,000 Byd (30/80) 3,750 Dar (40/80) 5,000 Fus(10/80) 1,250 Cash To record a $10,000 bonus to Box upon retirement.

35,000

Chapter 16

16-15

Solution E16-15 1

a Bil’s contribution ($20,000 + $60,000 + $15,000 - $30,000) Ken’s contribution Total tangible contributions

$ 65,000 50,000 $115,000

Ken’s contribution $50,000/.4 interest = $125,000 total capital Total capital based on Ken’s contribution $125,000 less amount contributed by Ken and Bil $115,000 = $10,000 goodwill 2

c Jay’s investment of $65,000 is greater than his capital credit of 1/3 of $175,000; thus, there is goodwill to the old partners. New capital = $65,000  1/3 = $195,000 New capital of $195,000 - (old capital $110,000 + $65,000 investment) = $20,000 goodwill. Revaluation is recorded: Goodwill (other assets) $20,000 Tho capital (50%) Mar capital (50%) Mar’s capital = $60,000 + $10,000 goodwill = $70,000

$ 10,000 10,000

c Total capital ($170,000 + $200,000 + $200,000) = $570,000 Zen’s interest $570,000  1/3 = $190,000 Therefore, Tin and Web receive a $10,000 bonus, shared equally.

c $90,000 investment > 25%  ($100,000 + $80,000 + $90,000), thus, there is goodwill to the old partners.

New capital $90,000/25% Old capital + new investment $180,000 + $90,000 Goodwill

$360,000 (270,000) $ 90,000

Fin capital $100,000 + (50%  $90,000 goodwill) Rho capital $80,000 + (50%  $90,000 goodwill) Che capital Total capital

$145,000 125,000 90,000 $360,000

b Payment to Gin at retirement Capital account before recording share of goodwill Gin’s share of goodwill

$200,000 170,000 $ 30,000

Total goodwill for partnership ($30,000/.3)

$100,000

Total assets before Gin’s retirement ($240,000 cash + $360,000 other assets + $100,000 goodwill) Less: Payment to Gin on retirement Total assets after Gin retires

$700,000 200,000 $500,000

Partnerships—Formation, Operations and Changes in Ownership Interests

16-16

Solution E16-16 1

a Ton capital Olg capital

$ 30,000 70,000 $100,000

Capital Interest 30% 70%

Income Interest 50% 50%

Since capital and income interests were not aligned at the time of Shi’s purchase, the $40,000 payment to Ton does not provide a basis for revaluation. Thus, half of Ton’s $30,000 capital balance should be transferred to Shi. 2

a Implied total valuation of partnership based on Dun’s $60,000 payment to partners ($60,000/.4) Entry to record goodwill: Goodwill Lin capital Que capital

$30,000 $ 15,000 15,000

Entry to transfer equal capital amounts to Dun: Lin capital $30,000 Que capital 30,000 Dun capital

$ 60,000

Capital accounts after admission of Dun: Lin capital ($50,000 + $15,000 - $30,000) Que capital ($70,000 + $15,000 - $30,000) Dun capital Total capital

$ 35,000 55,000 60,000 $150,000

c Old capital of $120,000  2/3 interest retained by old partners = $180,000 capitalization. $180,000 - $170,000 old capital and new investment = $10,000 goodwill.

McC New Oak Total 4

$150,000

Old Capital $ 70,000 50,000 $120,000

Admission of Oak $60,000 $60,000

New Capital $ 70,000 50,000 60,000 $180,000

b Bonus to Oak = ($170,000/3) - $50,000 = $6,667 bonus

McC New Oak Total

Old Capital $ 70,000 50,000 ________ $120,000

Admission of Oak $(3,333) (3,334) 56,667 $50,000

New Capital $ 66,667 46,666 56,667 $170,000

Chapter 16

16-17

Solution E16-16 (continued) 5

a Capital balances Revalue assets Adjusted balances Excess payment to Car 20/50 Ending balances

Ben $100,000 20,000 120,000

Car $200,000 30,000 230,000

Das $200,000 50,000 250,000

(4,000) $116,000

14,000 $244,000

(10,000) $240,000

Total $500,000 100,000 $600,000

Partnerships—Formation, Operations and Changes in Ownership Interests

16-18

Solution E16-17 [Based on AICPA] 1

a Withdrawal Less: Additional investment Net withdrawal Less: Net decrease in capital Pla’s share of net income

$130,000 25,000 105,000 60,000 $ 45,000

Total net income ($45,000/.3 Pla’s interest)

$150,000

a Fox Loss Interest Salaries Loss to divide Divided equally

$ (33,000) (22,000) (50,000) (105,000) 105,000 0

Gre

$ 12,000 30,000

(35,000) 7,000

(35,000) $(29,000)

6,000

b The bonus to Bec is $60,000, computed as follows: B = bonus B = .25($300,000 - B) B = $75,000 - .25B 1.25B = $75,000 B = $60,000

How $

4,000 20,000

(35,000) $(11,000)

Chapter 16

Solution E16-18 1

16-19

[Based on AICPA]

c Old capital at fair value = $300,000 = 80% of new capital New capital ($300,000/.8) Less: Old capital Cash to be invested b Elt Don Kra

Old Capital $ 70,000 60,000 $130,000

Capital Changes $(7,000) (3,000) 60,000 $50,000

New Capital $ 63,000 57,000 60,000 $180,000

b Wil’s $40,000 capital investment > capital credit ($140,000  25%) Thus, goodwill to old partners. New capital ($40,000/.25) Old capital Goodwill Revaluation entry: Goodwill Eli capital ($20,000  60%) Geo capital ($20,000  30%) Dic capital ($20,000  10%) Admission of Wil: Eli capital ($92,000  25%) Geo capital ($46,000  25%) Dic capital ($22,000  25%) Wil capital

$375,000 (300,000) $ 75,000

$160,000 140,000 $ 20,000 $20,000 $ 12,000 6,000 2,000

$23,000 11,500 5,500 $ 40,000

New capital balances: Eli capital ($92,000 - $23,000) Geo capital ($46,000 - $11,500) Dic capital ($22,000 - $5,500) Wil capital Total capital

$ 69,000 34,500 16,500 40,000 $160,000

b Purchase price paid by Sid Capital transferred to Sid ($444,000  20%) Combined gain to New and Sha

$132,000 88,800 $ 43,200

Because capital balances are not aligned with profit and loss sharing ratios, the $88,800 capital transferred to Sid will be charged to New and Sha by agreement. 5

$ 80,000 15,000 95,000

Partnerships—Formation, Operations and Changes in Ownership Interests

16-20

Gra’s capital interest Gra’s capital account

20% $ 19,000

E16-18 (continued) 6

a Excess payment to Dix [$74,000 - ($210,000 - $160,000)]

$ 24,000

Implied goodwill ($24,000 excess payment/.2 profit and loss interest of Dixon) $120,000 7

b Per books Asset revaluationa Balance after revaluation Goodwill recognitionb Balance before retirement Retirement of Wil a b

20% Wil $ 70,000 12,000 82,000 20,000 102,000 (102,000) 0

20% Bro $65,000 12,000 77,000 20,000 97,000

60% Low $150,000 36,000 186,000 60,000 246,000

$97,000

$246,000

Asset revaluation: $360,000 - $300,000 = $60,000 Goodwill: ($102,000 - $82,000)/.2 = $100,000

Total $285,000 60,000 345,000 100,000 445,000 (102,000) $343,000

Chapter 16

16-21

Solution E16-19 Kra, Lam, and Man Partnership Statement of Partners’ Capital for the year ended December 31, 2011 Kra

Lam

Man

Total

Capital January 1, 2011 Additional investment Withdrawals

$65,000 4,000

$75,000

$70,000

(5,000)

(4,000)

$210,000 4,000 (9,000)

Net contributed capital Net income (see schedule)

69,000 11,500

70,000 23,500

66,000 12,000

205,000 47,000

Capital December 31, 2011

$80,500

$93,500

$78,000

$252,000

Kra, Lam, and Man Partnership Schedule of Income Allocation for the year ended December 31, 2011 Net Income

Kra

Lam

Man

Income to divide Salary to Lam Interest allowances

$47,000 (11,000) (21,000)

$ 6,500

$11,000 7,500

$ 7,000

Remainder to divide Divided equally

15,000 (15,000)

5,000

$11,500

$23,500

$12,000

Income allocation

Partnerships—Formation, Operations and Changes in Ownership Interests

16-22

Solution E16-20 1

If assets are not revalued:

Gro Ham Iot

Before Admission of Iot

Transfers on Admission of Iot

Capital Balances After Admission

$ 45,000 65,000

$(22,500) (32,500) 55,000 0

$ 22,500 32,500 55,000 $110,000

$110,000 If assets are revalued:

Gro Ham Iot

Capital Balances Before Revaluation

Revaluation ($30,000)

Capital Balances After Revaluation

$ 45,000 65,000

$13,500 16,500

$ 58,500 81,500

$110,000

$30,000

$140,000

Transfers to Iot

Capital Balances After Admission

$(29,250) (40,750) 70,000 0

$ 29,250 40,750 70,000 $140,000

Since old partners transferred 50% of their interests in future profits, profits should be divided: 22.5% to Gro, 27.5% to Ham, and 50% to Iot. The partners can, of course, agree to any profit and loss sharing arrangement that they choose.

In the absence of a new partnership agreement, profits will be divided equally.

Chapter 16

16-23

Solution E16-21 Method 1: Bonus to retiring partner Cas capital Don capital Ear capital

$140,000 9,000 12,000

Cash $161,000 To record Cas’s retirement with a $21,000 bonus, shared by Don and Ear in their relative profit and loss sharing ratios (3/7 and 4/7, respectively). Method 2: Goodwill to retiring partner only Cas capital Goodwill

$140,000 21,000

Cash $161,000 To record Cas’s retirement and to record the $21,000 excess payment to Cas as goodwill. Method 3: Goodwill implied by excess payment Goodwill

$ 70,000 Cas capital $ 21,000 Don capital 21,000 Ear capital 28,000 To record goodwill implied by the excess payment to Cas on her retirement. Goodwill is computed as the excess payment divided by Cas’s profit and loss sharing ratio ($21,000/30%).

Cas capital

$161,000

Cash To record retirement of Cas.

$161,000

Partnerships—Formation, Operations and Changes in Ownership Interests

16-24

SOLUTIONS TO PROBLEMS Solution P16-1 Preliminary computation Beginning capital ($69,000 + $85,500 + $245,500) Capital adjustments: Additional investment less withdrawals Ending capital Net income

$400,000 (4,000) 396,000 (481,000) $ 85,000

Ell, Far, and Gar Statement of Partnership Capital for the year ended December 31, 2011 Capital balance January 1 Add: Additional investment Deduct: Salary allowances Net contributed capital Income allocation (see schedule) Capital balance December 31

Ell $69,000

Far $85,500

Gar $245,500 20,000

(12,000) 57,000

(12,000) 73,500

265,500

Total $400,000 20,000 (24,000) 396,000

24,200 $81,200

24,200 $97,700

36,600 $302,100

85,000 $481,000

Total $85,000 (24,000) 61,000 (61,000) 0

Ell

Far

Gar

$12,000

12,200 $24,200

Income allocation schedule: Income to divide Salary allowances Remainder to divide Divided 20:20:60 Income allocation

$ 36,600 $ 36,600

Chapter 16

16-25

Solution P16-2 1

Mor, Osc, and Tre Partnership Balance Sheet at January 2, 2011 Cash ($20,000 + $95,000) Accounts receivable — net Inventories Plant assets — net ($120,000 + $120,000) Goodwill Total assets

$115,000 100,000 200,000 240,000 40,000a $695,000

Accounts payable Mor capital (1/3 interest) ($120,000 + $85,000b + $20,000) Osc capital (1/3 interest) ($100,000 + $85,000b + $20,000) Tre capital (1/3 interest) Total equities

$ 50,000

a b c

225,000 205,000 215,000c $695,000

Tre’s $215,000  1/3 = $645,000 total capitalization $645,000 - $605,000 fv of old assets + Tre’s investment = $40,000 goodwill. $40,000 goodwill is divided equally between Mor and Osc Revaluation of assets to fair value ($170,000 divided equally between Mor and Osc) Tre’s investment ($95,000 cash + $120,000 building) = $215,000

Mor, Osc, and Tre Partnership Balance Sheet at January 2, 2011 Cash ($20,000 + $95,000) Accounts receivable — net Inventories Plant assets — net ($100,000 + $120,000) Total assets Accounts payable Mor capital (1/3 interest) ($120,000 + $35,000a) Osc capital (1/3 interest) ($100,000 + $35,000a) Tre capital (1/3 interest) Total equities

$115,000 100,000 50,000 220,000 $485,000 $ 50,000 155,000 135,000 145,000b $485,000

Tre is paying a bonus to Mor and Osc because his investment of $215,000 ($95,000 cash and $120,000 building) is worth more than a 1/3 interest in the book value of the combined assets ($215,000 + $220,000). The $70,000 bonus is evenly divided between Mor and Osc based on their profit sharing ratios. The journal entry to record Tre’s admission in the partnership is: Cash 95,000 Building 120,000 Tre Capital 145,000 Mor Capital 35,000 Osc Capital 35,000

Tre’s investment ($95,000 cash + $120,000 building) = $215,000

16-26

Partnerships—Formation, Operations and Changes in Ownership Interests Book value plus Tre’s investment is $220,000 + $215,000 = $435,000 Tre gets a 1/3 interest or $145,000.

Chapter 16

16-27

Solution P16-3 Ash and Bar Partnership Income Distribution Schedule for 2011 Net income to divide Interest allowance Remainder to divide Salary to Ash Remainder to divide Bonus to Ash B = .2($84,000 - B) 1.2B = $16,800 B = $14,000 Remainder to divide Divided equally Income distribution

$105,000 (9,000) 96,000 (12,000) 84,000

(14,000) 70,000 (70,000) 0

Ash

Bar

$ 4,000

$ 5,000

Total $

9,000

12,000

14,000

35,000 $65,000

35,000 $40,000

70,000 $105,000

Partnerships—Formation, Operations and Changes in Ownership Interests

16-28

Solution P16-4 1

Profit allocation schedule Ale Net loss for 2011 Salary to Ale Loss to divide Interest allowances: Ale $60,000  10% Car $100,000  10% Eri $110,000  10% Loss to divide Divided 30:30:40 Allocation of loss

(6,000) (10,000) (11,000) (49,000) 49,000 0

Car

Eri

$ 10,000 6,000 $ 10,000 $ 11,000

(14,700) 1,300

(14,700) $ (4,700)

(19,600) $ (8,600)

Ale, Car, and Eri Partnership Statement of Partnership Capital for the year ended December 31, 2011 Capital January 1, 2011 Add: Additional Investments Deduct: Withdrawals Deduct: Drawings Net contributed capital Net loss for 2011 Capital December 31, 2011

$(12,000) (10,000) (22,000)

Ale $ 60,000

Car $ 90,000

Eri $110,000

Total $260,000

60,000

30,000 120,000

20,000 130,000 (10,000)

(8,000) 52,000 1,300

120,000 (4,700)

120,000 (8,600)

50,000 310,000 (10,000) (8,000) 292,000 (12,000)

$ 53,300

$115,300

$111,400

$280,000

Correcting entry: Eri capital

$1,200 Ale capital $1,100 Car capital 100 To correct capital accounts for error in loss allocation: Correct loss allocation Less: Actual loss allocation Adjustment

Ale $ 1,300 (200) $ 1,100

Car $(4,700) 4,800 $ 100

Eri $(8,600) 7,400 $(1,200)

Chapter 16

16-29

Solution P16-5 1

Assumptions: Net income = $60,000, divided on basis of average capital balances. Kat:

Lyn:

Mol:

$ 80,000  3 months = 100,000  3 months = 90,000  6 months =

$240,000 300,000 540,000

$1,080,000/12 = $90,000

$ 80,000  4 months = 65,000  8 months =

$320,000 520,000

840,000/12 = $70,000

$ 90,000  8 months = 60,000  4 months =

$720,000 240,000

960,000/12 = $80,000

Allocation to Kat: Allocation to Lyn: Allocation to Mol: Net income 2

Assumptions: Net income = $50,000, 10% bonus to Kat, remainder divided on basis of beginning capital balances. Net income Bonus to Kat Remainder to divide Capital allowances $45,000  $80,000/$250,000 $45,000  $80,000/$250,000 $45,000  $90,000/$250,000 Allocation of net income

$22,500 17,500 20,000 $60,000

$60,000 net income  9/24 = $60,000 net income  7/24 = $60,000 net income  8/24 =

Profit $50,000 (5,000) 45,000 (14,400) (14,400) (16,200) 0

Kat

Lyn

Mol

$ 5,000 14,400 $14,400 $19,400

$14,400

$16,200 $16,200

Assumptions: Net loss = $35,000, Salary of $12,000 for Mol and a 10% interest on beginning capital balances, and remainder divided equally. Loss Net loss $(35,000) Salary allowance (12,000) Loss to divide $(47,000) Interest on beginning capital (25,000) Loss to divide (72,000) Divided equally 72,000 Loss allocation 0

Kat

Lyn

Mol 12,000

8,000

9,000

(24,000) (24,000) (24,000) $(16,000) $(16,000) $ (3,000)

Partnerships—Formation, Operations and Changes in Ownership Interests

16-30

Solution P16-6 1

Computation of reported capital balances: Jon Kel Capital January 2, 2011 $30,000 $30,000 Add: Investments for 2011 Less: Withdrawals for 2011 (5,000) (4,000) Net contributed capital 25,000 26,000 4,000 Income allocation — Schedule A 11,000 Capital December 31, 2011 36,000 30,000 Add: Investments for 2012 5,000 Less: Withdrawals for 2012 (3,000) Net contributed capital 41,000 27,000 4,500 Income allocation — Schedule B 12,100 Capital December 31, 2012 53,100 31,500 Add: Investments for 2013 Less: Withdrawals for 2013 (4,000) Net contributed capital 53,100 27,500 6,450 Income allocation — Schedule C 15,610 Capital January 1, 2014 $68,710 $33,950

Gla $30,000 5,000

(8,000) 31,000 5,400 36,400 6,000 (2,000) 40,400 6,940 $47,340

Total $ 90,000 5,000 (9,000) 86,000 19,000 105,000 5,000 (11,000) 99,000 22,000 121,000 6,000 (6,000) 121,000 29,000 $150,000

Kel

Gla

35,000 4,000 39,000

Schedule A Income to allocate Interest allowances: Jon ($30,000  10%) Kel ($30,000  10%) Gla ($30,000  10%) Remainder to divide Salary to Jon Remainder to divide Divided equally Income allocation

Net Income $19,000

Jon

(3,000) (3,000) (3,000) 10,000 (7,000) 3,000 (3,000) 0

$ 3,000

1,000 $11,000

1,000 $ 4,000

Schedule B Income to allocate Interest allowances: Jon ($36,000  10%) Kel ($30,000  10%) Gla ($39,000  10%) Remainder to divide Salary to Jon Remainder to divide Divided equally Income allocation

Net Income $22,000

Jon

Kel

(3,600) (3,000) (3,900) 11,500 (7,000) 4,500 (4,500) 0

$ 3,600

1,500 $12,100

1,500 $ 4,500

Schedule C Income to allocate Interest allowances: Jon ($53,100  10%) Kel ($31,500  10%) Gla ($36,400  10%) Remainder to divide Salary to Jon

Net Income $29,000

Jon

Kel

(5,310) (3,150) (3,640) 16,900 (7,000)

$ 5,310

$ 3,000 $

3,000

1,000 4,000

7,000

Gla

$ 3,000 $

3,900

1,500 5,400

7,000

Gla

$ 3,150 $ 7,000

3,640

Chapter 16

16-31

Remainder to divide Divided equally Income allocation

9,900 (9,900) 0

3,300 $15,610

3,300 $ 6,450

3,300 6,940

Partnerships—Formation, Operations and Changes in Ownership Interests

16-32

Solution P16-6 (continued) 2

Correct income and capital account balances: Reported income Understatement of depreciation Understatement of inventory at December 31, 2013 Corrected income Capital per books Understatement Capital as corrected

Jon $68,710 666 $69,376

2011 $19,000 (2,000)

2012 $22,000 (2,000)

2013 $29,000 (2,000)

$17,000

$20,000

8,000 $35,000

Kel $33,950 667 $34,617

Gla $47,340 667 $48,007

Total $150,000 2,000 $152,000

Correcting entry on January 1, 2014: Inventory

$ 8,000

Jon capital $ 666 Kel capital 667 Gla capital 667 Accumulated depreciation 6,000 To correct prior years’ profits and adjust inventory and accumulated depreciation. Note: Since residual income is divided equally, it is not necessary to recompute the income allocation and capital balances for each of the three years.

Chapter 16

16-33

Solution P16-7 1

Revaluation of assets and admission of Cat: Inventories $ 10,000 15,000 Plant assets — net Note payable 10,000 Goodwill 75,000 $ 5,000 Accounts receivable — net Add capital 63,000 Bal capital 42,000 To revalue assets and liabilities and record goodwill on the basis of the $150,000 paid by Cat for a 40% interest. Total capital of $375,000 [computed as $150,000/.4] less ($150,000 fair value of recorded net assets plus $150,000 investment by Cat) equals $75,000 goodwill. Cash

$150,000 Cat capital $150,000 To record Cat’s investment for a 40% interest in partnership capital and profits. Add, Bal, and Cat Partnership Balance Sheet at January 2, 2011

Assets Cash Accounts receivable — net Inventories Plant assets — net Goodwill Total assets Equities Accounts payable Note payable (15%) Add capital (33.87%) Bal capital (26.13%) Cat capital (40%) Total equities

$165,000 40,000 60,000 105,000 75,000 $445,000 $ 30,000 40,000 127,000 98,000 150,000 $445,000

Partnerships—Formation, Operations and Changes in Ownership Interests

16-34

Solution P16-8 1

Car sells one-half of her interest to Dar for $90,000: Capital account balances:

Ann capital Bob capital Car capital Dar capital Total capital

$ 75,000 100,000 62,500 62,500 $300,000

There is no basis for revaluation because the capital balances are not aligned with profit and loss sharing ratios. The entry to admit Dar transfers one-half of Car’s capital account to Dar, regardless of the amount Dar pays Car: Car capital

$62,500 Dar capital

$ 62,500

To admit Dar to a 25% interest in the partnership. 2

Dar invests $75,000 in the partnership for a 25% interest, and partnership assets are revalued: Capital account balances:

Ann capital Bob capital Car capital Dar capital Total capital

$ 75,000 100,000 125,000 100,000 $400,000

Since Dar’s investment of $75,000 is less than his capital credit under the bonus procedure [($300,000 + $75,000)  25%] and the assets are to be revalued, goodwill accrues to the new partner. The entry to record the admission of Dar to the partnership is: Cash Goodwill

$75,000 25,000 Dar capital

$100,000

To admit Dar to a 25% interest in the partnership and record goodwill computed as follows: Old capital $300,000/.75 interest retained by the old partners = $400,000 new capital. $400,000 new capital - ($300,000 old capital + $75,000 new investment) = $25,000 goodwill to new partner.

Chapter 16

16-35

Solution P16-8 (continued) 3

Dar invests $80,000 for a 20% interest in the partnership and partnership assets are revalued: Capital account balances:

Ann capital Bob capital Car capital Dar capital Total capital

$ 80,000 105,000 135,000 80,000 $400,000

Since Dar’s investment of $80,000 is greater than his capital credit under the bonus procedure [($300,000 + $80,000)  20%], and assets are to be revalued, goodwill accrues to the old partners. The entries are as follows: Goodwill

$20,000 Ann capital $ 5,000 Bob capital 5,000 Car capital 10,000 To record goodwill and adjust the partners’ capital accounts: Dar’s investment $80,000/20% = $400,000 new capital $400,000 - $380,000 old capital plus new investment = $20,000 goodwill to the old partners.

Cash

$80,000 Dar capital $ 80,000 To admit Dar to a 20% interest in the partnership for $80,000.

Dar invests $90,000 for a 30% interest in the partnership and assets are not revalued: Capital account balances:

Ann capital Bob capital Car capital Dar capital Total capital

$ 68,250 93,250 111,500 117,000 $390,000

Since Dar’s investment of $90,000 for a 30% interest is less than his capital credit [($300,000 + $90,000)  30%], and no goodwill is to be recorded, Dar receives the bonus. The entry is as follows: Cash Ann capital Bob capital Car capital

$90,000 6,750 6,750 13,500

Dar capital $117,000 To record Dar’s $90,000 investment for a 30% interest and allow him a bonus of $27,000 computed as follows: ($390,000 total capital  30%) - $90,000 investment = $27,000

Partnerships—Formation, Operations and Changes in Ownership Interests

16-36

Solution P16-9 1

Revaluation (goodwill to new partner) Cash Goodwill

$85,080 4,920

Con capital $90,000 To record admission of Con and goodwill to Con computed as: Old capital of $450,000 = 5/6 new capital New capital = $540,000 Con’s capital = $540,000  1/6 = $90,000 Goodwill to Con = $90,000 - $85,080 = $4,920 No revaluation (bonus to new partner) Cash Pat capital Mic capital Hay capital

$85,080 1,640 2,050 410

Con capital $89,180 To record admission of Con and bonus to Con computed as: New capital = $450,000 + $85,080 = $535,080 Con capital = $535,080  1/6 interest = $89,180 Bonus = $89,180 - $85,080 = $4,100, allocated 40:50:10 2

Revaluation Goodwill

$60,480 Pat capital (40%) $24,192 Mic capital (50%) 30,240 Hay capital (10%) 6,048 To record revaluation of old partnership computed as: New capital = $85,080  1/6 = $510,480 $510,480 - $450,000 = $60,480 undervaluation

Pat capital Mic capital Hay capital

$28,032 41,040 16,008

Con capital $85,080 To record capital transfers equal to 1/6 of old partners’ capital balances as adjusted: Pat ($144,000 + $24,192)/6 = $28,032 Mic ($216,000 + $30,240)/6 = $41,040 Hay ($90,000 + $6,048)/6 = $16,008 No revaluation Pat capital Mic capital Hay capital

$24,000 36,000 15,000

Con capital To transfer 1/6 of capital balances to Con.

$75,000

Chapter 16

16-37

Solution P16-10 1

Car pays $450,000 directly to Aid and Tha for 40% of each of their interests and the bonus procedure is used. Aid capital Tha capital

$200,000 112,000

Car capital Existing capital $780,000  40% = $312,000. 2

$312,000

Car pays $600,000 directly to Aid and Tha for 40% of each of their interests and goodwill is recorded. Goodwill

$720,000 Aid capital $360,000 Tha capital 360,000 Goodwill = Payment to old partners $600,000/.4 - $780,000 existing capital = $720,000

Aid capital Tha capital

$344,000 256,000

Car capital Aid capital = ($500,000 + $360,000)  .4 Tha capital = ($280,000 + $360,000)  .4 3

$600,000

Car invests $450,000 in the partnership for her 40% interest, and goodwill is recorded. Cash Goodwill

$450,000 70,000

Car capital $520,000 Old capital $780,000/.6 = $1,300,000 new capital New capital $1,300,000 - old capital $780,000 + new investment $450,000 = goodwill $70,000 4

Car invests $600,000 in the partnership for her 40% interest, and goodwill is recorded. Goodwill

$120,000 Aid capital $ 60,000 Tha capital 60,000 Goodwill = new investment $600,000/.4 = $1,500,000 total capital $1,500,000 - $1,380,000 old capital and new investment = $120,000

Cash

$600,000 Car capital To record new partner’s investment.

$600,000

Partnerships—Formation, Operations and Changes in Ownership Interests

16-38

Solution P16-11 Har, Ion, and Jer Partnership Statement of Partnership Capital for the years ended December 31, 2011 and 2012

Investment January 1, 2011 Additional investment — 2011 Withdrawal — 2011

Har Capital $20,000

Ion Capital $20,000 8,000

Jer Capital $20,000

Total Capital $ 60,000 8,000 (4,000)

(4,000)

Net contributed capital Net income — 2011

16,000 4,000

28,000 4,000

20,000 16,000

64,000 24,000

Capital December 31, 2011 Withdrawal — 2012

20,000 (4,000)

32,000 (8,000)

36,000

88,000 (12,000)

Net contributed capital Net income — 2012 Capital December 31, 2012

16,000 2,727 $18,727

24,000 4,364 $28,364

36,000 16,909 $52,909

76,000 24,000 $100,000

Computation of net income: Assets $129,500 - liabilities $29,500 = $100,000 capital December 31, 2012 Beginning capital $60,000 + investment $8,000 - withdrawals $16,000 = $52,000 $100,000 - $52,000 = $48,000 net income for the two year period. Schedule of Profit and Loss Distribution Income for 2011 Salary allowance to Jer Remainder to divide One-third to each partner Allocation of income Income for 2012 Salary allowance to Jer Remainder to divide Divided in beginning capital ratios: 20/88, 32/88, 36/88 Allocation of income

Net Income $24,000 (12,000) 12,000 (12,000) 0

Har

Ion

Jer $ 12,000

$ 4,000

4,000

$ 4,000

$ 16,000

$24,000 (12,000) 12,000

$ 12,000

(12,000)

$ 2,727

$ 4,364

4,909

$ 2,727

$ 4,364

$ 16,909

Chapter 16

16-39

Solution P16-12 1

Closing entries for Par and Boo Partnership Service revenue $50,000 Supplies expense $17,000 Utilities expense 4,000 Other miscellaneous expenses 5,000 Income summary 24,000 To close revenue and expense to profit and loss summary account. Par capital Boo capital

$ 8,000 10,000

Salaries to partners $18,000 To close salaries to partners (drawings) to partners’ capital accounts. Income summary $24,000 Par capital $12,000 Boo capital 12,000 To close income summary and to divide profits equally as required in the absence of a profit sharing agreement. 2

Par and Boo Partnership Statement of Partners’ Capital for the ten months ending December 31, 2011 Investments March 1, 2011 Add additional investments: Boo July 1 Par October 1 Less Par withdrawal May 2 Less monthly drawings (salaries) Net contributed capital Add: Partnership net income Partnership capital December 31, 2011

Par $30,000

Boo $30,000

Total $60,000

10,000 4,000 34,000 (4,000) (8,000) 22,000 10,625

(10,000) 30,000 13,375

10,000 4,000 74,000 (4,000) (18,000) 52,000 24,000

$32,625

$43,375

$76,000

40,000

Partnerships—Formation, Operations and Changes in Ownership Interests

16-40

Solution P16-12

(continued) Schedule of Profit and Loss Distribution

Net income Salary allowances Remainder to divide Divide in average capital ratios: Par 28/64 (or 43.75%) Boo 36/64 (or 56.25%) Distribution of income

Net Income $24,000 (18,000) 6,000 (2,625) (3,375) 0

Par

Boo

$ 8,000

$ 10,000

2,625 $10,625

3,375 $ 13,375

Computation of Average Capital Balances Average capital of Par $ 60,000 $30,000  2 months = 130,000 $26,000  5 months = 90,000 $30,000  3 months = Total $280,000 Average capital ($280,000/10 months) $ 28,000 3

Average capital of Boo $120,000 $30,000  4 months = 240,000 $40,000  6 months = Total $360,000 Average capital ($360,000/10 months)

$ 36,000

Par and Boo Partnership Schedule of Profit and Loss Distribution for the ten months ending December 31, 2011 Net income Salary allowances Remainder to divide Interest allowance: Par $28,000  12%  10/12 year Boo $36,000  12%  10/12 year

Net Income $24,000 (18,000) 6,000 (2,800)

Par

Boo

$ 8,000

$ 10,000

2,800

(3,600) 3,600

Loss to divide Divide loss 50:50 Distribution of income

(400) 400 0

(200) $10,600

(200) $ 13,400

Chapter 16

16-41

Solution P16-13 1

No revaluation of partnership assets Proposal 1. Tom purchases one-half of Pet’s capital from Pet Pet capital $37,500 Tom capital $37,500 To record Tom’s admission to the partnership for a one-fourth interest in capital and profits by direct purchase of one-half of Pet’s 50% interest. Tom’s capital credit is equal to capital transferred from Pet to Tom ($75,000  50%). Proposal 2. Tom purchases one-fourth of each partners’ capital from partners Pet capital $18,750 Qua capital 12,500 She capital 6,250 Tom capital $37,500 To record Tom’s admission to the partnership by direct purchase of one-fourth of each partner’s capital and future profits. Tom’s capital credit is equal to the capital transferred from the other partners: ($75,000  25%) + ($50,000  25%) + ($25,000  25%). Proposal 3. Tom invests cash in the partnership for a one-fourth interest Cash $55,000 Pet capital $ 1,875 Qua capital 1,125 She capital 750 Tom capital 51,250 To record Tom’s $55,000 investment for a one-fourth interest in capital and future profits. Total capital is $150,000 + $55,000. Tom’s share of total capital is $205,000  25%, or $51,250. Tom’s investment of $55,000 less Tom’s capital credit of $51,250 equals $3,750 bonus to old partners.

Partnership assets are revalued Proposal 1. Tom purchases one-half of Pet’s capital from Pet Goodwill $90,000 Pet capital $45,000 Qua capital 27,000 She capital 18,000 To record goodwill on basis of the price paid by Tom for a onefourth interest in capital and profits. Total capital is $240,000 ($60,000/25%). Total capital of $240,000 less recorded capital of $150,000 equals $90,000 goodwill. Pet capital

$60,000 Tom capital $60,000 To record Tom’s purchase of one-half of Pet’s capital and right to Pet’s profits.

Partnerships—Formation, Operations and Changes in Ownership Interests

16-42

Solution P16-13

(continued)

Proposal 2. Tom purchases one-fourth of partners’ capital from partners Goodwill $30,000 Pet capital $15,000 Qua capital 9,000 She capital 6,000 To record goodwill on the basis of the price paid by Tom for onefourth of the capital and profits of each of the partners. Total capital is $180,000 ($45,000/25%). Total capital of $180,000 less recorded capital of $150,000 equals $30,000 goodwill. Pet capital Qua capital She capital

$22,500 14,750 7,750

Tom capital $45,000 To record Tom’s admission to a one-fourth interest in partnership capital and profits. Tom’s capital is equal to the capital transferred after revaluation: ($90,000  25%) + ($59,000  25%) + ($31,000  25%). Proposal 3. Tom invests cash in the partnership for one-fourth interest Goodwill $15,000 Pet capital $ 7,500 Qua capital 4,500 She capital 3,000 To record goodwill based on Tom’s investment of $55,000 for a one-fourth interest in partnership capital and profit. Total capital of $220,000 - ($150,000 recorded capital + $55,000 investment) = $15,000 goodwill. Cash

$55,000 Tom capital $55,000 To record Tom’s $55,000 investment for a one-fourth interest in capital and profits. Total capital = $220,000; Tom’s capital is $220,000  25%, or $55,000.

Chapter 16

16-43

Solution P16-14 1

Average capital balances Tim $60,000  3 months = 70,000  5 months = 64,000  4 months = $786,000/12 months =

$180,000 350,000 256,000 $786,000 $ 65,500

2 Beginning balances Add: Investments Less: Withdrawals Less: Drawings Net contributed capital Add: Net income (see schedule) Ending capital balances

Las $75,000  4 months = 63,000  6 months = 57,000  2 months = $792,000/12 months =

$300,000 378,000 114,000 $792,000 $ 66,000

Tim $ 60,000 10,000 (6,000) (18,000) 46,000 54,600 $100,600

Las $75,000 0 (18,000) (24,000) 33,000 48,400 $81,400

Total $135,000 10,000 (24,000) (42,000) 79,000 103,000 $182,000

Tim

Las

$18,000

$ 24,000

36,600 $54,600

24,400 $ 48,400

Schedule of income allocation: Net income to allocate ($182,000 $79,000 Salary allowances Remainder to divide Divided 60 : 40 Income allocation

$103,000 (42,000) 61,000 (61,000) 0

Chapter 17 PARTNERSHIP LIQUIDATION Answers to Questions 1

Dissolution of a partnership terminates the partnership as a legal entity, but the partnership business may continue under a new agreement. When a partnership is liquidated, however, the partnership is terminated both as a legal and as a business entity. Thus, a partnership may be dissolved without liquidation, but it may not be liquidated without dissolution.

A simple partnership liquidation is the liquidation of a solvent partnership in which all partners have equity capital and all gains and losses are realized and recognized before any distributions are made to the partners. In simple partnership liquidations, only one cash distribution is made and the amounts distributed to individual partners are equal to their predistribution capital account balances.

The priority ranking for the distribution of assets in liquidation pursuant to UPA is Rank I Rank II

Amounts owed to creditors other than partners and amounts owed to partners other than for capital and profits Amounts due to partners after all assets have been liquidated and liabilities paid.

Normally if a partner has loaned money to the partnership, those liabilities are repaid before any capital distributions. However if a partner is owed money and they have a debit (negative) capital balance, the liability is deducted from the capital shortfall, rather than be distributed.

The assumptions for determining distributions to partners prior to recognition of all gains and losses on liquidation are (1) all partners are personally bankrupt such that no partner could contribute personal assets into the partnership and (2) all noncash assets are possible losses and should be considered actual losses for purposes of determining amounts to be distributed. In addition, liquidation expenses and probable loss contingencies should be estimated and assumed to be actual losses for purposes of determining advance distributions.

Capital balances represent one factor in determining a partner’s equity, but loans and advances payable to and receivable from the partnership are factors that must also be considered in calculating safe payments. Partner equities, rather than capital balances, are used in safe payment schedules in order to avoid making distributions to partners that may end up with debit capital balances; i.e., owing money to the partnership.

Safe payment computations per se do not affect ledger account balances. Actual cash distributions based on safe payments computations do reduce partnership assets and equities and require recognition in ledger accounts.

Partnership Liquidation

17-2

A statement of partnership liquidation is a summary of transactions and balances for a partnership during its liquidation stage. Such statements provide continuous records of liquidation events. Interim liquidation statements are particularly helpful in showing the progress that has been made toward liquidation to date and in identifying remaining assets to be liquidated and liabilities to be paid. Interim liquidation statements are helpful to partners and creditors in providing a basis for current decisions as well as future planning. Liquidation statements are important legal documents for partnership liquidations that come under the jurisdiction of a court.

Available cash may be distributed to partners according to their profit and loss sharing ratios only when nonpartner liabilities have been satisfied and partner equities (capital and loan balances combined) are aligned with the relative profit and loss sharing ratios of the partners. In the absence of loans or advances payable to or receivables from individual partners, cash can be distributed to partners in their profit and loss sharing ratios when capital balances are in the relative profit and loss sharing ratios of the partners and all nonpartner liabilities have been paid.

Vulnerability ranks are an ordering of partners on the basis of the adequacy of their equities in the partnership to absorb possible partnership losses. The ordering is typically from the most vulnerable to the least vulnerable. Vulnerability ranks are used in the preparation of assumed loss absorption schedules, which, in turn, are used in the construction of cash distribution plans.

Partnership insolvency occurs when partnership liabilities exceed partnership assets. In this case, all available cash is distributed to partnership creditors. Individual partners will be called upon to use their personal assets to satisfy the remaining claims of the partnership creditors.

Partners with credit capital balances after all partnership assets have been distributed in liquidation have a claim against partners with debit capital balances. If the partners with debit balances are personally solvent, they should pay amounts equal to their debit balances into the partnership so that partners with credit balances can receive their partnership claims in full. If partners with debit capital balances are insolvent, the partners with credit balances will absorb the losses of the insolvent partners with debit capital balances in relation to their relative profit and loss sharing ratios.

Chapter 17

17-3

SOLUTIONS TO EXERCISES Solution E17-1 Schedule of Capital Balances Capital balances January 1, 2011 January losses: Lumber $15,000 ($40,000 book value- $25,000 sales price) Receivables 4,000 ($25,000 - $21,000 collection) Capital balances before distribution

60% Flo $40,000 (9,000)

40% Fay $20,000 (6,000)

(2,400)

(1,600)

$28,600

$12,400

Cash distribution: Accounts payable Flo Fay Total cash

$15,000 28,600 12,400 $56,000

Cash balance: Beginning balance, $10,000 + $25,000 + $21,000 = $56,000

Partnership Liquidation

17-4

Solution E17-2 Sale of inventory Cash

$10,000

Inventory To record sale of inventory items. Distribution of cash Accounts payable Cash To record payment to creditors. Mac capital Nan capital Obe capital

$10,000

$ 5,000 $ 5,000 $12,600 6,200 25,200

Cash $44,000 To record distribution of available cash to partners computed as follows: Capital Possible Loss from Balance Unsold Inventory = Balance Mac capital $15,000 $2,400 $12,600 Nan capital 8,000 1,800 6,200 Obe capital 27,000 1,800 25,200 Totals $50,000 $6,000 $44,000

Chapter 17

17-5

Solution E17-3 January 1 balances Contingency fund of $10,000 Possible losses on asset disposal ($120,000)

30% Fed $85,000 (3,000)

30% Ela $25,000 (3,000)

40% Luc $90,000 (4,000)

(36,000) 46,000

(36,000) (14,000)

(48,000) 38,000

Loss on Ela’s possible defaulta divided 3/7 and 4/7 (6,000) 14,000 (8,000) Available cash is distributed 40,000 0 30,000 a Notice that Ela would have a debit balance in her capital account if the contingencies occurred and if the assets were a total loss. In order to determine how much cash is available for distribution, Fed and Luc’s balances must absorb Ela’s debit balance.

Partnership Liquidation

17-6

Solution E17-4 Beginning balances Offset Kim’s loan Loss on sale of assets ($180,000 - $120,000) Additional liability Distribute Kim’s debit balance 5/7, 2/7 Cash distribution

Creditors $60,000

50% Jan $59,000

30% Kim $29,000 (20,000)

20% Lee $52,000

5,000 65,000

(30,000) (2,500) 26,500

(18,000) (1,500) (10,500)

(12,000) (1,000) 39,000

$65,000

(7,500) $19,000

10,500 0

(3,000) $36,000

Kim owes $7,500 to Jan and $3,000 to Lee.

Chapter 17

17-7

Solution E17-5 Schedule to Correct Capital Accounts

December 31, 2011 balance Undervalued inventory Corrected balances

($15,000)

Ali Capital (40%) $60,000 6,000 $66,000

Bob Capital (20%) $25,000 3,000 $28,000

Kia Capital (40%) $65,000 6,000 $71,000

The capital balances are adjusted for the error in computing net income in the partners’ residual equity ratios.

Partnership Liquidation

17-8

Solution E17-6 Eve, Fae, and Gia Partnership Safe Payment Schedule Partner equities Loss on sale of assets Possible lossesa Allocate Eve’s debit balance

40% Eve $100,000 (52,000) 48,000 (84,000) (36,000) 36,000 0

40% Fae $250,000 (52,000) 198,000 (84,000) 114,000 (24,000) $ 90,000

20% Gia $170,000 (26,000) 144,000 (42,000) 102,000 (12,000) $ 90,000

Total $520,000 (130,000) 390,000 (210,000)a 180,000 ________ $180,000

Remaining noncash assets of $200,000 plus contingency fund of $10,000 equals $210,000 possible losses.

Cash to distribute: Beginning cash balance of $100,000 plus $170,000 from sale of assets less $10,000 contingency fund equals $260,000. Distribution of cash:

Accounts payable Fae Gia

$ 80,000 90,000 90,000 $260,000

Chapter 17

17-9

Solution E17-7 Schedule for Phase-out of the Partnership Capital balances Creditors’ recovery from Bev

30% Ali $ 20,000

40% Bev $(120,000)

30% Cal $ 70,000

Total $(30,000)

20,000

30,000 (90,000)

70,000

30,000 0

20,000 (35,000) (15,000)

20,000 (70,000) 70,000 0

70,000 (35,000) 35,000

Partnership recovery from Beva Write-off of Bev’s deficit Partnership recovery from Ali

10,000 (5,000) 5,000 0

20,000 20,000 20,000

10,000 35,000 30,000 Write-off of Ali’s deficit (5,000) 30,000 30,000 Cash distribution to Cal (30,000) (30,000) 0 0 aBev’s personal net assets after partnership creditor recovery are $80,000 personal assets - $60,000 personal liabilities = $20,000.

Partnership Liquidation

17-10

Solution E17-8 Dan, Edd, and Fed Partnership Schedule for Phase-out of Partnership

Capital balances Fed’s payment to creditors

40% Dan Capital $10,000

30% Edd Capital $60,000 60,000

30% Fed Capital $(90,000) 20,000 (70,000)

Total $(20,000) 20,000 0

10,000 10,000

60,000

40,000 (30,000)

40,000 40,000

(17,143) (7,143)

(12,857) 47,143

30,000 0

________ 40,000

5,000 (2,143)

_______ 47,143

5,000 45,000

2,143 0

(2,143) 45,000 (45,000) 0

Fed’s payment to the Partnership Write-off of Fed’s deficit in the relative profit sharing ratio of Dan and Edd 4/7:3/7 Dan’s payment to the partnership for his Deficit Write off of Dan’s deficit to Edd Payment to Edd a

(45,000) 0

Fed’s personal assets of $100,000 less the $40,000 owed to his personal creditors, and less the $20,000 paid to partnership creditors, equals $40,000 available for his debit capital account balance.

Chapter 17

17-11

Solution E17-9 Ace, Ben, Cid, and Don Statement of Partnership Liquidation for the period June 30 to July 31, 2011

Balances June 30, 2011 July 1, 2011 Investment of Ace July 1, 2011 Payment of Liabilities Balances July 1, 2011 July 15, 2011 Investment of Cid Investment of Don Loss on Cid’s Insolvencya Loss on Ben’s Insolvency July 31, 2011 Final distribution

Cash

Liabilities

Ace (50%) Capital

Ben(20%) Capital

Cid (20%) Capital

$200,000

$400,000

$ 40,000

$10,000

$(170,000)

200,000 400,000

400,000

200,000 240,000

________ 10,000

_________ _________ (170,000) (80,000)

(400,000)

________

_________

________

240,000

10,000

(170,000)

(80,000)

100,000 80,000 180,000

240,000

10,000

(70,000)

180,000

(50,000) 190,000

(20,000) (10,000)

70,000 0

180,000

(10,000) 180,000

10,000 0

(180,000) 0 () Debit capital balance or deduct. aAllocating

Don (10%) Capital $(80,000)

100,000

(180,000) 0

Cid’s insolvency to Ace & Ben: 70,000 x 2/7 = 20,000 Ben

70,000 x 5/7 = 50,000 Ace,

80,000 0

Partnership Liquidation

17-12

Solution E17-10 Dee, Ema, Lyn and Geo Partnership Safe Payment Schedule January 31, 2011 Possible Losses Partner’s equity at 1/1 January profit/loss transactions: Inventory sale Land sale Partner’s equity at 1/31 Possible losses — noncash Possible losses — contingent Possible losses — Lyn Possible losses — Geo

$395,000 20,000

Dee (20%) $150,000

Ema (10%) $80,000

Lyn (50%) $140,000

Geo (20%) $78,000

(6,000) 20,000

(3,000) 10,000

(15,000) 50,000

(6,000) 20,000

$87,000 175,000 (39,500) (197,500) (2,000) (10,000) $45,500 $(32,500) (6,500) 32,500 $39,000 $ 0 (1,333) $37,667

$92,000 (79,000) (4,000) $ 9,000 (13,000) $(4,000) 4,000 $ 0

$164,000 (79,000) (4,000) $81,000 (13,000) $ 68,000 (2,667) $65,333

Payments of $103,000 can be safely made to Dee and Ema in the amounts shown above. Check: Cash availablea $ 523,000 Accounts payable $(400,000) Contingencies (20,000) Available to partners $ 103,000 a(250,000

land + 45,000 inv. + 28,000 rec. + 200,000 cash)

Chapter 17

17-13

Solution E17-11 1

Supporting computations for Questions 1-3: See cash distribution plan that follows. Vulnerability Rankings Partners’ Equitiesa Sam $45,000 Red $25,000 Sal $25,000

  

30% 50% 20%

Loss Absorption Potential $150,000 50,000 125,000

Schedule of Assumed Loss Absorption Sam Predistribution equities $ 45,000 Loss to absorb Red (15,000) 30,000 Loss to absorb Sal $15,000/40% (22,500) Balance $ 7,500 Cash Distribution Plan Priority Creditors First $50,000 100% Next $7,500 Next $37,500 Remainder a Equity

Red $ 25,000 (25,000) 0

Sam Capital

Red Capital

100% 60% 30%

50%

Vulnerability Ranks 3 1 2

Sal $ 25,000 (10,000) 15,000

Total $ 95,000 (50,000) 45,000

(15,000) 0

Sal Loan

Sal Capital

26.667%

13.333% 20%

balance = Equity +/- loans to/from

(37,500) 7,500

Partnership Liquidation

17-14

Solution E17-12 1

d Answer b is correct for situations in which all partners have equity in partnership assets; in other words, credit capital balances.

c The debit balance in Mal’s capital account should be charged against the loan payable to Mal.

d Possible Losses Net capital balances Possible loss on inventories

$100,000

Gee’s debit balance 50:50 Distribution of cash after payment of accounts payable

25% Ben Capital $45,000 (25,000) 20,000 (5,000)

25% Sim Capital $35,000 (25,000) 10,000 (5,000)

$15,000

$ 5,000

20% Doc Capital $ 50,000

40% Fae Capital $220,000

40% Hal Capital $155,000

(70,000) (20,000) 20,000

(140,000) 80,000 (10,000)

(140,000) 15,000 (10,000)

$ 70,000

c Possible Losses Net capital balances Noncash assets: Accounts receivable Inventories Plant assets — net Contingency fund

$ 60,000 85,000 200,000 5,000 $350,000

Allocate Doc’s possible deficit Distribution of cash after payment of $60,000 liabilities

50% Gee Capital $40,000 (50,000) (10,000) 10,000

5,000

c Capital balances Tom’s contribution

30% Wes Capital $90,000 90,000

Van’s personal net assets 90,000 Van’s remaining deficit divided 3/7 to Wes and 4/7 to Tom

30% Van 40% Tom Capital Capital $(60,000) $(100,000) 70,000 (60,000) (30,000) 39,000a (21,000) (30,000)

(9,000) 81,000

Tom’s remaining personal net assets to offset his deficit capital balance Tom’s final deficit allocated to Wes and uncollectible Amount of Wes’s partnership equity that should be recoverable

21,000 0

(12,000) (42,000)

81,000

40,000b (2,000)

(2,000)

2,000

$79,000

Chapter 17 b (190,000

17-15

– 70,000 – 80,000) = 40,000

Partnership Liquidation

17-16

SOLUTIONS TO PROBLEMS Solution P17-1 1

Journal entry to distribute available cash on January 1 Ben capital

$25,000 Cash $25,000 To distribute available cash to Ben computed as follows: Safe Payments Schedule January 1, 2011 Possible Losses Ben Bev

Partners’ capital balances Allocation of possible losses Allocate deficits to Ben Safe payments to Ben 2

$90,000

Ron

$72,000

$28,000

$15,000

(30,000) 42,000

(30,000) (2,000)

(30,000) (15,000)

(17,000)

2,000

15,000

$25,000

Journal entry to record sale of assets on February 9 Cash Ben capital Bev capital Ron capital

$81,000 3,000 3,000 3,000

Inventory $72,000 Supplies 18,000 To record sale of inventory items and supplies and recognize loss. 3

Journal entry to distribute cash on February 10 Ben capital Bev capital Ron capital

$44,000 25,000 12,000

Cash $81,000 To distribute cash to partners in final liquidation. [Amounts are equal to final capital account balances.]

Chapter 17

17-17

Solution P17-2 Cam, Doc, and Guy Partnership Cash Distribution Plan Vulnerability ranks Cam Doc Guy

Equity $ 80,000 210,000 205,000

  

Profit and Loss Ratio 20% 30 50

Loss Absorption $400,000 700,000 410,000

Vulnerability Rank 1 3 2

Schedule of assumed loss absorption Cam $80,000 (80,000) 0

Equities Loss to absorb Cam Loss to absorb Guy ($5,000  5/8)

Doc $210,000 (120,000) 90,000

Guy $205,000 (200,000) 5,000

Total $495,000 (400,000) 95,000

(3,000) $ 87,000

(5,000) 0

(8,000) $ 87,000

Cam Capital

Doc Capital

Guy Capital

20%

100% 3/8 30%

5/8 50%

Cash distribution plan

First $90,000 Second $50,000 Third $37,000 Fourth $8,000 Remainder

Priority Creditors 100%

Loan from Doc 100%

Partnership Liquidation

17-18

Solution P17-3 Fed, Flo, and Wil Partnership Cash Distribution Plan Vulnerability Ranking Partnership Equity Fed $75,000 Flo 20,000 Wil 60,000

  

Profit and Loss Ratio 30% 20% 50%

Schedule of Assumed Loss Absorption 30% Fed Predistribution equity $75,000 Assumed loss to absorb Flo (30,000) $20,000  20% 45,000 Assumed loss to absorb Wil (6,000) $10,000  5/8 $39,000

Loss Absorption Potential $250,000 100,000 120,000

Vulnerability Ranking 3 1 2

20% Flo $20,000

50% Wil $60,000

Total $155,000

(20,000) 0

(50,000) 10,000

(100,000) 55,000

(10,000) 0

(16,000) $ 39,000

30% Fed

20% Flo

50% Wil

100% 3/8 30%

20%

5/8 50%

Cash Distribution Plan First $20,000 Next $39,000 Next $16,000 Remainder

Priority Creditors 100%

Chapter 17

17-19

Solution P17-4 1

Gil, Hal, Ian, and Joe Partnership Cash Predistribution Plan Schedule of Vulnerability Ranks:

Capital balance Loan to Hal Partner equity Divided by profit ratio Loss absorption potential Vulnerability ranks

Gil Equity

Hal Equity

Ian Equity

Joe Equity

$300,000 ________ $300,000

$320,000 (20,000) $300,000

$100,000 ________ $100,000

$ 110,000 __________ $ 110,000

40%

30%

20%

10%

$750,000

$1,000,000

$500,000

$1,100,000

Gil $300,000

Hal $300,000

Ian $100,000

Joe $110,000

(200,000) 100,000

(150,000) 150,000

(100,000) 0

(50,000) 60,000

(100,000) 0

(75,000) 75,000

(25,000) 35,000

(75,000) 0

(25,000) $ 10,000

Schedule of Assumed Loss Absorption: Equities Loss to absorb Ian’s equity Loss to absorb Gil’s Equity Loss to absorb Hal’s equity Cash Distribution Plan: Priority Liabilities 100%

First $100,000 Next $50,000 Next $10,000 Next $100,000 Next $200,000 Remainder

Contingency Fund

Gil

Hal

Ian

Joe

100% 100% 3/4 1/4 1/2 3/8 1/8 40% 30% 20% 10% (Profit and loss sharing ratios)

Available cash to distribute ($200,000 + $100,000)

First $100,000 Next 50,000 Next 10,000 Next 100,000 Next 40,000 Distribution to partners

Priority Contingency Liabilities Fund $100,000 $50,000

$300,000

Gil

Hal

20,000

75,000 $15,000

$10,000 25,000 5,000

$20,000

$90,000

$40,000

Ian

Joe

Chapter 17

17-21

Solution P17-5 Eli, Joe, and Ned, Consultants Statement of Partnership Liquidation for the month ended August 31, 2011

July 31 balances Receivables: Collections Assumption Write-off Liabilities paid Expenses paid Furniture: Sold to Joe Donated Predistribution balances To partners

Cash $13,000 8,000

Noncash Assets $47,000 (8,000) (3,000) (1,000)

(6,000) (3,000) 15,000

Accounts Payable $6,000

30% Joe Capital $15,000

50% Ned Capital $15,000

(200)

(300)

(3,000) (500)

(600)

(900)

(1,500)

(2,000)

(5,000)

(600) (1,200)

(3,000) (1,000) (900) (1,800)

19,400 (19,400) 0

7,100 (7,100) 0

500 (500) 0

(6,000) (25,000) (4,000) (6,000)

27,000 (27,000) 0

20% Eli Capital $24,000

(1,500) (3,000)

Partnership Liquidation

17-22

Solution P17-6 Jon, Sam, and Tad Partnership Statement of Partnership Liquidation for the liquidation period January 1, 2011 to March 31, 2011

Cash Balances $ 15,000 January 2011 Inventories sold 20,000 Receivables collections 14,000 Predistribution balance 49,000 Cash distribution to creditors (40,000) Balances January 31 February 2011 Land sold Land and buildings sold Receivables collections Balances February 28 March 2011 Write-off of furniture and fixtures Predistribution balance Cash distribution: Creditors Partners Balances March 31

Noncash Accounts Assets Payable $215,000 $ 80,000

30% Sam Capital $ 60,000

50% Tad Capital $50,000

(65,000) (9,000) (13,500) (22,500) (14,000) _________ _________ _________ ________ 136,000 80,000 31,000 46,500 27,500 (40,000) _________ _________ ________

9,000

136,000

60,000 40,000 3,000 112,000

112,000 (40,000) (72,000) 0

20% Jon Capital $ 40,000

40,000

31,000

46,500

27,500

(40,000) (70,000) ( 6,000) 20,000

40,000

4,000 (6,000) ( 600) 28,400

6,000 (9,000) ( 900) 42,600

10,000 (15,000) ( 1,500) 21,000

( 20,000) 0

40,000

( 4,000) 24,400

( 6,000) 36,600

(10,000) 11,000

(24,400) 0

(36,600) 0

(11,000) 0

(40,000) 0

Chapter 17

17-23

Solution P17-7 1 Cash distribution plan for Lin, Mae, and Nel partnership Vulnerability ranks Capital Balances Lin Mae Nel

$55,000 12,000 20,000 $87,000

Profit Loss Equity in and Loss Absorption Vulnerability Partnership Ratio Potential Ranking $55,000 12,000 20,000 $87,000

50% 30 20

$110,000 40,000 100,000 250,000

3 1 2

Schedule of assumed loss absorption Lin Mae Nel Total Predistribution equities $ 55,000 $ 12,000 $ 20,000 $87,000 Assumed loss to absorb Mae’s equity 50/30/20 (20,000) (12,000) ( 8,000) (40,000) 35,000 0 12,000 47,000 Assumed loss to absorb Nel’s equity 50/20 (30,000) (12,000) (42,000) $ 5,000 0 $ 5,000 Cash distribution plan Priority Creditors 100%

First $55,000 Next $5,000 Next $42,000 Remainder 2

Lin

Mae

Nel

100% 5/7 50%

30%

2/7 20%

Cash of $25,000 is realized from inventories and receivables with a $45,000 book value Cash balance December 31, 2011 Realized during 2012

$47,000 25,000 72,000 (10,000) $62,000

Less: Amount reserved for contingencies Cash available for distribution Lin, Mae, and Nel Partnership Schedule of January 2012 Cash Distribution Cash Available

Priority Creditors

Lin

Mae

Nel

Total

Cash to be distributed $62,000 Payments to creditors

(55,000)

Remainder

7,000

To Lin

(5,000)

Remainder

2,000

$55,000

$5,000

5,000

Partnership Liquidation

17-24 To Lin (5/7) and Nel (2/7) Cash distribution

(2,000) 0

$55,000

1,429 $6,429

$ 571 $ 571

2,000 $62,000

Chapter 17

17-25

Solution P17-8 Jax, Kya, and Bud Partnership Statement of Partnership Liquidation for the period January 1, 2011 through February 28, 2011

Balances January 1 Offset loan to Jax Collection of receivables Liquidation expenses Predistribution balances Cash distribution: Creditors Partners — Schedule A Balances January 31 Liability discovered Liquidation expenses Sale of remaining assets Predistribution balances Cash distribution: Creditors Partners — Schedule B Balances February 28

Cash 16,500

(

Noncash Assets $ 163,500 (14,000)

25,000 2,000)

(28,000)

39,500

121,500

(21,000) ( 13,500) 5,000

50% Priority Jax Liabilities Capital $ 21,000 $ 69,000 (14,000)

21,000

111,000

900) 600)

20% Bud Capital $ 43,000

( 1,500) ( 1,000)

( (

600) 400)

52,500

45,500

42,000

52,500 (1,500) (1,000)

( 1,100) 44,400 ( 900) ( 600)

(12,400) 29,600 ( 600) ( 400)

( 6,750)

( 4,050)

( 2,700)

43,250

38,850

25,900

$ 43,250 0

(38,850) 0

(25,900) 0

(21,000) _ 121,500

0 3,000

( 2,000) 108,000

30% Kya Capital $ 47,000

(121,500)

(3,000) (108,000) 0

3,000 (3,000) 0

Schedule A Possible Losses Partners’ equity January 31 Allocate possible losses

$126,500

Allocate Jax’s deficit Safe payments to partners January 31

50% Jax Equity $52,500 (63,250) (10,750) 10,750

30% Kya Equity $45,500 (37,950) 7,550 (6,450)

20% Bud Equity $42,000 (25,300) 16,700 (4,300)

$ 1,100

$12,400

50% Jax Equity $43,250 $43,250

30% Kya Equity $38,850 $38,850

20% Bud Equity $25,900 $25,900

Schedule B

Partners’ equity February 28 Safe payments to partners February 28

Partnership Liquidation

17-26

Solution P17-9 Ron, Sue, and Tom Partnership Statement of Partnership Liquidation for the period January 1, 2011 through February 28, 2011

Balances January 1 Offset loan to Sue Sale of assets Predistribution Balances Cash distribution: Creditors Partners — Schedule A Balances January 31 Sale of remaining Assets Offset loan to Ron capital Predistribution Balances Cash distribution: Partners — Schedule B Balances February 28

30% 30% 40% Ron Sue Tom Capital Capital Capital $ 9,900 $ 45,000 $ 60,000 (10,000) ________ ________ ________

Priority Liabilities $ 40,100

Ron Loan $ 5,000

40,000

Noncash Assets $ 140,000 (10,000) (40,000)

__________

_______

60,000

90,000

40,100

5,000

9,900

35,000

5,000

9,900

(2,814) (17,086) 32,186 42,914

Cash $ 20,000

(40,100)

(19,900) 0

90,000

21,000

(90,000)

__ 21,000

60,000

(20,700) (20,700) (27,600) (5,000)

(21,000) 0

5,000 _________ _________ (5,800)

$ (5,800) $

11,486

15,314

(9,000) (12,000) 2,486 $ 3,314

Note: Ron owes Sue $2,486 and Tom $3,314. These balances remain on the partnership books until it is determined if Ron is personally solvent and able to pay $5,800 to the other partners. Schedule A Possible Losses Partners’ equity January 1 Allocate possible losses

$90,000

Allocate Ron’s deficit Safe payments to partners January 31

30% Ron Equity

30% Sue Equity

40% Tom Equity

$14,900 (27,000) (12,100) 12,100

$35,000 (27,000) 8,000 (5,186)

$60,000 (36,000) 24,000 (6,914)

$ 2,814

$17,086

30% Sue Equity $11,486 (2,486) $ 9,000

40% Tom Equity $15,314 (3,314) $12,000

Schedule B

Partners’ equity February 28 Allocate Ron’s deficit Safe payments to partners February 28

30% Ron Equity $(5,800) 5,800 0

Note: Since cash was distributed to Sue and Tom in January and since Ron has negative equity, the distribution in February is necessarily in the 3/7 and 4/7 relative profit and loss sharing ratio of Sue and Tom.

Chapter 17

17-27

Solution P17-10 Cash $21,000

Balances October 1 Write-off Rob’s loan against capital Collected accounts Receivable 40,000 Sale of inventory 50,000 Sale of equipment 60,000 Payment of bank loan and accrued interest (50,600) Payment of accounts Payable (80,000) Liquidation expenses (2,000) Predistribution Balances 38,400 October 31 distribution 33,400 Balance November 1 5,000 Sale of equipment 38,000 Accounts receivable 10,000 Inventory to Val Write-off remaining inventory Liquidation expenses (800) Predistribution balances 52,200 Cash distributed (52,200) Balances 0

Noncash Assets $348,000

30% Rob Liabilities Capital $130,000 $43,600

50% Tom Capital $150,000

20% Val Capital $45,400

(15,000)

(44,000) (60,000) (55,000)

(1,200) (3,000) 1,500

(2,000) (5,000) 2,500

(800) (2,000) 1,000

(180)

(300)

(120)

(600)

(1,000)

(400)

25,120

144,200

43,080

174,000 (95,000) (19,000) (20,000)

25,120 (17,100) (2,700) (3,000)

(33,400) _______ 110,800 43,080 (28,500) (11,400) (4,500) (1,800) (5,000) (12,000)

(40,000)

(12,000) (240)

(20,000) (400)

(8,000) (160)

(9,920)

52,400 (45,314) 7,086

9,720 (6,886) 2,834

(50,000) (80,000) 174,000

(9,920)

Schedule of Safe Payments 30% Rob

50% Tom

20% Val

$25,120 (52,200)

$144,200 (87,000)

$43,080 (34,800)

(1,500) (28,580)

(2,500) 54,700

(1,000) 7,280

28,580 0

(20,414) 34,286 (886) 33,400

(8,166) (886) 886 0

$(9,920)

$ 52,400

$ 9,720

9,920 0

(7,086) $ 45,314

(2,834) $ 6,886

October 31 Partners’ equity October 31, 2011 Possible losses Possible loss on contingency fund

$174,000 5,000

Possible loss from Rob allocated 5/7 and 2/7 (rounded) Possible loss from Val Cash distribution November 30 Partners’ equity November 30 Possible loss from Rob’s debit balance 5/7 and 2/7 Cash distribution

Partnership Liquidation

17-28

Solution P17-11 1

Closing entry Revenue Jee capital Moe capital Ole capital

$200,000 25,000 75,000 100,000 Expenses

$400,000

To close revenue and expense items and distribute loss to partners as follows: Net Loss 20% Jee 40% Moe 40% Ole $(200,000) Salaries (50,000) $ 25,000 $ 25,000 Loss to divide (250,000) Divided 20:40:40 250,000 (50,000) (100,000) $(100,000) Loss allocated 0 $(25,000) $(75,000) $(100,000) 2

Cash distribution plan Vulnerability ranks

Jee: $250,000 balance - $25,000 loss Moe: $450,000 balance - $75,000 loss Ole: $370,000 balance - $100,000 loss

Equity

Loss Absorption

Vulnerability Rank

$225,000/20%

$1,125,000

$375,000/40%

937,500

$270,000/40%

675,000

Assumed loss absorption Predistribution equities Loss to absorb Ole Loss to absorb Moe $105,000  40/60

Jee

Moe

Ole

Total

$ 225,000 (135,000) 90,000

$375,000 (270,000) 105,000

$270,000 (270,000) 0

$870,000 (675,000) 195,000

(52,500) $ 37,500

(105,000) 0

(157,500) $ 37,500

Cash distribution plan Priority Creditors 100%

First $80,000 Second $37,500 Third $157,500 Remainder 3

Jee

Moe

Ole

100% 2/6 20%

4/6 40%

40%

Jee

Moe

Ole

Cash distribution schedule

First Second

$ 80,000 37,500

Priority Creditors $80,000

$37,500

Chapter 17

Third

17-29

18,000 $135,500

$80,000

6,000 $43,500

$12,000 $12,000

Partnership Liquidation

17-30

Solution P17-12 Bea, Pat, and Tim Partnership Statement of Partnership Liquidation for the period January 1, 2012 to March 31, 2012

Cash Balances January 1 $ 120,000 Collection of receivables 100,000 Sale of inventory 100,000 Predistribution balances 320,000 January distribution (schedule 1) Creditors (250,000) Pat ( 60,000) Balances February 1 10,000 Plant assets to Bea and loss distribution Sale of inventory 60,000 Liquidation expenses paid ( 2,000) Liability discovered Predistribution balances 68,000 February distribution (schedule 2) Creditors ( 8,000) Pat (30,000) Tim (20,000) Balances March 1 10,000 Sale of plant assets and write-off 110,000 Liquidation expenses paid ( 5,000) Predistribution balances 115,000 March distribution (115,000) Liquidation completed March 31 0

Noncash Assets $ 560,000

50% Bea Capital $ 170,000

30% Pat Capital $ 180,000

20% Tim Capital $ 80,000

10,000

6,000

4,000

180,000

186,000

84,000

_________ 180,000 (50,000) ( 5,000)

(60,000) 126,000

_________ 84,000

( 3,000)

( 2,000)

(30,000)

(18,000)

(12,000)

8,000

( 1,000) ( 4,000)

( 600) ( 2,400)

( 400) ( 1,600)

8,000

90,000

102,000

68,000

Liabilities $ 250,000

(100,000) ( 80,000) 380,000

_________ 380,000 (60,000)

250,000 (250,000) __________ 0

(120,000)

200,000

( 8,000) (30,000) 200,000 (200,000)

90,000

72,000

(20,000) 48,000

(45,000)

(27,000)

(18,000)

( 2,500)

( 1,500)

( 1,000)

42,500 (42,500)

43,500 (43,500)

29,000 (29,000)

Chapter 17

17-31

Solution 17-12 (continued) Schedule 1 Bea, Pat, and Tim Partnership Schedule of Safe Payments to Partners January Distribution

Noncash assets Contingency reserve Possible losses Distribution 50:30:20

Possible Losses

Bea Capital

Pat Capital

Tim Capital

$ 380,000 10,000 390,000 (390,000) 0

$ 180,000

$ 186,000

$ 84,000

(195,000) ( 15,000)

(117,000) 69,000

(78,000) 6,000

(

( 6,000) 0

Distribution of Bea’s deficit 60:40 Safe payment to Pat

15,000 0

9,000) 60,000

Schedule 2 Bea, Pat, and Tim Partnership Schedule of Safe Payments to Partners February Distribution

Noncash assets Contingency reserve Possible losses Distribution 50:30:20 Distribution of Bea’s deficit 60:40 Safe payment to Pat and Tim

Possible Losses

Bea Capital

Pat Capital

Tim Capital

$ 200,000 10,000 210,000 (210,000) 0

90,000

$ 102,000

$ 68,000

(105,000) ( 15,000)

( 63,000) 39,000

(42,000) 26,000

15,000

( 9,000)

( 6,000)

30,000

$ 20,000

Chapter 18 CORPORATE LIQUIDATIONS and REORGANIZATIONS Answers to Questions 1

Equity insolvency occurs when a debtor is unable to pay its debts as they come due. Bankruptcy insolvency occurs when a debtor’s liabilities exceed the fair value of all assets.

A bankruptcy proceeding is designated voluntary if the debtor corporation files the petition to place itself under the protection of the bankruptcy court and involuntary if creditors file the petition to bring the debtor into bankruptcy court. An involuntary petition may be filed by a single creditor with an unsecured claim of $14,425 or more if there are fewer than twelve unsecured creditors. Otherwise, three or more entities with unsecured claims totaling at least $14,425 must file in order to commence an involuntary case. The requirements are the same for Chapter 7 and Chapter 11 cases.

The duties of the U.S. trustee are to maintain and supervise a panel of private trustees eligible to serve in Chapter 7 cases, to serve as trustee or interim trustee in some bankruptcy cases, to supervise the administration of bankruptcy cases, and to preside over creditor meetings. Bankruptcy judges still supervise cases in districts without U.S. trustees.

The debtor corporation in a bankruptcy case has the following duties: (1) to file a list of creditors, a schedule of assets and liabilities, and a statement of the debtor’s financial affairs; (2) to cooperate with the trustee so that the trustee may perform his duties; (3) To surrender all property, including books, documents, records, and so on, to the trustee; and (4) to appear at hearings of the bankruptcy court as required.

A trustee is not appointed in all Title 11 cases. In Chapter 7 cases, a trustee will be elected by unsecured creditors if a majority of creditors vote for the trustee, and those creditors hold at least 20 percent of the claims. Otherwise, an appointed interim trustee serves as trustee. In Chapter 11 cases a trustee is appointed only if deemed necessary by the court, but otherwise, the debtor remains in possession of the estate and performs the duties of a trustee. Within 30 days from the time the court orders the appointment of a trustee in a Chapter 11 case, a party in interest may request the election of a trustee.

The trustee in a liquidation case takes possession of the debtor’s estate, converts estate assets into cash, and distributes the proceeds as directed by the court. They also performs other duties such as investigating the financial affairs of the debtor, providing information about the estate to parties of interest, examining creditor claims and objecting to those that appear improper, operating the debtor’s business if authorized to do so by the court, providing financial reports and summaries about the estate to the court, and filing reports on trusteeship as directed by the court.

The priority rankings in a Chapter 7 liquidation case are summarized in Exhibit 18–2 of the text. The priorities recognized for unsecured claims (Rank II) are: (1) administrative expenses, (2) claims incurred between an involuntary filing and appointment of a trustee, (3) salary claims up to $11,725 per individual earned within 180 days of filing, (4) employee benefit plan contribution claims up to $11,725 per individual earned within 180 days of filing, (5) individual claims up to $2,600 for goods and services purchased from, but not provided by the debtor, and (6) claims of governmental units for taxes owed by the debtor (subject to time restrictions), including taxes collected and withheld for which the debtor is liable.

Four ranks within the unsecured nonpriority claim category (general unsecured claims) are: (1) claims allowed that were timely filed, (2) claims allowed where proof was filed late, (3) claims allowed for fines, penalties or forfeitures, or damages, and arising before the court order for relief or appointment of a trustee, and (4) claims for interest on unsecured claims. Copyright © 2015 Pearson Education, Inc. 18-1

18-2

Corporate Liquidations and Reorganizations

The accountant’s statement of affairs is a financial statement that is designed to provide information about liquidation values and priority rankings for use by the trustee, the court, creditors, and other interested parties in the debtor’s estate. Assets are measured at expected net realizable values in the statement, but book values are also included for reference purposes. A debtor corporation’s estate may be liquidated even though the filing is under Chapter 11. This can occur when the case is transferred to Chapter 7 for liquidation. It can also be carried out in accordance with an approved Chapter 11 plan of reorganization that calls for sale and distribution of the proceeds from the debtor corporation’s estate.

A debtor in possession reorganization case is a Chapter 11 case in which the bankruptcy court does not appoint a trustee, but instead, allows the debtor corporation to carry out the duties that otherwise would be performed by a trustee.

A creditor committee can file a plan of reorganization under a Chapter 11 case after 120 days from the date the court order for relief is granted. The order for relief occurs when the debtor or creditor’s filing petition is approved by the court.

The approval of a plan of reorganization requires acceptance of the plan by at least two-thirds in dollar amount of claim holders and over half in number of claims in each class of claims. Further, each class of claims must accept the plan or not be impaired under it. A class of claims that would receive nothing if the corporation were liquidated is not impaired if it receives nothing under a plan and, accordingly, acceptance by that class of claims is not required.

Prepetition liabilities are the liabilities of an enterprise that were incurred prior to a Chapter 11 filing. They are reported at the amounts allowed by the bankruptcy court. Prepetition liabilities subject to compromise are those liabilities that may be impaired by a plan and that are eligible for compromise because they are either unsecured or undersecured.

Reorganization value is an estimate of the value of the reconstituted entity that will emerge from reorganization. It is also described as the fair value of the entity before considering liabilities. Reorganization value approximates the amount a willing buyer would pay for the assets of the entity immediately after the restructuring.

Fresh start reporting should be used by a company emerging from Chapter 11 if the following two conditions are met: (1) the reorganization value of the assets of the emerging entity immediately before the date of confirmation of the reorganization plan is less than the total of all postpetition liabilities and allowed claims and (2) holders of existing voting shares immediately before confirmation of the reorganization plan receive less than 50 percent of the voting shares of the emerging entity.

Entities not qualifying for fresh start reporting report liabilities compromised by a confirmed reorganization plan in a manner similar to that of a note issued in a noncash transaction under FASB ASC 835. Forgiveness of debt should be reported as an extraordinary item.

Chapter 18

18-3

SOLUTIONS TO EXERCISES Solution E18-1 1 b 2 d 3 c 4 d

Solution 18-2 1 a 2 d 3 c 4 d

Solution E18-3 Note receivable from Pat Amount secured by inventory items at expected recoverable value

$200,000 (50,000)

Unsecured portion of note receivable from Pat Expected recovery on the dollar for unsecured claims

150,000 .35

Expected recovery on unsecured portion of note Add: Secured portion

52,500 50,000

Total expected recovery on note from Pat

$102,500

Corporate Liquidations and Reorganizations

18-4

Solution E18-4 1

On the basis of the reorganization value, Bax qualifies for fresh start reporting because the estimated reorganization value of $2,000,000 is less than the postpetition liabilities and allowed claims. Estimated reorganization value Liabilities: Postpetition liabilities Prepetition liabilities Fully secured debt Excess liabilities over reorganization value

$2,000,000 $1,200,000 1,500,000 900,000

3,600,000 $1,600,000

Old stockholders must retain less than a 50% interest in the “new entity.” Reorganization value Less: Payment to prepetition claimants Reorganized capital structure: Postpetition liabilities Notes payable Fully secured debt New common stock to prepetition claimants New common stock to old stockholders

$2,000,000 150,000 1,850,000 $1,200,000 300,000 900,000 375,000

2,775,000 $ (925,000)

Chapter 18

18-5

Solution E18-5 Cash available for distribution Mortgage payable (secured portion) Priority claims (administrative expenses and salaries) Available for unsecured, nonpriority claims

$200,000 (100,000) 100,000 (20,000) $ 80,000

Unsecured, nonpriority claims: Balance of mortgage payable Accounts payable Unsecured, nonpriority claims

$ 60,000 100,000 $160,000

$80,000 available cash/$160,000 claims = $.50 on the dollar Schedule of Distribution of Available Cash Mortgage payable — secured portion Unsecured, priority claims Mortgage payable — unsecured portion ($60,000  $.50) Accounts payable ($100,000  $.50) Total cash distributed

$100,000 20,000 30,000 50,000 $200,000

Corporate Liquidations and Reorganizations

18-6

SOLUTIONS TO PROBLEMS Solution P18-1 1

Entries on trustee’s books: March 1, 2011 Cash Accounts receivable — net Inventories Land Buildings — net Intangible assets Accounts payable Note payable — unsecured Revenue received in advance Wages payable Mortgage payable Estate equity To record custody of Sco in liquidation.

4,000 8,000 36,000 20,000 100,000 26,000 $50,000 40,000 1,000 3,000 80,000 20,000

March 2011 Cash $ 7,200 Estate equity 800 $ 8,000 Accounts receivable — net To record collection of receivables and recognize loss. Cash Estate equity Inventories To record sale of inventories at a loss.

$ 19,400 16,600 $36,000

Cash $ 90,000 Estate equity 30,000 Land Buildings — net To record sale of land and buildings at a loss. Estate equity $ 26,000 Intangible assets To write off intangible assets at a loss. Estate equity Administrative expenses payable — new To accrue trustee expenses.

$ 20,000 100,000

$ 26,000

8,200

Chapter 18

18-7

Solution P18-1 (continued) 2

Sco in Trusteeship Balance Sheet at March 31, 2011 Assets Cash

$120,600

Liabilities And Deficit Accounts payable Note payable — unsecured Revenue received in advance Wages payable Mortgage payable Administrative expenses payable — new Total liabilities Less: Estate deficit

$ 50,000 40,000 1,000 3,000 80,000 8,200 182,200 (61,600)

Total liabilities less deficit

$120,600

Statement of Cash Receipts and Disbursements from March 1 to March 31, 2011 Cash balance, March 1, 2011 Add: Cash receipts Collections of receivables Sale of inventories Sale of land and buildings

$ $ 7,200 19,400 90,000

4,000

Less: Cash disbursements (none)

116,600 120,600 0

Cash balance, March 31, 2011

$120,600

Statement of Changes in Estate Equity from March 1 to March 31, 2011 Estate equity, March 1, 2011

$ 20,000

Less: Loss on uncollectible receivables Loss on sale of inventories Loss on sale of land and buildings Loss on write-off of intangibles Administrative expenses

800 16,600 30,000 26,000 8,200

Estate deficit, March 31, 2011

81,600 $(61,600)

Corporate Liquidations and Reorganizations

18-8

Solution P18-1 (continued) 3

Entries on trustee’s books: April 2011 Mortgage payable $80,000 Cash $80,000 To record payment of secured creditors from proceeds from sale of land and buildings. $ 8,200 Administrative expenses payable — new Revenue received in advance 1,000 Wages payable 3,000 Cash To record payment of priority liabilities.

$12,200

Accounts payable $15,800 12,600 Note payable — unsecured Cash $28,400 To record payment of $.316 per dollar to unsecured creditors (available cash of $28,400 divided by unsecured claims of $90,000). Accounts payable $34,200 27,400 Note payable — unsecured Estate equity $61,600 To write off remaining liabilities and close trustee’s records.

Chapter 18

18-9

Solution P18-2 1

Amount expected to be available for unsecured claims: Total amount expected to be available for all claims Less: Payments to secured and priority claims Mortgage payable Note payable Priority claims

$445,000 $220,000 75,000 80,000

Expected to be available for unsecured nonpriority claims 2

375,000 $ 70,000

Expected recovery per dollar of unsecured claims: Expected to be available (from 1) = $70,000 Unsecured claims ($550,000 - $375,000) = $175,000 Expected recovery on the dollar: $70,000/$175,000 = $.40

Expected recovery by class of creditors: $220,000 Fully secured — mortgage payable 85,000 Partially secured — note payable $75,000 + ($25,000  $.40) 80,000 Priority unsecured — liabilities to priority creditors Unsecured nonpriority creditors — accounts 60,000 payable ($150,000  $.40) Total

$445,000

Corporate Liquidations and Reorganizations

18-10

Solution P18-3 1

Ranking of claims: Fully secured: 8. Holders of first mortgage and related interest

$228,500

Unsecured priority: 1. Administrative expenses 6. Wages payable up to $11,725 per employee($48,000 – ($12,275 $11,725)) 7. Customer claims for merchandise paid for and not delivered (maximum $2,600 per individual) 5. State government for gross receipts taxes $ 3,000 3. Local government for property taxes 4,000 Total unsecured priority claims Unsecured nonpriority: 2. Merchandise creditors 4. Local bank for principal of loan 6. President for salary due over $11,725 4. Interest on unsecured bank loan Total unsecured nonpriority claims

47,450 1,500

7,000 68,450

$99,000 30,000 550

Total all claims 2

$ 12,500

129,550 4,500 134,050 $431,000

Distribution of available cash: 1st Mortgage holders (100%)

$228,500

2nd

Administrative expenses (100%)

12,500

3rd

Employees (up to $11,725 each) (100%)

47,450

4th

Customers for merchandise not delivered (100%)

1,500

5th

State government (100%) Local government (100%)

$ 3,000 4,000

7,000

[Remaining cash ($374,500 - $296,950) of $77,550/$129,550 claim of next rank = $.5986 return on dollar] 6th

Merchandise creditors ($99,000  .5986) Local bank for loan principal ($30,000  .5986) Company president ($550  .5986) Total distributed (equal to available cash) *Rounding error; should be $374,500.

$59,261 17,958 329

77,548 $374,498*

Chapter 18

18-11

Solution P18-4 1

Hanna Corporation Statement of Affairs on June 30, 2011 Assets Realizable ValuesLiability Offsets for Secured Creditors

Book Value $55,000

2,200 15,000 20,000

Pledged for partially secured creditors Equipment — net Less: Mortgage note payable and accrued interest

Realizable Value Available for Unsecured Creditors

$28,000 (31,000)

Available for priority and unsecured creditors Cash Accounts receivable — net Inventories

2,200 13,500 22,500

Total available for priority and unsecured creditors Less: Priority liabilities

38,200 12,000

Total available for unsecured creditors Estimated deficiency $92,200

26,200 10,800 $37,000

Liabilities And Stockholders’ Equity Book Value $12,000

31,000

26,400 7,600 55,000 (39,800) $92,200

Secured and Unsecured NonPriority Claims priority Claims Priority liabilities Wages payable (assumed under $4,000 per employee) Partially secured creditors Note payable and accrued interest Less: Equipment pledged as security

$12,000

$31,000 (28,000)

Unsecured creditors Accounts payable Rent payable Stockholders’ equity Capital stock Retained earnings (deficit)

$ 3,000 26,400 7,600

_______ $37,000

Corporate Liquidations and Reorganizations

18-12

Solution P18-4 (continued) 2

Estimated payments per dollar for unsecured creditors Cash available

$66,200

Distribution to partially secured and unsecured priority creditors: Note payable and interest Administrative expenses Wages payable

$28,000 4,000 12,000

44,000

Available to unsecured nonpriority creditors = A

$22,200

Note payable and interest (unsecured portion) Accounts payable Rent payable

$ 3,000 26,400 7,600

Unsecured nonpriority claims = B

$37,000

A/B = $22,200/$37,000 = $.60 per dollar Expected recovery for each class of claims Partially secured Note payable and interest Secured portion Unsecured portion ($3,000  $.60)

$28,000 1,800

$29,800

$ 4,000 12,000

16,000

$15,840 4,560

20,400

Unsecured priority Administrative expenses Wages payable Unsecured nonpriority Accounts payable ($26,400  $.60) Rent payable ($7,600  $.60) Total payments

$66,200

Chapter 18

18-13

Solution P18-5 1

Dawn Corporation — in Chapter 7 Statement of Affairs at July 10, 2011 Assets Book Value $210,000 250,000

80,000 200,000 150,000 10,000

Fully secured Accounts receivable — net Less: Notes payable Partially secured Land and buildings — net Less: Mortgage and interest payable Unsecured Cash Inventories Equipment — net Intangible assets Available for priority and unsecured Priority liabilities Available for nonpriority unsecured Estimated deficiency

Realizable ValueLiability Offsets

Realizable Value Available for Unsecured

$160,000 100,000

$ 60,000

$140,000 205,000

0 80,000 210,000 60,000 0 410,000 150,000 260,000 155,000 $415,000

$900,000 Equities Secured and Priority Claims

Book Value $ 50,000 24,000 76,000

Priority liabilities Accounts payable Wages payable Taxes payable

100,000

Fully secured Note payable Less: Accounts receivable — net

205,000

Partially secured Mortgage and interest payable Less: Land and buildings — net

350,000 300,000 (205,000) $900,000

UnsecuredNonpriority Claims

$ 50,000 24,000 76,000 150,000 $100,000 160,000 (60,000) $205,000 140,000 65,000

Unsecured Accounts payable Capital stock Retained earnings deficit

$ 65,000 350,000 _________ $415,000

Corporate Liquidations and Reorganizations

18-14

Solution P18-5 (continued) 2

Claims by Priority Ranks Priority claims Administrative expenses Accounts payable Wages payable Taxes payable Fully secured claims Note payable Partially secured claims Mortgage and interest payable Unsecured Accounts payable

Amounts to Amounts to Be Be Paid Written Off

$ 11,000 50,000 24,000 76,000

100,000

205,000

140,000 39,000

$ 26,000

350,000 $816,000

210,000 $650,000

140,000 $166,000

Calculation of recovery for unsecured nonpriority claims Cash available Less: Paid to priority claims Less: Paid to fully secured claims Less: Paid to partially secured creditors – secured portion

$650,000 (161,000) (100,000) (140,000)

$249,000

Cash available for unsecured

Unsecured claims: Partially secured ($205,000 - $140,000 secured) Accounts payable — nonpriority

$ 65,000 350,000

$415,000

Total unsecured claims

A  B = $249,000/$415,000 = $.60 recovery on the dollar

Chapter 18

18-15

Solution P18-6 1

Everlast Window Corporation Statement of Affairs on June 30, 2011 Assets Realizable ValuesRealizable Liability Value Offsets for Available for Secured Unsecured Creditors Creditors

Book Value $230,000

40,000 70,000 50,000 60,000 50,000

Pledged for fully secured creditors Land and building $170,000 Less: Mortgage payable and accrued interest (165,000) Available for priority and unsecured creditors Cash Accounts receivable — net Inventories Machinery — net Goodwill Total available for priority and unsecured Creditors Less: Priority liabilities Total available for unsecured creditors Estimated deficiency

$500,000

5,000 40,000 63,000 42,000 20,000 0

170,000 70,000 100,000 65,000 $165,000

Liabilities and Stockholders’ Equity Secured and Priority Claims

Book Value $ 60,000 10,000

Priority liabilities Wages payable Property taxes payable

150,000 15,000

Fully secured creditors Mortgage payable Interest on mortgage payable

110,000 50,000 5,000 200,000 (100,000)

$ 60,000 10,000 70,000 $150,000 15,000 165,000

Unsecured creditors Accounts payable Note payable — unsecured Interest payable — unsecured Stockholders’ equity Capital stock Retained earnings (deficit)

$110,000 50,000 5,000

________ $165,000

$500,000 2

Unsecured Non-priority Claims

Settlement per dollar of rank 1 unsecured creditors is $.6250 ($100,000 available for unsecured/$160,000 accounts and notes payable). No payment is made for the $5,000 unsecured interest claim. Copyright © 2015 Pearson Education, Inc.

18-16

Corporate Liquidations and Reorganizations

Chapter 18

18-17

Solution P18-7 1

The reorganization is eligible for fresh start accounting because the liabilities on June 30, 2011 of $16,500 exceed the reorganization value of $16,000 by $500. Also, the common stock of the new entity is allocated $5,000 to prepetition creditors and $2,000 to Lowstep’s old stockholders, so that the old stockholders have less than a 50 percent interest in the new entity.

Entries to adjust Lowstep’s accounts for the reorganization plan: Prepetition liabilities $12,500 Accounts payable (old) $ 800 Wages payable (old) 400 Note payable (new) 3,800 Common stock (new) 5,000 Gain on debt restructuring 2,500 To adjust prepetition liabilities to conform with the plan. Loss on asset adjustments to fair values Inventories Land Buildings — net Patent To adjust assets to their fair values.

$ 4,000 400 1,000

Common stock (old) Common stock (new) Additional paid-in capital To record exchange of common stock.

$ 7,000

$1,400 4,000

$2,000 5,000

Gain on debt discharge $ 2,500 Additional paid-in capital 5,000 Reorganization value in excess of fair value 1,000 Loss on asset adjustments to fair values $4,000 Deficit 4,500 To eliminate deficit and record adoption of fresh start reporting.

Corporate Liquidations and Reorganizations

18-18

Solution P18-7(continued) 3

Lowstep Corporation Final Balance Sheet as of July 8, 2011 Assets Cash Trade receivables — net Inventories Land Buildings — net Equipment — net Reorganization value in excess of fair values Total assets

$ 6,700 1,000 2,000 2,000 1,500 1,800 1,000 $16,000

Liabilities and Stockholders’ Equity Accounts payable Accounts payable (old) Wages payable Wages payable (old) Notes payable (new) Total liabilities Common stock (new) Total liabilities and stockholders’ equity

$ 3,000 800 1,000 400 3,800 9,000 7,000 $16,000

Note: The final balance sheet of Lowstep Corporation will be the same as the beginning balance sheet of Highstep Corporation.

Chapter 19 AN INTRODUCTION TO ACCOUNTING FOR STATE AND LOCAL GOVERNMENTAL UNITS Questions 1

The Governmental Accounting Standards Board has primary responsibility for setting standards that provide GAAP for state and local governmental units. The most authoritative literature includes GASB Statements of Standards and GASB Interpretations. The second level of authoritative literature includes GASB Technical Bulletins and those AICPA audit and accounting guides and statements of position that the AICPA intended to make applicable to governments and that the GASB has cleared. Before 1984, the Municipal Finance Officers Association (MFOA) and its National Committee on Governmental Accounting provided guidance via the publication of Municipal Accounting and Auditing in 1951 and Governmental Accounting, Auditing, and Financial Reporting (GAAFR) in 1968. Since 1974, the AICPA has also issued industry audit guides for audits of state and local governmental units.

The Municipal Finance Officers Association (MFOA), now referred to as the Government Finance Officers Association (GFOA), first issued Governmental Accounting, Auditing, and Financial Reporting (GAAFR) in 1968. For many years, this resource book – often referred to as the Blue Book due to its distinctive blue cover - constituted the most complete frameworks of accounting principles specific to governmental units, and provided standards for preparing and evaluating the financial reports of governmental units. Updated periodically to reflect changes to governmental accounting, the 2012 GAAFR is the most recent version.

According to the AICPA’s Audit and Accounting Guide, a governmental entity is generally created for the administration of public affairs and has one or more of the following characteristics: ▪ Popular election of officers or appointment (or approval) of a controlling majority of the members of the organization’s governing body by officials of one or more state or local governments; ▪ The potential for unilateral dissolution by a government with the net position reverting to a government; or ▪ The power to enact or enforce a tax levy. An organization may also be classified as a governmental entity if it possesses the ability to issue debt that is exempt from federal taxation.

A fund is a separate fiscal and accounting entity with a self-balancing set of accounts, “segregated for the purpose of carrying on specific activities or attaining certain objectives in accordance with special regulations, restrictions, or limitations.” [GASB Codification] Fund accounting facilitates budgetary control. A governmental unit may have hundreds of funds, but only eight fund types. The Codification discusses three fund categories (governmental, proprietary, and fiduciary) and eight fund types (general, special revenue, permanent, capital projects, debt service, internal service, enterprise, and trust and agency funds).

Governmental funds are “expendable” or “source and disposition” funds through which most governmental functions are financed. These funds are essentially working capital entities. They include the general fund, special revenue funds, permanent funds, capital projects funds, and debt service funds. Proprietary funds are “nonexpendable” or “commercial type” funds used to account for ongoing activities that are similar to those found in private enterprise. They use the business accounting equation and their reporting parallels that of a business entity in most regards. They include two fund types— enterprise funds and internal service funds. Copyright © 2015 Pearson Education, Inc. 19-1

An Introduction to Accounting for State and Local Governmental Units

19-2

Fiduciary funds are used to account for assets held by the governmental unit as trustee or agent for individuals, private organizations, and other governmental units. Fiduciary funds include trust funds (pension, investment, and private purpose) and agency funds. 6

The five types of governmental funds are the general fund, permanent funds, special revenue funds, capital projects funds, and debt service funds. Each is a working capital entity, therefore, each is used to account for a portion of a government’s general government working capital. They are distinguished by the purpose for which the resources of each fund may (must) be used. Working capital to be used for construction/acquisition of major general government fixed assets should be accounted for in capital projects funds; that to be used to pay principal and interest on general long-term debt should be accounted for in debt service funds. Special revenue funds are used to account for portions of working capital to be used for other specific general operating purposes. Permanent funds report resources that are legally restricted to the extent that only earnings, and not principal, may be used for purposes that support the reporting government’s programs—that is, for the benefit of the government of its citizenry.

The governmental fund accounting equation is: Current Assets - Current Liabilities = Fund Balance

The two types of proprietary funds are enterprise funds and internal service funds. Both charge fees for their services that are intended to recover part, if not all, of the costs of providing goods or services. The key distinction between the two is that the predominant customers of internal service funds are other departments or agencies of the government, whereas the predominant customers of enterprise funds are outside entities or individuals.

The accounting equation for a proprietary fund is essentially the business accounting equation— Current assets

Noncurrent assets

–

Current liabilities

–

Noncurrent liabilities

Net Position

Under the modified accrual basis of accounting, fixed assets are not recorded in the general fund, because general fixed assets do not represent financial resources available for current expenditures, i.e., they are not working capital items. In the fund financial statements, the general fund is used to account for unrestricted resources that can be expended currently for operating purposes. Since fixed assets result from expending resources for long-term needs, they are not included in the fund financial statements. With the advent of GASB 34, the general fund is reported in the government-wide statements under the accrual basis of accounting. General fund fixed assets – which have typically been documented informally in the accounting records and noted in the old general fixed asset account group – will appear in the government-wide statement of net position.

Modified accrual accounting is the system of accounting in which revenues are recognized in the accounting period in which they become available and measurable and expenditures are recognized in the accounting period in which the related fund liability is incurred and objectively measurable. Unmatured interest on general long-term debt is an exception for which the expenditure is recognized when due. Modified accrual accounting applies to governmental funds (general fund, special revenue funds, permanent funds, debt service funds, and capital projects funds) and to asset and liability accounting for agency funds.

Governmental and proprietary funds use different focuses when measuring financial positions and operating results in the fund financial statements. The two types of focuses are the “economic resources” measurement focus and the “flow of current financial resources” measurement focus. The accrual basis (used with proprietary funds and trust funds) refers to recognition of revenues and expenses as in business accounting and follows the economic resources measurement focus, whereby all economic resources, Copyright © 2015 Pearson Education, Inc.

Chapter 19

19-3

whether current or noncurrent, are reported. The modified accrual basis of accounting (used with governmental funds) is consistent with a flow of current financial resources measurement focus, whereby funds report on current resources and current obligations. Under GASB 34, both governmental funds and proprietary funds use the accrual basis of accounting and the “economic resources” measurement focus in the government-wide statements. 13

Governmental revenue sources, addressed in GASB 33, are varied and include taxes, grant receipts, and collections of user fees and fines. Exchange transactions are those “in which each party receives and gives up essentially equal values.” Nonexchange transactions are those “in which a government gives (or receives) value without directly receiving (or giving) equal value in exchange.” Many of the transactions in governmental funds are nonexchange in nature, because general governmental activities often address the needs of the public and are funded by taxpayers who generally do not receive benefits in direct relation to their tax payments.

A short term note payable will generally be paid with current resources, thus it is accounted for as a liability of the governmental fund. Long-term debt is not included in the fund financial statements, since it will be repaid with future, not current financial resources. The long term debt will, however, appear as a liability in the government-wide statement of net position. This is one of the reconciling items between the fund and government-wide statements.

Interfund transfers are not expenditures or expenses, and they are classified separately from revenues, expenditures, and expenses in the financial statements of the various funds. Interfund transfers are essentially shifts of resources between funds, not costs or liabilities incurred by the entity. Interfund transfers consist of residual equity transfers (nonrecurring or nonroutine transfers of equity between funds) and operating transfers (all other legally authorized transfers between funds). Interfund transactions that would be treated as revenues, expenditures, or expenses if they involved an external entity are not interfund transfers, but rather are quasi-external transactions and are treated as revenue, expenditures, or expenses in the normal fashion.

An appropriation is an authorization from the legislative body to make expenditures for specified purposes. If approval by the legislative body is for each detailed expenditure item in the budget (a line-item budget), the legislative body will have maximum control because each detailed change would require legislative approval. If the budget is approved in total or by major categories but not for each detailed item, the city manager (or other chief executive) can shift resources within the categories approved without legislative approval. An appropriation by department, for example, permits a city manager to shift appropriations for police supplies to police equipment or overtime pay without legislative approval.

Under GASB 34, the governmental and proprietary fund financial statements of a general-purpose government include the following: Fund financial statements Governmental Funds Balance sheet – governmental funds (modified accrual basis) Statement of revenues, expenditures, and changes in fund balances (modified accrual basis) Proprietary Funds Statement of net position (accrual basis) Statement of revenues, expenses, and changes in net position (accrual basis) Statement of cash flows (accrual basis, direct method)

A reciprocal transfer is one which is expected to be repaid by the fund borrowing the money; whereas with a nonreciprocal transfer repayment is not expected.

An Introduction to Accounting for State and Local Governmental Units

19-4

The GAAP Guidelines, listed in descending order of authority are as follows: 1. GASB Statements and GASB Interpretations. This category also includes AICPA and FASB pronouncements made applicable to state and local governments by a GASB Statement or Interpretation. 2. GASB Technical Bulletins. This category also includes AICPA Industry Audit and Accounting Guides and Statements of Position if specifically made applicable to state and local governments by the AICPA and cleared by the GASB. 3. Consensus positions of GASB’s Emerging Issues Task Force (EITF) and AICPA Practice Bulletins if specifically made applicable to state and local governments by the AICPA and cleared by the GASB. 4. Implementations Guides published by the GASB staff and industry practices that are widely recognized and prevalent in state and local government. 5. Other accounting literature (including FASB standards not made applicable to governments by a GASB standard). GASB statements are the most authoritative.

Interfund loans are loans that are made by one fund to another and must be repaid. Interfund transfers occur when one fund provides resources to another for legally authorized purposes (an operating transfer) or when one fund helps to establish or enhance another (a residual equity transfer). Interfund services provided and used include sales and purchases between funds at approximate external market value. An interfund reimbursement is necessary when an expenditure applicable to one fund is made by a different fund.

Expenses reflect the cost of assets or services used by an entity, and they are recognized in the period incurred. Expenditures, unique to government accounting, typically reflect the use of governmental fund working capital. Proprietary funds recognize expenses, whereas governmental funds recognize expenditures.

A comprehensive annual financial report (CAFR) contains three major sections—introductory, financial and statistical. The introductory section of a CAFR includes a table of contents, a letter of transmittal, a list of principal officers, and an organizational chart. The financial section includes the management’s discussion and analysis, the auditor’s report, the government-wide financial statements, and the fund financial statements. The statistical section contains statistical tables with comparative data from several periods of time.

Fiscal accountability is the responsibility of a government to demonstrate compliance with public decisions regarding the use of financial resources. Operational accountability measures the extent of a government’s success at meeting operating objectives efficiently and effectively and its ability to meet operating objectives in the future.

Chapter 19

19-5

SOLUTIONS TO EXERCISES Solution E19-1 1 2 3 4 5

c a c d d

Solution E19-2 [AICPA adapted] 1 d 2 c 3 c 4 a 5 c

Solution E19-4 1 c 2 b 3 d 4 c 5 d

Solution E19-3 1 2 3 4 5

b a a d b

Solution E19-5 1 c 2 b 3 d 4 b 5 d

Solution E19-6 1 trust and agency funds 2 enterprise funds 3 general funds 4 debt service funds 5 permanent funds 6 special revenue funds 7 internal service funds 8 capital projects funds

An Introduction to Accounting for State and Local Governmental Units

19-6

Solution E19-7 1

Current assets Current liabilities Fund balance

-30,000 +2,500 -32,500

Current assets Current liabilities Fund balance

+98,000 -+98,000

Current assets Current liabilities Fund balance

+60,000 +60,000 --

Current assets Current liabilities Fund balance Assumes repayment during the same year borrowed. If the note had not matured by the end of the year of the borrowing, interest expenditures and interest payable would be accrued.

-63,150 -60,000 -3,150

Current assets Current liabilities Fund balance At the same time a memo entry will be made noting a liability in the long-term debt records. This is used to prepare the government-wide statements where long-term debts are recorded in governmental funds.

+600,000 -+600,000

Current assets Current liabilities Fund balance At the same time a memo entry will be made noting an asset in the fixed asset records. This is used to prepare the government-wide statements where fixed assets are recorded in governmental funds.

-25,000 --25,000

Current assets Current liabilities Fund balance At the same time a memo entry will be made removing the asset from the fixed asset records.

+1,200 -+1,200

----

Chapter 19

19-7

Solution E19-8 1

Current assets Noncurrent assets Current liabilities Long-term liabilities Net Position

-30,000 -+2,500 --32,500

Current assets Noncurrent assets Current liabilities Long-term liabilities Net Position Actually, the net asset increase is reported as a $100,000 increase (revenues) and a $2,000 decrease (uncollectible accounts expense). Further, it is relatively uncommon to have tax revenues in proprietary activities

+98,000 ---+98,000

Current assets Noncurrent assets Current liabilities Long-term liabilities Net Position Assumes repayment during the same year borrowed. If the note had not matured by the end of the year of the borrowing, interest expense and interest payable would be accrued.

+60,000 -+60,000 ---

Current assets Noncurrent assets Current liabilities Long-term liabilities Net Position

-63,150 --60,000 --3,150

Current assets Noncurrent assets Current liabilities Long-term liabilities Net Position Interest expense should be accrued on proprietary fund long-term debt as well as on proprietary fund short-term debt.

+600,000 --+600,000 --

Current assets Noncurrent assets Current liabilities Long-term liabilities Net Position

-25,000 +25,000 ----

Current assets Noncurrent assets (Fully depreciated) Current liabilities Long-term liabilities Net Position

+1,200 0 --+1,200

An Introduction to Accounting for State and Local Governmental Units

19-8

Solution E19-8 (continued)

Current assets Noncurrent assets Current liabilities Long-term liabilities Net Position Solution E19-9 1 2 3 4 5

debt service fund permanent fund special revenue fund agency fund capital projects fund, debt service fund

Solution E19-10 1 2 3 4 5

capital projects fund internal service fund enterprise fund special revenue fund general fund

Solution E19-11 1 2 3 4 5

pension trust fund enterprise fund internal service fund general fund general fund (may also be allocated to other funds after collection)

---+50,000 -50,000

Chapter 19

19-9

Solution E19-12 1

General Fund Current assets Current liabilities Fund balance

-95,000 --95,000

General Fund Current assets Current liabilities Fund balance

-+25,000 -25,000

Year end accrual Current assets Current liabilities ($25,000  .08  .5) Fund balance At the same time a memo entry will be made noting an asset in the fixed asset account records. 3

General Fund Current assets Current liabilities Fund balance At the same time a memo entry will be made removing the asset from the fixed asset records.

-+1,000 -1,000

+30,000 -+30,000

General Fund Current assets Current liabilities Fund balance

-27,000 -26,000 -1,000

General Fund Current assets Current liabilities Fund balance

+500,000 -+500,000

Enterprise Fund Current Assets Noncurrent Assets Current liabilities Long-term liabilities Net Position

-500,000 ----500,000

General Fund Current assets Current liabilities Fund balance

+70,000 -+70,000

An Introduction to Accounting for State and Local Governmental Units

19-10

Solution E19-13 1

Capital Projects Fund Current assets Current liabilities Fund balance At the same time a memo entry will be made noting a liability in the long-term debt records. This is used to prepare the government-wide statements where long-term debts are recorded in governmental funds. General Fund Current assets Current liabilities Fund balance At the same time a memo entry will be made noting an asset in the fixed asset records. Enterprise Fund Current assets Noncurrent assets Current liabilities Long-term liabilities Net Position Capital Projects Current assets Current liabilities Fund balance At the same time a memo entry will be made noting a construction work in process asset in the fixed asset records.

+10,000,000 -+10,000,000

-22,000 --22,000

+500,000 ---+500,000

-2,000,000 --2,000,000

General Fund Current assets Current liabilities Fund Balance

-4,500 +500 -5,000

General Fund Current assets Current liabilities Fund balance

+7,500 +7,500 --

Chapter 20 ACCOUNTING FOR STATE AND LOCAL GOVERNMENTAL UNITS — GOVERNMENTAL FUNDS Questions 1

The governmental fund accounting equation is: Current Assets – Current Liabilities = Fund Balance

GASB 54 no longer allows the use of “reserved” or “unreserved” fund balance. The allowable classifications are nonspendable, restricted, committed, assigned and unassigned.

Taxpayers are billed the full $200,000. The amount recorded as Revenue would be $194,000 with $6,000 recorded as Allowance for Uncollectible Taxes.

Encumbrance means “commitment,” and encumbrance accounting records commitments made for goods on order and for unperformed contracts in order to provide additional control over expenditures.

The required governmental fund financial statements include a statement of net position or balance sheet and a statement of revenues, expenditures, and changes in fund balance. The fund financial statements for the governmental funds are prepared on the modified accrual basis of accounting.

Capital projects funds are used to account for the financing and acquisition of capital facilities or other capital assets (general fixed assets) of a governmental unit. They are not used to account for the acquisition of capital facilities financed through internal service or enterprise funds. General fixed assets may be purchased through the general fund or special revenue funds. General fixed assets may be acquired by donation in which case the capital projects fund would not likely be involved.

Capital projects funds may receive resources from numerous sources such as the proceeds of general obligation bond issues, state and federal grants, shared revenues, and transfers from other funds. A CPF is terminated when the capital facilities have been acquired and project liabilities settled. This may involve a short period of time in the case of assets acquired by purchase and several years in the case of assets acquired by construction. Assets remaining after a capital project has been completed and paid for are ordinarily transferred to the general fund or to the debt service fund with responsibility for servicing the debt issued to finance the project.

20-2

Accounting for State and Local Governmental Units

A government may treat supply acquisitions as expenditures either when purchased (purchases method) or when used (consumption method), as long as it reports significant amounts of inventory in the balance sheet. While the consumption method is similar to the manner in which commercial businesses record supplies, the purchases method better allows for comparison of expenditures and appropriations. Under the purchases method, a government with significant inventory balances at year-end will recognize the balances as assets in the fund balance sheet and establish an accompanying fund balance-nonspendable to reflect the fact that the supply amount is not an available financial asset.

Debt service funds may be used to account for debt service on any long-term, general government liabilities including debt service on special assessment debt for which the government is obligated in some manner. Debt issued for and intended to be repaid from resources of enterprise, internal service, or trust funds is accounted for in those funds. A transfer of resources by the general fund to the debt service fund to be used to retire all or a portion of the general long-term debt would affect the general fund and the debt service fund at the same time. Assuming that the amount of the transfer is $10,000, the entries would be:

GF Other financing uses--nonreciprocal transfer to debt service fund 10,000 Cash DSF Cash

10,000 Other financing sources--nonreciprocal transfer from general fund

10,000

Special assessment levies are charges made against specific property owners (or citizens) to pay for improvements (or services) that provide special benefits to the property owners. Such improvements are usually requested by those who receive the benefits and agree to pay their share of the cost. General tax levies are levied against all citizens of the governmental unit on a uniform basis to finance the general cost of government. General tax levies are determined by elected officials, apply to all (or virtually all) property in the jurisdiction, and may have little or no relationship to the actual benefits received by individual taxpayers. A final difference is that property taxes are levied each year for that year (or sometimes the following year). Special assessment levies often are for amounts to be collected over several years.

Chapter 20

20-3

Capital project funds are used to account for the construction activities of general government special assessment projects and the debt service fund is used to account for the related debt service if the government is obligated in some manner. Debt service for special assessment liabilities for which the government is not obligated in any manner is accounted for in agency funds, with the special assessment obligation being disclosed in notes to the financial statements.

When governments enter into capital lease agreements, the governmental fund acquiring the general fixed asset records an expenditure and other financing source, as if long-term debt had been issued. At the same time, the town notes a liability (capital lease payable) in the general long-term debt account records for the amount remaining due and adds an asset to the general fixed asset account records at the present value of the minimum lease payments determined by FASB 13 criteria. The asset and liability, as well as associated depreciation, will appear in the government-wide financial statements; however, only an expenditure and other financing source appear in the governmental fund statements. The town may record future capital lease payments as expenditures of principal and interest in the general fund or transfer resources to the debt service fund, which will recognize the expenditures. The notes to the financial statements disclose minimum lease payments for each of the following five years and in five-year increments thereafter.

14 Expenditures 420,000 Supplies Inventory To adjust the supplies inventory and supplies expenditures accounts.

420,000

The closing and reclassification entries will result in a 20,000 decrease in Fund balancenonspendable such as below. Note how the amount of unassigned fund balance that was “used up” in this year is the amount actually spent on supplies ($400,000) while the amount in the expenditures account ($420,000) is the amount consumed during the year. The difference is reflected in the $20,000 decrease in the fund balance-nonspendable account. Fund balance – nonspendable Fund balance – unassigned Expenditures To close and reclassify supply expenditures. 15

20,000 400,000 420,000

Governments record details of the planned revenues (such as property taxes, sales taxes, and license revenue) and appropriations (such as police supplies, mayor’s office expenses, and maintenance of the town hall) in subsidiary revenue and expenditure ledgers. The detail allows for better control over expenditures, as appropriations can be compared to expenditures and encumbrances at any time.

20-4

Accounting for State and Local Governmental Units

The amount that city officials can order prior to year end is $75,000 ($250,000 – $175,000). If they have not spent the full $250,000 in appropriations prior to year end, depending on the laws of the Village of Lester, all appropriations lapse at the end of the year for which they are made, with the exception of committed appropriations (encumbrances outstanding), which can continue to serve as authorizations for items on order or under contract. Since governments are no longer allowed to report “reserve for encumbrances” in the financial statements due to GASB 54, the government will need to establish a policy for how to record and report on outstanding commitments at the end of the year. One approach is to reverse all of the encumbrances and related reserve for encumbrances and report the commitments as Fund balance-committed.

Permanent funds (PF) account for contributions for which the grantor specifies that a principal amount must be maintained but for which interest accumulation or asset appreciation, or both, are to be used for a specified purpose. Funds that are expendable are accounted for in a special revenue fund. If contributions benefit parties external to the government, they are accounted for in private purpose trust funds.

The general fund is always a major fund. Other funds are considered major funds if they meet both of the following criteria: 1.

Total assets, liabilities, revenues, or expenditures/expenses (excluding extraordinary items) of that individual governmental or enterprise fund are at least 10% of the corresponding total (assets, liabilities, etc.) for all funds of that category or type. Total assets, liabilities, revenues, or expenditures/expenses (excluding extraordinary items) of that individual governmental or enterprise fund are at least 5% of the corresponding total for all governmental and enterprise funds combined.

A budgetary comparison schedule, which is required supplementary information for the general fund and for all special revenue funds with legally adopted budgets, includes columns for the original budget, the final budget, actual balances (on the budgetary basis) and variances (optional). The budgetary comparison schedule includes the same classifications as the GAAP operating statement, however, the amounts reported for revenues, expenditures, and fund balances often differ between the two statements. Differences exist when a government uses a non-GAAP basis of accounting for budgeting purposes. It should be included in a CAFR.

Since the government-wide statements are prepared on the accrual basis of accounting while the fund financial statements for the governmental funds are prepared on the modified accrual basis of accounting, governments must convert governmental fund financial information to the accrual basis of accounting for inclusion in the governmentwide statements of activities and net position. A conversion worksheet is an optional tool that facilitates reconciliation of the two statements. Copyright © 2015 Pearson Education, Inc.

Chapter 20

20-5

Examples of items that might appear on the reconciliation between the governmental fund balance sheet and the government-wide statement of net position include: 1. 2. 3.

Governmental fund fixed assets are recorded as expenditures in the fund statements and must be recorded at cost in the government-wide statements. The depreciation associated with the governmental fixed assets must be recorded in the government-wide statements. Capital project fund construction expenditures should be recorded as an asset “construction in progress” in the government-wide statements.

Examples of items that might appear on the reconciliation between the governmental fund operating statement and the government-wide statement of activities include: 1. 2. 3.

Governments must adjust for instances where revenue recognition differs between the modified accrual and accrual bases of accounting. It is necessary to eliminate interfund balances within the governmental funds. Bond proceeds provide current financial resources in the fund statement, but issuing debt increases long-term liabilities in the statement of net position.

SOLUTIONS TO EXERCISES Solution E20-1

Solution E20-2

1 2 3 4 5

a b b a c

Solution E20-4 1 2 3 4 5

a c d a b

c d a b b

Solution E20-5 [AICPA adapted] 1 c 2 c 3 b 4 d 5 b

Solution E20-3 [AICPA adapted] 1 2 3 4 5

b D C D a

Solution E20-6 [AICPA adapted] 1 c 2 b 3 c 4 b 5 c

20-6

Accounting for State and Local Governmental Units

Solution E20-7 1

Journal entries to account for property taxes in the general fund March 21, 2014 Taxes receivable — current Allowance for uncollectible current taxes Revenue To record the property tax levy. May 4, 2014 Cash Taxes receivable — current To record collection of property taxes.

2,500,000 50,000 2,450,000

1,900,000

Taxes receivable-delinquent Allowance for uncollectible current taxes Taxes receivable — current Allowance for uncollectible delinquent taxes To reclassify uncollected taxes as delinquent. May 5-December 31, 2014 Cash Taxes receivable — delinquent To record collection of property taxes. November 1, 2014 Allowance for uncollectible taxes — delinquent Taxes receivable — delinquent To write off tax receivable determined to be uncollectible. January 1, 2015— February 28, 2015 Cash Taxes receivable — delinquent To record collection of 2014 taxes.

1,900,000

600,000 50,000 600,000 50,000

150,000 150,000

5,000 5,000

87,750

Chapter 20

20-7

Solution E20-7 (continued) 2

Jedville Township Partial Balance Sheet December 31, 2014 Assets Taxes receivable — delinquent (net of $45,000 estimated uncollectible taxes)

$ 400,000

Revenue would equal tax levy less uncollectible amounts less amounts not collected within 60 day period. Since governmental units rarely complete the closing process within 60 days of year end, the amounts collected within 60 days of year end will be known. ($1,900,000 + $150,000 + $87,750 = $2,137,750) ($2,500,000 - $50,000 - $312,250 = $2,137,750)

20-8

Accounting for State and Local Governmental Units

Solution E20-8 Closing entries: Fund balance - unassigned Appropriations Estimated revenues To reverse entry to record budget.

500 17,500 18,000

Reserve for encumbrances — prior year 2,000 Reserve for encumbrances 1,000 Revenues 17,380 Nonreciprocal transfer in 3,200 Expenditures — current year 16,450 Expenditures — prior year 1,900 Encumbrances 1,000 Fund balance — committed* 1,000 Fund balance — unassigned 3,230 To close accounts, including the prior year’s reserve for encumbrances. *assumes the prior year encumbrance was cleared out with the prior year expenditure and that city policy is to continue any outstanding encumbrances from the current year as committed Fund balance

Chapter 20

20-9

Solution E20-9 Millar City General Fund Balance Sheet June 30, 2011 Assets Cash Taxes receivable Less: Allowance for uncollectible accounts Due from other funds Supplies inventory Total assets Liabilities and Fund Balance Liabilities: Vouchers payable Due to other funds Total liabilities Fund balance: Committed Nonspendable Unassigned Total fund balance Total liabilities and fund balance

$12,000 $30,000 2,000

28,000 3,000 4,000 $47,000

$13,000 5,000 $18,000

$ 6,000 4,000

10,000 19,000 29,000 $47,000

20-10

Accounting for State and Local Governmental Units

Solution E20-10 Madelyn City General Fund Statement of Revenues, Expenditures, and Changes in Fund Balance for the year ended December 31, 2011 Revenues Expenditures Excess of revenues over expenditures Other financing sources (uses): Reciprocal transfers in Nonreciprocal transfers out Excess of revenues and other financing sources over (under) expenditures and other financing uses Total fund balance, January 1, 2011 Total fund balance, December 31, 2011 Estimated revenues Encumbrances Expenditures Expenditures—prior year Nonreciprocal transfers out

Fund Balance - unassigned $100,000 $ 25,000 4,000 95,000 94,000 5,000 4,800 101,000 18,000 27,000 32,200

$101,000 98,800 2,200 27,000 (18,000) $ 11,200 25,000 $ 36,200 Preclosing balance Appropriations Reserve for encumbrances— prior year Revenues Reciprocal transfers in Ending balance

Total ending fund balance = $32,200 + $4,000 (Fund balance – committed or restricted or assigned…. as a result of encumbrances) = $36,200.

Chapter 20

20-11

Solution E20-11 Journal entries in the general fund: 1

Estimated revenues Appropriations Fund balance – unassigned To record the annual budget.

250,000 248,000 2,000

Taxes receivable—current 200,000 Revenues Allowance for uncollectible taxes—Current To record tax levy for the year (1% estimated uncollectible). Cash

150,000 Taxes receivable—current To record tax collections.

198,000 2,000

150,000

Due from special revenue fund Cash To record loan to SRF.

15,000

Encumbrances Reserve for encumbrances To encumber orders for supplies.

18,000

15,000

18,000

Reserve for encumbrances 18,000 Encumbrances To reverse encumbrance entry on receipt of supplies ordered.

18,000

Expenditures Vouchers payable To record purchase of supplies.

18,150

Expenditures Due to stores fund (ISF) To record materials acquired from the stores fund.

800 800

Other financing uses--transfer to DSF Cash To record payment to DSF for debt service.

5,000

Expenditures Cash To record purchase of equipment.

15,000

5,000

15,000

20-12

Accounting for State and Local Governmental Units

Solution E20-11 (continued) 10

Cash

3,000 Revenues To record collection of license revenue.

3,000

Taxes receivable—delinquent Allowance for uncollectible taxes—current Taxes receivable—current Allowance for uncollectible taxes—delinquent To reclassify uncollected current taxes as delinquent.

50,000 2,000

Cash

30,000

50,000 2,000

Taxes receivable—delinquent To record collection of delinquent taxes.

30,000

Revenues ($20,000 - $2,000)/2 9,000 Revenue collected in advance 9,000 To defer revenue recognition on taxes expected to be collected after the 60 day revenue recognition cutoff.

Chapter 20

20-13

Solution E20-12 1

Cash

75,000 Tax anticipation notes payable To record issuance of short-term notes.

75,000

Encumbrances Reserve for encumbrances To record order of equipment.

33,000

Reserve for encumbrances Expenditures Encumbrances Vouchers payable To record receipt of equipment.

33,000 33,250

Other financing uses--transfer to DSF Cash To record transfer to debt service fund.

200,000

Property taxes receivable—current Allowance for uncollectible current Taxes Revenue collected in advance Revenues To record property tax levy.

1,000,000

Cash

33,000

33,000 33,250

200,000

50,000 50,000 900,000

100,000 Revenue collected in advance To record receipt of restricted grant.

$100,000

Expenditures Vouchers payable (or cash) To record expenditures for grant program.

75,000

Revenue collected in advance Revenues To record revenues to date on the grant.

75,000

20-14

Accounting for State and Local Governmental Units

Solution E20-13 1

CPF Cash

769,000 Other financing sources—proceeds from bond issue To record issuance of bonds.

769,000

CPF Other financing uses—nonreciprocal transfer to DSF Cash To transfer the premium to the debt service fund. DSF Cash

19,000 19,000

19,000 Other financing sources— nonreciprocal transfer from CPF To record receipt of bond premium.

SRF Cash (or Grants receivable) Revenue collected in advance To record grant revenue.

19,000

450,000 450,000

GF Other financing uses—(non)reciprocal transfer to CPF Cash To record transfer to establish CPF.

500,000 500,000

CPF 500,0000

Cash Other financing sources— (non)reciprocal transfer from General Fund To record the transfer from the GF. 4

PF Cash

500,000

10,000,000 Revenue – contribution/endowment To record a permanent fund contribution.

GF Expenditures Vouchers payable (or cash) To record vehicle purchases.

10,000,000

375,000

Chapter 20

20-15

Solution E20-13 (continued) 6

GF Cash

30,000 Other financing sources – proceeds from sale of assets 30,000 To record the sale of governmental assets. (This is a governmental fund entry. Under accrual accounting, the asset would be removed and a gain on sale recognized.)

GF Cash

1,200 Other financing sources – proceeds from sale of assets 1,200 To record the sale of governmental assets. (This is a governmental fund entry. Under accrual accounting, the asset would be removed and a gain on sale recognized.)

GF Other financing uses—nonreciprocal transfer to DSF Cash To record transfer to debt service. DSF Cash

50,000 50,000

50,000 Other financing sources— nonreciprocal transfer from General Fund To record receipt of transfer from GF.

DSF Expenditures Cash To record interest payment.

50,000

20-16

Accounting for State and Local Governmental Units

Solution E20-14

Cash Investments Tax receivable— delinquent Accounts receivable Supplies inventory Allowances for uncollectible taxes— delinquent Vouchers payable Revenue collected in advance Note payable (shortterm) Fund balance—committed Fund balance-unassigned

Fixed Assets Accumulated depreciation Long term debt payable Capital Lease payable Total Net Position

Trial Balance DR CR $410,000 300,000

Adjustments DR CR

150,000 30,000 60,000

Govt. Wide Stmt. of Net Position DR CR 410,000 300,000 150,000 30,000 60,000

10,000 140,000 40,000

10,000 140,000 d) 40,000

150,000 90,000

520,000 b) 100,000 _ a) 35,000 _ ________ ________ c) 75,000 d) 40,000 $950,000 $950,000 a) 100,000

________ $315,000

420,000 100,000

a) 65,000 65,000 b) 100,000 100,000 c) 75,000 75,000 $315,000 _________ _________ $1,050,000 $1,050,000

Chapter 20

20-17

Solution E20-15 Net change in fund balance—total governmental funds

$1,408,950

Amounts reported for governmental activities in the statement of net assets differ from those in the governmental fund balance sheet because: Governmental funds report capital outlays as expenditures; the assets are capitalized and depreciated in the government-wide statements Grant revenues in the statement of activities that do not provide current financial resources are not reported as revenues in the funds Debt proceeds provide current financial resources in the fund statement, but issuing debt increases long-term liabilities in the statement of net position A capital lease is treated as an expenditure in the governmental funds in the year that the lease agreement is entered into; however, it increases long-term liabilities in the statement of net position Change in net position of governmental activities

225,000 165,000

(350,000)

20,000* $1,468,950

* The reconciling difference is $75,000 – $55,000 = $20,000, where fund balance was reduced by the full $75,000 that was properly charged to expenditures for the fund statements while net position will only be reduced by the $55,000 increase in long-term debt that is reported in the government-wide statements.

20-18

Accounting for State and Local Governmental Units

PROBLEMS

Solution P20-1 City of Orchard Park General Fund Balance Sheet December 31, 2014 Assets Cash Taxes receivable — delinquent (net of $30,000 allowance for uncollectible taxes) Accounts receivable (net of $2,000 allowance for bad debts) Supplies on hand Due from Agency Fund Total assets Liabilities and Fund Balance Vouchers payable Due to Utility Fund Taxes received in advance Liabilities

$ 40,000 180,000 23,000 3,000 10,000 $256,000 $155,000 20,000 10,000 185,000

Fund balance – committed Fund balance – nonspendable Fund balance – unassigned Fund balance Total liabilities and fund balance Supporting computations Adjusting entry: Supplies on hand Fund balance - nonspendable To record supplies on hand and related reserve. Closing entries Appropriations Fund balance - unassigned Estimated revenues To reverse budget entry. Revenues Expenditures Encumbrances Fund balance - unassigned

50,000 3,000 18,000 71,000 $256,000

3,000 3,000

900,000 10,000 910,000

910,000

858,000 50,000 2,000

Chapter 20

20-19

Solution P20-1 (continued) Ending fund balance: Fund balance-unassigned = $26,000 (preclosing balance) - $10,000 + 2,000 = $18,000 Fund balance – committed (for encumbrances) = $50,000 Fund balance – nonspendable (for supplies) = $3,000 Total ending fund balance = $18,000 + $50,000 + $3,000 = $71,000

20-20

Accounting for State and Local Governmental Units

Solution P20-2 City of Batavia General Fund Statement of Revenues, Expenditures, and Changes in Fund Balance For the year ended June 30, 2015 Revenues Expenditures Excess revenues over expenditures Other financing sources (uses): Nonreciprocal transfers out Excess of revenues and other financing sources over (under) expenditures and other financing uses Total fund balance, July 1, 2014 (given) Total fund balance, June 30, 2015

$980,000 940,000 40,000 (10,000) 30,000 80,000 $110,000

City of Batavia General Fund Balance Sheet June 30, 2015 Assets Cash Taxes receivable — delinquent Less: Allowance for uncollectible taxes Due from County Total assets

$ 80,000 $160,000 30,000

Liabilities and Fund Balance Liabilities: Vouchers payable Notes payable Total liabilities Fund balance: Fund balance – restricted (* due to enabling legislation) Fund balance – unassigned Total fund balance Total liabilities and fund balance

130,000 18,000 $228,000

$ 58,000 60,000 118,000

$ 20,000 90,000

110,000 $228,000

Chapter 20

20-21

Solution P20-3 1 Journal entries for the Town of Tyler Estimated Revenues 400,000 Appropriations Fund Balance - unassigned To record the budget for the year July 1, 2014 to June 30, 2015.

395,000 5,000

Encumbrances (prior year) 9,000 Reserve for Encumbrances (prior year) 9,000 To reinstate the prior year encumbrance. ((NOTE: this is like General Fund entry #11 in the example in the chapter but is done at beginning of year – it allows the bookkeeper to use encumbrance accounting for all expenditures regardless of the budget or accounting year. If the encumbrance were not re-established, entry “i” below would omit the encumbrance accounts. This is essentially a “reverse” entry and is optional.)) . a

Taxes Receivable Revenue — Taxes Allowance for uncollectible taxes To record tax levy for the year.

200,000

Cash

190,000

198,000 2,000

Taxes Receivable — current Taxes Receivable — delinquent To record cash collections for the year. c

176,000 14,000

Allowance for uncollectible taxes — delinquent Taxes Receivable — delinquent To record write-off of uncollectible account.

1,000

Cash

20,000

1,000

Revenues--Licenses and Permits To record hunting licenses. e

Cash

20,000

200,000 Miscellaneous Revenues To record Miscellaneous revenues.

200,000

Expenditures Vouchers Payable To record salaries for the year.

20,000

Encumbrances Reserve for encumbrances To record order of equipment.

15,000

20,000

15,000

20-22

Accounting for State and Local Governmental Units

Solution P20-3 (continued) h

Reserve for encumbrances Expenditures Encumbrances Vouchers Payable To record receipt of equipment.

15,000 14,000 15,000 14,000

Expenditures–prior year 9,500 Reserve for encumbrance (prior year) * 9,000 Vouchers Payable Encumbrances (prior year) To record receipt of equipment ordered during the prior year and chargeable against the prior year’s reserve for encumbrances. * see NOTE for first entry – the encumbrance is optional.

9,500 9,000

Encumbrances 11,000 Reserve for encumbrances To record the purchase order for operating supplies.

11,000

Reserve for encumbrances 5,000 Encumbrances To reverse the encumbrance entry upon receipt of the supplies.

5,000

Supplies inventory Vouchers Payable To record receipt of operating supplies.

5,000 5,000

Note Payable Cash To record payment of note payable.

15,000

Expenditures Cash To record payment of various expenditures.

348,040

Expenditures Supplies inventory To adjust the supplies inventory & expenditures.

15,000

348,040

8,000

Chapter 20

20-23

Solution P20-3 (continued) n

Taxes Receivable–delinquent 24,000 Allowance for uncollectible taxes–current 2,000 Taxes Receivable — current Allowance for uncollectible taxes–delinquent To reclassify past-due taxes receivable as delinquent. Closing Entries o

Appropriations Fund Balance – unassigned Estimated Revenues To close the “budgetary” accounts

395,000 5,000

Revenues Expenditures Expenditures-prior year Fund Balance - unassigned To close the revenue and expenditure accounts

418,000

Reserve for Encumbrances Encumbrances To close encumbrance accounts

24,000 2,000

400,000

390,040 9,500 18,460

6,000 6,000

Fund balance—committed* 3,000 Fund balance—nonspendable** 3,000 Fund balance--unassigned 6,000 To reclassify Fund Balance accounts *The FB-committed balance should be $6,000 credit for the outstanding encumbrance of $6,000. The balance is $9,000 credit, so we must debit the fund balance $3,000. **The FB-nonspendable is equivalent to the supplies balance. The ending supplies are $3,000 so the FB-nonspendable is adjusted from its beginning balance of $6,000 credit.

20-24

Accounting for State and Local Governmental Units

Solution P20-3 (continued) Town of Tyler General Fund Statement of Revenues, Expenditures, and Changes in Fund Balance Budget and Actual (Budgetary Basis) For the year ended June 30, 2015 Original Budget

Final Budget

Actual (Budgetary Basis)

Variance Positive (Negative)

Revenues Taxes Licenses and permits Miscellaneous revenue Total Revenues

$250,000 20,000 130,000 400,000

$198,000 20,000 200,000 418,000

$(52,000) 0 70,000 18,000

Total expenditures and encumbrances

$395,000

$396,040*

(1,040)

5,000 10,000

21,960 10,000

16,960 0

(500)

31,460

$ 16,460

Excess of revenues over expenditures and encumbrances Budgetary fund balance June 30, 2014 Less excess prior year’s actual expenditure over encumbrances Budgetary Fund Balance at June 30, 2014

$ 15,000

Encumbrances outstanding Fund balance June 30, 2015 *

6,000 $ 37,460

Actual expenditures on a budgetary basis includes the $6,000 supplies purchase commitment chargeable against the 2014-15 appropriations, but excludes the $9,500 expenditures chargeable against the prior year’s carryover appropriation.

3. Given the limited information, the reconciling items which are certain include the playground equipment in item h and the other equipment in item i.

Chapter 20

20-25

Solution P20-4

Adjustments

Statement of

Activities

Statement of Net Position

Cash and cash equivalents

DR 541,100

Investments

520,000

Taxes receivable

520,000

Accounts receivable

187,500

Due from other governments

364,970

Supplies inventory

290,000

Statement of Net Position CR

290,000

Vouchers payable

379,500

Contracts payable Revenue collected in advance Fund balance/Net Position, beg

47,500

55,000

Revenues Expenditures

6) 55,000

912,720

2) 30,000

3,507,450

6) 55,000

3,043,600

1) 9,000

942,720 3,562,450 3,014,600

3) 20,000 OFS—Bond proceeds

500,000

4) 500,000

OFS—Capital lease

65,000

5) 65,000

OFS—Transfers in

75,250

7) 75,250

OFU—Transfers out Fixed Assets

75,250

________

5,542,420

7) 75,250

1) 9,000

104,000

2) 95,000 2) 65,000

Accumulated Depreciation Construction in Progress

20,000 4) 500,000

Bonds Payable Capital leases payable

65,000

3) 20,000 _________

5) 65,000

819,250

500,000 65,000

547,850

Change in net position

a) Assume no depreciation in the first year, since no depreciation policy is provided.

________

2,547,570

1,999,720

________

547,850

2,547,570

20-26

Accounting for State and Local Governmental Units

Solution P20-5 [AICPA adapted]

Oslo School District General Fund Transactions July 1, 2013 — June 30, 2014 Estimated revenues 3,000,000 Appropriations Fund balance – unassigned To record the budget for the year. Taxes receivable Revenues — taxes Estimated uncollectible taxes To record tax levy for the year.

2,870,000

Estimated uncollectible taxes Taxes receivable To write-off uncollectible taxes.

40,000

Cash

2,800,000 70,000

40,000

2,940,000 Taxes receivable Miscellaneous revenues To record cash collections for the year.

2,980,000 20,000

2,810,000 130,000

Vouchers payable Cash To record cash payments for the year.

2,640,000

Encumbrances Reserve for encumbrances To record encumbrances.

2,700,000

Reserve for encumbrances Encumbrances To reverse encumbrances.

2,700,000

Expenditures Vouchers payable To record vouchers for payment of current operations.

2,700,000

Expenditures — prior year Vouchers payable To record expenditures for prior year.

2,640,000

2,700,000

58,000

Chapter 20

20-27

Solution P20-5 (continued) j

Fund balance — committed Expenditures — prior year Fund balance - assigned To close excess reserve to fund balance.

60,000

Due to other funds Vouchers payable To record vouchers for payment to other funds.

210,000

Expenditures Due to other funds To record expenditures for amounts due other funds.

142,000

58,000 2,000

210,000

142,000

Encumbrances 91,000 Fund balance — committed 91,000 To record commitment for new contract. NOTE: we usually see encumbrances and reserve for encumbrances in the same entry. In the closing entries the encumbrances will be closed and a debit to Fund balance – unassigned (this makes sense as there is less fund balance available due to the commitment)

20-28

Accounting for State and Local Governmental Units

Solution P20-6 [AICPA adapted] Journal entries for the City of Lahti General Fund 1

Estimated revenues Appropriations Fund balance - unassigned To record the budget.

2,000,000

Taxes receivable Revenues Allowance for uncollectible taxes To record the property tax levy.

1,870,000

Allowance for uncollectible taxes Taxes receivable To write off uncollectible taxes receivable. Cash

1,940,000 60,000

1,860,000 10,000

8,000 8,000

1,820,000 Taxes receivable To record property tax collections.

1,820,000

Encumbrances 1,070,000 Fund balance — committed* 1,070,000 To record purchase commitments. * This shows the approach to encumbrances/commitments by making entries during the accounting period directly into the fund balance account. The advantage of this method is that the fund balance account will be more accurate throughout the year. The disadvantage is that tradition is to offset Encumbrances with Reserve for Encumbrances.

Fund balance — committed Expenditures Encumbrances Vouchers payable To record actual expenditures.

1,000,000 1,840,000

Vouchers payable Cash To record payment of vouchers.

1,852,000

Revenues Fund balance - unassigned Estimated revenues To close revenues accounts.

1,860,000 140,000

1,000,000 1,840,000

1,852,000

2,000,000

Chapter 20

20-29

Solution P20-6 (continued) 9

Appropriations Expenditures Encumbrances Fund balance - unassigned To close expenditure — related accounts

1,940,000

1,840,000 70,000 30,000

20-30

Accounting for State and Local Governmental Units

Solution P20-7 Volendam County General Fund Statement of Revenues, Expenditures, and Changes in Fund Balance For the year ended December 31, 2014 Revenues: Taxes Licenses and permits Intergovernmental grants Total revenues Expenditures: Current operating: General government Public safety Judicial Health and welfare Total current operating Capital outlay Total expenditures

$10,000,000 2,000,000 300,000 $12,300,000

$ 8,000,000 1,500,000 1,000,000 1,200,000 11,700,000 600,000

Excess of revenues over expenditures

12,300,000 0

Other financing sources (uses): Operating transfer to debt service fund Residual equity transfer from other fund

(320,000) 2,000,000

Excess (Deficiency) of revenues and other sources over expenditures and other uses

1,680,000

Fund balance, January 1, 2014 Fund balance, December 31, 2014

3,130,000 $4,810,000

Note: The short-term note affects only the balance sheet. The interfund collection affects the balance sheet only.

Chapter 20

20-31

Solution P20-8 1

Cash ($3,000,000  .06  .5) OFS - Nonreciprocal transfer from GF To record transfer from general fund.

90,000

Expenditures — interest Cash To record interest payment.

90,000

Cash

90,000

1,090,000 OFS - Nonreciprocal transfer from GF To record transfer from general fund.

Expenditures — interest Expenditures — principal retirement Cash To record payment of principal and interest.

1,090,000

90,000 1,000,000 1,090,000

None.

Cash ($2,000,000  .06  .5) OFS - Nonreciprocal transfer from GF To record transfer from general fund.

60,000

Expenditures — interest Cash To record interest payment.

60,000

20-32

Accounting for State and Local Governmental Units

Solution P20-9 1

October 1, 2014 GF OFU – nonreciprocal transfer to CPF Cash To record transfer of cash to CPF. CPF

Cash

200,000 200,000

200,000 OFS – Nonreciprocal transfer from gen fund To record receipt of cash from GF.

200,000

November 1, 2014 CPF Encumbrances 580,000 Reserve for encumbrances To record encumbrances for the amount of the contract. April 15, 2015 CPF Cash

401,000 Other financing sources--Proceeds from bond issue To record sale of bonds.

CPF

DSF

401,000

OFU - nonreciprocal transfer to debt service fund Cash To transfer bond premium to the DSF.

1,000

Cash

1,000

OFS - nonreciprocal transfer from CPF To record receipt of bond premium. 4

580,000

May 2, 2015 CPF Expenditures — capital outlay 580,000 Contracts payable To record expenditures on the municipal building project. Reserve for encumbrances 580,000 Encumbrances To remove encumbrances when construction is complete.

1,000

580,000

Chapter 20

20-33

Solution P20-9 (continued)

May 12, 2015 CPF Contracts payable 580,000 Cash 580,000 To record payment to Crooked Construction for building contract. CPF

CPF

Other financing uses--transfer to general fund Cash To record transfer to general fund.

20,000

OFS - nonreciprocal transfer from general fund Other financing sources--Proceeds from bond issue Expenditures Other financing uses-- transfer to general fund OFU - nonreciprocal transfer to DSF To close the books of the CPF.

200,000 401,000

Cash

20,000

580,000 20,000 1,000

Other financing sources--transfer from CPF To record receipt of cash from CPF.

20,000

20-34

Accounting for State and Local Governmental Units

Solution P20-10 1

Journal entries for Malmo City July 1, 2014 CPF Encumbrances Reserve for encumbrances To encumber the construction contract. CPF

Cash

480,000 480,000

255,000 OFS - Proceeds from bond issue To record proceeds of bond issue.

CPF

DSF

255,000

OFU - nonreciprocal transfer to debt service fund 5,000 Cash To transfer premium to the DSF. (This premium transfer is commonly presumed in problems.) Cash

5,000 OFS - nonreciprocal transfer from CPF To record receipt of premium transferred from CPF.

December 20, 2014 CPF Reserve for encumbrances Encumbrances To reduce encumbrances for work completed. CPF

5,000

160,000

Expenditures 160,000 Contracts payable To record expenditures for one-third of Gunnarsson contract.

160,000

Chapter 20

20-35

Solution P20-10 (continued) January 1, 2015 CPF Contracts payable Contracts payable — retained percentage Cash To record partial payment on the contract. GF

DSF

160,000 16,000 144,000

OFU - nonreciprocal transfer to debt service fund 2,500 Cash To transfer funds to DSF for January 1, 2012 interest payment.

2,500

2,500 Cash ($250,000  .06  .5) - $5,000 OFS - nonreciprocal transfer from GF 2,500 To receive funds from GF for the January 1, 2012 interest payment.

DSF

Expenditures–interest 7,500 Cash 7,500 To record the January 1, 2015 interest payment on the 6% serial bonds ($250,000  6%  1/2 year). June 30, 2015 CPF Encumbrances Reserve for encumbrances To reduce encumbrances for work completed. CPF

Expenditures — capital outlay Contracts payable Contracts payable—retained percentage To record billing for work completed.

160,000 160,000

160,000 144,000 16,000

Closing entry CPF

OFS - Proceeds from bond issue Fund balance – unassigned* Reserve for encumbrances Fund balance - restricted Expenditures–capital outlay Encumbrances OFU - nonreciprocal transfer to DSF To close the books of CPF at end of fiscal year.

255,000 230,000 160,000 160,000 320,000 160,000 5,000

*Since there is a deficit – we use the unassigned category outside of the general fund. As also noted below, the deficit will be covered by issuing the additional $250,000 in bonds.

20-36

Accounting for State and Local Governmental Units

Solution P20-10 (continued) At June 30, 2015 the balance sheet of the CPF would appear as follows: Assets Cash

$106,000 $106,000

Total assets Liabilities Contracts payable Contracts payable — retained percentage Fund balance Restricted Unassigned* Total liabilities and fund balance *

$144,000 32,000

$160,000 (230,000)

This deficit will be provided for by issuing the additional $250,000 of bonds.

$176,000

(70,000) $106,000

Chapter 20

20-37

Solution P20-11 [AICPA adapted] 1

City of Cerone Civic Center Construction Fund General Journal

July 1, 2014 (1) Cash

500,000 Due to general fund To record the loan from the general fund.

(2)

500,000

Expenditures 320,000 Cash To record payment of engineering and planning costs.

December 1, 2014 (3) Cash 10,100,000 OFS - Proceeds from bond issue To record receipt of proceeds from 6% bond issue. OFU - nonreciprocal transfer to DSF Cash To transfer bond premium to debt service fund.

320,000

10,100,000

100,000 100,000

March 15, 2015 (4) Encumbrances 12,000,000 Reserve for encumbrances 12,000,000 To record construction commitment to Candu Construction Company. (5)

Encumbrances Reserve for encumbrances To record commitment for materials on order.

April 1, 2015 (6) Cash

(7)

55,000 55,000

2,500,000 Grant revenue 320,000 Revenue collected in advance 2,180,000 To record receipt of state grant. Expenditures of $320,000 to date.

Expenditures 51,000 Reserve for encumbrances 55,000 Vouchers payable Encumbrances To record receipt of materials and elimination of encumbrances. Vouchers payable Cash To record payment of voucher.

51,000 55,000

51,000

20-38

Accounting for State and Local Governmental Units

Solution P20-11 (continued) June 15, 2015 (8) Expenditures 2,000,000 Contracts payable — current 1,880,000 Contracts payable — retained percentage 120,000 To record progress billing on contract with a 6% retained percentage. Reserve for encumbrances Encumbrances To reduce encumbrances for amounts billed. (9)

2,000,000 2,000,000

Due to general fund 500,000 Cash To record repayment of initial financing to the general fund.

June 30, 2015 Revenue collected in advance Revenue To recognize grant revenue earned.

500,000

2,051,000 2,051,000

Note that the entry recognizing grant revenue presumes that the first $5 million of expenditures will be recoverable from the state. In some cases, the grantor only agrees to pay a certain percentage of the cost, up to some maximum. If this were the case in this problem, the amount of revenue recognized would be one-third of $2,371,000, or approximately $790,000. Closing entries Revenue OFS - Proceeds from bond issue Reserve for encumbrances Fund balance - restricted Expenditures OFU - nonreciprocal transfer to DSF Encumbrances To close the books at June 30, 2015.

2,371,000 10,100,000 10,000,000

10,000,000 2,371,000 100,000 10,000,000

Chapter 20

20-39

Solution P20-11 (continued)

City of Cerone Civic Center Construction Fund Balance Sheet June 30, 2015 Assets Cash Total assets Liabilities and Fund Balance Revenue collected in advance Contracts payable — current Contracts payable — retained percentage Total liabilities Fund balance: Restricted Total fund balance Total liabilities and fund balance

$12,129,000 $12,129,000 $129,000 1,880,000 120,000 $2,129,000 $10,000,000

10,000,000 $12,129,000

20-40

Accounting for State and Local Governmental Units

Solution P20-12 1 CPF

Cash

510,000 OFS - Proceeds from bonds To record issuance of bonds at a premium.

CPF

DSF

510,000

OFU - nonreciprocal transfer to debt service fund Cash To record transfer of bond premium to DSF.

10,000

Cash

10,000

OFS - nonreciprocal transfer from CPF To record transfer of bond premium. 2

CPF

DSF

10,000

Encumbrances Reserve for encumbrances To encumber contract awarded for construction.

960,000

Reserve for encumbrances Encumbrances To reduce encumbrances for work completed.

320,000

Expenditures Contracts payable To record expenditures for work completed.

320,000

960,000

320,000

Contracts payable 320,000 Contracts payable — retained percent Cash To record partial payment on construction contract.

32,000 288,000

OFU - nonreciprocal transfer to DSF Cash To record transfer to DSF.

30,000 30,000

Cash

30,000 OFS - nonreciprocal transfer from GF To record transfer from GF.

DSF

Expenditures–interest 20,000 Cash To record payment of interest (500,000  .08  .5).

30,000

20,000

Chapter 20

20-41

Solution P20-12 (continued) 7

CPF

DSF

Reserve for encumbrances Encumbrances To reduce encumbrances for work completed.

320,000

Expenditures Contracts payable Contracts payable—retained percentage To record expenditures for work completed.

320,000

OFU - nonreciprocal transfer to DSF Cash To record transfer to DSF.

90,000

Cash

90,000

320,000

288,000 32,000

90,000

OFS - nonreciprocal transfer from GF To record transfer from GF. 9

DSF

CPF

90,000

Expenditures — interest Expenditures — principal retirement Cash To record debt service payment.

20,000 50,000

Cash

500,000

70,000

OFS - Proceeds from bonds To record issuance of bonds.

500,000

20-42

Accounting for State and Local Governmental Units

Solution P20-12 (continued)

City of Catalina Capital Projects Fund Statement of Revenues, Expenditures, and Changes in Fund Balance for the year ended June 30, 2015 Expenditures: Capital outlay Deficiency of revenues over expenditures Other financing sources and uses: OFS--Proceeds from bonds OFU - nonreciprocal transfer out Total other financing sources and uses Excess of revenues and other financing sources over expenditures and other financing uses Fund balance, July 1, 2014 Fund balance June 30, 2015

$640,000 ($640,000) $1,010,000 (10,000) 1,000,000 360,000 0 $360,000

City of Catalina Capital Projects Fund Balance Sheet June 30, 2015 Assets Cash

$ 712,000 $ 712,000

Total assets Liabilities and Fund Balance Liabilities: Contracts payable Contracts payable — retained percentage Fund balance: Restricted Committed Total liabilities and fund balance

$288,000 64,000 $320,000 40,000

$ 352,000

360,000 $ 712,000

Chapter 21 ACCOUNTING FOR STATE AND LOCAL GOVERNMENTAL UNITS — PROPRIETARY AND FIDUCIARY FUNDS Answers to Questions 1

Enterprise and internal service funds are similar in the sense that their operations are like those of similar business enterprises. They use full accrual accounting practices (including depreciation), have a capital maintenance or profit objective, are financed through user charges, and have the same financial reporting requirements. The primary difference between the two fund types is that an EF provides goods and services to citizens and customers outside the government on a user charge basis, while an ISF provides services to other departments and agencies within the same governmental unit (or occasionally to other governmental units).

Typical operations of internal service funds include motor pools, centralized risk financing activities, data processing services, printing shops, centralized purchasing, repair shops, and storage or warehouse operations. Internal service funds may engage in almost any kind of operations that one would find in private enterprise.

An EF (and also an ISF) is required to prepare a statement of net position, a statement of revenues, expenses, and changes in net position, and a statement of cash flows for fair presentation in accordance with GAAP. The government-wide statement of net position and statement of activities both include enterprise fund data.

In the fund financial statements, governments include internal service funds with the proprietary funds. They are aggregated into a single column within the proprietary fund statement of net position, the statement of revenues, expenses, and changes in net position, and the statement of cash flows. Within the government-wide statements, governments report internal service funds with the governmental activities. The internal service fund asset and liability accounts are generally included in the governmental activity column of the statement of net position. The statement of activities will include only those internal service fund transactions involving entities other than the primary reporting entity. Governments add external internal service fund revenues and expenses to the statement of activities, but they exclude internal governmental transactions. (See also Question 7.)

Internal service funds are never considered major funds and proprietary fund statements report internal service funds in a single column with the enterprise funds. Major enterprise funds are reported in a single column on the proprietary fund statement of net position, statement of revenues, expenses, and changes in net position, and statement of cash flows.

Because proprietary funds account for transactions in much the same manner as commercial business organizations, the GASB allows some reference to FASB statements. GASB Statement No. 20, “Accounting and Financial Reporting for Proprietary Activities,” governs which accounting and reporting standards apply to proprietary activities.

It is important to differentiate between revenues generated by interfund transactions and transactions with external parties because of the way that these transactions are reported on the government-wide statements. The statement of activities will include only those internal service fund transactions involving entities other than the primary reporting entity. To avoid double counting of interfund transactions, governments add external service fund revenues and expenses to the statement of activities, while they exclude internal governmental transactions. First, GASB Statement No. 34 makes the direct method mandatory for statement presentation. Second, GASB Statement No. 9 requires separating financing activities into noncapital and capital related.

21-2

Accounting for State and Local Governmental Unit—Proprietary and Fiduciary Funds

The fiduciary fund category includes trust funds (private-purpose, investment, and pension) and agency funds. They are reported in the fund financial statements only in a statement of fiduciary net position and a statement of changes in fiduciary net position.

Governmental units often provide the initial financing of an ISF through a contribution of cash or operating facilities, expecting the ISF to be self-sustaining in future periods. Alternatively, the governmental unit may provide a loan to the ISF to be repaid from future operating flows of the fund. A contribution is classified as a nonreciprocal transfer, which flows through the statement of revenues, expenses, and changes in fund net position; whereas a loan is recorded as a long-term liability of the ISF in the statement of net position. A government records short-term interfund loans as due to Fund A and due from Fund B.

Private-purpose trust funds are fiduciary funds used to account for resources (other than investment pools and employee benefits) that are held for the benefit of parties outside the governmental entity. Permanent funds are governmental funds which report resources whose use is permanently restricted, but whose earnings are expendable for the benefit of the government or its citizens.

The government-wide statement of net position would need at least three columns—one for governmental activities (including the general fund, special revenue funds, and internal service funds), one for businesstype activities (enterprise funds), and one for the component unit. Most governments also present optional total and comparative total columns.

The net pension liability is now required to be reported on the balance sheet. A net pension liability indicates the pension liability exceeds the pension plan assets, and thus the pension plan is not fully funded. If the pension plan is fully funded, no net pension liability will be reported.

The accounting equation for an agency fund is Assets = Liabilities.

If an enterprise fund issues debt that is backed by its revenue-generating activity (i.e., revenue-backed debt instruments), the government must present certain detailed segment information in the notes to the financial statements.

Since the government-wide statement of activities and statement of net position report all items using the accrual basis of accounting, conversion between the fund and government-wide statements is not necessary. Also, recall that governments report internal service funds with the governmental activities in the government-wide statements.

Chapter 21

21-3

SOLUTIONS TO EXERCISES Solution E21-1 1 2 3 4 5

b c d c d

Solution E21-4 1 2 3 4 5

b a a a c

Solution E21-2 [AICPA adapted] 1 d 2 d 3 d 4 c 5 a

Solution E21-3 1 2 3 4 5

c d c b c

Solution E21-5 [AICPA adapted] 1 d 2 d 3 b 4 b 5 a 6 c

Solution E21-6 City of Laramee Tax Collection Agency Fund Statement of Fiduciary Net Position Tax Collection Agency Fund at December 31, 2014 Assets Taxes receivable Total assets Liabilities Liability to Laramee Liability to Bloomer County Liability to Bloomer School District Total liabilities Total Net Position

Taxing Units City of Laramee Bloomer County Bloomer School District

$50,000 $50,000 $15,000 10,000 25,000 $50,000 $0

Schedule of Taxes Receivable Amounts Certified for Collection Collections $ 60,000 $ 45,000 40,000 30,000 100,000 75,000 $200,000 $150,000

NOTE: This solution assumes that the collection fee is recognized when cash is collected.

Balance at Year End $15,000 10,000 25,000 $50,000

Accounting for State and Local Governmental Unit—Proprietary and Fiduciary Funds

21-4

Solution E21-7 1

Cash

3,000,000 Revenue collected in advance To record receipt of grant.

3,000,000

Revenue collected in advance is reported as a liability in the balance sheet. Operating grant revenues are reported as nonoperating revenues in the period qualifying costs are incurred. 2

Expenses — Program A 1,200,000 Vouchers payable (or Cash) To record expenses incurred for the program financed by the grant.

1,200,000

Revenue collected in advance Revenues — operating grant To record revenues earned on the grant.

1,200,000

Nonoperating revenues of $1,200,000 should be reported in the enterprise fund’s statement of revenues, expenses, and changes in net position. 3

Cash

7,000,000 Revenue collected in advance To record receipt of capital grant.

7,000,000

Revenue collected in advance are reported as a liability in the balance sheet. When qualifying costs are incurred, the liability is reduced and contributed capital from intergovernmental grants, not revenues, is recognized. 4

Construction in progress 4,000,000 Cash To record construction costs incurred on capital grant project.

4,000,000

Revenue collected in advance 4,000,000 Contributed capital–capital grants 4,000,000 To record increase in contributed capital as a result of incurring qualifying costs under capital grant. The increase in contributed capital of $4,000,000 is reported as an addition to contributed capital..

Solution E21-8 1 2 3 4 5 6 7 8 9 10

Enterprise Fund Capital Projects Fund and Debt Service Fund Capital Projects Fund and Debt Service Fund Private Purpose Trust Fund Internal Service Fund Enterprise Fund Special Revenue Fund General Fund Agency Fund Investment Trust Fund

Chapter 21

21-5

Solution E21-9 1 Enterprise Fund Cash Operating Revenue 2

Agency Fund Cash Due to other governmental units Capital Projects Fund Cash Other financing source — proceeds from bond issue Other financing use — nonreciprocal transfer to Debt Service Fund Cash Debt Service Fund Cash Other financing source — nonreciprocal transfer from Capital Projects Fund

4,500 4,500

125,000 125,000

1,050,000 1,050,000 50,000 50,000

50,000 50,000

Private Purpose Trust Fund Bond Investments Contributions

50,000

Internal Service Fund Cash Nonreciprocal transfer from General Fund

150,000

General Fund Other financing use - Nonreciprocal transfer to Internal Service Fund Cash

150,000

Enterprise Fund Cash Bonds payable Special Revenue Fund* Cash Other Financing Source – Reciprocal transfer from General Fund General Fund Other Financing Use - Reciprocal transfer to Special Revenue Fund – Highway Beautification Cash

50,000

150,000

1,000,000 1,000,000

50,000 50,000

50,000

General Fund Taxes Receivable — current 5,000,000 Allowance for uncollectible taxes — current Revenue * An entry recording grants receivable (debit) and Revenue collected in advance (credit) is optional.

50,000

50,000 4,950,000

Accounting for State and Local Governmental Unit—Proprietary and Fiduciary Funds

21-6

Solution E21-10 Transaction

Net investment in Restricted net capital assets position (net of related debt) 1 decrease n/a 2 decrease n/a 3* n/a n/a 4 increase n/a 5 n/a n/a 6 n/a n/a *Assume capital asset is 100% financed with debt.

Unrestricted net position increase increase n/a decrease increase decrease

Chapter 21

21-7

SOLUTIONS TO PROBLEMS Solution P21-1 1

Cash Equipment Nonreciprocal transfer from General Fund Reciprocal transfer from General Fund

500,000 550,000

Equipment Cash

200,000

Due from Various Departments Service Revenue

345,000

Cash

300,000

550,000 500,000

200,000

345,000

Due from Various Departments 4

12/31

300,000

Salaries expense Payroll taxes expense Reciprocal transfer to General Fund Other operating expenses Cash

180,000 37,800 50,000 120,000

Depreciation Expense Accum. Depr. - Equipment

20,000

Net position, invested in capital assets, net of related debt Net position, unrestricted

20,000

Nonreciprocal transfer from General Fund Net position, invested in capital assets, net of related debt

550,000

Net position, unrestricted Net position, invested in capital assets, net of related debt

200,000

Reciprocal transfer from General Fund Net position, unrestricted

500,000

Net position, unrestricted Reciprocal transfer to General Fund

50,000

387,800

20,000

550,000

200,000

500,000

50,000

Accounting for State and Local Governmental Unit—Proprietary and Fiduciary Funds

21-8

Solution P21-2 1

Cash

30,000,000 Nonreciprocal transfer from General Fund

Building

30,000,000 25,250,000

Cash 3

25,250,000

Cash

5,000,000 Bonds payable

5,000,000

Accounts Receivable Charges for services

4,500,000

Cash

4,400,000

4,500,000

Accounts Receivable 6

Building

4,400,000 3,500,000

Cash 7

3,500,000

Salaries expense Cash

700,000

Interest Expense Interest Payable Cash

400,000

Operating Expenses Accounts Payable Cash

1,100,000

Depreciation Expense Accumulated Depreciation

1,050,000

Net position, unrestricted Net position, invested in capital assets, net of related debt

28,750,000

Net position, invested in capital assets, net of related debt Net position, unrestricted

1,050,000

Nonreciprocal transfer from General Fund Net position, unrestricted

30,000,000

700,000

100,000 300,000

100,000 1,000,000

1,050,000

28,750,000

1,050,000

30,000,000

Chapter 21

21-9

Solution P21-2 (continued) Fiedler County Utility Plant Adjusted Trial Balance Cash Accounts Receivable Building Accumulated Depreciation Interest Payable Accounts Payable Nonreciprocal transfer from General Fund Bond Payable Charges for Services Salaries Expense Interest Expense Operating Expenses Depreciation Expense

$ 8,650,000 100,000 28,750,000 $ 1,050,000 100,000 100,000 30,000,000 5,000,000 4,500,000 700,000 400,000 1,100,000 1,050,000 $40,750,000

$40,750,000

Accounting for State and Local Governmental Unit—Proprietary and Fiduciary Funds

21-10

Solution P21-3 Douwe County Motor Pool Fund Statement of Revenues, Expenses, and Changes in Fund Net Position for the year ended June 30, 2015 Revenues Revenue from billings Expenses Supplies used Salaries expense Utilities expense Depreciation expense Operating income Transfers out Change in net position Net position, June 30, 2014* Net position, June 30, 2015*

$120,000 $68,000 25,000 9,000 16,000

118,000 2,000 (12,000) (10,000) 92,000 $ 82,000

*Total net position includes the contribution from the General Fund. Douwe appears to be keeping track of the contribution in a separate account internally, but for financial statement purposes included with the account titled “net position” which perhaps is how Douwe kept internal records on all other changes in net assets other than the general fund contribtion. Note in the statement of net position below that total net position is $82,000. Douwe County Motor Pool Fund Statement of Net Position On June 30, 2015 Current assets Cash Due from electric fund Supplies on hand

$37,000 4,000 14,000

Noncurrent assets Autos Less: Accumulated depreciation Total assets

$99,000 56,000

Liabilities Accounts payable Advance from general fund Total liabilities

$11,000 5,000

Net Position Invested in capital assets, net of related debt Unrestricted Total net position

$43,000 39,000

$55,000

43,000 $98,000

$16,000

$ 82,000

Chapter 21

21-11

Solution P21-3 (continued) Douwe County Motor Pool Fund Statement of Cash Flows for the Year Ended June 30, 2015 Cash Flows from Operating Activities Cash received from users (plug) Less: Cash paid to suppliers* Cash paid for salaries Cash paid for utilities Net cash provided by operating activities Cash Flows from Noncapital Financing Activities Operating transfers to general fund Cash from Capital and Related Financing Activities Purchase of automobiles

$127,000 $(69,000) (25,000) (9,000)

(103,000) 24,000 (12,000) (19,000)

Cash Flows from Investing Activities Decrease in cash for 2015 Add: Cash and cash equivalents, June 30, 2014 Cash and cash equivalents, June 30, 2015

--(7,000) 44,000 $ 37,000

* Change in supplies (12,000 beginning + 70,000 [plug] – 68,000 used = 14,000 ending); Cash paid is 70,000 less change in accounts payable (11,000 – 10,000 = 1,000) Reconciliation of Net Operating Income to Net Cash Provided by Operating Activities Cash Flows from Operating Activities Operating income Adjustments for noncash expenses, revenues, losses and gains included in income: Depreciation expense Decrease in due from general fund Increase in due from electric fund Increase in Supplies on hand Increase in Accounts payable Total adjustments Net cash flow from operating activities

$ 2,000

16,000 8,000 (1,000) (2,000) 1,000 22,000 $24,000

Accounting for State and Local Governmental Unit—Proprietary and Fiduciary Funds

21-12

Solution P21-4

Cash

Investments Building — net Dividends receivable Held in trust for student aid

Summary Calculations for Principal Trust Fund Increase Decrease $ 100,000 donated $600,000 stock purchase 40,000 rentals 550,000 bonds sold 500,000 donated bonds 500,000 bonds sold 600,000 stock purchases 400,000 donated 20,000 Depreciation 60,000 on stock 40,000 Rentals 20,000 Depreciation 30,000 Bond interest 60,000 Dividend income 20,000 Gain on bonds

Net $ 90,000 600,000 380,000 60,000

130,000

Student Aid Principal Trust Fund Statement of Fiduciary Net Position At December 31, 2014 Assets

Net Position

Cash Investments Building — less accumulated depreciation Dividends receivable Total assets

$ 90,000 600,000 380,000 60,000 $1,130,000

Held in trust for endowment Held in trust for student aid

$1,000,000 130,000

Total Net Position

$1,130,000

Student Aid Earnings Trust Fund Statement of Changes in Fiduciary Net Position For the Year ending December 31, 2014 Additions Contributions: Cash Investments Buildings Total contributions

$100,000 500,000 400,000 $ 1,000,000

Investment earnings Rental income Dividend income Gain on bonds Bond interest Depreciation expense Total earnings Total additions

40,000 60,000 20,000 30,000 (20,000) 130,000 1,130,000

Deductions Total deductions Change in net position Net position—beginning Net position--ending

0 1,130,000 0 $1,130,000

Chapter 21

21-13

Solution P21-5 Duchy County Trust Fund Statement of Changes in Fiduciary Net Position Trust Fund For the year ended June 30, 2015 Additions Contributions Investment earnings Interest* Total Additions

$500,000 18,750 $518,750

Deductions Distributions to homeless shelters Total Deductions

$ 11,250 11,250

Changes in Net Position Net position — beginning of the year Net position — end of the year

507,500 0 $507,500

* $500,000 x 4.5% x 6/12 = $11,250 received Mar 1 $500,000 x 4.5% x 4/12 = $7,500 accrued through Jun 30 Duchy County Trust Fund Statement of Fiduciary Net Position At June 30, 2015 Assets Investments Interest receivable Total assets

$500,000 7,500 $ 507,500

Net Position Held in trust for endowment Held in trust for homeless shelters Total Net Position

$ 500,000 7,500 $ 507,500

Accounting for State and Local Governmental Unit—Proprietary and Fiduciary Funds

21-14

Solution P21-6 [AICPA adapted] CITY OF MERINGEN Central Garage Fund Journal Entries July 1, 2014 to June 30, 2015 1

Inventory of Materials and Supplies Vouchers Payable To record purchases on account.

74,000

Materials and Supplies Expense Inventory of Materials and Supplies To record ending inventory and materials and supplies used.

96,000

Salaries and Wages Expense Cash To record salaries and wage expense paid.

230,000

Utility Expense Cash To record payment of utility charges.

30,000

Depreciation Expense — Building Depreciation Expense — Machinery and Equipment Accumulated Depreciation — Buildings Accumulated Depreciation — Machinery and Equipment To record depreciation.

5,000 8,000

Due from General Fund Due from Water and Sewer Fund Due from Special Revenue Fund Service Revenue To record billings to departments for services.

262,000 84,000 32,000

Cash

376,000

74,000

96,000

230,000

30,000

5,000 8,000

378,000

Due from General Fund Due from Water and Sewer Fund Due from Special Revenue Fund To record collection of receivables. 8

Vouchers Payable Cash To record payment of vouchers.

276,000 84,000 16,000

98,000

Chapter 21

21-15

Solution P21-6 (continued) 2

CITY OF MERINGEN Central Garage Fund Closing Entries June 30, 2015 Service Revenue Materials and Supplies Expense Salaries and Wage Expense Utility Expense Depreciation Expense — Building Depreciation Expense — Machinery and Equipment Net position, unrestricted To close revenue and expense accounts.

378,000

Net position, invested in capital assets, net of related debt Net position, unrestricted To remove depreciation expense for period.

13,000

96,000 230,000 30,000 5,000 8,000 9,000

13,000

Accounting for State and Local Governmental Unit—Proprietary and Fiduciary Funds

21-16

Solution P21-7 Caleb County Enterprise Fund Statement of Cash Flows for the Year Ended . . . Cash Flows from Operating Activities Cash received from customers

$3,276,500

Less: Cash paid to suppliers

(2,694,500)

Cash paid for salaries

(479,300)

Cash paid for operating costs

(819,200)

Net cash provided by operating activities

($716,500)

Cash Flows from Noncapital Financing Activities Property Taxes Received

217,000

Long-term debt repayment

(515,000)

Net cash provided by noncapital financing activities Cash Flows from Capital and Related Financing Activities Capital grant proceeds

750,000

Proceeds from sale of capital asset

522,000

Net cash provided by capital and related financing activities Cash Flows from Investing Activities Purchase of equity investments

(298,000)

1,272,000 (165,000)

Net cash provided by investing activities

(165,000)

Increase in cash

92,500

Add: Cash, beginning

714,525

Cash, ending

$807,025

Chapter 22 ACCOUNTING FOR NOT-FOR-PROFIT ORGANIZATIONS Questions 1

The financial statements required for nongovernmental not-for-profit entities include a statement of financial position, a statement of activities, and a cash flow statement. Voluntary health and welfare organizations also provide a statement of functional expenses.

Each hospital, college, and voluntary health and welfare organization (and other not-for-profit organizations as well) must be evaluated to determine whether it meets the definition of a government in the authoritative literature. Those that meet the definition of a government must apply the government GAAP hierarchy. GASB standards are the most authoritative guidance for these entities. All other entities are to apply FASB standards.

The AICPA guides became nonauthoritative GAAP in 2009 with changes at both FASB and GASB. FASB 162 issued in 2008 specified the hierarchy of GAAP for nongovernmental organizations to be moved from SAS 69 (i.e. the auditing standards) to FASB (i.e. the accounting standards). Similarly, GASB 55 issued in 2009 specified the hierarchy of GAAP for governmental entities to be moved from SAS 69 to GASB. Subsequently, FASB 168 issued in 2009 – the last FASB “Statement” issued – created the codification of GAAP in the Accounting Standards Codification as the sole authoritative source of GAAP for nongovernmental organizations. FASB now has two categories, the ASC which is authoritative and everything else is non-authoritative. GASB 55 keeps the prior hierarchy whereby the AICPA audit and accounting guides are level b – just beneath GASB Statements and Interpretations.

A conditional promise to give depends on the occurrence of a specified future and uncertain event to bind the promisor. An unconditional promise to give depends only on the passage of time or demand by the promisee for performance. Organizations recognize conditional promises to give as contribution revenue and receivables when the conditions are substantially met (in other words, when the conditional promise to give becomes unconditional); however, they account for a conditional gift of cash or other asset that may have to be returned to the donor if the condition is not met as a refundable advance (liability). Organizations recognize unconditional promises to give as restricted or unrestricted contribution revenue and receivables in the period in which the promise is received.

A donor-imposed condition provides that the donor will have his resources returned (or will be released from the promise to give) if the condition is not met. A donor-imposed restriction only limits the purpose or timing of use of the contributed assets.

Unconditional promises to give with payments due in the next period are reported as restricted support (net of an appropriate allowance for uncollectible accounts) that increase temporarily restricted net assets, even if the resources are not restricted for specific purposes.

When a time restriction is met, temporarily restricted net assets are reclassified as unrestricted net assets. The entry includes a debit to temporarily restricted net assets—reclassifications out and a credit to unrestricted net assets—reclassifications in. (Different account titles, such as amounts released from restrictions, are permitted as well.)

22-2

Accounting for Not-for-Profit Organizations

Gifts in kind are reported as unrestricted support that increases unrestricted net assets if the not-for-profit entity has discretion over the disposition of the resources and a fair value can be reasonably determined. If fair value cannot be determined, the items are recorded as sales revenue when they are sold. If the not-forprofit entity has little or no discretion over disposition of the items, the gifts in kind should be accounted for as agency transactions.

Program services of voluntary health and welfare organizations are expenses incurred in meeting the social service objectives of the organization. Examples are research, public education, community services, and patient services. Supporting services consist of the organization’s administrative and fund-raising costs, and expenses for these items are so classified in the statement of activities.

The statement of functional expenses for voluntary health and welfare organizations is intended to reconcile the functional classification of expenses (which results in highly aggregated data) with basic object-of-expense classifications that are less aggregated and easier for many users to understand.

Contributed services are recognized only if the services (a) create or enhance nonfinancial assets of the organization or (b) require specialized skills, are provided by individuals possessing those skills, and would typically need to be purchased if not provided by donation.

Charity care is excluded from both gross patient service revenue and from expense. The hospital’s policy for providing charity care and the level of charity care provided are disclosed in notes to the financial statements.

Net patient service revenues of hospitals are measured by deducting courtesy allowances and contractual adjustments from gross patient revenues. Uncollectible accounts expenses are not deducted in computing net patient service revenues. Net patient service revenues are reported in the statement of activities.

The three major revenue groupings used by hospitals are patient service revenues, other operating revenue, and nonoperating gains. Examples are: Patient service revenues—routine care, emergency room, recovery room, pharmacy Other operating revenues—tuition from educational programs, research grants for specific purposes, gift shop sales Nonoperating gains—unrestricted gifts, unrestricted endowment income, gain on sale of plant assets, rents from property not used in hospital operations (Premium fees also are significant for many hospitals today. They would be reported as a separate line item under operating revenues.)

Both the provision for bad debts (other than for charity care, which is not recorded as revenue) and depreciation are expenses of a hospital. Hospitals use full accrual accounting procedures.

FASB Statement No. 117 (now codified in FASB ASC 958) requires private not-for-profit universities to provide a set of financial statements that includes a statement of financial position, statement of activities, statement of cash flows, and accompanying notes. Governmental universities are considered specialpurpose governments under GASB Statements No. 34 and 35. Special-purpose governments with more than one governmental program or both governmental and business-type activities present both government-wide and fund financial statements, as well as the MD&A, notes, and required supplementary information. Special-purpose governments with only one governmental program may combine fund and government-wide statements, whereas those with only business-type activities should report only the financial statements required for enterprise funds, as well as the MD&A, notes, and required supplementary information.

Government colleges and universities no longer have the option of using the AICPA college guide; however, many organizations may have retained AICPA model features for internal accounting and control purposes. Copyright © 2015 Pearson Education, Inc.

Chapter 22

22-3

Much guidance comes from the Financial Accounting and Reporting Manual, an accounting manual prepared by the National Association of College and University Business Officers (NACUBO) which is available as an online subscription service.

GASB Statements No. 34 and 35 require special-purpose government with more than one governmental program or both governmental and business-type activities to present both government-wide and fund financial statements, as well as the MD&A, notes, and required supplementary information. Specialpurpose governments with only one governmental program may combine fund and government-wide statements, whereas those with only business-type activities should report only the financial statements required for enterprise funds, as well as the MD&A, notes and required supplementary information.

Functional classifications include the following: • Instruction. Expenses for the educational programs • Resource. Expenses to produce research outcome • Public Service. Expenses for activities to provide noninstructional services to external groups • Academic support. Expenses to provide support for instruction, research, and publications • Student Services. Amounts expended for admissions and registrar, and amounts expended for students’ emotional, social, and physical well-being • Institutional support. Amounts expended for administration and the long-range planning of the university • Operation and maintenance of plant. Expenses for operating and maintaining the physical plant (net of amounts to auxiliary enterprises and university hospitals) • Student aid. Expenses from restricted or unrestricted funds in the form of grants, scholarships, or fellowships to students.

Property, plant, and equipment acquired by a not-for-profit organization with unrestricted or restricted resources may be recorded at acquisition as unrestricted or temporarily restricted. If temporarily restricted, the assets are reclassified when depreciation is recognized.

22-4

Accounting for Not-for-Profit Organizations

SOLUTIONS TO EXERCISES Solution E22-1 1 d 2 a 3 d 4 c 5 b

Solution E22-2 1 b 2 a 3 d 4 b 5 c

Solution E22-3 1 b 2 b 3 c 4 d 5 a

Solution E22-4 1 a 2 b 3 a 4 a 5 c

Solution E22-5 1 b 2 b 3 c 4 c 5 d

Solution E22-6 1 b 2 a 3 a 4 c 5 b

Solution E22-7 1 b 2 a 3 c 4 a 5 d Solution E22-8 Program services: Education Public Health Research

$20,400 15,700 12,000

$48,100

Supporting services: Fund raising Management and general

$11,400 5,500

$16,900

Chapter 22

22-5

Solution E22-9 1) Contributions receivable Allowance for uncollectible contributions Unrestricted support — contributions Temporarily restricted support — contributions To record contribution revenues and an allowance for uncollectible accounts.

20,000 600 13,580 5,820

Contributions that are not due until the next period imply a time restriction unless the donor explicitly stipulates that the pledge is for current expenditures. Thus, unrestricted net assets are increased by $13,580 and temporarily restricted net assets are increased by $5,820. 2) Cash

200 Temporarily restricted support — contributions To record a gift restricted to a special project. (Recall that some NFPs may record as unrestricted if the restriction is met in the same period.

Expenses — community service [program services] Cash To record expenditures for restricted purpose.

200

Temporarily restricted net assets — reclassifications out Unrestricted net assets — reclassifications in To record satisfaction of temporary restriction.

200

3) Equipment Unrestricted support — Contributions To record receipt of donated equipment.

6,000

Depreciation expense — community services Accumulated depreciation — equipment To record depreciation expense for the year on unrestricted long-lived assets.

1,500

6,000

1,500

The organization may also adopt an accounting policy that implies a time restriction that expires over the useful life of the donated asset. If the gift is reported as restricted support in temporarily restricted net assets, depreciation is recorded as an expense in unrestricted net assets, which results in a reclassification for the amount of the depreciation from temporarily restricted to unrestricted net assets. 4) Cash

8,000

Temporarily restricted support — contributions To record receipt of donation restricted to the purchase of a truck. Investment Cash To record purchase of investment. Accrued interest receivable Temporarily restricted revenue — investment income To record accrual of interest on funds restricted for the purchase of a truck.

8,000

8,000 8,000

215

The contribution of cash restricted for long-lived asset purchases increased temporarily restricted net assets, as did the donor-restricted investment income on those funds.

215

22-6

Accounting for Not-for-Profit Organizations

Solution E22-9 (continued) 5) Accounts receivable Unrestricted revenues — tuition and fees To record tuition and fees.

735,000

Tuition reduction: unrestricted—student aid Accounts receivable To record tuition reductions.

65,000

Expenses—educational and general—institutional support Allowance for uncollectible accounts To record allowance for uncollectible accounts.

7,350

6) Cash

735,000

65,000

7,350

3,000,000

Temporarily restricted revenues--contribution To record receipt of restricted donation.

3,000,000

Expenses — tobacco research Cash To record expenses for tobacco research.

1,200,000

Temporarily restricted net assets — reclassifications out Unrestricted net assets—reclassifications in To reclassify the contribution as unrestricted.

1,200,000

Chapter 22

22-7

PROBLEMS Solution P22-1 Voluntary Health and Welfare Organization gift 1 a Cash Unrestricted support—contributions To record cash contribution received. b

Expenses (by function) Cash To record operating expenses paid.

Private University Gift 2 a Cash

5,000,000 5,000,000

2,300,000 2,300,000

5,000,000 Temporarily restricted revenues—contributions To record restricted cash gift received.

5,000,000

Expenses—research Cash To record research expenses.

2,300,000

Temporarily restricted net assets— reclassifications out Unrestricted net assets — reclassifications in To record release of assets from temporary restrictions.

2,300,000

Local Hospital Gift 3 a Cash

2,300,000

5,000,000 Temporarily restricted support To record cash gift restricted for construction of capital asset.

5,000,000

Construction in progress Cash To record construction costs incurred.

2,300,000

Temporarily restricted net assets — reclassifications out Unrestricted net assets — reclassifications in To record release of assets from temporary restrictions.

2,300,000

22-8

Accounting for Not-for-Profit Organizations

Solution P22-2 Payment of salaries Expenses — management and general 2,920 Expenses — community service 11,680 Cash To record payment of salaries allocated 20% to management and general services and 80% to program services. Donated services Expenses — management and general Unrestricted support — donated services To record donated services.

900 900

Donated facilities Expenses — management and general 600 Expenses — community service 2,400 Unrestricted support — donated facilities To record allocation of donated facilities 20% to management and general and 80% to program services. Payment of utilities Expenses — management and general 360 Expenses — community service 1,440 Cash To record payment of utilities allocated 20% to management and general and 80% to program services. Purchase and use of supplies Supplies inventory Cash To record purchase of supplies.

3,000

1,800

300

Expenses — management and general 60 Expenses — community service 240 Supplies inventory To record allocation of supplies expense 20% to management and general and 80% to program services. Administration and other expenses Expenses — management and general 1,200 Expenses — community service 4,800 Cash To record payment of recordkeeping expenses allocated 20% to management and general and 80% to program services. Gifts in kind are reported as contributions since Share Shop has discretion over their distribution and a fair value is determinable. When gifts in kind are distributed to recipients, they are recorded as program expenses. If fair value cannot be determined, neither the contribution nor distribution would be recorded.

14,600

300

6,000

Chapter 22

22-9

Solution P22-2 (continued) Inventory — nonperishable food Inventory — household items Unrestricted support — contributions To record receipt of donated food and household items.

60,000 40,000

Expenses — community service Inventory — nonperishable food Inventory — household items To record distribution of food and household items to qualified recipients.

65,000

Cash contributions Cash Unrestricted support — contributions To record receipt of cash contributions. Unconditional promises to give (solution assumes all pledges were due in 2011) Contributions receivable Unrestricted support — contributions Allowance for uncollectible contributions To record pledges received and 10% estimated uncollectible pledges.

100,000

45,000 20,000

10,000 10,000

20,000 18,000 2,000

Cash 15,000 Unrestricted support — contributions 3,000 Allowance for uncollectible contributions 1,000 Contributions receivable Temporarily restricted support — contributions To record receipt of cash, adjust the allowance account for the overstatement of uncollected pledges, and reclassify uncollected support. Grant Grant receivable Temporarily restricted support — grant To accrue grant from Town of North Ptarmigan due in 2012.

15,000 4,000

25,000 25,000

22-10

Accounting for Not-for-Profit Organizations

Solution P22-3 Hometown Memorial Hospital Statement of Operations For the year ended December 31, 2011 Unrestricted revenues, gains, and other support: Net patient service revenues ($2,500,000 - $400,000 - $100,000) Other operating revenues ($300,000 + $50,000) Income from investment in affiliate Investment income Unrestricted contributions Net assets released from restrictions for operating purposes Total operating revenues, gains, and net assets released from restrictions for operations Expenses and Losses: Nursing services Other professional services General services Administrative services Uncollectible accounts Loss on sale of fixed assets Depreciation Total expenses and losses

$2,000,000 350,000 80,000 270,000 200,000 80,000 2,980,000

1,000,000 500,000 290,000 310,000 150,000 50,000 200,000 2,500,000

Excess of revenues, gains, and other support over expenses and losses Net assets released from restrictions for acquisitions of fixed assets Increase in unrestricted net assets

480,000

97,000 $ 577,000

Chapter 22

22-11

Solution P22-4 Accounts receivable Unrestricted revenues — tuition and fees To record tuition and fees.

2,000,000

Tuition reduction: unrestricted—student aid Accounts receivable To record tuition reductions.

120,000

Cash

2,000,000

120,000

1,100,000 Unrestricted revenues — state appropriation Unrestricted revenues — local appropriation To record governmental appropriations.

800,000 300,000

Cash

500,000 Revenue – auxiliary operations To record auxiliary revenues.

500,000

Expenses – auxiliary operations Cash To record auxiliary expenses.

480,000

Cash

90,000

480,000

Unrestricted revenues—endowment income Temporarily restricted revenues— endowment income To record contributions received.

20,000 70,000

Cash

380,000

Unrestricted revenues—gifts and grants Temporarily restricted revenues—gifts and grants To record gifts and grants received. Expenses – educational and general - instruction Expenses – educational and general - research Expenses – educational and general – student services Expenses – educational and general – operation of plant Expenses – educational and general – student aid Cash (or payables) To record educational and general expenses.

80,000 300,000

2,100,000 100,000 120,000 180,000 200,000

Temporarily restricted net assets — reclassifications out Unrestricted net assets — reclassifications in To reclassify temporarily restricted assets (assumes all scholarships and research were from temporarily restricted assets).

2,700,000

300,000 300,000

22-12

Accounting for Not-for-Profit Organizations

Solution P22-4 (continued) Nongovernmental NFP College Statement of Activities for the year 2014 Revenues Tuition and fees (net)

$1,880,000

State and local appropriations

1,100,000

Private grants and gifts

80,000

Endowment income

20,000

Sales and services of auxiliary enterprises

500,000

Total revenues

$3,580,000

Total net assets released from restrictions for operations

300,000

Total revenues and reclassifications

$ 3,880,000

Expenses Educational and general Instruction

2,100,000

Research

100,000

Student services

120,000

Operation and maintenance of plant

180,000

Student aid

200,000

Auxiliary operations

480,000

Total operating expenses

3,180,000

Net increase in unrestricted net assets

700,000

Changes in temporarily restricted net assets: Private grants and gifts

300,000

Endowment income

70,000

Net assets released from restrictions*

(300,000)

Increase in temporarily restricted net assets

70,000

Change in net assets

770,000

Net assets, beginning

Net assets, ending

$770,000

*assumes all scholarships and research were from temporarily restricted funds

Chapter 22

22-13

Solution P22-5 Community Society Statement of Activities For the Year Ended December 31, 2011 Changes in Unrestricted Net Assets Revenues and gains Contributions Membership dues Investment income Total revenue and gains Net assets released from restrictions: For research For fixed assets Total unrestricted revenues, gains and other support

$3,000,000 400,000 83,000 3,483,000 $ 500,000 3,789,000

Expenses: Program Services: Research Education Total Program Services Supporting Services: Management and general Fund raising Total Supporting Services Total expenses Increase in unrestricted net assets

4,289,000 7,772,000

2,300,000 300,000 2,600,000 117,000 223,000 340,000 2,940,000 4,832,000

Changes in Temporarily Restricted Net Assets Contributions ($438,000 + $425,000 - $16,000) Investment income Gain on sale of investments Net assets released from restrictions Decrease in temporarily restricted net assets

847,000 22,500 5,000 (4,289,000) (3,414,500)

Changes in Permanently Restricted Net Assets Contributions Increase in permanently restricted net assets Increase in net assets Net assets, beginning Net assets, ending

37,000 37,000 1,454,500 5,475,000 $6,929,500

22-14

Accounting for Not-for-Profit Organizations

Solution P22-6 1 Tuition and fees receivable Unrestricted Revenues — tuition and fees To record tuition revenues. Expenses—unrestricted—student aid Expenses—educational and general—institutional support Tuition and fees receivable Allowance for uncollectible accounts To record scholarships and estimated bad debts. Cash

6,000,000 6,000,000

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

4,800,000 Tuition and fees receivable To record collections of receivables.

Cash

4,800,000

800,000 Revenues — sales and services of auxiliary enterprises To record sales of bookstore.

800,000

Expenses — educational and general Expenses — auxiliary enterprises Cash To record payroll.

2,430,000 170,000

Mortgage payable Cash To record mortgage payment.

1,000,000

Mortgage payable Interest expense Cash To record debt service payment.

360,000 600,000

Cash

440,000

2,600,000

1,000,000

960,000

Temporarily restricted revenues— contributions To record restricted gift. 7

440,000

Expenses—educational and general — instruction Cash To record expenditures for program.

237,000

Temporarily restricted net assets— reclassifications out Unrestricted net assets—reclassifications in To reclassify revenues equal to qualifying expenditures.

237,000

Temporarily restricted net assets— reclassifications out Unrestricted net assets—reclassifications in To reclassify revenues equal to qualifying expenditures.

44,000

Equipment Cash To record equipment purchased.

44,000

237,000

44,000

Chapter 22

22-15

Solution P22-7 1

Expenses Cash To record use of restricted cash for expenses.

20,000

Temporarily restricted net assets — reclassifications out Unrestricted net assets — reclassifications in To record satisfaction of time restriction.

20,000

Contributions receivable Cash Allowance for uncollectible contributions Unrestricted support — contributions* To record contributions.

65,000 35,000

20,000

3,250 96,750

To the extent that pledges are not collected by year end a time restriction will be implied. An adjusting entry reducing unrestricted support and recording temporarily restricted support for the net realizable value of the uncollected pledges will be required.

Inventory of materials Unrestricted support — donated materials To record donations of food.

150,000

Expenses — Program services Inventory of materials To record expenses for food used.

151,200

Inventory of supplies Cash To record purchases of supplies.

27,000

Expenses — management and general Expenses — Program services* Inventory of supplies Cash To record expenses incurred. * ($8,000 + 70,000 + [27,000 – 5,000 account increase])

10,000 100,000

300,000

Contributions receivable Allowance for uncollectible contributions Temporarily restricted support — contributions To record restricted pledges.

150,000

151,200

27,000

22,000 88,000

15,000 285,000

22-16

Accounting for Not-for-Profit Organizations

Solution P22-8 1

Patient accounts receivable Patient service revenues—unrestricted To record patient service charges at established rates.

102,300

Contractual adjustments Patient accounts receivable To record contractual adjustments.

30,000

Bad debt expense Allowance for uncollectible patient accounts receivable To establish an allowance for uncollectible receivables.

2,046

Cash

54,000

102,300

30,000

2,046

Premium revenue — unrestricted To record premium revenue from capitation agreements 3

Cash

54,000

16,000 Other operating revenue - unrestricted To record pharmacy revenue.

16,000

Nursing services expense Other professional services expense General services expense Fiscal services expense Administrative services expense Cash To record salaries and wages.

35,000 11,000 10,000 2,000 20,000

Cash

12,000

78,000

Grant revenue - restricted To record receipt of restricted grant funds. 6

12,000

Supplies inventory Cash (or accounts payable) To record the purchase of nursing supplies.

13,000

Nursing services expense Supplies inventory To record the use of nursing supplies.

6,700

13,000

6,700

Chapter 23 ESTATES AND TRUSTS Answers to Questions 1

No, trust accounting is essentially cash basis accounting.

Income is earned on the principal amounts of estate and trust assets. Estates frequently realize income from various investments between the time that the property inventory is filed by the executor and the time the estate is fully administered. A primary reason for dividing estate principal and income is that the beneficiaries are likely to be different. Separation of principal and income is also important for trusts, because often a trust’s principal is to be maintained intact until the death of the beneficiary.

A devise is a testamentary disposition of real or personal property.

If a decedent had a valid will in force at the time of death, he or she is said to have died testate. In the absence of a valid will, the decedent is said to have died intestate.

The Uniform Probate Code entitles the surviving spouse to a homestead allowance that is exempt from and has priority over all claims against the estate. The surviving spouse and minor children who were dependent on the deceased are also entitled to a reasonable family allowance to be paid out of estate property during the period in which the estate is being administered. The family allowance is exempt from and has priority over all claims except the homestead allowance. Allowance amounts vary across the states.

Yes, the value of the estate is reduced by funeral expenses, settlements of estate liabilities, bequests to qualified charities, a marital deduction, state-level taxes, expenses of estate administration, and a tax exempt amount.

The taxable amount of an estate is based on fair values of all estate assets at the date of death.

Yes, within certain limitations. Currently any number of annual gifts of $14,000 each can be made, with a lifetime limit of $5,250,000.

Income for estates and trusts and applicable tax rates are defined in essentially the same manner as for individuals. Income includes interest and dividends, rent, etc. Deductions and/or exemptions for estate administration fees, charitable donations and distributions to beneficiaries reduce taxable income. The fiduciary of the estate must provide applicable information to the beneficiary on Schedule K-1.

A valid will ensures the disposition of estate assets in accordance with the wishes of the deceased. If a valid will is not in place, assets will be distributed in accordance with state probate laws.

23-2

Estates and Trusts

Preparation of a will is also an important part of overall estate planning and can be useful in reducing estate and inheritance taxes. 11

In addition to federal and state estate and inheritance taxes, estates are also subject to federal (and possibly state) income taxes. An estate is a taxable entity and is subject to tax on income earned from the date of death until final settlement of the estate. The tax may be paid by the estate or by the beneficiary if estate property has already been distributed to the beneficiary.

SOLUTIONS TO EXERCISES Solution E23-1 a

Cash (+A)

9,000

Interest receivable - bonds (-A)

4,400

Estate income (R,+SE)

4,600

Devise - Atlanta Animal Shelter (E,-SE)

100,000

Cash (-A) c

Funeral expenses (E,-SE)

100,000 16,400

Cash (-A) d

16,400

Certificate of Deposit (+A)

50,000

Interest receivable (+A)

1,200

Assets subsequently discovered (-A) Cash (+A)

51,200 3,000

Interest receivable (-A)

1,200

Estate income (R,+SE)

1,800

Chapter 23

23-3

Solution E23-2 a

Cash (+A)

15,000

Interest receivable - bonds (-A)

11,600

Estate income (R,+SE)

3,400

Devise - symphony orchestra (E,-SE)

150,000

Cash (-A) c

Probate expenses (E,-SE)

150,000 2,800

Cash (-A) d

Funeral expenses (E,-SE)

2,800 12,800

Cash (-A) e

Hospital expense (-SE)

12,800 44,000

Debt of decedent (+L)

44,000

Solution E23-3 a

Dividend receivable (+A)

300,000

Estate income (R,+SE)

300,000

No entry on this date, since no distribution has yet been made.

Probate court expenses (E,-SE)

3,800

Cash (-A) d

Funeral expenses (E,-SE)

3,800 11,600

Cash (-A) e

Hospital fees and expenses (E,-SE)

11,600 37,000

Cash (-A) f

Cash (+A)

37,000 300,000

Dividends receivable (-A)

300,000

23-4

Estates and Trusts

Solution E 23-4 Melanie Triciao, Testator Inventory of Estate Assets As of the date of Death on August 15, 2013 Description of Property

Fair Value

Cash

118,225

Savings accounts

250,000

ViaReggio common stock

225,000

City of Roma municipal bonds

412,000

Mercedes sports car

41,000

Condominium on Italian Riviera

1,265,500

Atlanta personal residence

430,000

Collection of rare hand puppets

85,000

Fully restored Model T Ford

125,000 $2,951,725

Submitted by K. T. Tim, executor Solution E23-5 1. Estate Inventory Jeff Carpenter, Testator Inventory of Estate Assets As of the date of death on August 25, 2013 Description of Property

Fair Value

Cash in Oxford National Bank

$15,000

Certificates of deposit, includes $7,000 accrued interest

807,000

Personal effects*

$822,000

*The probate court permitted exclusion of Jeff’s personal effects from the estate inventory. Prepared by Ms. Colleen Ryan, Executrix, Oxford National Bank

Chapter 23

23-5

Solution E23-5 (continued) 2. a

Cash (+A)

11,500

Interest receivable (-A)

7,000

Estate income (R,+SE)

4,500

Cash (+A)

800,000

Certificates of deposit (-A) c

Estate principal

800,000 100,000

Cash (-A) d

100,000

Funeral expenses (E,-SE)

7,200

Cash (-A) e

7,200

Executrix expenses (E,-SE)

2,500

Cash (-A)

2,500

Devise - J.J. Kara (E,-SE)

716,800

Cash (-A) 3.

716,800

Closing Entries Estate principal (-SE)

722,000

Estate income (-R,-SE)

4,500

Funeral expenses (-E,+SE)

7,200

Executrix expenses (-E,+SE)

2,500

Devise - J.J. Kara

(-E,+SE)

716,800

23-6

Estates and Trusts

Solution E23-5 (continued) 4. Charge-Discharge Statement Estate of Jeff Carpenter Charge-Discharge Statement For the period of estate administration, August 25 to September 28, 2013 Estate principal I charge myself for: Assets included in estate inventory - total estate principal charge

$822,000

I credit myself for: Funeral expenses paid Executrix expenses paid

7,200 2,500

Trust account for Sooner XXV

100,000

Devise paid in cash to J.J. Kara

712,300

Total estate principal discharge

$822,000

Estate income I charge myself for: Estate income received during estate administration

$4,500

I credit myself for: Payment of estate income to J.J. Kara

$4,500

Respectfully submitted, Colleen Ryan, Estate Executrix, September 28, 2013.

Chapter 23

23-7

Solution E23-6 9/15

Cash (+A)

100,000

Trust fund principal (+SE) 9/16

Money market investment (+A)

100,000 100,000

Cash (-A) 10/16

100,000

Cash (+A)

417

Trust fund income (R,+SE) 10/19

417

Trust fund expenses (E,-SE)

300

Cash (-A) 10/27

300

Trust fund expenses (E,-SE)

Cash (-A) 11/16

Cash (+A)

417

Trust fund income (R,+SE) 11/22

417

Trust fund expenses (E,-SE)

300

Cash (-A) 12/16

300

Cash (+A)

417

Trust fund income (R,+SE) 12/28

417

Trust fund expenses (E,-SE)

700

Cash (-A) 12/31

700

Trust fund expenses (E,-SE)

100

Cash (-A) 12/31

100

Cash (+A)

208

Trust fund income (R,+SE) Collected interest for last ½ month. 12/31

208

Trust fund principal (-SE)

100,000

Trust fund income (-R,-SE)

1,459

Trust fund expenses (-E,+SE)

1,422

Money market investment (-A)

100,000

Cash (-A)

23-8

Estates and Trusts

Solution E23-7 Sooner XXV Trust Charge-Discharge Statement For the period of trust administration, September 15 to December 31, 2013 Trust principal I charge myself for: Assets included in trust - total estate principal charge

$100,000

I credit myself for: Transfer of money market investment to J.J. Kara

$100,000

Trust income I charge myself for: Trust income received during trust administration

$1,459

I credit myself for: Funeral expenses paid

700

Trust administration fee paid

100

Payments to Puppy Paradise

622

Total trust income discharge Payment of remaining trust income to J.J. Kara

$1,422 $ 37

Respectfully submitted, Colleen Ryan, Trust Officer, December 31, 2013.

Chapter 23

23-9

Solution E23-8 6/1

Cash (+A)

1,000,000

Trust fund principal (+SE) 6/2

Investment in certificate of deposit (+A)

1,000,000 500,000

Cash (-A) 6/3

Investment in stock mutual fund (+A)

500,000 500,000 500,000

Cash (-A) 7/2

Cash (+A)

2,500

Trust fund income (R,+SE) ($500,000 x 6% x 1/12 year) 7/3

Trust fund expenses (E,-SE) Cash (-A)

2,500 41 41

23-10

Estates and Trusts

Solution E 23-9 Cash (+A)

218,220

Savings accounts (+A)

300,000

Microsystems common stock (+A)

400,000

Big Casino common stock (+A)

120,000

Vintage sports car (+A)

31,000

Mountain cottage (+A)

114,500

Personal residence (+A)

457,500

Trust fund principal (+SE)

1,641,220

- To record receipt of property transferred from executor. Solution E 23-10 a.

Fair value of gross estate

$10,600,000

2013 Tax Exempt Estate

(5,250,000)

Taxable estate

$5,350,000

40% Estate Tax Due

$2,140,000

Balance inherited by Emily

$8,460,000

There were many estate planning options for Mr. Dogbert. For example, he could have given assets to Emily during his lifetime or bequeathed funds to his church or some favorite charities, excluding those amounts from his estate. If the reduced estate value would fall below the federal tax threshold, it would have left a zero inheritance tax. However, all of these options expired with Dogbert’s demise.

Chapter 23

23-11

Solution E 23-11 Fair value of gross estate

$7,200,000

2013 Tax Exempt Estate

(5,250,000)

Taxable estate

$1,950,000

40% Estate Tax Due

$780,000 $6,420,000

Balance inherited by Emily, Laura and Tom Solution E 23-12 Fair value of gross estate

$23,400,000

2013 Tax Exempt Estate

(5,250,000)

Taxable estate

$18,150,000

40% Estate Tax Due

$7,260,000

Balance inherited by Maggie

$16,140,000

23-12

Estates and Trusts

Solution P 23-1 Part 1 June 22

June 24

Cash (+A)

15,000

Interest receivable (-A)

5,000

Estate income (R,+SE)

10,000

Cash (+A)

12,000

Dividends receivable (-A) June 30

12,000

Repair expense (E,-SE)

250

Cash (-A) July 4

250

Funeral expense (E,-SE)

4,900

Cash (-A) July 12

4,900

Cash (+A)

501,300

Certificate of deposit (-A)

500,000

Estate income (R,+SE) July 15

1,300

Cash (+A)

750,000

Certificate of deposit (+A)

500,000

Interest receivable (+A)

5,000

Stock investments (+A)

460,000

Dividend receivable (+A)

12,000

Lake Michigan cottage (+A)

40,000

2012 Corvette (+A)

35,000

Estate principal (+SE) July 20

1,802,000

Devise - 2012 Corvette - Clark Olson (E,SE)

35,000

Devise- Lake cottage - Kent Olson (E,-SE)

40,000

Devise - ½ stocks -

230,000

Clark Olson (E,-SE)

Devise - ½ stocks - Kent Olson (E,-SE)

230,000

Lake Michigan cottage (-A)

40,000

2012 Corvette (-A)

35,000

Stock investments (-A)

460,000

Chapter 23

23-13

Solution P 23-1 (continued) July 21

Devise - cash fees - Clark Olson (E,-SE)

5,000

Devise - Lana Lang (E,-SE)

200,000

Devise - Jimmy’s church (E,-SE)

50,000

Devise - Symphony (E,-SE)

50,000

Cash (-A)

305,000

Distribution to Lois Olson

6,150

Cash (-A) Part 2

Closing Entries

July 22

Estate income (-R,-SE)

6,150

11,300

Funeral expenses (-E,+SE)

4,900

Repair expense (-E, +SE)

250

Distribution to Lois Olson (-A) Close estate income, expenses and distribution to Lois. Estate principal (-SE)

6,150

840,000

Devise- Corvette – C.Olson (-E,+SE)

35,000

Devise - Cottage - Kent Olson (,+SE)

40,000

Devise - ½ stock -

C. Olson (-E,+SE)

230,000

Devise - ½ stock – K. Olson (-E,+SE)

230,000

Devise - cash fees – C.Olson (-E,+SE)

5,000

Devise - Lana Lang (-E,+SE)

200,000

Devise - Jimmy’s church (-E,+SE)

50,000

Devise - Symphony (E,-SE)

50,000

Close devise distributions Estate principal (-SE)

962,000

Cash (-A) Close estate and transfer remaining cash balance to Trust

962,000

23-14

Estates and Trusts

Solution P 23-1 (continued) Part 3 Estate of Jimmy Olson Charge-Discharge Statement For the Period of Estate Administration June 15 to July 22, 2013 Estate Principal I charge myself for: Assets included in estate inventory

$1,802,000

I credit myself for: Devises paid in cash to: Clark Olson

5,000

Lana Lang

200,000

Jimmy’s church

50,000

Metropolis Symphony Orchestra

50,000

305,000

Devises distributed in kind to: Clark Olson

265,000

Kent Olson

270,000

535,000

Transferred to Trust account for Lois Olson: Cash

962,000

Total estate principal discharge

$1,802,000

Estate Income I charge myself for: Estate income received during estate administration

$11,300

I credit myself for: Funeral expenses paid

$4,900

Cottage repairs paid

250

Payment of estate net income to Lois Olson Total estate income discharge Respectfully submitted: Clark Olson, Estate Executor, July 22, 2013

5,150 6,150 $11,300

Chapter 23

23-15

Solution P 23-2 Date

Accounts

July 22

Cash (+A)

Debit

Credit

962,000

Trust fund principal (+SE) July 23

Certificate of deposit (+A)

962,000 300,000

Cash (-A) July 25

Super Stock Mutual Fund (+A)

300,000 500,000

Cash (-A) July 31

Smallville Municipal Bonds (+A)

500,000 100,000

Cash (-A) August 22

Cash (+A)

100,000 1,500

Trust income (R,+SE) August 23

1,500

Cash (+A)

305

Trust fund expenses (E,-SE)

100

Trust income (R, +SE) August 31

Distribution to Lois Olson (E,-SE)

405 3,700

Cash (-A)

3,700

23-16

Estates and Trusts

Solution P 23-3 Date

Accounts

March 15

Cash (+A)

Debit

Credit

66,500

Dividends receivable (+A)

400

Interest receivable (+A)

2,400

Life insurance receivable (+A)

500,000

Personal residence (+A)

325,000

Household furnishings and personal effects (+A)

76,000

Automobile (+A)

21,000

Investments in stocks (+A)

25,000

Investments in bonds (+A)

200,000

Estate principal (+SE)

1,216,300

Record estate inventory at fair values. March 25

Funeral expenses (E,-SE)

2,800

Cash (-A) March 30

Cash (+A)

2,800 500,000

Life insurance receivable (-A) April 9

Land (+A)

500,000 10,000

Assets subsequently discovered (-A)

10,000

Record lakefront property at cost, awaiting an appraisal. April 15

Cash (+A)

3,000

Interest receivable (-A)

2,400

Estate income (R,+SE) April 19

Land (+A)

600 18,000

Assets subsequently discovered (-A)

18,000

Adjust lakefront property to appraisal. April 28

Debts of decedent paid (E,-SE)

13,250

Cash (-A)

13,250

Chapter 23

23-17

Solution P 23-3 (continued) April 29

April 30

Cash (+A)

500

Dividends receivable (-A)

400

Estate income (R,+SE)

100

Devise - Helen Wilson (Home, furnishings and personal effects) (E,SE)

401,00 0

Devise Helen (cash) (E,-SE)

66,500

Personal residence (-A)

325,000

Household furnishings and personal effects (-A)

76,000

Cash (-A)

66,500

Transfer cash and property to Helen. Devise (stocks)- Denise (E,-SE)

25,000

Devise (automobile) - Dennis (E,-SE)

21,000

Devise (cash) - Denise (E,-SE)

350

Devise (cash) – Dennis (E, -SE)

350

Automobile (-A)

21,000

Investments in stocks (-A)

25,000

Cash (-A) (Estate Income)

700

Transfer property to Denise & Dennis. April 30

Assets subsequently discovered (+A)

28,000

Estate principal (-SE)

501,55 0

Estate income (-R, -SE)

700

Devise - Helen Wilson (-E,+SE)

467,500

Devise - Denise (-E,+SE)

25,350

Devise - Dennis (-E,+SE)

21,350

Debts of decedent paid (-E,+SE)

13,250

Funeral expenses (-E,+SE)

2,800

Closing entries.

23-18

Estates and Trusts

Solution P 23-3 (continued) April 30

Estate principal (-SE)

714,75 0

Cash (-A)

486,750

Investment in bonds (-A)

200,000

Land (-A)

28,000

Transfer estate property to Wilson Family Trust.

Chapter 23

23-19

Solution P 23-4 Estate of George Wilson Charge-Discharge Statement For the period of estate administration, March 1 to April 30, 2013 Estate principal I charge myself for: Assets included in estate inventory

$1,216,300

Assets subsequently discovered 28,000 Assets included in estate inventory - total estate principal charge

$1,244,300

I credit myself for: Funeral expenses paid Estate debts paid Devise - transfer cash, residence & furnishings to Helen

2,800 13,250 467,500

Devise - Transferred automobile to Dennis

21,000

Devise - Transferred stocks to Denise

25,000

Transferred bond investments to Wilson Family Trust

200,000

Transferred Land to Wilson Family Trust

28,000

Transferred cash to Wilson Family Trust

486,750

Total estate principal discharge

$1,244,300

Estate income I charge myself for: Estate income received during estate administration

$700

I credit myself for: Payment of estate income to Denise Wilson

$350

Payment of estate income to Dennis Wilson

350

Total payments

$700

Respectfully submitted, Estate Executrix, April 30, 2013.

23-20

Estates and Trusts

Solution P 23-5 Date

Accounts

Debit

Credit

April 30

Cash (+A)

486,750

Land (+A)

28,000

Investment in Bonds (+A)

200,000

Trust fund principal (+SE) May 3

Certificate of deposit (+A)

714,750 450,000

Cash (-A) May 25

May 31

Cash (+A)

450,000 31,300

Land (-A)

28,000

Trust income (R,+SE)

3,300

Trust expense (E,-SE)

165

Cash (-A) June 3

Cash (+A)

165 2,250

Trust income (R,+SE) June 15

Distribution to Jimmy Wilson(E,SE)

2,250 8,700

Cash (-A) June 30

Trust expense (E,-SE) Cash (-A)

8,700 165 165

Chapter 23

23-21

Solution P 23-6 Date

Accounts

May 31

Dividends receivable (+A)

1,200

Interest receivable (+A)

6,750

Life insurance receivable (+A)

Debit

Credit

750,000

Automobile (+A)

2,600

Investments in stocks (+A)

52,000

Investments in bonds (+A)

400,000

Estate principal (+SE)

1,212,550

Record estate inventory at fair values. June 5

Government bonds investment (+A)

200,000

Life insurance receivable (+A)

50,000

Assets subsequently discovered (-A) June 15

Cash (+A)

250,000 750,000

Life insurance receivable (-A) June 16

June 18

750,000

Cash (+A)

8,000

Interest receivable (-A)

6,750

Estate income (R,+SE)

1,250

Funeral expenses (E,-SE)

4,300

Cash (-A) June 22

4,300

Interest receivable (+A)

15,000

Assets subsequently discovered (-A) Cash (+A)

June 23

15,000 215,000

Government bonds investment (-A)

200,000

Interest receivable (-A)

15,000

Cash (+A)

50,000

Life insurance receivable (-A) June 24

Debts of decedent paid (E,-SE) Cash (-A)

50,000 18,250 18,250

23-22

Estates and Trusts

Solution P 23-6 (continued) June 28

Cash (+A)

1,600

Dividends receivable (-A)

1,200

Estate income (R,+SE) June 30

June 30

400

Devise (stocks) - Sue (E,-SE)

52,000

Devise (automobile) - Pat (E,-SE)

2,600

Executrix fees (E,-SE)

2,500

Devise - Humane society (E,-SE)

1,650

Automobile (-A)

2,600

Investments in stocks (-A)

52,000

Cash (-A)

4,150

Assets subsequently discovered (+A)

265,000

Estate income (-R, -SE)

1,650

Estate principal (-SE)

185,350

Devise - Sue (-E,+SE)

52,000

Devise - Pat (-E,+SE)

2,600

Devise - Humane society (-E,+SE)

1,650

Debts of decedent paid (-E,+SE)

18,250

Executrix fees (-E,+SE)

2,500

Funeral expenses (-E,+SE)

4,300

Closing entries June 30

Estate principal (-SE)

1,397,900

Cash (-A)

997,900

Investment in bonds (-A)

400,000

Transfer estate property to Josephson Family Trust.

Chapter 23

23-23

Solution P 23-7 Estate of Tom Josephson Charge-Discharge Statement For the period of estate administration, May 16 to June 30, 2013 Estate principal I charge myself for: Assets included in estate inventory

$1,212,550

Assets subsequently discovered 265,000 Assets included in estate inventory - total estate principal charge

$1,477,550

I credit myself for: Funeral expenses paid

4,300

Estate debts paid

18,250

Executrix fees paid

2,500

Devise - Transferred automobile to Pat

2,600

Devise - Transferred stocks to Sue

52,000

Transferred bond investments to Josephson Family Trust Transferred cash to Josephson Family Trust Total estate principal discharge

400,000 997,900 $1,477,550

Estate income I charge myself for: Estate income received during estate administration

$1,650

I credit myself for: Payment of estate income to Humane Society Respectfully submitted, Estate Executrix, June 30, 2013.

$1,650

23-24

Estates and Trusts

Solution P 23-8 Date

Accounts

Debit

Credit

June 30

Cash (+A)

997,900

Investment in Bonds (+A)

400,000

Trust fund principal (+SE) July 5

Certificate of deposit (+A)

1,397,900 750,000

Cash (-A) July 31

750,000

Trust expense (E,-SE)

275

Cash (-A) August 5

Cash (+A)

275 3,750

Trust income (R,+SE) August 19

Distribution to Academy (E,-SE)

3,750 15,000

Cash (-A)

15,000

Chapter 1 ELECTRONIC SUPPLEMENT SOLUTIONS Solution W1-1 The acquisition method follows traditional accounting. The net assets acquired in the business combination are recorded based on their fair market value at the combination date. Under pooling, the net assets are recorded based on their existing book values on the records of the combining companies. Solution W1-2 If total paid-in capital of the combining companies exceeded the par or stated value of the outstanding shares of the surviving company, the amount of excess becomes the additional paid-in capital of the surviving company, and the total retained earnings of the combining companies becomes the retained earnings of the surviving company. If the par or stated value of outstanding shares of the surviving exceeded the total paid-in capital of the combining companies, the combined retained earnings is reduced by the excess and the surviving company has no additional paid-in capital. Solution W1-3 Under both pooling and the acquisition method, all costs of the combination are recorded as expenses of the combined companies in the year of combination. Costs of registering and issuing securities are an exception. These are charged against additional paid-in of the parent/acquirer. Solution W1-4 1.

Solution W1-5 1. Solution W1-6 1.

Solution W1-7 Net assets (+A) Common stock (+SE) APIC (+SE) Retained earnings (+SE) Expenses (E,-SE) Cash (-A)

2,200 1,200 800 200 60 60

Solution W1-8 Net assets (+A) 2,070 Common stock (+SE) Retained earnings (+SE) Investment in Service Corporation (-A)

1,470 570 30

Solution W1-9 Pooled Balance Sheets Tansy

Vatters

800,000 shares

1,000,000 shares

Current assets

15,000

4,000

19,000

Plant assets - net

40,000

6,000

46,000

Total assets

55,000

10,000

65,000

Liabilities

10,000

3,000

13,000

Common stock

30,000

4,000

38,000

40,000

APIC

3,000

2,000

Retained earnings

12,000

1,000

12,000

Total equities

55,000

10,000

65,000

Solution W1-10 1.

Net assets (+A) Common stock (+SE) APIC +-SE) Retained earnings (+SE)

800

Net assets (+A) Common stock (+SE) Retained earnings (+SE)

800

350 150 300

770 30

Solution W1-11 Net assets (+A) Treasury stock (-SE) Common stock (+SE) APIC (+SE) Retained earnings (+SE)

11,500 500 10,000 1,000 1,000

Solution W1-12 Part 1. a. Investment in EPA (+A) Common stock (+SE) APIC (+SE) Retained earnings (+SE) b.

18,300 13,000 4,000 1,300

Investment in Century (+A) 18,700 Common stock (+SE) 12,000 Retained earnings (+SE) 6,700 Note: Century=s Inventory and Retained Earnings would each have increased by $1,000 to reflect the change to FIFO. The adjustment would have been made prior to recording the combination.

Other expenses (E,-SE) Cash (-A)

200 200

Part 2. Patio Assets Cash Receivables - net Inventories Investment in EPA Investment in Century Land Building - net Equipment - net Total assets Liabilities & Equity Accounts payable Bonds payable Capital stock APIC Retained earnings Total equities

EPA

2,000 3,000 5,500 21,000

4,000 5,000 14,000 18,300 18,700 3,000 10,500 8,500 82,000

Eliminations DR CR POOLE D 4,000 5,000 14,000 18,300 0 18,700 0 3,000 10,500 8,500 45,000

2,300 0 6,000 2,700 10,000 21,000

5,000 3,000 41,000 8,300 24,700 82,000

5,000 3,000 25,000 1,300 10,700 45,000

Century Combined

3,000 3,500 6,000

1,000 1,500 8,000

37,000

1,000 7,500 3,000 24,000

25,000 1,300 10,700 37,000

2,700 3,000 10,000 4,300 4,000 24,000

18,300 18,700

16,000 7,000 14,000 37,000 37,000

Solution W1-13 Pooling Ainsley

Biker

Elimin. CR

Assets Cash 3,000 Receivables - net 5,500 Inventories 6,000 Other current assets 1,500 Investment in Biker 7,000 Plant assets - net 16,000 Total assets 39,000

5,000 12,000

Consolidate d 4,000 7,500 9,500 2,000 7,000 0 21,000 44,000

Liabilities & Equity Accounts payable 5,000 Other liabilities 3,800 Capital stock 20,000 APIC 3,000 Retained earnings 7,200 Total equities 39,000

1,800 3,200 3,000 1,200 2,800 12,000

3,000 1,200 2,800 7,000

6,800 7,000 20,000 3,000 7,200 44,000

Biker

1,000 2,000 3,500 500

Acquisition Method Ainsley Assets Cash 3,000 Receivables - net 5,500 Inventories 6,000 Other current assets 1,500 Investment in Biker 12,500 Goodwill Plant assets - net 16,000 Total assets 44,500

5,000 12,000

Liabilities & Equity Accounts payable 5,000 Other liabilities 3,800 Capital stock 20,000 APIC 10,500 Retained earnings 5,200 Total equities 44,500

1,800 3,200 3,000 1,200 2,800 12,000

1,000 2,000 3,500 500

7,000

Elimin. CR

500 100 2,300 2,400

200 3,000 1,200 2,800 12,500

Consolidate d 4,000 7,500 10,000 2,100 12,500 0 2,300 23,400 49,300

12,500

6,800 6,800 20,000 10,500 5,200 49,300

Chapter 3 ELECTRONIC SUPPLEMENT SOLUTIONS Solution W3-1 If the combining companies continue to exist as separate legal entities, then pooling procedures are based on parentsubsidiary accounting procedures. Solution W3-2 The parent company accounts for its investment on its records using the equity method of accounting (cost method or partial equity method accounting are also acceptable). In preparing financial statements, the parent company must consolidate the pooled subsidiary. Pooling differs from acquisition method accounting in that it is based on recorded book values of the subsidiary=s net assets, not fair values at the combination date. Solution W3-3 A parent company may pool all of the retained earnings of a 100% owned subsidiary, as long as the par value of shares issued in the combination is less than or equal to the par value of the outstanding stock of the subsidiary. Solution W3-4 The Investment account represents the parent company=s share of the net assets of the subsidiary company. The capital stock account records parent company shares issued in the combination at par value. Retained earnings are subsidiary company retained earnings being recognized by the combined company (again based on the percentage of shares acquired). The APIC represents a plug figure to balance the entry. It also can be viewed as APIC of the subsidiary being recognized by the combined company. Solution W3-5 Yes, the parent was able to recognize the full amount of retained earnings. This is evidenced by the credit to retained earnings. The APIC will be less than the parent company APIC prior to the pooling. The entry records a decrease in APIC. Solution W3-6 GAAP requires that subsequent acquisition of noncontrolling interest shares be accounted for using the acquisition method. Therefore, the 4% interest would have been recorded using fair value at the acquisition date. All subsequent share purchases are treated as treasury stock transactions. Solution W3-7 1.

Investment in Sun (+A) Capital stock (+SE) APIC (+SE) Retained earnings (+SE)

1,260 500 580 180

Solution W3-7 (continued) 2. Eliminations Pal *

Sun

Debits

Credits

Current assets

4,000

Investment in Sun

1,260

Plant assets - net

6,000

1,400

7,400

Total assets

11,260

2,200

12,200

Liabilities

4,000

800

4,800

Noncontrolling interest (10%)

800

Consolidated 4,800

1,260

140

Capital stock

3,500

800

3,500

Additional paid-in capital

2,580

400

2,580

Retained earnings

1,180

200

1,180

Total equities

11,260

2,200

12,200

* Reflects investment entry. Solution W3-8 1.

Investment in Sir (+A) 500,000 Common stock (+SE) APIC (+SE) Retained earnings (+SE)

250,000 100,000 150,000 Eliminations

Pam * Capital stock

Sir

Debits

Credits

Consolidated

1,000

300

1,000

Additional paid-in capital

600

Retained earnings

350

150

350

* Reflects investment

Solution W3-8 (continued) 2.

Investment in Sir (+A) 450,000 Common stock (+SE) Retained earnings (+SE)

350,000 100,000 Eliminations

Pam * Noncontrolling interest (10%)

Sir

Debits

Credits

Consolidated 50

Capital stock

850

300

850

Additional paid-in capital

500

Retained earnings

300

150

300

* Reflects investment Solution W3-9 1.

Investment in Sal (+A) Common stock (+SE) APIC (+SE) Retained earnings (+SE)

5,000,000 3,000,000 1,500,000 500,000 Eliminations

Pen *

Sal

Debits

Credits

Consolidated

Capital stock

13,000

3,000

13,000

Additional paid-in capital

2,500

1,500

2,500

Retained earnings

5,500

500

5,500

* Reflects investment 2.

Investment in Sal (+A) Common stock (+SE)

5,000,000 5,000,000 Eliminations Pen *

Sal

Debits

Credits

Consolidated

Capital stock

15,000

3,000

15,000

Additional paid-in capital

1,000

1,500

1,000

Retained earnings

5,000

500

5,000

Solution W3-9 (continued) 3.

Investment in Sal (+A) Common stock (+SE) APIC (+SE) Retained earnings (+SE)

4,500,000 3,000,000 1,050,000 450,000 Eliminations

Pen * Noncontrolling interest (10%)

Sal

Debits

Credits

500

Consolidated 500

Capital stock

13,000

3,000

13,000

Additional paid-in capital

2,050

1,500

2,050

Retained earnings

5,450

500

5,450

Investment in Sal (+A) APIC (-SE) Common stock (+SE)

4,500,000 500,000 5,000,000 Eliminations Pen *

Noncontrolling interest (10%) Capital stock Additional paid-in capital Retained earnings

Sal

Debits

Credits 500

Consolidated 500

15,000

3,000

15,000

500

1,500

500

5,000

500

5,000

Chapter 4 ELECTRONIC SUPPLEMENT SOLUTIONS Solution W4-1 The method used by a parent company in accounting for its subsidiary can be determined by examining the separate financial statements of the parent company and the subsidiary. If the cost method is used, the parent company will report dividend income from the subsidiary and the investment account will be stated at original cost (fair value). If the equity method is used, the parent company will report investment income from the subsidiary, and the investment account will reflect subsidiary income since acquisition. When the equity method is used but the difference between investment fair value and book value has not been amortized on the parent company’s books, the difference between the investment balance and underlying book value at any statement date will reflect the difference between the investment fair value and underlying book value at the time of acquisition. Solution W4-2 When the cost method is used, reciprocity between the investment account balance and the underlying subsidiary equity is established by adjusting the parent company’s investment and retained earnings accounts for the parent’s share of the change in subsidiary retained earnings between the dates the subsidiary was acquired and the beginning of the current year. Solution W4-3 1

Cost method Cash 30,000 Dividend income To record receipt of dividends ($40,000  75%). Cost method Investment cost January 1, 2013 Less: Dividends in excess of earnings ($30,000 - $10,000)  75% Investment account balance — cost method Equity method Investment in Sin 45,000 Income from Sin To record share of Sin’s net income ($60,000  75%). Cash

30,000 Investment in Sin To record receipt of dividends ($40,000  75%).

30,000

$300,000 (15,000) $285,000

45,000

30,000

Investment balance under equity method Investment cost Add: Share of income for 2013 and 2014 ($70,000  75%) Less: Share of dividends for 2013 and 2014 ($70,000  75%) Investment in Sin balance December 31, 2014

$300,000 52,500 (52,500) $300,000

Consolidated net income Pin’s separate income Add: Investment income Controlling share of consolidated net income

$ 90,000 45,000 $135,000

109

110

Consolidation Techniques and Procedures

Solution W4-4 Cost method 1a

Investment balance December 31, 2011 (original cost) Price implies book value equals fair value

Consolidated net income under cost method Net income of Pot Less: Dividend income from Sil ($25,000  80%) Separate income of Pot Add: Pot’s share of Sil’s income ($60,000  80%) Controlling share of consolidated net income

$160,000

$120,000 (20,000) 100,000 48,000 $148,000

Equity method 2a

2b 2c

Investment in Sil December 31, 2011 Cost January 1, 2011 Add: Income from Sil Less: Dividends from Sil Investment in Sil under equity method

$160,000 48,000 (20,000) $188,000

Controlling share of consolidated net income (equal to Pot’s income)

$120,000

Noncontrolling interest December 31, 2011 Sil’s equity January 1 Add: Net income Deduct: Dividends Sil’s equity at December 31 Noncontrolling interest percentage Noncontrolling interest December 31

$200,000 60,000 (25,000) $235,000 20% $ 47,000

Chapter 4

111

Solution W4-5 1

Pan Company Balance Sheet at December 31, 2011 Assets Cash Accounts receivable Other assets Investment in Sim Total assets

2,500 15,000 120,000 88,000

$225,500

Liabilities and Stockholders’ Equity Liabilities $ 80,000 Stockholders’ equity: Capital stock $100,000 Paid-in excess 10,000 Retained earnings 35,500 145,500 Total equities $225,500

Pan Company and Subsidiary Consolidated Income Statement for the year ended December 31, 2011 Sales Cost of goods sold Gross profit Operating expenses Total consolidated net income Less: Noncontrolling interest shareb Controlling share of consolidated net income b

$190,000 80,000 110,000 65,000 45,000 4,000 $ 41,000

Noncontrolling interest share is 20% of Sim’s $20,000 income.

Pan Company and Subsidiary Consolidated Balance Sheet at December 31, 2011 Assets Cash Accounts receivable Other assets Goodwilla

$ 17,500 40,000 220,000 10,000

Total assets

$287,500

a b c

Liabilities and Stockholders’ Equity Liabilities $110,000 Stockholders’ equity: Capital stock $100,000 Paid-in excess 10,000 Retained earningsb 43,500 Noncontrolling interestc 24,000 177,500 Total equities $287,500

(Cost $88,000 – implies total fair value = $110,000. Book value equals $100,000. Therefore, goodwill equals $10,000.) Retained earnings — Pan January 1 of $22,500 plus controlling share of consolidated net income of $41,000 less dividends of Pan of $20,000. Noncontrolling interest January 1 of $22,000 (at fair value) plus noncontrolling interest share of income of $4,000 less noncontrolling interest dividends of $2,000.

112

Consolidation Techniques and Procedures

Solution W4-6 Preliminary computations Investment cost

$ 98,000

Implied total fair value ($98,000 / 70%) Book value of Sim Excess fair value over book value

$140,000 100,000 $ 40,000

Excess allocated to: Inventories (sold in 2011) Patents (amortized over 10 years at $3,000 per year) Excess fair value over book value

$ 10,000 30,000 $ 40,000

Conversion to equity method Retained Earnings — Pil

Investment in Sim

Income from Sim

Prior-year effect Excess allocated to inventory Patent amortization 2011

$(10,000) (3,000)

Current-year effect Patent amortization Total Adjustment

$(13,000)

(3,000) $(16,000)

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

Phil’s 70% share

$ (9,100)

$(11,200)

$(2,100)

Working paper entries in journal form A

Income from Sim 2,100 9,100 Retained earnings — Pil Investment in Sim 11,200 To correct investment income, the investment in Sim account and retained earnings for amortization of fair value — book value differentials.

Income from Sim 18,900 Dividends 14,000 Investment in Sim 4,900 To eliminate income and dividends from Sim and return the investment account to its beginning-of-the-period balance.

40,000 Retained earnings — Sim 80,000 Capital stock — Sim Patents 27,000 Investment in Sim 102,900 Noncontrolling interest December 31, 2011 44,100 To eliminate reciprocal equity and investment balances, establish beginning noncontrolling interest, and enter unamortized patents.

Other expenses Patents To enter current patent amortization.

3,000

Noncontrolling interest share Dividends — Sim

8,100

3,000

6,000

Chapter 4

113

Noncontrolling Interest 2,100 Enter noncontrolling interest share of sub. income and dividends

114

Consolidation Techniques and Procedures

Solution W4-6 (continued) Conversion to equity as first working paper entry: Pil Corporation and Subsidiary Consolidation Working Papers for the year ended December 31, 2012

Income Statement Sales Income from Sim

Pil

Sim 80%

$ 500,000 21,000

$ 100,000

240,000* 174,000*

40,000* 30,000*

Cost of sales Other expenses Consolidated NI Noncontrolling share Controlling share of NI

$ 107,000

Retained Earnings Retained earnings — Pil

$ 110,000

Retained earnings December 31 Balance Sheet Cash Accounts receivable Inventories

107,000✓ 70,000*

Dividends

3,000

8,100

9,100

280,000* 207,000* $ 113,000 8,100* $ 104,900

40,000

$ 100,900

c 40,000 104,900

30,000✓ 20,000*

b e

14,000 6,000

70,000*

50,000

$ 135,800

30,000 20,000 15,000 105,000

58,000 40,000 60,000 220,000 119,000

a 11,200 b 4,900 c 102,900 c 27,000 d 3,000

$ 497,000

$ 170,000

50,000 300,000 147,000✓

$ 497,000 Noncontrolling interest January 1 Noncontrolling interest December 31 Deduct

30,000

Patents

$ 600,000

$ 147,000

Plant assets — net Investment in Sim

Accounts payable Capital stock Retained earnings

Consolidated Statements

a 2,100 b 18,900

Retained earnings — Sim Controlling share of NI

Adjustments and Eliminations

40,000 80,000

24,000 $ 572,000 $

c 80,000

50,000✓

88,000 60,000 75,000 325,000

90,000 300,000 135,800

$ 170,000 c e

44,100 2,100

46,200 $ 572,000

Chapter 4

115

Solution W4-7 (continued) Alternative solution — no initial conversion to equity Working paper entries in journal form a

Income from Sim 21,000 Dividends 14,000 Investment in Sim 7,000 To establish reciprocity as of the beginning of the period. [This entry eliminates the investment increase for 2012 as it was reported in Pil’s books against the dividends received from Sim, and credits the investment account for the difference. The investment account balance is now the beginning-of-the-period balance.]

7,000 Retained earnings — Pil 80,000 Capital stock — Sim 40,000 Retained earnings — Sim Patents 30,000 Investment in Sim 112,000 Noncontrolling interest January 1 45,000 To eliminate reciprocal investment and equity amounts, establish beginning noncontrolling interest, enter the original patents, and charge Pil’s retained earnings for 70% of the excess allocated to inventories.

2,100 Retained earnings — Pil Noncontrolling interest 900 Other expenses 3,000 Patents 6,000 To enter the current year’s patent amortization and charge both Pil’s retained earnings and the noncontrolling interest for patent amortization for 2011.

Noncontrolling Interest share 8,100 6,000 Dividends — Sim Noncontrolling Interest 2,100 To enter noncontrolling interest share of sub.income and dividends

116

Consolidation Techniques and Procedures

Solution W4-7 (continued) Alternative solution — no initial conversion to equity Pil Corporation and Subsidiary Consolidation Working Papers for the year ended December 31, 2012

Income Statement Sales Income from Sim Cost of sales Other expenses Consolidated NI Noncontrolling expense Controlling share of NI Retained Earnings Retained earnings — Pil

Pil

Sim 80%

$ 500,000 21,000 240,000* 174,000*

$ 100,000

$ 107,000

$ 107,000✓ 70,000*

Dividends Retained earnings December 31 Balance Sheet Cash Accounts receivable Inventories

3,000

8,100

280,000* 207,000* $ 113,000 8,100*

40,000

$ 104,900

b 7,000 c 2,100 b 40,000

$ 100,900 104,900

30,000✓ 20,000*

a d

14,000 6,000

70,000*

50,000

$ 135,800

30,000 20,000 15,000 105,000

58,000 40,000 60,000 220,000 119,000

b 30,000 $ 497,000 $

$ 497,000

a 7,000 b 112,000 c 6,000

$ 170,000

50,000 $ 300,000 147,000✓

Noncontrolling interest January 1 Noncontrolling interest December 31 Deduct

30,000

Patents

$ 600,000

$ 147,000

Plant assets — net Investment in Sim

Accounts payable Capital stock Retained earnings

Consolidated Statements

a 21,000 40,000* 30,000*

$ 110,000

Retained earnings — Sim Controlling share of NI

Adjustments and Eliminations

88,000 60,000 75,000 325,000

24,000 $ 572,000

40,000 80,000 b 80,000 50,000✓

90,000 300,000 131,000

$ 170,000 C

900

b d

45,000 2,100

46,200 $ 572,000

Chapter 4

117

Solution W4-7 Supporting computations Investment cost January 1, 2011 Implied total fair value ($180,000 / 60%) Book value Excess fair value over book value – allocated to machinery 2011 Amortization of excess

Machinery $50,000/4 years

$180,000 $300,000 250,000 $ 50,000 $12,500

Consolidated net income: Put’s separate income ($116,000 - $6,000 dividends from Set) Add: Income from Set (($60,000 - $12,500 amortization)  60%) Controlling share of consolidated net income

$110,000 28,500 $138,500

Investment in Set (equity basis): Investment cost January 1, 2011 Share of Set’s income for 2011 Less: Dividends for 2011 ($20,000  60%) Investment in Set December 31, 2011 (under the equity method)

$180,000 28,500 (12,000) $196,500

Working paper entries in general journal form: a

Dividends receivable 6,000 Dividends from Set 6,000 Error correction—dividends declared but not recorded by Put.

Dividends from Set 12,000 Dividends Error correction from using the cost method.

12,000

50,000 Retained earnings — Set 200,000 Capital stock — Set 50,000 Plant and equipment — net Investment in Set 180,000 Noncontrolling interest 120,000 To eliminate reciprocal equity and investment balances and enter excess allocated to plant and equipment, and beginning noncontrolling interest.

Operating expenses 12,500 12,500 Plant and equipment — net To record depreciation on excess allocated to plant and equipment.

Dividends payable Dividends receivable To eliminate reciprocal balances.

6,000

Accounts payable Accounts receivable To eliminate reciprocal balances.

5,000

Noncontrolling Interest Share Dividends — Set

19,000

6,000

5,000

8,000

118

Consolidation Techniques and Procedures

Noncontrolling Interest 11,000 To enter noncontrolling interest share of sub.income and dividends

Chapter 4

119

Solution W4-7 (continued) Put Corporation and Subsidiary Consolidation Working Papers for the year ended December 31, 2011 Put Income Statement Net sales Dividends from Set Cost of goods sold Operating expenses Consolidated net income Noncontrolling share Controlling share of NI Retained Earnings Retained earnings — Put Retained earnings — Set Controlling share of NI Dividends Retained earnings December 31 Balance Sheet Cash Accounts receivable Inventories Other current assets Land Plant and equipment — net Investment in Set Dividends receivable

Accounts payable Dividends payable Other liabilities Capital stock Retained earnings

$900,000 6,000 600,000* 190,000*

150,000* 90,000*

$ 1,200,000 b

12,000

12,500

g $116,000

6,000

750,000* 292,500* 157,500 19,000* 138,500

112,000

19,000

$ 60,000

$112,000 $ 50,000 116,000✓ 100,000*

$ 90,000

26,000 26,000 82,000 80,000 160,000 340,000 200,000

15,000 20,000 60,000 5,000 30,000 230,000

$914,000

$360,000

$ 24,000

$ 15,000 10,000 45,000 200,000

62,000 700,000 128,000✓

50,000 138,500

60,000✓ 20,000*

$128,000

Noncontrolling interest January 1 Noncontrolling interest December 31 Deduct

$300,000

Consolidated Statements

$914,000

Adjustments and Eliminations

Set 80%

b g

50,000

6,000

12,000 8,000

100,000* $

150,500

41,000 41,000 142,000 85,000 190,000 607,500

5,000

d 12,500 c 200,000 e 6,000

$ 1,106,500 f e

5,000 6,000

c 200,000

90,000✓

34,000 4,000 107,000 700,000 150,500

$360,000 c 100,000 g 11,000

111,000 $ 1,106,500

120

Consolidation Techniques and Procedures

Solution W4-8 Preliminary computations Note: Dividend income ($57) / Total Dividend ($60) = 95%. Fair value — book value differential: Investment cost July 1, 2011

$104,500

Implied fair value ($104,500 / 95%) Book value Excess fair value over book value

$110,000 71,000 $ 39,000

Allocation and amortization schedule: Plant and equipment (5-year life) Patents (amortized over 10 years)

Allocation $15,000 24,000 $39,000

Amortization 2012 — 2014 $ 9,000 7,200 $16,200

Unamortized June 30, 2014 $ 6,000 16,800 $22,800

Sue’s reported net income Less: Current year amortization of excess fair values Sue’s adjusted net income

$ 62,000 (5,400) $ 56,600

Noncontrolling interest share (5%) Pap’s Income from Sue (95%)

$ 2,830 $ 53,770

Consolidated net income Pap’s separate income ($115,000 - $57,000 dividend income) Add: Income from Sue Controlling share of consolidated net income

$ 58,000 53,770 $111,770

Cost-to-Equity Conversion Schedule Retained Investment Income Earnings in Sue from Sue Prior years’ effect 95% of Sue’s change in retained earnings ($81,000 - $21,000  95%)

$57,000

Amortization of excess (95%): Plant and equipment Patents

(8,550) (6,840)

Current year’s effect Reclassify dividend income as a decrease in the investment account

(57,000)

Equity in Sue’s adjusted Income

53,770

$53,770

$38,380

$53,770

$41,610

Dividend Income

$(57,000)

Chapter 4

121

Solution W4-8 (continued) A

Dividend income 57,000 Investment in Sue 38,380 41,610 Retained earnings — Pap Income from Sue 53,770 To convert Pap’s investment from cost to equity as explained in the conversion to equity schedule.

Income from Sue 53,770 Investment in Sue 3,230 Dividends 57,000 To eliminate income and dividends and return the investment account to its beginning-of-the-period balance.

81,000 Retained earnings — Sue Unamortized excess 22,800 50,000 Capital stock — Sue Investment in Sue 146,110 Noncontrolling interest 7,690 To eliminate reciprocal equity and investment balances, and enter the unamortized excess and beginning noncontrolling interest.

Plant and equipment 15,000 Patents 16,800 Accumulated depreciation 9,000 Unamortized excess 22,800 To allocate the unamortized excess as of June 30, 2014.

Other expenses 5,400 Accumulated depreciation Patents To enter current year amortization of excess.

3,000 2,400

100,000 Note payable — 8% Note receivable 100,000 To eliminate reciprocal note receivable and payable amounts.

Interest payable 4,000 Interest receivable 4,000 To eliminate reciprocal interest receivable and payable amounts.

Interest income 8,000 Interest expense 8,000 To eliminate reciprocal interest income and expense amounts.

Dividends payable 14,250 Dividends receivable 14,250 To eliminate reciprocal dividends receivable and payable amounts.

Noncontrolling Interest share 2,830 3,000 Dividends — Sue Noncontrolling Interest 170 To enter noncontrolling interest share of sub.income and dividends

122

Consolidation Techniques and Procedures

Solution W4-8 (continued) Pap and Subsidiary Consolidation Working Papers for the year ended June 30, 2015 Pap Income Statement Sales Dividend income Income from Sue Interest income Cost of sales Interest expense Other expenses Consolidated NI Noncontrolling share Controlling share of NI Retained Earnings Retained earnings — Pap

$ 500,000 57,000

8,000

420,000* e

5,400

2,830

215,400* $ 114,600 2,830* $ 111,770

41,610

b j

57,000 3,000

$ 189,610

81,000 111,770

62,000✓ 60,000*

50,000*

83,000

$ 251,380

22,000 30,000

67,250 60,000 4,000 14,250 100,000 300,000 72,000*

100,000

g i 75,000 200,000 50,000*

$ 678,000

$ 277,000

40,000 25,000

400,000 213,000✓ $ 678,000

Noncontrolling interest June 30, 2014 Noncontrolling interest June 30, 2015 Deduct

81,000

53,770

Note receivable Patents Unamortized excess

$ 213,000

104,500

Note payable — 8% Capital stock Retained earnings

62,000

115,000✓ 50,000*

Investment in Sue

Accounts payable Dividends payable Interest payable

57,000 53,770 8,000

$ 148,000

Dividends

Balance Sheet Cash Accounts receivable Interest receivable Dividends receivable Other assets Plant and equipment Accumulated Depreciation

120,000* 8,000* 60,000*

Consolidated Statements $ 750,000

a b h

150,000*

Retained earnings — Sue Controlling share of NI

Retained earnings - June 30

$ 250,000

8,000 300,000*

$ 115,000

Adjustments and Eliminations

Sue

4,000 14,250 175,000 515,000

15,000

a b

38,380 3,230

d c

16,800 22,800

89,250 90,000

d 9,000 e 3,000 c 146,110

134,000*

f 100,000 e 2,400 d 22,800

14,400 $ 749,650

25,000 15,000 4,000 100,000

i 14,250 g 4,000 f 100,000

50,000

170

65,000 25,750

400,000 251,380

83,000✓ $ 277,000 c

7,690 7,520 $ 749,650