ADVANCED ACCOUNTING 15TH EDITION BY JOE BEN HOYLE, THOMAS SCHAEFER AND TIMOTHY DOUPNIK SOLUTIONS MAN by QuentinAxel

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ADVANCED ACCOUNTING 15TH EDITION BY JOE BEN HOYLE, THOMAS SCHAEFER AND TIMOTHY DOUPNIK SOLUTIONS MANUAL CHAPTER 1-19

CHAPTER 1 THE EQUITY METHOD OF ACCOUNTING FOR INVESTMENTS Chapter Outline I.

Four methods are principally used to account for an investment in equity securities along with a fair value option. A. Fair value method: applied by an investor when only a small percentage of a company‘s voting stock is held. 1. The investor recognizes income when the investee declares a dividend. 2. Portfolios are reported at fair value. If fair values are unavailable, investment is reported at cost. B. Cost Method: applied to investments without a readily determinable fair value. When the fair value of an investment in equity securities is not readily determinable, and the investment provides neither significant influence nor control, the investment may be measured at cost. The investment remains at cost unless 1. A demonstrable impairment occurs for the investment, or 2. An observable price change occurs for identical or similar investments of the same issuer. The investor typically recognizes its share of investee dividends declared as dividend income. C. Consolidation: when one firm controls another (e.g., when a parent has a majority interest in the voting stock of a subsidiary or control through variable interests, their financial statements are consolidated and reported for the combined entity. D. Equity method: applied when the investor has the ability to exercise significant influence over operating and financial policies of the investee. 1. Ability to significantly influence investee is indicated by several factors including representation on the board of directors, participation in policy-making, etc. 2. GAAP guidelines presume the equity method is applicable if 20 to 50 percent of the

outstanding voting stock of the investee is held by the investor. Current financial reporting standards allow firms to elect to use fair value for any new investment in equity shares including those where the equity method would otherwise apply. However, the option, once taken, is irrevocable. The investor recognizes both investee dividends and changes in fair value over time as income.

II.

Accounting for an investment: the equity method A. The investor adjusts the investment account to reflect all changes in the equity of the investee company. B. The investor accrues investee income when it is reported in the investee‘s financial statements. C. Dividends declared by the investee create a reduction in the carrying amount of the Investment account. This book assumes all investee dividends are declared and paid in the same reporting period.

III.

Special accounting procedures used in the application of the equity method A. Reporting a change to the equity method when the ability to significantly influence an investee is achieved through a series of acquisitions. 1. Initial purchase(s) will be accounted for by means of the fair value method (or at cost) until the ability to significantly influence is attained. 2. When the ability to exercise significant influence occurs following a series of stock purchases, the investor applies the equity method prospectively. The total fair value at the date significant influence is attained is compared to the investee‘s book value to determine future excess fair value amortizations. B. Investee income from other than continuing operations 1. The investor recognizes its share of investee reported other comprehensive income (OCI) through the investment account and the investor‘s own OCI. 2. Income items such as discontinued operations that are reported separately by the investee should be shown in the same manner by the investor. The materiality of these other investee income elements (as it affects the investor) continues to be a criterion for separate disclosure. C. Investee losses 1. Losses reported by the investee create corresponding losses for the investor. 2. A permanent decline in the fair value of an investee‘s stock should be recognized immediately by the investor as an impairment loss. 3. Investee losses can possibly reduce the carrying value of the investment account to a zero balance. At that point, the equity method ceases to be applicable and the fair-value method is subsequently used. D. Reporting the sale of an equity investment 1. The investor applies the equity method until the disposal date to establish a proper book value. 2. Following the sale, the equity method continues to be appropriate if enough shares are still held to maintain the investor‘s ability to significantly influence the investee. If that ability has been lost, the fair-value method is subsequently used.

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IV.

Excess investment cost over book value acquired A. The price an investor pays for equity securities often differs significantly from the investee‘s underlying book value primarily because the historical cost based accounting model does not keep track of changes in a firm‘s fair value. B. Payments made in excess of underlying book value can sometimes be identified with specific investee accounts such as inventory or equipment. C. An extra acquisition price can also be assigned to anticipated benefits that are expected to be derived from the investment. In accounting, these amounts are presumed to reflect an intangible asset referred to as goodwill. Goodwill is calculated as any excess payment that is not attributable to specific identifiable assets and liabilities of the investee. Because goodwill is an indefinite-lived asset, it is not amortized.

Deferral of intra-entity gross profit in inventory A. The investor‘s share of intra-entity profits in ending inventory are not recognized until the transferred goods are either consumed or until they are resold to unrelated parties. B. Downstream sales of inventory 1. ―Downstream‖ refers to transfers made by the investor to the investee. 2. Intra-entity gross profits from sales are initially deferred under the equity method and then recognized as income at the time of the inventory‘s eventual disposal. 3. The amount of gross profit to be deferred is the investor‘s ownership percentage multiplied by the markup on the merchandise remaining at the end of the year. C. Upstream sales of inventory 1. ―Upstream‖ refers to transfers made by the investee to the investor. 2. Under the equity method, the deferral process for intra-entity gross profits is identical for upstream and downstream transfers. The procedures are separately identified in Chapter One because the handling does vary within the consolidation process.

Answers to Discussion Questions The textbook includes discussion questions to stimulate student thought and discussion. These questions are also designed to allow students to consider relevant issues that might otherwise be overlooked. Some of these questions may be addressed by the instructor in class to motivate student discussion. Students should be encouraged to begin by defining the issue(s) in each case. Next, authoritative accounting literature (FASB ASC) or other relevant literature can be consulted as a preliminary step in arriving at logical actions. Frequently, the FASB Accounting Standards Codification will provide the necessary support. Unfortunately, in accounting, definitive resolutions to financial reporting questions are not always available. Students often seem to believe that all accounting issues have been resolved in the past so that accounting education is only a matter of learning to apply historically prescribed procedures. However, in actual practice, the only real answer is often the one that provides the fairest representation of the firm‘s transactions. If an authoritative solution is not available, students should be directed to list all of the issues involved and the consequences of possible alternative actions. The various factors presented can be weighed to produce a viable solution. The discussion questions are designed to help students develop research and critical thinking skills in addressing issues that go beyond the purely mechanical elements of accounting.

Did the Cost Method Invite Manipulation? The cost method of accounting for investments often caused a lack of objectivity in reported income figures. With a large block of the investee‘s voting shares, an investor could influence the amount and timing of the investee‘s dividend declarations. Thus, when enjoying a good earnings year, an investor might influence the investee to withhold declaring a dividend until needed in a subsequent year. Alternatively, if the investor judged that its current year earnings ―needed a boost,‖ it might influence the investee to declare a current year dividend. The equity method effectively removes managers‘ ability to increase current income (or defer income to future periods) through their influence over the timing and amounts of investee dividend declarations. At first glance it may seem that the fair value method allows managers to manipulate income because investee dividends are recorded as income by the investor. However, dividends paid typically are accompanied by a decrease in fair value (also recognized in income), thus leaving reported net income unaffected. Does the Equity Method Really Apply Here? The discussion in the case between the two accountants is limited to the reason for the investment acquisition and the current percentage of ownership. Instead, they should be examining the actual interaction that currently exists between the two companies. Although the ability to exercise significant influence over operating and financial policies appears to be a rather vague criterion, ASC 323 "Investments—Equity Method and Joint Ventures," clearly specifies actual events that indicate this level of authority (paragraph 323-10-15-6): Ability to exercise that influence may be indicated in several ways, such as representation on the board of directors, participation in policy-making processes, material intra-entity transactions, interchange of managerial personnel, or technological dependency. Another important consideration is the extent of ownership by an investor in relation to the concentration of other shareholdings, but substantial or majority ownership of the voting stock of an investee company by another investor does not necessarily preclude the ability to exercise significant influence by the investor. In this case, the accountants would be wise to determine whether Dennis Bostitch or any other member of the Highland Laboratories administration is participating in the management of Abraham, Inc. If any individual from Highland's organization is on Abraham‘s board of directors or is participating in management decisions, the equity method would seem to be appropriate. Likewise, if significant transactions have occurred between the companies (such as loans by Highland to Abraham), the ability to apply significant influence becomes much more evident. However, if James Abraham continues to operate Abraham, Inc., with little or no regard for Highland, the equity method should not be applied. This possibility seems especially likely in this case since one stockholder, James Abraham, continues to hold a majority (2/3) of the voting stock. Thus, evidence of the ability to apply significant influence must be present before the equity method is viewed as applicable. The mere holding of 1/3 of the stock is not conclusive.

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Answers to Questions 1. Through its voting rights over an investee, an investor firm can elect members to the investee‘s board of directors and thus exercise power over the strategic direction of the investee in ways that align with the investor‘s own operating and financial interests. 2. An investor should apply the equity method when it has the ability to exercise significant influence over the operating and financial policies of the investee. However, if the investor controls the investee, consolidating the financial information of the two companies will normally be the appropriate method for reporting the investment. 3. For equity securities without readily determinable fair values, ASC 321 allows the cost method for the investment asset. The investor recognizes dividend income for its share of investee dividends declared. Under the cost method, the investment account remains at cost unless there is (a) a demonstrable impairment or (b) observable price changes for identical or similar investments of the same issuer. 4. According to FASB ASC paragraph 323-10-15-6 "Ability to exercise that influence may be indicated in several ways, such as representation on the board of directors, participation in policy-making processes, material intra-entity transactions, interchange of managerial personnel, or technological dependency. Another important consideration is the extent of ownership by an investor in relation to the extent of ownership of other shareholdings." The most objective of the criteria established by the Board is that holding (either directly or indirectly) 20 percent or more of the outstanding voting stock is presumed to constitute the ability to hold significant influence over the decision-making process of the investee. 5. Dividends received from an investee reduce the investment account. The investor does not record such dividends as revenue, to avoid reporting the income from the investee twice. The equity method is appropriate when an investor has the ability to exercise significant influence over the operating and financing decisions of an investee. Because dividends represent financing decisions, the investor may have the ability to influence dividend timing. If investors recorded dividends received as income, managers could affect reported income in a way that does not reflect actual performance. Therefore, in reflecting the close relationship between the investor and investee, the equity method employs accrual accounting to record income when reported by the investee. The investor increases its investment account for the investor‘s share of the investee‘s net income and then decreases the investment accounts as the investee distributes its net income through dividends. From the investor‘s view, the decrease in the investment asset (from investee dividends) is offset by an immediate increase in dividends receivable and an eventual increase in cash. 6. If Jones cannot significantly influence the operating and financial policies of Sandridge, the equity method should not be applied regardless of the ownership level. However, an owner of 25 percent of a company's outstanding common stock is assumed to possess this ability. This presumption stands until overcome by predominant evidence to the contrary. Examples of indications that an investor may be unable to exercise significant influence over the operating and financial policies of an investee include (ASC 323-10-15-10): a. Opposition by the investee, such as litigation or complaints to governmental regulatory authorities, challenges the investor's ability to exercise significant influence. b. The investor and investee sign an agreement under which the investor surrenders

significant rights as a shareholder. c. Majority ownership of the investee is concentrated among a small group of shareholders who operate the investee without regard to the views of the investor. d. The investor needs or wants more financial information to apply the equity method than is available to the investee's other shareholders (for example, the investor wants quarterly financial information from an investee that publicly reports only annually), tries to obtain that information, and fails. e. The investor tries and fails to obtain representation on the investee's board of directors. 7. The following events necessitate changes in this investment account. a. Net income earned by Watts would be reflected by an increase in the investment balance whereas a reported loss is shown as a reduction to that same account. b. Dividends declared by the investee decrease its book value, thus requiring a corresponding reduction to be recorded in the investment balance. c. If, in the initial acquisition price, Smith paid extra amounts because specific investee assets and liabilities had values differing from their book values, amortization of this portion of the investment account is subsequently required. As an exception, if the specific asset is land or goodwill, amortization is not appropriate. d. Intra-entity gross profits created by sales between the investor and the investee must be deferred until resale to outside parties or consumed by the purchasing affiliate. The initial deferral entry made by the investor reduces the investment balance while the eventual recognition of the gross profit increases this account. 8. The equity method has been criticized because it allows the investor to recognize income that may not be received in any usable form in the foreseeable future. The investor accrues income based on the investee's reported earnings, not on the investor‘s share of investee dividends. Frequently, equity income will exceed the investor‘s share of investee cash dividends with no assurance that the difference will ever be forthcoming. Many companies have contractual provisions (e.g., debt covenants, managerial compensation contracts) based on ratios in the main body of the financial statements. Relative to consolidation, a firm employing the equity method will report smaller values for assets and liabilities. Consequently, higher rates of return for its assets and sales, as well as lower debtto-equity ratios may result. Meeting such contractual provisions may provide managers incentives to maintain technical eligibility for the equity method rather than full consolidation. 9. Accounting standards require that an investor treat a change to the equity method prospectively. Any new investment (or other investor or investee activity) that provides significant influence requires application of the equity method. At the date the investor‘s influence becomes significant, the investor prepares an investment fair value allocation schedule. The resulting excess fair value over book value amortizations serve to compute future equity in investee earnings. 10. In reporting equity earnings for the current year, Riggins must separate its accrual into two components: (1) net income and (2) other comprehensive income or loss. This handling enables the reader of the investor's financial statements to assess the nature of the change to the investment account. 11. Under the equity method, losses are recognized by an investor at the time that they are reported by the investee. However, because of the conservatism inherent in accounting, any

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permanent losses in value should also be recorded immediately. Because the investee's stock has suffered a permanent impairment in this question, the investor recognizes the loss applicable to its investment. 12. Following the guidelines established by the ASC, Wilson would recognize an equity loss of $120,000 (40 percent) stemming from Andrews' reported loss. However, since the book value of this investment is only $100,000, Wilson's loss is limited to that amount with the remaining $20,000 omitted. The investor will record subsequent income based on investee dividends. If Andrews is ever able to generate sufficient future profits to offset the total unrecognized losses, the investor will revert to the equity method. 13. In accounting, goodwill is derived as a residual figure. It is the investor's cost in excess of its share of the fair value of the investee assets and liabilities. Although a portion of the acquisition price may represent either goodwill or valuation adjustments to specific identifiable investee assets and liabilities, the investor records the entire cost in a single investment account. No separate identification of the cost components is made in the reporting process. Subsequently, the cost figures attributed to specific accounts (having a limited life), besides goodwill and other indefinite life assets, are amortized based on their anticipated lives. This amortization reduces the investment and the accrued income in future years. 14. On June 19, Princeton removes the portion of this investment account that has been sold and recognizes the resulting gain or loss. For proper valuation purposes, the equity method is applied (based on the 40 percent ownership) from the beginning of Princeton's fiscal year until June 19. Princeton's method of accounting for any remaining shares after June 19 will depend upon the degree of influence that is retained. If Princeton still has the ability to significantly influence the operating and financial policies of Yale, the equity method continues to be appropriate based on the reduced percentage of ownership. Conversely, if Princeton no longer holds this ability, the fair-value method becomes applicable, based on the remaining equity value after the sale. 15. Downstream sales occur when an investor sells to the investee while upstream sales are from the investee to the investor. These titles reflect the traditional positions given to the two parties when presented on an organization-type chart. Under the equity method, no accounting distinction exists between downstream and upstream sales. Separate presentation is made in this chapter only because the distinction becomes significant in the consolidation process as demonstrated in Chapter Five. 16. The portion of an intra-entity gross profit is computed based on the markup on any transferred inventory retained by the buyer at year's end. The markup percentage (based on sales price) multiplied by the intra-entity ending inventory gives the seller‘s profit remaining in the buyer‘s ending inventory. The product of the ownership percentage and this profit figure is the investor‘s share of gross profit from the intra-entity transaction. The investor defers this gross profit in the recognition of equity earnings until subsequently recognized following use or resale to an unrelated party. 17. Intra-entity transfers do not affect the financial reporting of the investee except that the related party transactions must be appropriately disclosed and labeled. 18. Under fair value accounting, firms report the investment‘s fair value as an asset and changes in fair value as earnings. Dividends from an investee are included in earnings under fair value accounting. Dividends are not recognized in income but instead reduce the investment

account under the equity method. Also, under the equity method, firms recognize their ownership share of investee profits adjusted for excess cost amortizations and intra-entity profits. Answers to Problems

1. D 2. B 3. C 4. B 5. D 6. B Acquisition price ........................................................................... Equity income ($750,000 × 30%) .................................................. Dividends (90,000 shares × $1.00)................................................ Investment in O‘Fallon as of December 31..................................

$2,295,000 225,000 (90,000) $2.430,000

Acquisition price ........................................................................... Income accruals: 2023—$170,000 × 20%..................................... 2024—$210,000 × 20%..................................... Amortization (see below): 2023 .................................................... Amortization: 2024 ........................................................................ Dividends: 2023—$70,000 × 20% ................................................. 2024—$70,000 × 20% ................................................. Investment in Martes, December 31, 2024...................................

$700,000 34,000 42,000 (10,000) (10,000) (14,000) (14,000) $728,000

Acquisition price of Martes............................................................. Acquired net assets (book value) ($3,000,000 × 20%) .................

$700,000 (600,000) $100,000 $10,000

7. A

Excess cost over book value to patent...................................................

Annual amortization (10 year remaining life) ............................... 8. B Purchase price of Johnson stock .................. $500,000 Book value of Johnson ($900,000 × 40%)...... (360,000) Cost in excess of book value .................... $140,000 Remaining Payment identified with undervalued life

Building ($140,000 × 40%) ................

56,000 7 yrs.

Annual amortization

$ 8,000

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Trademark ($210,000 × 40%) ............ Total ...................................................

84,000 10 yrs. $ -0-

8,400 $16,400

8. (continued) Investment purchase price ............................................ Basic income accrual ($90,000 × 40%) .................... Amortization (above) ................................................. Dividends declared ($30,000 × 40%) ........................ Investment in Johnson...................................................

$500,000 36,000 (16,400) (12,000) $507,600

9. D The 2023 purchase is reported using the equity method. Purchase price of Max stock ................................................... Book value of Max stock ($1,200,000 × 40%) ......................... Goodwill .................................................................................... Life of goodwill ......................................................................... Annual amortization .................................................................

$600,000 (480,000) $120,000 indefinite $ (-0-)

Cost on January 1, 2023 .......................................................... 2023 Income accrued ($140,000 × 40%) .................................. 2023 Dividend ($50,000 × 40%) ................................................ 2024 Income accrued ($140,000 × 40%).................................. 2024 Dividend ($50,000 × 40%) ................................................ 2025 Income accrued ($140,000 × 40%).................................. 2025 Dividend ($50,000 × 40%) ................................................ Investment in Max, 12/31/25.....................................................

$600,000 56,000 (20,000) 56,000 (20,000) 56,000 (20,000) $708,000

10. D 11. A Gross profit rate (GPR): $15,000 ÷ $75,000 = 20%

Inventory remaining at year-end ............................................... GPR.............................................................................................. Gross profit............................................................................ Ownership................................................................................... Intra-entity gross profit—deferred.......................................

$30,000 × 20% $ 6,000 × 35% $ 2,100

12. B

Purchase price of Steinbart shares .......................................... Book value of Steinbart shares ($1,200,000 × 40%)................. Trade name ................................................................................. Remaining life of trade name..................................................... Annual amortization ................................................................... 2023 Gross profit rate = $30,000 ÷ $100,000 = 30% 2024 Gross profit rate = $54,000 ÷ $150,000 = 36% 2024—Equity income in Steinbart: Income accrual ($110,000 × 40%) .............................................. Amortization (above) .................................................................. Recognition of 2023 deferred gross profit ($25,000 × 30% GPR × 40% ownership)............................... Deferral of 2024 intra-entity gross profit ($45,000 × 36% GPR × 40% ownership ................................ Equity income in Steinbart—2024 ....................................... 13. (6 minutes) (Investment account after one year) Purchase price ................................................................................. Basic 2024 equity accrual ($260,000 × 40%) .................................. Amortization of copyright: Excess payment ($1,160,000 – $820,000 = $340,000) to copyright allocated over 10 year remaining life ............. Dividends (50,000 × 40%) ................................................................ Investment account balance at year end .......................................

$530,000 (480,000) $ 50,000 20 years $ 2,500

$44,000 (2,500) 3,000 (6,480) $38,020

$1,160,000 104,000

(34,000) (20,000) $1,210,000

14. (7 minutes) a. Purchase price............................................................................ Equity income accrual ($720,000 × 35%) .................................. Other comprehensive loss accrual ($100,000 × 35%).............. Dividends (20,000 × 35%)........................................................... Investment in Sharon at December 31, 2024............................

$2,290,000 252,000 (35,000) (7,000) $2,500,000

b. Equity in Earnings of Sharon = $252,000 (does not include OCI share which is reported separately). 15.(15 minutes) (Investment account after 2 years)

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a. Acquisition price ........................................................................ Book value acquired ($5,175,000 × 20%) .................................. Excess payment ......................................................................... Excess fair value: Computing equipment ($700,000 × 20%) Excess fair value: Patented technology ($3,900,000 × 20%) Excess fair value: Trademark ($1,850,000 × 20%) .............. Goodwill ......................................................................................

$2,700,000 1,035,000 $1,665,000 140,000 780,000 370,000 $ 375,000

Amortization: Computing equipment ($140,000 ÷ 7) .................................. Patented technology ($780,000 ÷ 3)..................................... Trademark (indefinite)........................................................... Goodwill (indefinite).............................................................. Annual amortization ...................................................................

$ 20,000 260,000 -0-0$280,000

Basic equity accrual 2023 ($1,800,000 × 20%) ......................... Amortization—2023 (above) ...................................................... Equity in 2023 earnings of Sauk Trail .......................................

$360,000 (280,000) $ 80,000

Basic equity accrual 2024 ($1,985,000 × 20%) ......................... Amortization—2024 (above) ...................................................... Equity in 2024 earnings of Sauk Trail .......................................

$397,000 (280,000) $117,000

Acquisition price ........................................................................ Equity in 2023 earnings of Sauk Trail (above) ......................... Dividends—2023 ($150,000 × 20%) ........................................... Investment in Sauk Trail, 12/31/23 ............................................

$2,700,000 80,000 (30,000) $2,750,000

Investment in Sauk Trail, 12/31/23 ............................................

$2,750,000

Equity in 2024 earnings of Sauk Trail (above) ......................... Dividends—2024 ($160,000 × 20%) ........................................... Investment in Sauk Trail, 12/31/24 ............................................

117,000 (32,000) $2,835,000

16.(10 minutes) (Investment account after 2 years with fair value accounting included)

a. Acquisition price ........................................................................ Book value—assets minus liabilities ($125,000 × 40%) .......... Excess payment ......................................................................... Value of patent in excess of book value ($15,000 × 40%) ....... Goodwill ......................................................................................

$60,000 50,000 $10,000 6,000 $ 4,000

Amortization: Patent ($6,000 ÷ 6) ...................................................................... Goodwill ...................................................................................... Annual amortization ...................................................................

$1,000 -0$1,000

Acquisition price ........................................................................ Basic equity accrual 2023 ($30,000 × 40%) .............................. Dividends—2023 ($10,000 × 40%) ............................................. Amortization—2023 (above) ...................................................... Investment in Chestnut, 12/31/23 .............................................. Basic equity accrual —2024 ($50,000 × 40%) ........................... Dividends—2024 ($15,000 × 40%) ............................................. Amortization—2024 (above) ...................................................... Investment in Chestnut, 12/31/24 ..............................................

$60,000 12,000 (4,000) (1,000) $67,000 20,000 (6,000) (1,000) $80,000

Dividend income ($15,000 × 40%) ............................................. Increase in fair value ($75,000 – $68,000) ................................. Investment income under fair value accounting—2024 ..........

$ 6,000 7,000 $13,000

17. (10 minutes) (Equity entries for one year, includes intra-entity transfers but no gross profit deferral) Purchase price of Burks stock .................................................. Book value of Burks stock ($360,000 × 40%) ........................... Unidentified asset (goodwill)..................................................... Life ............................................................................................... Annual amortization ...................................................................

$210,000 (144,000) $ 66,000 indefinite $ -0-

No intra-entity profit exists at year‘s end because all of the transferred merchandise was used during the period. 17. (continued) Investment in Burks, Inc. .......................................... Cash (or a Liability) ..............................................

210,000 210,000

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To record acquisition of a 40 percent interest in Burks. Investment in Burks, Inc. .......................................... 32,000 Equity in Investee Income ................................... 32,000 To recognize 40 percent income earned during period by Burks, an equity method investment. Dividend Receivable.................................................. Investment in Burks, Inc...................................... To record investee dividend declaration.

10,000

Cash............................................................................ Dividend Receivable. ........................................... To record collection of dividend from investee.

10,000

18.(25 Minutes) (Equity entries for one year, includes prospective application of equity method) JANUARY 1, 2024 (Date significant influence is attained) Purchase price of 30% of Seida‘s stock ......................................

$600,000

Fair value of original 10% investment in Seida...........................

200,000

Total fair value of 40% investment in Seida ................................

800,000

Book value of Seida stock ($1,850,000 × 40%)............................

(740,000)

Fair value in excess of book value...............................................

$ 60,000

Excess cost assigned to undervalued land ($120,000 × 40%).......................................................................

(48,000)

Trademark ......................................................................................

$ 12,000

Remaining life of Trademark ........................................................

÷ 8 years

Annual Amortization .....................................................................

$ 1,500

Journal Entries: To record acquisition of Seida stock. Investment in Seida................................................... Cash ......................................................................

600,000 600,000

Investment in Seida................................................... 120,000 Equity in Investee Income ................................... 120,000 To record income for the year: 40% of the $300,000 reported income.

Equity in Investee Income ........................................ Investment in Seida ............................................. To record 2024 amortization.

1,500 1,500

Dividend Receivable.................................................. 44,000 Investment in Seida ............................................. To record dividend declaration from Seida (40% of $110,000).

44,000

Cash............................................................................ Dividend Receivable ............................................ To record collection of dividend from investee.

44,000

19.(7 minutes) (Deferral of intra-entity gross profit) Ending inventory ($200,000 – $85,000) ............................................... Gross profit percentage (GP $80,000 ÷ Sales $200,000).................... Gross profit on sale to Eckerle ............................................................ Ownership ............................................................................................. Intra-entity gross profit—deferred.......................................................

$115,000 × 40% $ 46,000 × 30% $ 13,800

Entry to Defer Intra-entity Gross Profit: Equity in Investee Income................................................. 13,800 Investment in Eckerle ..............................................

13,800

20. (10 minutes) (Reporting of equity income and transfers) a. Equity in investee income:

Equity income accrual ($100,000 × 25%).................................. $25,000 Less: deferral of intra-entity gross profit (below) ................... (3,000) Less: patent amortization (given) .................................................. (10,000) Equity in investee income.................................................... $12,000 Deferral of intra-entity gross profit: Remaining inventory—end of year ........................................... $32,000 Gross profit percentage (GP $30,000 ÷ Sales $80,000) ................ × 37½% Profit within remaining inventory ............................................. $12,000 Ownership percentage .............................................................. × 25% Intra-entity gross profit deferral ..................................................... $ 3,000

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b. In 2024, the deferral of $3,000 can be recognized by BuyCo‘s use or sale of

this inventory. Thus, the equity accrual for 2024 will be increased by $3,000 in that year. Recognition of this amount is simply being delayed from 2023 until 2024, the year when the goods are sold to customers outside the affiliated entity. c. The direction (upstream versus downstream) of the intra-entity transfer does

not affect the above answers. However, as discussed in Chapter Five, a controlling interest (greater than 50% ownership) calls for a 100% gross profit deferral for downstream intra-entity transfers. In the presence of only signification influence, however, equity method accounting is identical regardless of whether an intra-entity transfer is upstream or downstream. 21.(25 minutes) (Equity method with a subsequent partial investment sale) Equity method income accrual for 2024 25 percent of $600,000 for ½ year = ...................................... $ 75,000 21 percent of $600,000 for ½ year = ...................................... 63,000 Total income accrual (no amortization or deferred gross profit) ............... $138,000 Gain on sale (below) ......................................................................... 32,000 Total income statement effect–2024 ..................................................... $170,000 Gain on sale of 12,000 shares of Sedgwick: Cost of initial acquisition—2022 ........................................................... $1,480,000 25% income accrual—2022 ............................................................... 85,000 25% of dividends—2022 .................................................................... (30,000) 25% income accrual—2023 ............................................................... 120,000 25% of dividends—2023 .................................................................... (35,000) 25% income accrual for ½ year—2024 ............................................. 75,000 25% of dividends for ½ year—2024 .................................................. (20,000) Book value of 75,000 shares on July 1, 2024 ....................................... $1,675,000 Cash proceeds from the sale: 12,000 shares × $25 ........................... $300,000 Less: book value of shares sold: $1,675,000 × (12,000 ÷ 75,000) ...... 268,000 Gain on sale ....................................................................................... $ 32,000 22. (25 minutes) (Verbal overview of equity method. a. In 2023, the fair-value method was appropriate. Thus, Eileen recognizes in its investment income 10 percent of Bravo‘s dividends declared along with the change in the investment‘s fair value. b. The assumption is that Eileen‘s level of ownership now provides the

company with the ability to exercise significant influence over the operating and financial policies of Bravo. Factors that indicate such a level of influence are described in the textbook and include representation on the investee‘s board of directors, material intra-entity transactions, and interchange of managerial personnel. c. Despite holding 25 percent of Bravo‘s outstanding stock, the equity method is inappropriate absent the ability to apply significant influence. Factors indicating a lack of such influence include: an agreement whereby the owner surrenders significant rights, a concentration of the remaining ownership, and failure to gain representation on the board of directors. d. The equity method attempts to reflect the relationship between the investor and the investee in two ways. First, the investor recognizes investment income as soon as it is earned by the investee. Second, the Investment account reported by the investor is increased and decreased to indicate changes in the underlying book value of the investee. e. Criticisms of the equity method include  its emphasis on the 20-50% of voting stock in determining significant influence vs. control  allowing off-balance sheet financing  potential biasing of performance ratios Relative to consolidation, the equity method will report smaller amounts for assets, liabilities, revenues and expenses. However, income is typically the same as reported under consolidation. Therefore, companies that use the equity method, and avoid consolidation, often show enhanced debt-to equity ratios, as well as ratios for returns on assets and sales. f. When an investor buys enough additional shares to gain the ability to exert significant influence, accounting for any shares previously owned is applied using the equity method on a prospective basis. g. The total fair value of the January 1, 2024, 25% investment in Bravo is compared to 25% of Bravo‘s January 1, 2024 book value Any excess payment is then assigned to specific assets and liabilities based on differences between book value and fair value. If any residual amount of the purchase price remains unexplained, it is assigned to goodwill. 22. (continued) h. Investee dividends reduce its book value. Because the investor‘s Investment account tracks the investee‘s book value, Eileen records the dividend as a reduction in its investment account. This method of recording also avoids double-counting of the revenue since the investor has already recorded the amount when earned by the investee. Under the equity method, revenues are recognized when earned by the investee but not through dividends as a 2-164 © McGraw Hill LLC. All rights reserved. No reproduction or distribution without the prior written consent of McGraw Hill LLC.

Solution Manual For All Chapters

distribution of the same earnings. i. Eileen records the fair value of the investment in Bravo at January 1, 2024 equal to $975,000 ($585,000 plus $390,000). Next, Eileen prospectively records an equity accrual equal to 25 percent of Bravo‘s 2024 income. The investment balance will be reduced by 25 percent of Bravo‘s 2024 dividends. Finally, the Investment account will be decreased by any amortization expense for 2024. 23.(20 minutes) (Verbal overview of intra-entity transfers and their impact on application of the equity method) a. An upstream transfer goes from investee to investor whereas a downstream transfer is made by the investor to the investee. b. The direction of an intra-entity transfer has no impact on reporting when the equity method is applied. The direction of the transfers was introduced in Chapter One because it does have an important impact on consolidation accounting as explained in Chapter Five. c. To determine the intra-entity gross profit when applying the equity method, the transferred inventory that remains at year‘s end is multiplied by the gross profit percentage. This computation derives the gross profit. The intraentity portion of this gross profit is found by multiplying it by the percentage of the investee that is owned by the investor. d. Parrot, as the investor, will accrue 42 percent of the income reported by Sunrise. However, this equity income will then be reduced by the amount of the investor‘s share of the intra-entity gross profit. These amounts can be combined and recorded as a single entry, increasing both the Investment account and an Equity Income account. As an alternative, separate entries can be made. The equity accrual is added to these two accounts while the deferral of the intra-entity gross profit serves as a reduction. 23. (continued) e. In the second year, Parrot again records an equity accrual for 42 percent of the income reported by Sunrise. The intra-entity portion gross profit created by the transfers for that year are delayed in the same manner as for 2023 in (d) above. However, for 2024, the gross profit deferred from 2023 must now be recognized. This transferred merchandise was sold during this second year so that the earnings process has now been culminated. f. If none of the transferred merchandise remains at year-end, the intra-entity transactions create no impact on the recording of the investment when applying the equity method. No gross profit remains unrecognized. g. The intra-entity transfers create no direct effects for Sunrise, the investee.

However, as related party transactions, the amounts, as well as the relationship, must be properly disclosed and labeled. 24.(15 minutes) (Verbal overview of the sale of a portion of an investment being reported on the equity method and the accounting for any shares that remain) a. The equity method must be applied up to the date of the sale. Therefore, for the current year until August 1, Einstein records an equity accrual recognizing 40 percent of Brooks‘ reported income for that period. In addition, Einstein records any dividends declared by Brooks as a reduction in the carrying amount of the investment account. Finally, amortization of acquisition-date excess fair over book values are recorded through August 1. These entries establish an appropriate book value as of the date of sale. Then, an amount of that book value equal to the portion of the shares sold is removed to compute a gain or loss on sale. b. Subsequent accounting for the remaining shares depends on the influence retained post-sale. If Einstein maintains the ability to apply significant influence to the operating and financial decisions of Brooks, the equity method is still applicable based on the smaller new ownership percentage. However, if significant influence has been lost, Einstein should report the remaining shares by means of the fair-value method. c. In this situation, several figures would be reported by Einstein. First, an equity income balance is recorded that includes both the accrual and amortization prior to August 1. Second, a gain or loss should be shown for the sale of the shares. Third, any change in the 2 percent investment fair value since August 1 along with 2 percent of investee dividends declared after August 1 must be included in Einstein‘s investment income for the current year. 24. (continued) d. No, the ability to apply significant influence to the investee was present prior to August 1 so that the equity method was appropriate. No change is made in those figures. However, after the sale, the remaining investment must be accounted for by means of the fair-value method. 25.(12 minutes) (Equity balances for one year includes intra-entity transfers) a. Equity income accrual—2024 ($90,000 × 30%) .......................... Amortization—2024 (given) ......................................................... Intra-entity profit recognized on 2023 transfer* ......................... Intra-entity profit deferred on 2024 transfer** ............................ Equity income recognized by Matthew in 2024..........................

$27,000 (9,000) 1,200 (2,640) $16,560

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*Gross profit rate (GPR) on 2023 transfer ($16,000/$40,000) .... Intra-entity gross profit: Remaining inventory ($40,000 × 25%)......................................... GPR (above) .................................................................................. Ownership percentage................................................................. Intra-entity profit deferred from 2023 until 2024 ........................

40% $10,000 × 40% × 30% $ 1,200

**GPR on 2024 transfer ($22,000/$50,000) .................................. Intra-entity gross profit: Remaining inventory ($50,000 × 40%)......................................... GPR (above) .................................................................................. Ownership percentage................................................................. Intra-entity profit deferred from 2024 until 2025 ........................

44% $20,000 × 44% × 30% $ 2,640

Investment in Lindman, 1/1/24..................................................... Equity income—2024 (see [a] above) ......................................... Dividends—2024 ($30,000 × 30%) ............................................... Investment in Lindman, 12/31/24.................................................

$335,000 16,560 (9,000) $342,560

26. (20 Minutes) (Equity method including prospective application; Allocate investment cost and calculate amortization expense; Fair-value accounting) Part a Allocation and annual amortization—12/31/23 Purchase price of 25% interest ................................................... Carrying amount of 5% interest (5% × $380,000)....................... Total fair value of Akron‘s investment in Zip........................ Net book value ($290,000 × 30%) ................................................ Franchise agreements ................................................................. Remaining life of franchise agreements..................................... Annual amortization................................................................

$95,000 19,000 114,000 (87,000) $27,000 ÷ 10 years $ 2,700

1. Equity Income—2024

2024 basic equity income accrual ($88,000 × 30%) ................... 2024 amortization (above) ........................................................... Equity income—2024 ..............................................................

$26,400 (2,700) $23,700

2. Investment in Zip account

December 31, 2023 total fair value ..............................................

$114,000

2024 basic equity income (above)............................................... 2024 dividends ($15,000 × 30%) .................................................. Investment in Zip—December 31, 2024 .................................

23,700 (4,500) $133,200

Dividend income (30% × $15,000) .............................................. Increase in fair value (30% × [$480,000 - $380,000]) .................. Total reported income from Investment in Zip .....................

$ 4,500 30,000 $ 34,500

Investment in Zip (30% × $480,000).............................................

$144,000

Part b 1.

27. (30 minutes) (Equity method, sale of investment, and intra-entity gross profit) Part a Allocation and annual amortization Purchase price of 30 percent interest......................................... Net book value ($800,000 × 30%) ........................................... Copyright ...................................................................................... Remaining life of Copyright .............................................................. Annual Amortization..........................................................................

$312,000 (240,000) $ 72,000 ÷ 16 yrs $ 4,500

Equity income—2023 2023 basic equity income accrual ($180,000 × 30%)....................... 2023 excess fair over book value amortization (above) ................ Equity income—2023 ...................................................................

$54,000 (4,500) $49,500

Equity income 2024 2024 basic equity income accrual ($230,000 × 30%) ................. 2024 excess fair over book value amortization (above)............ Equity income 2024 ...........................................................................

$69,000 (4,500) $64,500

Part b Investment in Sheffield Purchase price—January 1, 2023 .....................................................

$312,000

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2023 equity income (above)......................................................... 2023 dividends ($70,000 × 30%) .................................................. 2024 equity income above ........................................................... 2024 dividends ($80,000 × 30%) .................................................. Investment in Sheffield—12/31/24 ....................................................

49,500 (21,000) 64,500 (24,000) $381,000

Gain on sale of investment in Sheffield Sales price (given)........................................................................ Book value 1/1/25 (above)............................................................ Gain on sale of investment.....................................................

$400,000 (381,000) $ 19,000

Problem 27 continued: Part c 2023 intra-entity gross profit to be recognized in 2024 Ending inventory........................................................................ Gross profit percentage ($20,000 ÷ $50,000) ........................... Intra-entity gross profit ........................................................ Belden‘s ownership ................................................................... Intra-entity gross profit recognized in 2024 .......................

$20,000 × 40% $ 8,000 × 30% $ 2,400

Deferral of 2024 intra-entity ending inventory gross profit into 2025 Ending inventory ............................................................................. $ 40,000 Gross profit percentage ($27,000 ÷ $60,000) ........................... × 45% Intra-entity gross profit ............................................................. $ 18,000 Belden‘s ownership ................................................................... × 30% Intra-entity gross profit deferred ......................................... $ 5,400 Equity Income—2024 2024 equity income (part a above)............................................ Recognition of 2023 intra-entity profit (part c above) ............. Deferral of 2024 intra-entity profit (part c above) .................... Equity Income—2024............................................................

$ 64,500 2,400 (5,400) $ 61,500

28.(25 Minutes) (Preparation of journal entries for two years, includes losses and intra-entity transfers of inventory) Journal Entries for Harper Co. 1/1/23 Investment in Kinman Co................ Cash ............................................ (To record initial investment) During 2023

210,000

Dividends Receivable...................... 4,000 Investment in Kinman Co........... (To record dividend declaration: $10,000 × 40%)

210,000

4,000

Cash.................................................. Dividends Receivable ................ (To record receipt of dividend)

4,000 4,000

12/31/23 Equity in Investee Income............... 16,000 8,000 Other Comprehensive Loss of Kinman 24,000 Investment in Kinman Co. ......... (To record accrual of income and OCI from equity investee, 40% of reported balances) 12/31/23 Equity in Investee Income............... 3,300 Investment in Kinman Co. ......... 3,300 (To record amortization relating to acquisition of Kinman— see Schedule 1 below) 28. (continued) 12/31/23 Equity in Investee Income............... 2,000 Investment in Kinman Co. ......... 2,000 (To defer Harper‘s share of gross profit on intra-entity sale, see Schedule 2 below) During 2024

Dividends Receivable...................... 4,800 Investment in Kinman Co........... (To record dividend declaration: $12,000 × 40%)

4,800

Cash.................................................. Dividends Receivable................. (To record receipt of dividend)

4,800

12/31/24 Investment in Kinman Co................ 16,000 Equity in Investee Income ......... 16,000 (To record 40% accrual of income as earned by equity investee) 12/31/24 Equity in Investee Income............... 3,300 Investment in Kinman Co. ......... 3,300 (To record amortization relating to acquisition of Kinman) 12/31/24 Investment in Kinman Co................ 2,000 Equity in Investee Income ......... (To recognize income deferred from 2023)

2,000

12/31/24 Equity in Investee Income............... 3,600 Investment in Kinman Co. ......... 3,600 (To defer Harper‘s share of gross profit on intra-entity sale— see Schedule 3 below) 28. (continued)

Solution Manual For All Chapters

Schedule 1—Allocation of Purchase Price and Related Amortization Purchase price ................................................................. $210,000 Percentage of book value acquired ($400,000 × 40%) ......................................................... (160,000) Payment in excess of book value................................... $ 50,000 Excess payment identified with specific Annual assets: Remaining Life Amortization Building ($40,000 × 40%) $16,000 10 yrs. $1,600 Royalty agreement ($85,000 × 40%) 34,000 20 yrs. 1,700 Total annual amortization $3,300 Schedule 2—Deferral of Intra-entity Gross Profit—2023 Inventory remaining at end of year .............................................. Gross profit percentage ($30,000 ÷ $90,000) ................................. Gross profit remaining in inventory.......................................... Ownership percentage .................................................................... Intra-entity gross profit to be deferred until 2024....................

$15,000 × 33⅓% $ 5,000 × 40% $ 2,000

Schedule 3—Deferral of Intra-entity Gross Profit—2024 Inventory remaining at end of year (30%) .................................... Gross profit percentage ($30,000 ÷ $80,000) ............................... Gross profit remaining in inventory.......................................... Ownership percentage .................................................................. Intra-entity gross profit to be deferred until 2025....................

$24,000 × 37½% $9,000 × 40% $ 3,600

29. (35 Minutes) (Investment sale with equity method applied both before and after. Includes other comprehensive loss and intra-entity inventory transfer) Income effects for year ending December 31, 2024 Equity income in Seacrest, Inc. (Schedule 1)...........................

$116,000

Other comprehensive loss—Seacrest, Inc. 1/1/24 to 8/1/24 ($120,000 × 40% × 7/12 year)..................$(28,000) 8/1/24 to 12/31/24 ($120,000 × 32% × 5/12 year) .......... (16,000)

$(44,000)

Gain on sale of 8,000 shares of Seacrest (Schedule 2) ..............

$ 25,000

Schedule 1—Equity Income in Seacrest, Inc. Investee income accrual—operations $342,000 × 40% × 7/12 year ................................................ $79,800 $342,000 × 32% × 5/12 year ........................................... 45,600

$125,400

Amortization

$12,000 × 7/12 year ........................................................ After 20 percent of stock is sold (8,000 ÷ 40,000 shares): $12,000 × 80% × 5/12 year......................... Recognition of intra-entity gross profit Remaining inventory—12/31/23.................................... Gross profit percentage on original sale ($20,000 ÷ $50,000)................................................... Gross profit remaining in inventory............................. Ownership percentage.................................................. Intra-entity gross profit recognized in 2024 ................ Equity income in Seacrest, Inc.....................................

$ 7,000 4,000

(11,000)

$10,000 × 40% $ 4,000 × 40% 1,600 $116,000

29. (continued) Schedule 2—Gain on Sale of Investment in Seacrest, Inc. Book value—investment in Seacrest, Inc.—1/1/24 (given)......... Investee income accrual—1/1/24 – 8/1/24 (Schedule 1).............. Investee other comprehensive loss 1/1/24 – 8/1/24 .................... Amortization—1/1/24 – 8/1/24 (Schedule 1) ................................. Recognition of deferred profit (Schedule 1) ................................ Investment in Seacrest book value 8/1/24................................... Percentage of investment sold (8,000 ÷ 40,000 shares) ............. Book value of shares being sold .................................................. Proceeds from sale of shares ....................................................... Gain on sale of 8,000 shares of Seacrest. ..............................

$293,600 79,800 (28,000) (7,000) 1,600 $340,000 × 20% $ 68,000 93,000 $ 25,000

30.(30 Minutes) (Compute equity balances for three years. Includes intra-entity inventory transfer) Part a. Equity Income 2022 Basic equity accrual ($598,000 × ½ year × 25%) .................... Amortization (½ year—see Schedule 1) ................................. Equity Income—2022 ..........................................................

$74,750 (30,800) $ 43,950

Equity Income 2023 Basic equity accrual ($639,600 × 25%) ................................... Amortization (see Schedule 1) ................................................ Deferral of intra-entity profit (see Schedule 2)....................... Equity Income—2023 ..........................................................

$159,900 (61,600) (6,000) $ 92,300

Equity Income 2024 Basic equity accrual ($692,400 × 25%) ................................... Amortization (see Schedule 1) ................................................

$173,100 (61,600)

Solution Manual For All Chapters

Recognition of deferred profit (see Schedule 2).................... Equity Income—2024 ..........................................................

6,000 $117,500

30. (continued) Schedule 1—Acquisition Price Allocation and Amortization Acquisition price (88,000 shares × $13) $1,144,000 Book value acquired ($2,925,600 × 25%) 731,400 Payment in excess of book value $ 412,600 Excess payment identified with Annual specific assets: Remaining Life Amortization Equipment ($364,000 × 25%) $ 91,000 7 yrs. $13,000 Copyright ($972,000 × 25%) 243,000 5 yrs. 48,600 Trademark 78,600 indefinite -0Total annual amortization (full year) $61,600 Schedule 2—Deferral of Intra-entity Gross Profit Intra-entity Gross Profit Percentage: Sales $152,000 Cost of goods sold 91,200 Gross profit $ 60,800 Gross profit percentage: $60,800 ÷ $152,000 = 40% Inventory remaining at December 31, 2023 ............................ Gross profit percentage .......................................................... Total profit on intra-entity sale still held by affiliate.............. Investor ownership percentage............................................... Intra-entity gross profit deferred from 2023 until 2024 .........

$60,000 × 40% $24,000 × 25% $ 6,000

Part b. Investment in Carter—December 31, 2024 balance $1,144,000 Acquisition price ...................................................................... 2022 Equity income (above) .................................................... 43,950 2022 Dividends declared during half year (88,000 shares × $1.00) (88,000) 2023 Equity income (above) .................................................... 92,300 2023 Dividends declared (88,000 shares × $1.00 × 2)............ (176,000) 2024 Equity income (above) .................................................... 117,500 2024 Dividends declared (88,000 shares × $1.00 × 2)............ (176,000) Investment in Carter—12/31/24 .......................................... $ 957,750 31.(35 Minutes) (Journal entries for several years. Includes sale of a portion of the investment) 1/1/23

Investment in Bowden ................................ 982,000 Cash ....................................................... (To record cost of 80,000 shares of Bowden Company.)

982,000

9/15/23 Cash ............................................................. 40,000 Investment in Bowden .......................... 40,000 (Annual dividend declared and received from Bowden [40% × $100,000]) 12/31/23 Investment in Bowden ................................ 160,000 Equity in Investee Income .................... 160,000 (To accrue 2023 income based on 40% ownership of Bowden) 12/31/23 Equity in Investee Income .......................... 4,000 Investment in Bowden .......................... 4,000 (Amortization of $60,000 excess patent fair value [indicated in problem] over 15 years) 7/1/24

Investment in Bowden ................................ 76,000 Equity in Investee Income .................... 76,000 (To accrue ½ year income of 40% ownership = $380,000 × ½ × 40%)

7/1/24

Equity in Investee Income .......................... 2,000 Investment in Bowden .......................... 2,000 (To record ½ year amortization of patent to establish correct book value for investment as of 7/1/24)

7/1/24

Cash ............................................................. 330,000 Investment in Bowden .......................... 293,000 Gain on Sale of Investment .................. 37,000 (20,000 shares of Bowden Company sold; investment basis computed below.)

31. (continued) Investment in Bowden and cost of shares sold: 1/1/23 Acquisition .................................................................. 9/15/23 Dividends ................................................................... 12/31/23 Basic equity accrual................................................ 12/31/23 Amortization............................................................. 7/1/24 Basic equity accrual.................................................... 7/1/24 Amortization ................................................................ Investment in Bowden—7/1/24 balance .......................... Percentage of shares sold (20,000 ÷ 80,000) .................. Carrying amount of shares sold ......................................

$ 982,000 (40,000) 160,000 (4,000) 76,000 (2,000) $1,172,000 × 25% $ 293,000

Because 20,000 of 80,000, or ¼, of shares are sold, the percentage retained is ¾ of 40% = 30%. 9/15/24 Cash ............................................................. Investment in Bowden ..........................

30,000 30,000

Solution Manual For All Chapters

(To record annual dividend declared and received) 12/31/24 Investment in Bowden ................................ 57,000 Equity in Investee Income .................... 57,000 (To record ½ year income based on remaining 30% ownership: $380,000 × 1/2 × 30%) 12/31/24 Equity in Investee Income .......................... 1,500 Investment in Bowden .......................... 1,500 (To record ½ year of patent amortization—computation presented below) Annual patent amortization—original computation ................. $4,000 Percentage of shares retained (60,000 ÷ 80,000) ...................... × 75% Annual patent amortization—current ....................................... $3,000 Patent amortization for half year................................................ $1,500 32.(25 Minutes) (Equity income balances for two years, intra-entity transfers) Equity Income 2023 Basic equity accrual ($250,000 × 30%) ........................................ Amortization (see Schedule 1) ..................................................... Deferral of intra-entity gross profit (see Schedule 2) ................. Equity Income—2023 ...............................................................

$75,000 (18,000) (9,000) $48,000

Equity Income (Loss—2024) Basic equity accrual ($100,000 [loss] × 30%) .............................. Amortization (see Schedule 1) ..................................................... Realization of deferred gross profit (see Schedule 2) ................ Deferral of intra-entity gross profit (see Schedule 3) ................. Equity Loss—2024 ...................................................................

$(30,000) (18,000) 9,000 (4,500) $(43,500)

Schedule 1 Purchase price ............................................... $770,000 Book value acquired ($1,200,000 × 30%) ..... 360,000 Payment in excess of book value................. $410,000 Remaining Excess payment identified with specific Life assets: Customer list ($300,000 × 30%) 90,000 5 yrs. Excess not identified with specific accounts Goodwill $320,000 indefinite Total annual amortization Schedule 2 Inventory remaining at December 31, 2023 ...................................... Gross profit percentage ($60,000 ÷ $160,000) ..................................

Annual Amortization

$18,000

-0$18,000 $80,000 × 37½%

Total intra-entity gross profit ............................................................. Investor ownership percentage ......................................................... Intra-entity gross profit deferral—12/31/23 (To be deferred until 2024)............................................................ Schedule 3 Inventory remaining at December 31, 2024 ...................................... Gross profit percentage ($35,000 ÷ $175,000) .................................. Total intra-entity gross profit ............................................................. Investor ownership percentage ......................................................... Intra-entity gross profit deferral—12/31/24 (Deferred until 2025) ...........................................................................

$30,000 × 30% $ 9,000 $75,000 × 20% $15,000 × 30% $ 4,500

Solutions to Develop Your Skills Data Analysis Case 1: Determine Maximum Investment Price (less difficult)—see Connect for the Excel file solution Parts 1, 2 and 3 Growth rate in income Dividends Cost Annual amortization 1st year Omega income Percentage owned

10% $30,000 $700,000 (given in problem) $15,000 $185,000 40%

Omega reported income Amortization Equity earnings

2024 $74,000 15,000 $59,000

2025 $81,400 15,000 $66,400

2026 $89,540 15,000 $74,540

2027 $98,494 15,000 $83,494

Beginning Balance Equity earnings Dividends Ending Balance

$700,000 59,000 (12,000) $747,000

$747,000 66,400 (12,000) $801,400

$801,400 74,540 (12,000) $863,940

$863,940 $ 935,434 83,494 93,343 (12,000) (12,000) $935,434 $1,016,777

ROI Average

8.43% 9.25%

8.89%

9.30%

9.66%

2028 $108,343 15,000 $ 93,343

9.98%

Part 3 Growth rate in income Dividends Cost Annual amortization 1st year Omega income

10% $30,000 $639,794 (Determined through Solver [may need to be added] under Tools command) $15,000 $185,000

Solution Manual For All Chapters

Percentage owned

40%

Omega reported income Amortization Equity earnings

$74,000 15,000 $59,000

$81,400 15,000 $66,400

$89,540 15,000 $74,540

$98,494 $108,343 15,000 15,000 $83,494 $ 93,343

Beginning Balance Equity earnings Dividends Ending Balance

$639,794 59,000 (12,000) $686,794

$686,794 66,400 (12,000) $741,194

$741,194 74,540 (12,000) $803,734

$803,734 $875,228 83,494 93,343 (12,000) (12,000) $875,228 $956,571

9.22% 10.00%

9.67%

10.06%

ROI Average

10.39%

10.67%

Data Analysis Case 2: Compute Equitable Transfer Price (more difficult)—see Connect for the Excel file solution

Intergen‘s ownership percentage of Ryan = 40% Equitable Intra-entity Transfer Price = 1,050,000 Ryan's Income Statement Sales Beginning inventory Purchases from Intergen Inventory Ending inventory Cost of goods sold Net income Income to Intergen—40% Income to two equity partners— 60%

$900,000 $ -0$1,050,000 25% $ 262,500

$787,500 $112,500 $ 45,000 $ 67,500

Intergen's Income Statement Sales Cost of goods sold Gross profit Equity in Ryan's earnings Net income

$1,050,000 $ 850,000 $ 200,000 $ 25,000* $ 225,000

*[45,000 – (40% × 262,500 × 200,000 ÷ 1,050,000)]

Rate of Return Analysis Intergen Two outside equity partners Difference

Investment Base $1,000,000 $300,000

Rate of Return 22.50% 22.50% 0.00%

Solution Manual For All Chapters

Solution to Coca-Cola Company Research and Discussion Case 1. In its 2020 10-K, Coca-Cola lists the following companies among its significant equity

method investees (page 90):         

Coca-Cola European Partners plc Monster Beverage Corporation Coca-Cola Amatil Limited Coca-Cola FEMSA, S.A.B. de C.V. Coca-Cola HBC AG Coca-Cola Bottlers Japan Holdings Inc. Coca-Cola Consolidated, Inc Coca-Cola İçecek A.Ş. Embotelladora Andina S.A.

2. As part of strategic business alliances, each of these companies bottle, market, and

distribute Coca-Cola‘s products in various designated geographic areas throughout the world, thus generating substantial revenues for the Coca-Cola Company. According to Coca-Cola‘s 2020 annual report (page 7), …from time to time we make equity investments representing noncontrolling interests in selected bottling operations with the intention of maximizing the strength and efficiency of the Coca-Cola system's production, marketing, sales and distribution capabilities around the world by providing expertise and resources to strengthen those businesses. These investments are intended to result in increases in unit case volume, net revenues and profits at the bottler level, which in turn generate increased concentrate sales for our Company's concentrate business. When our equity investment provides us with the ability to exercise significant influence over the investee bottler's operating and financial policies, we account for the investment under the equity method. 3. From the Coca-Cola Company‘s 2020 10-K report (page 38), We use the equity method to account for investments in companies, if our investment provides us with the ability to exercise significant influence over operating and financial policies of the investee. Our consolidated net income includes our Company‘s proportionate share of the net income or loss of these companies. Our judgment regarding the level of influence over each equity method investment includes considering key factors such as our ownership interest, representation on the board of directors, participation in policy-making decisions and material intercompany transactions. 4. 2020 equity income = $978 million. 5. See page 90 of Coca-Cola‘s 2020 10-K annual report for a listing of the fair values and carrying amounts of its equity method investments that are publicly traded. In general, the equity method provides cost-based values while fair values provide exit-based values. The relevance of the equity method valuation derives from the investment‘s nature as a productive asset for the investor. Because of their business relationship the investee represents an extension of the investor and frequently a key part of the investor‘s business model. Coca-

Cola, for example, has a high level of operational influence over its investees who, in turn receive exclusive rights to bottle and distribute Coca-Cola products in specific geographic areas. Because of its significance influence, investors may wish to judge the results of operations of Coca-Cola‘s investees as it related to Coca-Cola‘s ownership. Additionally, the equity method provides results consistent with accrual accounting recognizing the net effect of investee revenues and expenses as they are earned by the investor. When possible, fair values are measured using market prices for the investor‘s shares of the investee. Although exit prices represent a ―hypothetical‖ sale transaction, they indicate the market‘s assessment of the investor‘s position in the investee and thus may be relevant. However, if the investor has no plans to sell the shares, exit prices may be of limited relevance for investors‘ decision making. RESEARCH AND ANALYSIS CASE—IMPAIRMENT 1. Paragraph 323-10-35-32 of the FASB ASC states that

A loss in value of an investment which is other than a temporary decline shall be recognized. Evidence of a loss in value might include, but would not necessarily be limited to, absence of an ability to recover the carrying amount of the investment or inability of the investee to sustain an earnings capacity which would justify the carrying amount of the investment. A current fair value of an investment that is less than its carrying amount may indicate a loss in value of the investment. However, a decline in the quoted market price below the carrying amount or the existence of operating losses is not necessarily indicative of a loss in value that is other than temporary. All are factors to be evaluated. 2. Given the facts in the case, a very good case can be made that the decline in value

appears permanent. The change in competitive environment, decline in revenues, drop in share value, and the lack of a responsive business plan all point to a loss that is other than temporary. 3. No, according to FASB ASC para. 350-20-35-59, the equity method investment as a

whole is reviewed for impairment, not the underlying assets. The FASB concluded that because equity method goodwill is not separable from the related investment, that goodwill should not be separately tested for impairment. Research Case Solution -- Noncontrolling Shareholder Rights 1. Protective Rights (ASC Topic 810, Consolidation 810-10-25-10)

Noncontrolling rights (whether granted by contract or by law) that would allow the noncontrolling shareholder to block corporate actions would be considered protective rights and would not overcome the presumption of consolidation by the investor with a majority voting interest in its investee. The following list is illustrative of the protective rights that often are provided to the noncontrolling shareholder but is not all-inclusive:

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a. Amendments to articles of incorporation of the investee b. Pricing on transactions between the owner of a majority voting interest and the investee and related self-dealing transactions c. Liquidation of the investee or a decision to cause the investee to enter bankruptcy or other receivership d. Acquisitions and dispositions of assets that are not expected to be undertaken in the ordinary course of business (noncontrolling rights relating to acquisitions and dispositions of assets that are expected to be made in the ordinary course of business are participating rights; determining whether such rights are substantive requires judgment in light of the relevant facts and circumstances [see paragraphs 810-10-2513 and 810-10-55-1]) e. Issuance or repurchase of equity interests. 2. Substantive Participating Rights (ASC Topic 810, Consolidation 810-10-25-11) Noncontrolling rights (whether granted by contract or by law) that would allow the noncontrolling shareholder to participate in determining certain financial and operating decisions in the ordinary course of business shall be considered substantive participating rights and would overcome the presumption that the investor with a majority voting interest shall consolidate its investee. Example: Prior to obtaining 100% of Clearwire‘s voting stock, despite a majority voting interest, Sprint cited substantive participating rights of the noncontrolling interest as a reason for not consolidating its investment in Clearwire. Currently, Sprint consolidates Clearwire as a wholly-owned subsidiary. 3. (FASB ASC Topic 810, Consolidation 810-10-25-11) Substantive participating rights would overcome the presumption that the investor with a majority voting interest shall consolidate its investee. The following list is illustrative of substantive participating rights, but is not necessarily all-inclusive: a. Selecting, terminating, and setting the compensation of management responsible for implementing the investee's policies and procedures b.

Establishing operating and capital decisions of the investee, including budgets, in the ordinary course of business.

4. Assessing Individual Noncontrolling Rights (FASB ASC Topic 810, Consolidation

810-10-55-1 b and c) b. Existing facts and circumstances should be considered in assessing whether the rights of the noncontrolling shareholder relating to an investee's incurring additional indebtedness are protective or participating rights. For example, if it is reasonably possible or probable that the investee will need to incur the level of borrowings that requires noncontrolling shareholder approval in its ordinary course of business, the rights of the noncontrolling shareholder would be viewed as substantive participating rights. c. The rights of the noncontrolling shareholder relating to dividends or other distributions may be protective or participating and should be assessed in light of the available facts and circumstances. For example, rights to block customary or expected dividends or other distributions may be substantive participating rights, while rights to block extraordinary distributions would be protective rights.

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CONSOLIDATION OF FINANCIAL INFORMATION Accounting standards for business combination are found in FASB ASC Topic 805, ―Business Combinations‖ and Topic 810, ―Consolidation.‖ These standards require the acquisition method which emphasizes acquisition-date fair values for recording all business combinations. In this chapter, we first provide coverage of expansion through corporate takeovers and an overview of the consolidation process in conjunction with the acquisition method of accounting for business combinations. In Appendix 2A we present limited coverage of the purchase method and pooling of interests followed by limited coverage of pushdown accounting in Appendix 2B. Chapter Outline I.

Business combinations and the consolidation process A. A business combination is the formation of a single economic entity, an event that occurs whenever one company gains control over another B. Business combinations can be created in several different ways 1. Statutory merger—only one of the original companies remains in business as a legally incorporated enterprise. a. Assets and liabilities can be acquired with the seller then dissolving itself as a corporation. b. All of the capital stock of a company can be acquired with the assets and liabilities then transferred to the buyer followed by the seller‘s dissolution. 2. Statutory consolidation—assets or capital stock of two or more companies are transferred to a newly formed corporation 3. Acquisition by one company of a controlling interest in the voting stock of a second. Dissolution does not take place; both parties retain their separate legal incorporation. C. Financial information from the members of a business combination must be consolidated into a single set of financial statements representing the entire economic entity. 1. If the acquired company is legally dissolved, a permanent consolidation is produced on the date of acquisition by entering all account balances into the financial records of the surviving company. 2. If separate incorporation is maintained, the parent company simulates consolidation whenever financial statements are to be prepared. This process is carried out through the use of worksheets and consolidation entries. Consolidation worksheet entries are used to adjust and eliminate subsidiary company accounts. Entry ―S‖ eliminates the equity accounts of the subsidiary. Entry ―A‖ allocates excess payment amounts to identifiable assets and liabilities based on the fair value of the subsidiary accounts. (Consolidation journal entries are never recorded in the books of either company, they are worksheet entries only.)

II.

The Acquisition Method A. For business combinations resulting in complete ownership, the acquisition method is distinguished by four characteristics. 1. All assets acquired and liabilities assumed in the combination are recognized and measured at their individual fair values (with few exceptions).

III.

2. The fair value of the consideration transferred provides a starting point for valuing and recording a business combination. a. The consideration transferred includes cash, securities, and contingent performance obligations. b. Direct combination costs are expensed as incurred. c. Stock issuance costs are recorded as a reduction in paid-in capital. d. The fair value of any noncontrolling interest also adds to the valuation of the acquired firm and is covered beginning in Chapter 4 of the text. 3. Any excess of the fair value of the consideration transferred over the net amount assigned to the individual assets acquired and liabilities assumed is recognized by the acquirer as goodwill. 4. Any excess of the net amount assigned to the individual assets acquired and liabilities assumed over the fair value of the consideration transferred is recognized by the acquirer as a ―gain on bargain purchase.‖ B. In-process research and development acquired in a business combination is recognized as an asset at its acquisition-date fair value. Convergence between U.S. GAAP and IAS IFRS 3 – nearly identical to U.S. GAAP because of joint efforts.

APPENDIX 2A: I.

The Purchase Method A. The purchase method was applicable for business combinations occurring for fiscal years beginning prior to December 15, 2008. It was distinguished by three characteristics. 1. One company was clearly in a dominant role as the purchasing party 2. A bargained exchange transaction took place to obtain control over the second company. 3. A historical cost figure was determined based on the acquisition price paid. a. The cost of the acquisition included any direct combination costs. b. Stock issuance costs were recorded as a reduction in paid-in capital and are not considered to be a component of the acquisition price. B. Purchase method procedures 1. The assets and liabilities acquired were measured by the buyer at fair value as of the date of acquisition. 2. Any portion of the payment made in excess of the fair value of these assets and liabilities was attributed to an intangible asset commonly referred to as goodwill. 3. If the price paid was below the fair value of the assets and liabilities (rarely occurred), the acquired company accounts were still measured at fair value except that certain noncurrent asset values were reduced by the excess cost. If these values were not great enough to absorb the entire reduction, an extraordinary gain was recognized.

II.

The Pooling of Interest Method (prohibited for combinations after June 2002) A. A pooling of interests reflected united ownership of two companies through the exchange of equity securities. The characteristics of a pooling are fundamentally different from either the purchase or acquisition methods. 1. Neither party was truly viewed as an acquiring company. 2. Precise cost figures from the exchange of securities were difficult to ascertain. 3. The transaction affected the stockholders rather than the companies.

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B. Pooling of interests accounting 1. Because of the nature of a pooling, an acquisition price was not relevant. a. Since no acquisition price was computed, all direct costs of creating the combination were expensed immediately. b. No new goodwill was recognized from the combination. Similarly, no valuation adjustments were recorded for any of the subsidiary assets or liabilities. 2. The book values of the two companies were simply brought together to produce consolidated financial statements. A pooling was viewed as a uniting of the owners rather than the two companies. 3. The results of operations reported by both parties were combined on a retroactive basis as if the companies had always been together. 4. Controversy historically surrounded the pooling of interests method. a. Cost figures indicated by the exchange transaction were ignored. b. Income balances previously reported were combined on a retrospective basis. c. Reported net income was usually higher in subsequent years than in a purchase because the lack of valuation adjustments reduced amortization. APPENDIX 2B: Pushdown Accounting I.

Pushdown accounting is the application of the parent‘s acquisition-date valuations for the subsidiary‘s standalone financial statements. A newly acquired entity may elect the option to apply pushdown accounting in the reporting period immediately following the acquisition. The rationale is that the acquisition-date fair values for the subsidiary‘s assets and liabilities are more representationally faithful and relevant to users of the subsidiary‘s financial statements.

II.

When push-down accounting is elected, A. The subsidiary revalues its assets and liabilities based on the acquisition-date fair value allocations. The subsidiary then recognizes periodic amortization expense on those allocations with definite lives. Therefore, the subsidiary‘s recorded income equals its impact on consolidated earnings (except in the presence of a bargain purchase gain). B. Any goodwill from the combination is reported in the acquired entity‘s separate financial statements. In the case of a bargain purchase gain, pushdown accounting recognize an adjustment to its additional paid-in capital, not as a gain in its income statement. C. the subsidiary‘s retained earnings are revalued to zero recognizing the new reporting entity as of the parent‘s acquisition date.

III.

The parent uses no special procedures when push-down accounting is being applied. However, if the equity method is in use, amortization need not be recognized by the parent since that expense is included in the figure reported by the subsidiary.

Answer to Discussion Question What if an acquired entity is not a business?

The accounting and reporting implications to this question are included in the discussion followed by an example of an asset acquisition by Celgene Corporation. The question is designed to provide class discussion on the definition of a business and meeting that definition as a requirement for use of the acquisition method. The instructor can point out that the acquisition method can be very complex and costly to implement. Companies that simply are acquiring an asset (even though it may be incorporated) do not need to incur the additional costs of complying with FASB ASC Topic 805, ―Business Combinations.‖ Accounting cost savings in asset acquisitions (vs. a business combination that requires the acquisition method) can result from less effort in determining fair values for contingent consideration, assessing periodic impairment for in-process research and development, assessing periodic impairment for goodwill, etc. Thus, companies that are simply purchasing an asset will avoid many of the complications of ASC 805 compliance. The FASB issued Accounting Standards Update 2017-01 to help companies evaluate whether a set of acquired assets is a business or not by providing a new definition of a business. The new definition replaces a previous one that was considered broad and challenging to apply. ASU 2017-01 is expected to restrict the number of acquisitions that qualify for the acquisition method. Answers to Questions 1.

A business combination is the process of forming a single economic entity by the uniting of two or more organizations under common ownership. The term also refers to the entity that results from this process.

Synergy is the concept that through combination, two or more companies will produce more revenue than either one could separately, or eliminate or streamline duplicate efforts, resulting in cost reductions. In a business combination, examples of synergies include utilizing existing distribution channels of one firm for the combined firm to increase revenues. Cost savings may be available through elimination of duplicate facilities. Larger size and scale can also provide additional negotiating power for the combined firm.

(1) A statutory merger is created whenever two or more companies come together to form a business combination and only one remains in existence as an identifiable entity. This arrangement is often instituted by the acquisition of substantially all of an enterprise‘s assets. (2) A statutory merger can also be produced by the acquisition of a company‘s capital stock. This transaction is labeled a statutory merger if the acquired company transfers its assets and liabilities to the buyer and then legally dissolves as a corporation. (3) A statutory consolidation results when two or more companies transfer all of their assets or capital stock to a newly formed corporation. The original companies are being ―consolidated‖ into the new entity. (4) A business combination is also formed whenever one company gains control over another through the acquisition of outstanding voting stock. Both companies retain their separate legal identities although the common ownership indicates that only a single economic entity exists.

Consolidated financial statements represent accounting information gathered from two or more separate companies. This data, although accumulated individually by the organizations, is brought together (or consolidated) to describe the single economic entity created by the business combination.

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Companies that form a business combination will often retain their separate legal identities as well as their individual accounting systems. In such cases, internal financial data continues to be accumulated by each organization. Separate financial reports may be required for outside shareholders (a noncontrolling interest), the government, debt holders, etc. This information may also be utilized in corporate evaluations and other decision making. However, the business combination must periodically produce consolidated financial statements encompassing all of the companies within the single economic entity. The purpose of a worksheet is to organize and structure this process. The worksheet allows for a simulated consolidation to be carried out on a regular, periodic basis without affecting the financial records of the various component companies.

Several situations can occur in which the fair value of the 50,000 shares being issued might be difficult to ascertain. These examples include:  The shares may be newly issued (if Jones has just been created) so that no accurate value has yet been established;  Jones may be a closely held corporation so that no fair value is available for its shares;  The number of newly issued shares (especially if the amount is large in comparison to the quantity of previously outstanding shares) may cause the price of the stock to fluctuate widely so that no accurate fair value can be determined during a reasonable period of time;  Jones‘ stock may have historically experienced drastic swings in price. Thus, a quoted figure at any specific point in time may not be an adequate or representative value for long-term accounting purposes.

For combinations resulting in complete ownership, the acquisition method allocates the fair value of the consideration transferred to the separately recognized assets acquired and liabilities assumed based on their individual fair values.

The revenues and expenses (both current and past) of the parent are included within reported figures. However, the revenues and expenses of the subsidiary are consolidated from the date of the acquisition forward within the worksheet consolidation process. The operations of the subsidiary are only applicable to the business combination if earned subsequent to its creation.

Morgan‘s additional acquisition value may be attributed to many factors: expected synergies between Morgan‘s and Jennings‘ assets, favorable earnings projections, competitive bidding to acquire Jennings, etc. In general however, any amount paid by the parent company in excess of the fair values of the subsidiary‘s net assets acquired is reported as goodwill.

10.

In the vast majority of cases the assets acquired and liabilities assumed in a business combination are recorded at their fair values. If the fair value of the consideration transferred (including any contingent consideration) is less than the total net fair value assigned to the assets acquired and liabilities assumed, then an ordinary gain on bargain purchase is recognized for the difference.

11.

Shares issued are recorded at fair value as if the stock had been sold and the money obtained used to acquire the subsidiary. The Common Stock account is recorded at the par value of these shares with any excess amount attributed to additional paid-in capital.

12.

The direct combination costs of $98,000 are allocated to expense in the period in which they occur. Stock issue costs of $56,000 are treated as a reduction of APIC.

Answers to Problems

10.

11.

12.

B Consideration transferred (fair value) Cash $150,000 Accounts receivable 140,000 Software 320,000 Research and development asset 200,000 Liabilities (130,000) Fair value of net identifiable assets acquired Goodwill

13.

$800,000

680,000 $120,000

C Legal and accounting fees accounts payable $15,000 Contingent liability 20,000 Donovan‘s liabilities assumed 60,000 Liabilities assumed or incurred $95,000

14.

D Consideration transferred (fair value) Current assets $90,000 Building and equipment 250,000 Unpatented technology 25,000 Research and development asset 45,000 Liabilities (60,000) Fair value of net identifiable assets acquired Goodwill Current assets

$420,000

350,000 $ 70,000

$ 90,000

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Building and equipment Unpatented technology Research and development asset Goodwill Total assets 15.

16.

17.

18.

19.

250,000 25,000 45,000 70,000 $480,000

B Consideration transferred (fair value) .............................. Book value of subsidiary (assets minus liabilities) ........ Fair value in excess of book value .............................. Allocation of excess fair over book value identified with specific accounts: Inventory........................................................................ Patented technology..................................................... Land ............................................................................... Liabilities ....................................................................... Goodwill.........................................................................

$400,000 (300,000) 100,000

TruData patented technology............................................ Webstat patented technology (fair value) ........................ Acquisition-date consolidated balance sheet amount....

$230,000 200,000 $430,000

TruData common stock before acquisition...................... Common stock issued (par value) .................................... Acquisition-date consolidated balance sheet amount....

$300,000 50,000 $350,000

TruData‘s 1/1 retained earnings........................................ TruData‘s income (1/1 to 7/1) ............................................ Acquisition-date consolidated balance sheet amount....

$130,000 80,000 $210,000

Patrick‘s assets .................................................................. Less: investment in Sean .................................................. Sean‘s assets ..................................................................... Inventory write-up .............................................................. Goodwill from the combination (see below) .................... Total consolidated assets .................................................

$1,395,000 (460,000) 415,000 25,000 145,000 $1,520,000

Consideration transferred ................................................. Fair value of net identifiable assets (see below) ............. Goodwill ..............................................................................

$460,000 315,000 $145,000

Sean‘s assets (carrying amount)...................................................

$415,000 125,000 290,000 25,000

30,000 20,000 25,000 10,000 $15,000

Sean‘s liabilities (carrying amount = $95,000 + $30,000) ........ Sean‘s net assets (carrying amount) ........................................ Inventory adjustment to fair value ......................................

Fair value of Sean‘s net identifiable assets .......................

20.

21.

$315,000

Patrick‘s stockholders‘ equity total. Value of shares issued (51,000 × $3) ................................ Par value of shares issued (51,000 × $1).......................... Additional paid-in capital (new shares) ........................... Additional paid-in capital (existing shares) .................... Consolidated additional paid-in capital (fair value) ........

$153,000 51,000 $102,000 90,000 $192,000

Acquisition-date consolidated retained earning equal the parent‘s retained earning less any acquisition costs ($300,000 – $10,000 = $290,000) 22. a. Intangible assets acquired in a business combination are recognized

apart from goodwill if they arise from contractual or other legal rights (regardless of whether those rights are transferable or separable from the acquired enterprise or from other rights and obligations). If an intangible asset does not arise from contractual or other legal rights, it is recognized apart from goodwill only if it is separable--capable of being separated or divided from the acquired enterprise and sold, transferred, licensed, rented, or exchanged (regardless of whether there is intent to do so). An intangible asset that cannot be sold, transferred, licensed, rented, or exchanged individually is considered separable if it can be sold, transferred, licensed, rented, or exchanged with a related contract, asset, or liability. b.    

23.

Trademarks—usually meet both the separability and legal/contractual criteria. Copyrights on artistic materials—usually meet both the separability and legal/contractual criteria. Agreements to receive royalties on leased intellectual property— usually meet the legal/contractual criterion. Unpatented technology—meets separability criterion if capable of being sold even if in conjunction with a related contract, asset, or liability.

(12 minutes) (Journal entries to record a merger—acquired company dissolved) Inventory Land Buildings

600,000 990,000 2,000,000

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24.

25.

Trademarks Goodwill Accounts Payable Common Stock Additional Paid-In Capital Cash

800,000 590,000

Professional Services Expense Cash

42,000

Additional Paid-In Capital Cash

25,000

80,000 40,000 960,000 3,900,000 42,000 25,000

(12 minutes) (Journal entries to record a bargain purchase—acquired company dissolved) Inventory Land Buildings Trademarks Accounts Payable Cash Gain on Bargain Purchase

600,000 990,000 2,000,000 800,000

Professional Services Expense Cash

42,000

80,000 4,200,000 110,000 42,000

(15 Minutes) (Consolidated balances) In acquisitions, the fair values of the subsidiary's assets and liabilities are consolidated (there are a limited number of exceptions). Goodwill is reported at $80,000, the amount that the $760,000 consideration transferred exceeds the $680,000 fair value of Sol‘s net assets acquired.         

Inventory = $670,000 (Padre's book value plus Sol's fair value) Land = $710,000 (Padre's book value plus Sol's fair value) Buildings and equipment = $930,000 (Padre's book value plus Sol's fair value) Franchise agreements = $440,000 (Padre's book value plus Sol's fair value) Goodwill = $80,000 (calculated above) Revenues = $960,000 (only parent company operational figures are reported at date of acquisition) Additional paid-in capital = $265,000 (Padre's book value adjusted for stock issue less stock issuance costs) Expenses = $940,000 (only parent company operational figures plus acquisition-related costs are reported at date of acquisition) Retained earnings, 1/1 = $390,000 (Padre's book value only)



26.

Retained earnings, 12/31 = $410,000 (beginning retained earnings plus revenues minus expenses, of Padre only)

(20 minutes) Journal entries for a merger using alternative values.

a. Acquisition date fair values: Cash paid Contingent performance liability Consideration transferred Fair values of net assets acquired Gain on bargain purchase

$700,000 35,000 $735,000 750,000 $ 15,000

Receivables Inventory Copyrights Patented Technology Research and Development Asset Current liabilities Long-Term Liabilities Cash Contingent Performance Liability Gain on Bargain Purchase

90,000 75,000 480,000 700,000 200,000

Professional Services Expense Cash

100,000

160,000 635,000 700,000 35,000 15,000 100,000

b. Acquisition date fair values: Cash paid Contingent performance liability Consideration transferred Fair values of net assets acquired Goodwill

$800,000 35,000 $835,000 750,000 $ 85,000

Receivables Inventory Copyrights Patented Technology Research and Development Asset Goodwill Current Liabilities Long-Term Liabilities Cash Contingent Performance Liability

90,000 75,000 480,000 700,000 200,000 85,000

Professional Services Expense Cash

100,000

160,000 635,000 800,000 35,000 100,000

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27.

(20 Minutes) (Determine selected consolidated balances) Under the acquisition method, the shares issued by Wisconsin are recorded at fair value using the following journal entry: Investment in Badger (value of debt and shares issued) .. 900,000 Common Stock (par value).............................................. 150,000 Additional Paid-In Capital (excess over par value) ....... 450,000 Liabilities........................................................................... 300,000 The payment to the broker is accounted for as an expense. The stock issue cost is a reduction in additional paid-in capital. Professional Services Expense............................................ Additional Paid-In Capital ..................................................... Cash ..................................................................................

30,000 40,000 70,000

Allocation of Acquisition-Date Excess Fair Value: Fair value of Badger (consideration transferred) ............... Carrying amount acquired, 6/30 ........................................... Excess fair value ................................................................... to equipment (undervalued) ............................................ to patented technology (overvalued).............................. Goodwill.......................................................................

$900,000 770,000 $130,000 100,000 (20,000) $ 50,000

CONSOLIDATED BALANCES: a. Net income (adjusted for professional services expense. The figures earned by the subsidiary prior to the takeover are not included) $ 210,000 b. Retained earnings, 1/1 (the figures earned by the subsidiary prior to the takeover are not included) 800,000 c. Patented technology (the parent's book value plus the fair value of the subsidiary) 1,180,000 d. Goodwill (computed above) 50,000 e. Liabilities (the parent's book value plus the fair value of the subsidiary's debt plus the debt issued by the parent in acquiring the subsidiary) 1,210,000 f. Common stock (the parent's book value after recording the newly-issued shares) 510,000 g. Additional Paid-in Capital (the parent's book value after recording the two entries above) 680,000 28.

(20 minutes) (Preparation of a consolidated balance sheet)* CASEY CORPORATION AND CONSOLIDATED SUBSIDIARY KENNEDY Worksheet for a Consolidated Balance Sheet

January 1, 2024

Cash Accounts receivable Inventory Investment in Kennedy Buildings (net) Licensing agreements Goodwill Total assets Accounts payable Long-term debt Common stock Additional paid-in cap. Retained earnings Total liab. & equities

Debit

Consolidation Entries Credit

Casey 457,000 1,655,000

Kennedy 172,500 347,000

Consolidated 629,500 2,002,000

1,310,000 3,300,000

263,500 -0-

6,315,000 -0-

2,090,000 3,070,000

(A)

347,000 13,384,000

-05,943,000

(A)

(394,000)

(393,000)

(3,990,000) (3,000,000) -0-

(2,950,000) (1,000,000) (500,000)

(S) (S)

1,000,000 500,000

(6,940,000) (3,000,000) -0-

(6,000,000)

(1,100,000)

(S)

1,100,000

(6,000,000)

(13,384,000)

(5,943,000)

1,573,500 (S)

2,600,000

(A)

700,000

(A)

108,000

382,000

426,000

-08,787,000 2,962,000 773,000 16,727,000 (787,000)

3,408,000

(16,727,000)

*Although this solution uses a worksheet to compute the consolidated amounts, the problem does not require it.

29.

(50 Minutes) (Determine consolidated balances for a bargain purchase.) a. Presidio‘s acquisition of Mason represents a bargain purchase because the fair value of the net assets acquired exceeds the fair value of the consideration transferred as follows: Fair value of net assets acquired Fair value of consideration transferred Gain on bargain purchase

$515,000 400,000 $115,000

In a bargain purchase, the acquisition is recorded at the fair value of the net assets acquired instead of the fair value of the consideration transferred (an exception to the general rule). Presidio records three journal entries related to the business combination. Investment in Mason ..................................................... 515,000 Long-term Liabilities ..................................................................... 200,000 Common Stock (par value)...................................................... 20,000 Additional Paid-In Capital ............................................................. 180,000 Gain on Bargain Purchase ........................................................... 115,000 (To record liabilities and stock issued for Mason acquisition fair value)

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Professional Services Expense................................. Cash ....................................................................... (to record payment of professional fees)

30,000

Additional Paid-In Capital .......................................... Cash ....................................................................... (To record payment of stock issuance costs)

12,000

30,000

12,000

Presidio's post-acquisition trial balance is adjusted for these transactions (as shown in the worksheet that follows). b. SEPARATELY DETERMINED CONSOLIDATED TOTALS             

Cash = $38,000. Add the two book values less acquisition and stock issue costs Receivables = $360,000. Add the two book values. Inventory = $505,000. Add the two book values plus the fair value adjustment Land = $400,000. Add the two book values plus the fair value adjustment. Buildings = $670,000. Add the two book values plus the fair value adjustment. Equipment = $210,000. Add the two book values. Total assets = $2,183,000. Summation of the above individual figures. Accounts payable = $190,000. Add the two book values. Long-term liabilities = $830,000. Add the two book values plus the debt incurred by the parent in acquiring the subsidiary. Common stock = $130,000.The parent's book value after stock issue to acquire the subsidiary. Additional paid-in capital = $528,000.The parent's book value after the stock issue to acquire the subsidiary less the stock issue costs. Retained earnings = $505,000. Parent company balance less $30,000 in professional services expense plus $115,000 gain on bargain purchase. Total liabilities and equity = $2,183,000. Summation of the above figures.

29. (continued)

PRESIDIO COMPANY AND CONSOLIDATED SUBSIDIARY MASON Worksheet to prepare a Consolidated Balance Sheet January 1, 2024 Accounts Cash Receivables Inventory Land Buildings (net) Equipment (net) Investment in Mason

Presidio Mason Company* Company 18,000 20,000 270,000 90,000 360,000 140,000 200,000 180,000 420,000 220,000 160,000

Consolidation Debit

(A) (A) (A)

Entries Credit

5,000 20,000 30,000

50,000

Consolidated Totals 38,000 360,000 505,000 400,000 670,000 210,000

515,000

(S) 460,000

Total assets

(A)

55,000

1,943,000

700,000

0 2,183,000

Accounts payable Long-term liabilities Common stock Additional paid-in capital Retained earnings, 1/1/24 Total liab. and owners‘ equity

(150,000)

(40,000)

(190,000)

(630,000)

(200,000)

(830,000)

(130,000)

(120,000)

(528,000)

-0-

(505,000)

(340,000)

(S) 340,000

(1,943,000)

(700,000)

515,000

(S) 120,000

(130,000) (528,000)

(505,000)

515,000

(2,183,000)

Presidio's accounts have been adjusted for acquisition entries (see part a.). 30.

(Prepare a consolidated balance sheet) Consideration transferred at fair value..................... Book value .................................................................. Excess fair over book value ...................................... Allocation of excess fair value to specific assets and liabilities: to computer software............................................ to equipment.......................................................... to client contracts .................................................

$495,000 265,000 230,000

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

Solution Manual For All Chapters

to in-process research and development .......... to notes payable.................................................... Goodwill ......................................................................

Cash Receivables Inventory Investment in Spider

Pratt 36,000 116,000 140,000 495,000

Spider 18,000 52,000 90,000 -0-

210,000

20,000 (A)

595,000

130,000

308,000

40,000

175,000 $ 55,000

Consolidation Entries Debit Credit Consolidated 54,000 168,000 230,000 (S) 265,000 (A)

Computer software Buildings (net) Equipment (net) Client contracts Research and development asset Goodwill Total assets Accounts payable Notes payable Common stock Additional paid-in capital Retained earnings Total liabilities and equities

40,000 (5,000)

230,000

50,000

-0280,000 725,000

(A)

10,000

338,000

-0-

-0- (A)

100,000

-0-

-0- (A)

40,000

-01,900,000 (88,000)

-0- (A) 350,000 (25,000)

55,000

55,000 1,990,000 (113,000)

(510,000)

(60,000)

(380,000)

(100,000) (S)

100,000

(380,000)

(170,000)

(25,000) (S)

25,000

(170,000)

(752,000)

(140,000) (S)

140,000

(752,000)

(350,000)

510,000

(1,900,000)

(A)

5,000

510,000

(575,000)

(1,990,000)

30. (continued)

Pratt Company and Subsidiary Consolidated Balance Sheet December 31, 2024 Assets Cash Receivables Inventory Computer software Buildings (net) Equipment (net) Client contracts Research and development asset Goodwill Total assets 31.

Liabilities and Owners’ Equity $ 54,000 Accounts payable $ 113,000 168,000 Notes payable 575,000 230,000 280,000 725,000 338,000 100,000 40,000 Common stock 380,000 Additional paid in capital 170,000 55,000 Retained earnings 752,000 $1,990,000 Total liabilities and equities $1,990,000

(15 minutes) (Acquisition method entries for a merger)

a. Fair value of consideration transferred Fair value of net identifiable assets Excess to goodwill

$145,000 120,000 $25,000

Journal entry on Allerton‘s books: Current Assets Building Land Trademark Goodwill Liabilities Cash

60,000 50,000 20,000 30,000 25,000 40,000 145,000

b. Bargain Purchase under acquisition method Fair value of consideration transferred Fair value of net identifiable assets Gain on bargain purchase

$110,000 120,000 $ 10,000

Journal entry on Allerton‘s books: Current Assets Building Land Trademark Gain on Bargain Purchase Liabilities Cash

60,000 50,000 20,000 30,000 10,000 40,000 110,000

Solution Manual For All Chapters

Problem 31. (continued) In a bargain purchase, the acquisition method employs the fair value of the net identifiable assets acquired as the basis for recording the acquisition. Because this basis exceeds the amount paid, Allerton recognizes a gain on bargain purchase. This is an exception to the general rule of using the fair value of the consideration transferred as the basis for recording the combination. 32.

(25 minutes) (Combination entries—acquired entity dissolved) Cash consideration transferred Contingent performance obligation Consideration transferred (fair value) Fair value of net identifiable assets* Goodwill

$310,800 17,900 328,700 294,700 $ 34,000

* Acquisition date Sundown book value $190,000 Excess building fair value 43,100 Unrecorded database 25,200 In-process research and development 36,400 Acquisition date Sundown fair value of net identifiable assets $294,700

Journal entries:

33.

Receivables Inventory Buildings Equipment Database Research and Development Asset Goodwill Current Liabilities Long-Term Liabilities Contingent Performance Liability Cash

83,900 70,250 122,000 24,100 25,200 36,400 34,000

Professional Services Expense Cash

15,100

12,900 54,250 17,900 310,800 15,100

(30 Minutes) (Overview of the steps in applying the acquisition method when shares have been issued to create a combination. Part h. includes a bargain purchase.) a. The fair value of the consideration includes Fair value of stock issued Contingent performance obligation Fair value of consideration transferred

$1,500,000 30,000 $1,530,000

b. Stock issue costs reduce additional paid-in capital. c. In a business combination, direct acquisition costs (such as fees paid to investment banks for arranging the transaction) are recognized as expenses. d. The par value of the 20,000 shares issued is recorded as an increase of $20,000 in the Common Stock account. The $74 fair value in excess of par value ($75 – $1) is an increase to additional paid-in capital of $1,480,000 ($74 × 20,000 shares). e. Fair value of consideration transferred (above) $1,530,000 Receivables $ 80,000 Patented technology 700,000 Computer software 500,000 In-process research and development 300,000 Liabilities (400,000) 1,180,000 Goodwill $ 350,000 f. Revenues and expenses of the subsidiary from the period prior to the combination are omitted from the consolidated totals. Only the operational figures for the subsidiary after the purchase are applicable to the business combination. The previous owners earned any previous profits. g. The subsidiary‘s Common Stock and Additional Paid-in Capital accounts have no impact on the consolidated totals. h. The fair value of the consideration transferred is now $1,030,000. This amount indicates a bargain purchase calculated as follows: Fair value of consideration transferred Receivables Patented technology Computer software Research and development asset Liabilities` Gain on bargain purchase

$1,030,000 $ 80,000 700,000 500,000 300,000 (400,000)

1,180,000 $ 150,000

The values of Sandstone‘s assets and liabilities would be recorded at fair value, but there would be no goodwill recognized and a gain on bargain purchase would be reported. 34.

(50 Minutes) (Prepare balance sheet for a statutory merger using the acquisition method. Also, use worksheet to derive consolidated totals.)

Solution Manual For All Chapters

a. In accounting for the combination of NewTune and On-the-Go, the fair value of the acquisition is allocated to each identifiable asset and liability acquired with any remaining excess attributed to goodwill. Fair value of consideration transferred (shares issued) $750,000 Fair value of net assets acquired: Cash $ 29,000 Receivables 63,000 Trademarks 225,000 Record music catalog 180,000 In-process research and development 200,000 Equipment 105,000 Accounts payable (34,000) Notes payable (45,000) 723,000 Goodwill $ 27,000 Journal entries by NewTune to record combination with On-the-Go: Cash 29,000 Receivables 63,000 Trademarks 225,000 Record Music Catalog 180,000 Research and Development Asset 200,000 Equipment 105,000 Goodwill 27,000 Accounts Payable Notes Payable Common Stock (NewTune par value) Additional Paid-In Capital (To record merger with On-the-Go at fair value) Additional Paid-In Capital Cash (Stock issue costs incurred)

34,000 45,000 60,000 690,000

25,000 25,000

Problem 34 (continued): Post-Combination Balance Sheet: Assets Cash Receivables Trademarks Record music catalog Research and development asset

Liabilities and Owners‘ Equity $ 64,000 Accounts payable $ 144,000 213,000 Notes payable 415,000 625,000 1,020,000 200,000 Common stock

460,000

Equipment

425,000 Additional paid-in capital 27,000 Retained earnings $2,574,000 Total

Goodwill Total

695,000 860,000 $2,574,000

b. Because On-the-Go continues as a separate legal entity, NewTune first records the acquisition as an investment in the shares of On-the-Go. Journal entries: Investment in On-the-Go 750,000 Common Stock (NewTune, Inc., par value) Additional Paid-In Capital (To record acquisition of On-the-Go's shares)

60,000 690,000

Additional Paid-In Capital Cash (Stock issue costs incurred)

25,000

Next, NewTune‘s accounts are adjusted for the two immediately preceding entries to facilitate the worksheet preparation of the consolidated financial statements. 34. (continued) b. NEWTUNE, INC., AND ON-THE-GO CO. Consolidation Worksheet January 1, 2024 Consolidation Entries Accounts Cash Receivables Investment in Onthe-Go Trademarks Record music catalog Research and development asset Equipment Goodwill Totals Accounts payable Notes payable

NewTune, Inc. 35,000 150,000 750,000

On-theGo Co. 29,000 65,000 -0-

400,000 840,000

95,000 60,000

(A) (A)

130,000 120,000

-0625,000 1,020,000

-0-

(A)

200,000

320,000 -02,495,000 110,000 370,000

105,000 -0354,000 34,000 50,000

(A)

27,000

(A)

5,000

Debit

Credit (A) (S)

2,000 270,000

(A)

480,000

Consolidated Totals 64,000 213,000

425,000 27,000 2,574,000 144,000 415,000

Solution Manual For All Chapters

Common stock Additional paid-in capital Retained earnings Totals

460,000 695,000

50,000 30,000

(S) (S)

50,000 30,000

860,000 2,495,000

190,000 354,000

(S)

190,000 752,000

460,000 695,000 860,000 2,574,000

752,000

Note: The accounts of NewTune have already been adjusted for the first three journal entries indicated in the answer to Part b. to record the acquisition fair value and the stock issuance costs. The consolidation entries are designed to:  Eliminate the stockholders‘ equity accounts of the subsidiary (S)  Record all subsidiary assets and liabilities at fair value (A)  Recognize the goodwill indicated by the acquisition fair value (A)  Eliminate the Investment in On-the-Go account (S, A)

c. The consolidated balance sheets in parts a. and b. above are identical. The financial reporting consequences for a 100% stock acquisition vs. a merger are the same. The economic substances of the two forms of the transaction are identical and, therefore, so are the resulting financial statements. The difference is in the journal entry to record the acquisition in the parent company books. 35.

(40 minutes) (Prepare a consolidated balance sheet using the acquisition method). a. Journal entries to record the acquisition on Pacifica‘s records. Investment in Seguros 1,062,500 Common Stock (50,000 × $5) Additional Paid-In Capital (50,000 × $15) Contingent Performance Obligation

250,000 750,000 62,500

The contingent consideration is computed as: $130,000 payment × 50% probability × 0.961538 present value factor Professional Services Expense Cash Additional Paid-In Capital Cash

15,000 15,000 9,000 9,000

b. and c.

Solution Manual For All Chapters

c. Consolidation Entries Pacifica

Consolidated Totals

Seguros

Revenues Expenses Net income

(1,200,000) 890,000 (310,000)

Retained earnings, 1/1 Net income Dividends declared Retained earnings, 12/31

(950,000) (310,000) 90,000 (1,170,000)

Cash Receivables and inventory Property, plant and equipment Investment in Seguros

86,000 750,000 1,400,000 1,062,500

85,000 190,000 450,000

Research and development asset Goodwill Trademarks Total assets

300,000 3,598,500

160,000 885,000

Liabilities Contingent performance obligation Common stock Additional paid-in capital Retained earnings Total liabilities and equities

(500,000) (62,500) (650,000) (1,216,000) (1,170,000) (3,598,500)

(180,000)

36.

(200,000) (70,000) (435,000) (885,000)

(A)

(A) (A) (A)

(S) (S) (S)

(A)

10,000

(S) (A)

705,000 357,500

150,000

100,000 77,500 40,000

200,000 70,000 435,000 1,072,500

171,000 930,000 2,000,000 0 100,000 77,500 500,000 3,778,500

1,072,500

(680,000) (62,500) (650,000) (1,216,000) (1,170,000) (3,778,500)

(30 minutes) Prepare an acquisition date consolidated balance sheet. Subsidiary has pre-existing goodwill.

Cash Accounts receivable

James 245,000 1,830,000

Johnson 110,000 360,000

Consolidation Entries

Consolidated* 355,000 2,190,000

Inventory Investment in Johnson

3,500,000 3,050,000

280,000 0

Patents Trademarks Goodwill Total assets

7,000,000 -0150,000 15,775,000

1,000,000 3,200,000 75,000 5,025,000

Accounts payable Long-term debt Common stock Additional paid-in capital Retained earnings Total liabilities and equities

(100,000) (4,300,000) (5,000,000) -0(6,375,000) (15,775,000)

(515,000) (2,210,000) (1,000,000) (200,000) (1,100,000) (5,025,000)

3,780,000

(A)

800,000

(A)

25,000

(S) (S) (S)

1,000,000 200,000 1,100,000 3,125,000

(S) (A)

2,300,000 750,000

(A)

75,000

3,125,000

-08,800,000 3,200,000 175,000 18,500,000 (615,000) (6,510,000) (5,000,000) -0(6,375,000) (18,500,000)

Chapter 03 – Consolidations – Subsequent to the Date of Acquisition – Hoyle, Schaefer, Doupnik, Advanced Accounting, 15e

Consolidation Worksheet Entry (S) Common stock-Johnson Additional paid-in capital-Johnson Retained earnings-Johnson Investment in Johnson

1,000,000 200,000 1,100,000 2,300,000

Consolidation Worksheet Entry (A) Patents Goodwill (new) Goodwill (pre-existing subsidiary) Investment in Johnson

800,000 25,000 75,000 750,000

*Although this solution uses a worksheet to compute the consolidated amounts, the problem does not require it. Answers to Appendix 2A Problems

37.

(25 minutes) Journal entries for a merger using legacy purchase method. Also compare to acquisition method.

a. Purchase Method 1. Purchase price (including acquisition costs) $635,000 Fair values of net assets acquired 525,000

Goodwill

$110,000

Journal entry: Current Assets Equipment Trademark Goodwill Liabilities Cash 2.

80,000 180,000 320,000 110,000 55,000 635,000

Acquisition date fair values: Purchase price (including acquisition costs) $450,000 Fair values of net assets acquired 525,000 Bargain purchase ($ 75,000)

Allocation of bargain purchase to long-term assets acquired: Fair value

Equipment

$180,000

Prop.

36%

Total reduction

Asset reduction

$75,000 =

$27,000

Chapter 03 – Consolidations – Subsequent to the Date of Acquisition – Hoyle, Schaefer, Doupnik, Advanced Accounting, 15e

Trademark

320,000 $500,000

64%

75,000 =

48,000 $75,000

Journal entry: Current Assets Equipment ($180,000 – $27,000) Trademark ($320,000 – $48,000) Liabilities Cash

80,000 153,000 272,000 55,000 450,000

37. continued b. Acquisition Method 1.

Consideration transferred Fair values of net assets acquired Goodwill

$ 610,000 525,000 $ 85,000

Journal entry: Current Assets Equipment Trademark Goodwill Liabilities Cash

80,000 180,000 320,000 85,000

Professional Services Expense Cash

25,000

55,000 610,000 25,000

Consideration transferred Fair values of net assets acquired Gain on bargain purchase

$425,000 525,000 ($100,000)

Journal entry: Current Assets Equipment Trademark Liabilities Gain on Bargain Purchase Cash

80,000 180,000 320,000

Professional Services Expense Cash

25,000

55,000 100,000 425,000 25,000 3-2

Chapter 03 – Consolidations – Subsequent to the Date of Acquisition – Hoyle, Schaefer, Doupnik, Advanced Accounting, 15e

38.

(25 minutes) (Pooling vs. purchase involving an unrecorded intangible)

a. Inventory Land Buildings Unpatented technology Goodwill Total

Purchase $ 650,000 750,000 1,000,000 1,500,000

Pooling $ 600,000 450,000 900,000 -0-

600,000 $4,500,000

-0$1,950,000

b. The purchase method excluded pre-acquisition revenues and expenses from consolidated results, but the pooling method included them. c. Poolings typically produced higher rates of return on assets than purchase accounting because the denominator was often much lower. The Swimwear acquisition pooling produced an increment to total assets of $1,950,000 compared to $4,500,000 under purchase accounting. Future EPS under poolings were also higher because of lower future amortization of the smaller asset base. Managers whose compensation contracts involved accounting performance measures clearly had incentives to use pooling of interest accounting whenever possible. Answers to Appendix 2B Problems

39.

40.

(12 minutes) (Pushdown Accounting Application) Quigley Corporation Balance Sheet May 1 Cash Receivables Inventory Land Building and equipment (net) Patented technology Goodwill Total assets

$ 95,000 200,000 260,000 110,000 330,000 220,000 125,000 $1,340,000

Accounts payable Long-term liabilities Common stock—5 par value Additional paid-in capital

$ 120,000 510,000 210,000 90,000 3-3

Chapter 03 – Consolidations – Subsequent to the Date of Acquisition – Hoyle, Schaefer, Doupnik, Advanced Accounting, 15e

APIC from pushdown accounting Retained earnings, 1/1 Total liabilities and stockholders' equity

410,000 -0$1,340,000

Chapter 2 Develop Your Skills CONSIDERATION OR COMPENSATION CASE (estimated time 50 minutes) According to FASB ASC (805-10-55-25): If it is not clear whether an arrangement for payments to employees or selling shareholders is part of the exchange for the acquiree or is a transaction separate from the business combination, the acquirer should consider the following indicators: a. Continuing employment. The terms of continuing employment by the selling shareholders who become key employees may be an indicator of the substance of a contingent consideration arrangement. The relevant terms of continuing employment may be included in an employment agreement, acquisition agreement, or some other document. A contingent consideration arrangement in which the payments are automatically forfeited if employment terminates is compensation for post combination services. Arrangements in which the contingent payments are not affected by employment termination may indicate that the contingent payments are additional consideration rather than compensation. b. Duration of continuing employment. If the period of required employment coincides with or is longer than the contingent payment period, that fact may indicate that the contingent payments are, in substance, compensation. c. Level of compensation. Situations in which employee compensation other than the contingent payments is at a reasonable level in comparison to that of other key employees in the combined entity may indicate that the contingent payments are additional consideration rather than compensation. d. Incremental payments to employees. If selling shareholders who do not become employees receive lower contingent payments on a per-share basis than the selling shareholders who become employees of the combined entity, that fact may indicate that the incremental amount of contingent payments to the selling shareholders who become employees is compensation. e. Number of shares owned. The relative number of shares owned by the selling shareholders who remain as key employees may be an indicator of the substance of the contingent consideration arrangement. For example, if the selling shareholders who owned substantially all of the shares in the acquiree continue as key employees, that fact may indicate that the arrangement is, in substance, a profitsharing arrangement intended to provide compensation for post combination services. Alternatively, if selling shareholders who continue as key employees owned only a small number of shares of the acquiree and all selling shareholders receive the same amount of contingent consideration on a per-share basis, that fact may indicate that the contingent payments are additional consideration. The preacquisition ownership interests held by parties related to selling shareholders who continue as key employees, such as family members, also should be considered. f. Linkage to the valuation. If the initial consideration transferred at the acquisition date is based on the low end of a range established in the valuation of the acquiree and the contingent formula relates to that valuation approach, that fact may suggest that the contingent payments are additional consideration. Alternatively, if the contingent payment formula is consistent with prior profit-sharing arrangements, 3-4 © McGraw Hill LLC. All rights reserved. No reproduction or distribution without the prior written consent of McGraw Hill LLC.

Chapter 03 – Consolidations – Subsequent to the Date of Acquisition – Hoyle, Schaefer, Doupnik, Advanced Accounting, 15e

that fact may suggest that the substance of the arrangement is to provide compensation. g. Formula for determining consideration. The formula used to determine the contingent payment may be helpful in assessing the substance of the arrangement. For example, if a contingent payment is determined based on a multiple of earnings, that might suggest that the obligation is contingent consideration in the business combination. Thus, the formula is intended to establish or verify the fair value of the acquiree. In contrast, a contingent payment that is a specified percentage of earnings might suggest that the obligation to employees is a profit-sharing arrangement to compensate employees for services rendered. Suggested answer: Note: This case was designed to have conflicting indicators across the various criteria identified in the FASB ASC for determining the issue of compensation vs. consideration. Thus, the solution is subject to alternative explanations and students can be encouraged to use their own judgment and interpretations in supporting their answers. In the author‘s judgment, the $8 million contingent payment (fair value = $4 million) is contingent consideration to be included in the overall fair value AutoNav records for its acquisition of Easy-C. This contingency is not dependent on continuing employment (criteria a.), and uses a formula based on a component of earnings (criteria g.). Even though the four former owners of Easy-C owned 100% of the shares (criteria e.), which suggests the $8 million is compensation, the overall fact pattern indicates consideration because no services are required for the payment. The profit-sharing component of the employment contract appears to be compensation. Criteria g. specifically identifies profit-sharing arrangements as indicative of compensation for services rendered. Criteria a. also applies given that the employees would be unable to participate in profit-sharing if they terminate employment. Although the employees receive non-profit sharing compensation similar to other employees (criteria c.), the overall pattern of evidence suggests that any payments made under the profit-sharing arrangement should be recognized as compensation expense when incurred and not contingent consideration for the acquisition. ASC RESEARCH CASE—DEFENSIVE INTANGIBLE ASSET (45 MINUTES) a. The ASC Glossary defines a defensive intangible asset as ―An acquired intangible asset in a situation in which an entity does not intend to actively use the asset but intends to hold (lock up) the asset to prevent others from obtaining access to the asset.‖ ASC 820-10-35-10D also observes that To protect its competitive position, or for other reasons, a reporting entity may intend not to use an acquired nonfinancial asset actively, or it may intend not to use the asset according to its highest and best use. For example, that might be the case for an acquired intangible asset that the reporting entity plans to use defensively by preventing others from using it. Nevertheless, the reporting entity shall measure the fair value of a nonfinancial asset assuming its highest and best use by market

Chapter 03 – Consolidations – Subsequent to the Date of Acquisition – Hoyle, Schaefer, Doupnik, Advanced Accounting, 15e

participants. According to ASC 350-30-25-5 a defensive intangible asset should be accounted for as a separate unit of accounting (i.e., an asset separate from other assets of the acquirer). It should not be included as part of the cost of an entity's existing intangible asset(s) presumably because the defensive intangible asset is separately identifiable. b. The identifiable assets acquired in a business combination should be measured at their acquisition-date fair values (ASC 805-20-30-1). c. A fair value measurement assumes the highest and best use of an asset by market participants. Highest and best use is determined based on the use of the asset by market participants, even if the intended use of the asset by the reporting entity is different (ASC 820-10-35-10). Importantly, highest and best use provides maximum value to market participants. The highest and best use of the asset establishes the valuation premise used to measure the fair value of the asset—in this case an inexchange premise maximizes the value of the asset at $2 million. d. A defensive intangible asset shall be assigned a useful life that reflects the entity's consumption of the expected benefits related to that asset. The benefit a reporting entity receives from holding a defensive intangible asset is the direct and indirect cash flows resulting from the entity preventing others from realizing any value from the intangible asset (defensively or otherwise). An entity shall determine a defensive intangible asset's useful life, that is, the period over which an entity consumes the expected benefits of the asset, by estimating the period over which the defensive intangible asset will diminish in fair value. The period over which a defensive intangible asset diminishes in fair value is a proxy for the period over which the reporting entity expects a defensive intangible asset to contribute directly or indirectly to the future cash flows of the entity. (ASC 350-30-35A) It would be rare for a defensive intangible asset to have an indefinite life because the fair value of the defensive intangible asset will generally diminish over time as a result of a lack of market exposure or as a result of competitive or other factors. Additionally, if an acquired intangible asset meets the definition of a defensive intangible asset, it shall not be considered immediately abandoned. (ASC 350-30-35B) RESEARCH CASE—PELOTON‘S ACQUISITION OF PRECOR, INC. (35 Minutes) 1. From Peloton‘s June 30, 2021 10-K report:

―The Company acquired Precor to establish its U.S. manufacturing capacity, boost research and development capabilities with Precor's highly-skilled team, and accelerate Peloton's penetration of certain commercial markets.‖ (p. 83) According to the April 1, 2021 Peloton‘s press release, ―Precor is one of the largest global commercial fitness equipment providers with a significant U.S. manufacturing presence…we expect we'll be able to not only continue our relationship with our current customers, but scale the Peloton experience that millions of people have at home to even more hotels, campuses, and multifamily residences.‖

Chapter 03 – Consolidations – Subsequent to the Date of Acquisition – Hoyle, Schaefer, Doupnik, Advanced Accounting, 15e 2. Peloton accounted for its acquisition of Precor using the acquisition method in

accordance with ASC 805. Accordingly, Peloton recorded the acquisition at $412 million. 3. Peloton recognized $135 million of goodwill from the Precor acquisition computed as

follows (amounts below in millions): Consideration transferred Accounts receivable Inventories Prepaid expenses and other current assets Property and equipment Intangible assets Operating lease right-of-use assets Deferred tax asset Other assets Accounts payable and accrued expenses Customer deposits and deferred revenue Operating lease liabilities, current Other current liabilities Operating lease liabilities, non-current Other non-current liabilities Goodwill

$412 $ 50.2 99.1 6.5 23.8 180.1 20.3 0.9 0.7 (60.1) (11.5) (6.2) (2.8) (13.6) (10.4)

277 $135

4. Acquisition-related costs totaled $6 million and expensed as incurred during the fiscal

year ended June 30, 2021. The costs were included in general and administrative expenses in the consolidated income statement. 5. Peloton included the Precor acquisition price, net of cash acquired, as an investing

activity in its statement of cash flows. RESEARCH CASE—ANALOG DEVICES ACQUISITION OF MAXIM INTEGRATED PRODUCTS (40 minutes) 1. Analog Devices is one of the largest U.S. commercial semiconductor equipment companies focusing on data capture, measurement, processing, and transfer. Analog serves the automotive, healthcare, aerospace, and other industrial sectors. Maxim also supplies integrated circuits to communications firms, data centers, automotive, computing, and other industrial firms. The deal provides Analog with needed scale to capture an increasing share of the fast growing semiconductor engineering market. The deal also provides the combined company with over 10,000 engineers to help with innovation and product development through a broader set of capabilities in research and development. 2. Along with a relatively small amount of cash, Analog paid the owners of Maxim by issuing 169.2 million shares of its common stock with an acquisition-date value of $27,754,161,000. Also included in the consideration transferred was $194,890,000 of equity replacement awards.

Chapter 03 – Consolidations – Subsequent to the Date of Acquisition – Hoyle, Schaefer, Doupnik, Advanced Accounting, 15e

3. As reported its 2021 10-K (page 71), Analog included $194.89 million, the fair value of partially vested restricted stock and restricted stock unit replacement awards in the total consideration transferred as part of the acquisition. According to ASC 805-30-30-11 The portion of the fair-value-based measure of the replacement award that is part of the consideration transferred in exchange for the acquiree equals the portion of the acquiree award that is attributable to pre-combination service.

4. (amounts in thousands)

Consideration transferred Cash and cash equivalents Accounts Receivable Inventories Prepaid expenses and other current assets Property, plant and equipment Intangible assets Other long-term assets Accounts payable Income taxes payable Accrued liabilities Long-term debt Deferred income taxes Other non-current liabilities Goodwill

$27,949,098 $2,450,597 609,245 858,300 59,310 759,544 12,429,100 80,373 (112,828) (137,590) (590,855) (1,072,150) (1,665,356) (363,668)

$13,304,022 $14,645,076

5. According to the 2021 Analog annual 10-K report, customer relationships acquired in the Maxim combination will be expensed over an amortization period of 14 years. Developed technologies recognized in the acquisition will be amortized over 8 years, at which point they will be reclassified as core and developed technology and backlog will be amortized over 2 years. RESEARCH CASE— ANIKA THERAPEUTICS ACQUISITIONS OF PARCUS MEDICAL AND ARTHROSURFACE (40 minutes) 1. ―Contingent consideration represents additional payments that the Company may be required to make in the future, which totals up to $60.0 million depending on the level of net sales of Parcus Medical products generated in 2020 through 2022... The Company may be required to make future payments of up to $40.0 million depending on the achievement of regulatory milestones and the level of net sales of Arthrosurface products in 2020 through 2021.‖ (pages 67 and 69, 2020 Anika 10-K report) 2. Arthrosurface: Estimated fair value of contingent consideration $28,376,000 Parcus Medical: Estimated fair value of contingent consideration $40,700,000 For Parcus Medical: ―The fair value of contingent consideration related to net sales was determined based on a Monte Carlo simulation model in an option pricing framework at the acquisition date, whereby a range of possible scenarios were 3-8 © McGraw Hill LLC. All rights reserved. No reproduction or distribution without the prior written consent of McGraw Hill LLC.

Chapter 03 – Consolidations – Subsequent to the Date of Acquisition – Hoyle, Schaefer, Doupnik, Advanced Accounting, 15e

simulated.‖ (page 67, 2020 Anika 10-K report) For Arthrosurface: The fair value of contingent consideration related to regulatory milestones was determined through a scenario-based discounted cash flow analysis using scenario probabilities and regulatory milestone dates. The fair value of contingent consideration related to net sales was determined based upon a Monte Carlo simulation approach at acquisition date, whereby a range of possible scenarios were simulated.‖ (page 69, 2020 Anika 10-K report) 3. The liability for contingent consideration is included in current and long-term liabilities on the consolidated balance sheets and will be remeasured at each reporting period until the contingency is resolved. (page 67, 2020 Anika 10-K report) 4. Possible motivations for inclusion of contingent payments in business acquisitions revolve around the inherent uncertainty of future outcomes that may significantly affect the future value of combination. For example, regulatory hurdles, if not achieved, can reduce the future cash flows of the acquired firm. Therefore, to reduce risk, acquisitions like Arthrosurface contain contingencies based on the achievement of regulatory milestones. Note that as reported in Anika‘s 2020 10-K, Arthrosurface did indeed obtain regulatory clearance for one of its contingencies and thus received a $5 million payment. The remaining contingencies for Arthrosurface and Parcus Medical rely on the subsidiaries meeting net sales targets. Again, the use of contingent payments in the acquisition target reduces Anika‘s risk and provides for payment to the subsidiaries‘ former owners should the net sales performance meet negotiated amounts.

CHAPTER 3 CONSOLIDATIONS—SUBSEQUENT TO THE DATE OF ACQUISITION I.

II.

Several factors serve to complicate the consolidation process when it occurs subsequent to the date of acquisition. In all combinations within its own internal records the acquiring company will utilize a specific method to account for the investment in the acquired company. 1. Three alternatives are available a. Initial value method (also known as the cost method) b. Equity method c. Partial equity method 2. Depending upon the method applied, the acquiring company will record earnings from its ownership of the acquired company. This total must be eliminated on the consolidation worksheet and be replaced by the subsidiary‘s revenues and expenses. 3. Under each of these three methods, the balance in the Investment account will also vary. It too must be removed in producing consolidated statements and be replaced by the subsidiary‘s assets and liabilities. For combinations subsequent to the acquisition date, certain procedures are required. If the parent applies the equity method, the following process is appropriate. A. Assuming that the acquisition was made during the current fiscal period

Chapter 03 – Consolidations – Subsequent to the Date of Acquisition – Hoyle, Schaefer, Doupnik, Advanced Accounting, 15e

1. The parent adjusts its own Investment account to reflect the subsidiary‘s income and dividend declarations as well as any amortization expense relating to excess acquisition-date fair value over book value allocations and goodwill. 2. Worksheet entries are then used to establish consolidated figures for reporting purposes. a. Entry S offsets the subsidiary‘s stockholders‘ equity accounts against the book value component of the Investment account (as of the acquisition date). b. Entry A recognizes the excess fair over book value allocations made to specific subsidiary accounts and/or to goodwill. c. Entry I eliminates the investment income balance accrued by the parent. d. Entry D removes intra-entity dividend declarations e. Entry E recognizes the current excess amortization expenses on the excess fair over book value allocations. f. Entry P eliminates any intra-entity payable/receivable balances. B. Assuming that the acquisition was made during a previous fiscal period 1. Most of the consolidation entries described above remain applicable regardless of the time that has elapsed since the combination was formed. 2. The amount of the subsidiary‘s stockholders‘ equity to be removed in Entry S will differ each period to reflect the balance as of the beginning of the current year 3. The allocations established by entry A will also change in each subsequent consolidation. Only the unamortized balances remaining as of the beginning of the current period are recognized in this entry. III.

For a combination where the parent has applied an accounting method other than the equity method, the consolidation procedures described above must be modified. A. If the initial value method is applied by the parent company, the intra-entity dividends eliminated in Entry I will only consist of the dividends transferred from the subsidiary. No separate Entry D is needed. B. If the partial equity method is in use, the intra-entity income to be removed in Entry I is the equity accrual only; no amortization expense is included. Intra-entity dividends are eliminated through Entry D. C. In any time period after the year of acquisition. 1. The initial value method recognizes neither income in excess of dividend declarations nor excess amortization expense. Thus, for all years prior to the current period, both of these figures must be entered directly into the consolidation. Entry*C is used for this purpose; it converts all prior amounts to equity method balances. 2. The partial equity method does not recognize excess amortization expenses. Therefore, Entry*C converts the appropriate account balances to the equity method by recognizing the expense that relates to all of the past years.

IV.

Bargain purchases A. As discussed in Chapter Two, bargain purchases occur when the parent company transfers consideration less than net fair values of the subsidiary‘s assets acquired and liabilities assumed. B. The parent recognizes an excess of net asset fair value over the consideration transferred as a ―gain on bargain purchase.‖

Goodwill Impairment A. When is goodwill impaired?

Chapter 03 – Consolidations – Subsequent to the Date of Acquisition – Hoyle, Schaefer, Doupnik, Advanced Accounting, 15e

1. Goodwill is considered impaired when the fair value of its related reporting unit falls below its carrying value. Goodwill should not be amortized, but should be tested for impairment at the reporting unit level (operating segment or lower identifiable level). 2. Goodwill should be tested for impairment at least annually. 3. Interim impairment testing is necessary in the presence of negative indicators such as an adverse change in the business climate or market, legal factors, regulatory action, an introduction of competition, or a loss of key personnel. B. How is goodwill tested for impairment? 1. All acquired goodwill should be assigned to reporting units. It would not be unusual for the total amount of acquired goodwill to be divided among a number of reporting units. Goodwill may be assigned to reporting units of the acquiring entity that are expected to benefit from the synergies of the combination even though other assets or liabilities of the acquired entity may not be assigned to that reporting unit. 2. Goodwill is first assessed for potential impairment through an optional assessment process. a. Entities are allowed the option of conducting a qualitative assessment of goodwill to assess whether further quantitative measurement is needed. Under the qualitative assessment, management evaluates relevant events or circumstances to determine whether it is more likely than not that the fair value of a reporting unit is less than its carrying amount. If it is more likely than not that the fair value of a reporting unit is less than its carrying amount, then the entity performs a quantitative test and impairment measurement. Otherwise, no further tests are required. c. The quantitative test simply compares the fair value amount of a reporting unit to its carrying amount. If the fair value of the reporting unit exceeds its carrying amount, goodwill is not considered impaired and no further analysis is necessary. d. If the carrying amount of the reporting unit exceeds its fair value, then goodwill is considered impaired. Goodwill impairment is measured as the excess of the carrying amount of a reporting unit over its fair value (not to exceed the carrying amount of goodwill). C. How is the impairment recognized in financial statements? 1. The aggregate amount of goodwill impairment losses should be presented as a separate line item in the operating section of the income statement unless a goodwill impairment loss is associated with a discontinued operation. 2. A goodwill impairment loss associated with a discontinued operation should be included (on a net-of-tax basis) within the results of discontinued operations. VI.

Amortization and Impairment of Other Intangibles A. Subsequent to a business combination, any newly recognized subsidiary identifiable intangible assets (i.e., other than goodwill) considered to possess indefinite lives are not amortized but instead are assessed for impairment on an annual basis. B. Similar to goodwill impairment assessment, an entity has the option to first perform qualitative assessments for its indefinite-lived intangibles to see if further quantitative tests are necessary. C. For intangible assets with finite lives, amortization expense is recognized over the intangible asset's useful life. The amortization method should reflect the pattern of decline in the economic usefulness of the asset. If no such pattern is apparent, the straight-line method of amortization should be used. 3-11 © McGraw Hill LLC. All rights reserved. No reproduction or distribution without the prior written consent of McGraw Hill LLC.

Chapter 03 – Consolidations – Subsequent to the Date of Acquisition – Hoyle, Schaefer, Doupnik, Advanced Accounting, 15e

VII.

Contingent consideration A. The fair value of any contingent consideration is included as part of the consideration transferred. B. If the contingency results in a liability (typically a cash payment), changes in the fair value of the contingency are recognized in income as they occur. C. If the contingency calls for an additional equity issue at a later date, the acquisitiondate fair value of the contingency is not adjusted over time. Any subsequent shares issued as a consequence of the contingency are simply recorded at the original acquisition-date fair value. This treatment is similar to other equity issues (e.g., common stock, preferred stock, etc.) in the parent‘s owners‘ equity section.

Answers to Discussion Questions How Does a Company Really Decide Which Investment Method to Apply? Students can come up with dozens of factors that Pilgrim should consider in choosing its internal method of accounting for its subsidiary, Crestwood Corporation. The following is only a partial list of possible points to consider.  Use of the information. If Pilgrim does not monitor its subsidiary‘s income levels closely, applying the equity method may not be fruitful. A company must plan to use the data before the task of accumulation becomes worthwhile. For example, Crestwood may use the information for evaluating the performance of the subsidiary‘s managers. 

Size of the subsidiary. If the subsidiary is large in comparison to Pilgrim, the effort required of the equity method may be important. Income levels would probably be significant. However, if the subsidiary is actually quite small in relation to the parent, the impact might not be material enough to warrant the extra effort.



Size of dividend declarations. If Crestwood distributes most of its income as dividends, that figure will approximate equity income. Little additional information would be accrued by applying the equity method. In contrast, if dividends are small or not declared on a regular basis, a Dividend Income balance might vastly understate the profits to be recognized by the business combination.



Amount of excess amortizations. If Pilgrim has paid a significant amount in excess of book value, its annual amortization charges are high, and use of the equity method might be preferred to show the amortization effect each reporting period. In this case, waiting until year end and recognizing all of the expense at one time through a worksheet entry might not be the best way to reflect the impact of the expense.



Amount of intra-entity transactions. As with amortization, the volume of transfers can be an important element in deciding which accounting method to use. If few intra-entity sales are made, monitoring the subsidiary through the application of the equity method is less essential. Conversely, if the amount of these transactions IS significant, the added data can be helpful to company administrators evaluating operations.



Sophistication of accounting systems. If Pilgrim and Crestwood both have advanced accounting systems, application of the equity method may be relatively easy. Unfortunately, if these systems are primitive, the cost and effort necessary to apply the equity method may outweigh any potential benefits.

Chapter 03 – Consolidations – Subsequent to the Date of Acquisition – Hoyle, Schaefer, Doupnik, Advanced Accounting, 15e



The timeliness and accuracy of income figures generated by Crestwood. If the subsidiary reports operating results on a regular basis (such as weekly or monthly) and these figures prove to be reliable, equity totals recorded by Pilgrim may serve as valuable information to the parent. However, if Crestwood's reports are slow and often require later adjustment, Pilgrim's use of the equity method will provide only questionable results.

Answers to Discussion Questions (continued) In consolidation worksheet entry *C, we adjust the parent’s beginning of the year retained earnings to a full accrual basis. Why don’t we adjust to the parent’s end of the year retained earnings balance on the consolidated worksheet? This first part of the discussion question is addressed in the textbook immediately below the above question. How does the consolidation worksheet entry *C differ when the parent uses the initial value method versus the partial equity method? Why is no *C adjustment needed when consolidated statements are prepared for the first fiscal year-end after the business combination? Under the initial value method, the parent recognizes no subsidiary income and therefore needs to adjust the investment account in worksheet entry *C for the full change in subsidiary income over time (less acquisition-date excess fair over book value amortization). In contrast, under the partial equity method, the parent has not recognized on its books only the acquisition-date excess fair over book value amortization—thus worksheet entry *C includes only this excess amortization. Finally, because the parent include all subsidiary earnings and excess amortization in applying the equity method, no worksheet entry *C is needed. The parent‘s retained earning already provide a full-accrual measure of consolidated retained earnings. Answers to Questions 1.

a. CCES Corp., for its own recordkeeping, may apply the equity method to its Investment in Schmaling. Under this approach, the parent's records parallel the activities of the subsidiary. The parent accrues income as it is earned by the subsidiary. Dividends declared by Schmaling reduce its book value; therefore, CCES reduces the investment account. In addition, any excess amortization expense associated with CCES's acquisition-date fair value allocations is recognized through a periodic adjustment. By applying the equity method, both the parent‘s income and investment balances accurately reflect consolidated totals. The equity method is especially helpful in monitoring the income of the business combination. This method can be, however, rather difficult to apply and a time consuming process. b. The initial value method. The initial value method can also be utilized by CCES Corporation. Any dividends declared are recognized as income but no other investment entries are made. Thus, the initial value method is easy to apply. However, the resulting account balances of the parent may not provide a reasonable representation of the totals that result from consolidating the two companies. c. The partial equity method combines the advantages of the previous two techniques. Income is accrued as earned by the subsidiary as under the equity method. Similarly, 3-13 © McGraw Hill LLC. All rights reserved. No reproduction or distribution without the prior written consent of McGraw Hill LLC.

Chapter 03 – Consolidations – Subsequent to the Date of Acquisition – Hoyle, Schaefer, Doupnik, Advanced Accounting, 15e

dividends reduce the investment account. However, no other entries are recorded; more specifically, amortization is not recognized by the parent. The method is, therefore, easier to apply than the equity method but the subsidiary's individual totals will still frequently approximate consolidated balances. 2. a. The consolidated total for equipment is made up of the sum of Maguire‘s book value, Williams‘ book value, and any unamortized excess acquisition-date fair value over book value attributable to Williams‘ equipment. b. Although an Investment in Williams account is appropriately maintained by the parent, from a consolidation perspective the balance is intra-entity in nature. Thus, the entire amount is eliminated in arriving at consolidated financial statements. c. Only dividends declared to outside parties are included in consolidated statements. Because Maguire owns 100 percent of Williams, all of the subsidiary's dividends are intra-entity. Consequently, only the dividends declared by the parent company will be reported in the financial statements for this business combination. d. Any acquisition-date goodwill must still be reported for consolidation purposes. Reductions to goodwill are made if goodwill is determined to be impaired. e. Unless intra-entity revenues have been recorded, consolidation is achieved in subsequent periods by adding the two book values together. f.

Consolidated expenses are determined by combining the parent's and subsidiary amounts including any amortization expense associated with the acquisition-date fair value allocations. As discussed in Chapter Five, intra-entity expenses can also require elimination in arriving at consolidated figures.

g. Only the parent‘s common stock outstanding is included in consolidated totals. h. The net income for a business combination is calculated as the difference between consolidated revenues and consolidated expenses. 3.

Under the equity method, the parent accrues subsidiary earnings and amortization expense (associated with acquisition-date fair value allocations) in the same manner as in the consolidation process. The equity method parallels consolidation. Thus, the parent‘s net income and retained earnings each year will equal the consolidated totals.

In the consolidation process, excess amortizations must be recognized annually for any portion of the acquisition-date fair value allocations to specific assets or liabilities (other than indefinite-lived assets). Although this expense can be simulated in total on the parent's books by an equity method entry, the actual amortization of each allocated fair value adjustment is appropriate for consolidation. Hence, the effect of the parent's equity method amortization entry is removed as part of Entry I so that the amortization of specific accounts (e.g., depreciation) can be recognized (in consolidation Entry E).

When a parent applies the initial value method, no accrual is recorded to reflect the subsidiary's change in book value subsequent to acquisition. Recognition of excess amortizations relating to the acquisition is also omitted by the parent. The partial equity method, in contrast, records the subsidiary‘s book value increases and decreases but not amortizations. Consequently, for both of these methods, a technique must be employed in the consolidation process to recognize the omitted figures. Entry *C simply brings the parent's figures (more specifically, the beginning retained earnings balance and the 3-14 © McGraw Hill LLC. All rights reserved. No reproduction or distribution without the prior written consent of McGraw Hill LLC.

Chapter 03 – Consolidations – Subsequent to the Date of Acquisition – Hoyle, Schaefer, Doupnik, Advanced Accounting, 15e

investment account) up-to-date as of the first day of the current year. If the acquirer applies the initial value method, changes in the subsidiary's book value in previous years are recognized on the worksheet along with the appropriate amount of amortization expense. For the partial equity method, only the amortization relating to these prior years needs to be recognized. No similar entry to *C is needed when the parent applies the equity method. The parent will record changes in the subsidiary's book value as well as excess amortization each year. Thus, under the equity method, the parent's investment and beginning retained earnings balances are both correctly established and need no further adjustment. 6.

Lambert's loan payable and the receivable held by Jenkins are intra-entity accounts. The consolidation process offsets these reciprocal balances. The $100,000 is neither a debt to nor a receivable from an unrelated (or outside) party and is, therefore, not reported in consolidated financial statements. Any interest income/expense recognized on this loan is also intra-entity in nature and must likewise be eliminated.

Because Benns applies the equity method, the $920,000 is composed of four balances: a. The original consideration transferred by the parent; b. Benns‘ annual accruals to recognize subsidiary net income as it is earned c. The reductions that are created by the subsidiary's declaration of dividends d. The periodic amortization recognized by Benns in connection with the allocations identified with its acquisition-date fair value allocations.

The $100,000 attributed to goodwill is reported at its original amount unless a portion of goodwill is impaired or a unit of the business where goodwill resides is sold.

A parent should recognize an impairment loss for goodwill associated with an acquired subsidiary when, at the reporting unit level, the fair value is less than its carrying amount. Goodwill impairment is measured as the excess of the carrying amount of a reporting unit over its fair value (not to exceed the carrying amount of goodwill).

10.

The acquisition-date fair value of the contingent payment is part of the consideration transferred by Reimers to acquire Rollins and thus is part of the overall fair value assigned to the acquisition. If the contingency is a liability (to be settled in cash or other assets) then the liability is adjusted to fair value through time. If the contingency is a component of equity (e.g., to be settled by the parent issuing equity shares), then the equity instrument is not adjusted to fair value over time.

Chapter 03 – Consolidations – Subsequent to the Date of Acquisition – Hoyle, Schaefer, Doupnik, Advanced Accounting, 15e

Answers to Problems

1. A 2. B 3. D Interest expense is reduced by $2,500 resulting from the acquisition-date fair value of long-term debt allocation. The debt is increased by $20,000 less $2,500 (1 year of interest amortization). 4. C 5. A Paar‘s equipment book value—12/31/23 .......................... Kimmel‘s equipment book value—12/31/23 ..................... Original acquisition-date allocation to Kimmel's equipment ($400,000 – $272,000) ......................................................... Amortization of allocation ($128,000 ÷ 10 years for 3 years) ................................. Consolidated equipment....................................................

$294,000 190,400 128,000 (38,400) $574,000

6. A 7. A 8. D 9. B 10. B Palmcroft revenues Palmcroft expenses Net income before Salt River effect Equity income from Salt River Consolidated net income

$498,000 350,000 148,000 55,000 $203,000

Consolidated revenues Consolidated expenses (includes $35K amortization) Consolidated net income

$783,000 580,000 $203,000

-or-

11. A (Consolidated retained earnings are the same as the parent‘s retained earnings because Palmcroft uses the equity method). 12. C Consideration transferred at fair value Book value acquired Excess fair over book value

$600,000 420,000 180,000

Chapter 03 – Consolidations – Subsequent to the Date of Acquisition – Hoyle, Schaefer, Doupnik, Advanced Accounting, 15e

to equipment to database (4-year remaining life)

80,000 $100,000

Three years after acquisition, ¼ of acquisition-date value remains. 13. B 14.(35 Minutes) (Determine consolidated retained earnings when parent uses various accounting methods. Determine Entry *C for each of these methods) a. CONSOLIDATED RETAINED EARNINGS--EQUITY METHOD Herbert (parent) balance—1/1/23 ................................... $400,000 Herbert income—2023 .................................................... 40,000 Herbert dividends—2023 (subsidiary dividends are intra-entity and, thus, eliminated) .................................. (10,000) Rambis income—2023 (not included in parent's income) 20,000 Amortization—2023 ......................................................... (12,000) Herbert income—2024 .................................................... 50,000 Herbert dividends—2024 ................................................. (10,000) Rambis income—2024 .................................................... 30,000 Amortization—2024 ......................................................... (12,000) Consolidated retained earnings, 12/31........................... $496,000 

PARTIAL EQUITY METHOD AND INITIAL VALUE METHOD Consolidated RE are the same regardless of the method in use: the beginning balance plus the income less the dividends of the parent plus the income of the subsidiary less amortization expense. Thus, December 31, 2024 consolidated RE are $496,000 as computed above.

b. Investment in Rambis—equity method Rambis fair value 1/1/23 ........................................................ Rambis income 2023 ............................................................. Rambis dividends 2023 ......................................................... Herbert‘s 2023 excess fair over book value amortization . Investment account balance 1/1/24......................................

$574,000 20,000 (5,000) (12,000) $577,000

Investment in Rambis—partial equity method Rambis fair value 1/1/23 ........................................................ Rambis income 2023 ............................................................. Rambis dividends 2023 ......................................................... Investment account balance 1/1/24......................................

$574,000 20,000 (5,000) $589,000

Investment in Rambis—Initial value method Rambis fair value 1/1/23 ........................................................ Investment account balance 1/1/24......................................

$574,000 $574,000

14. (continued)

Chapter 03 – Consolidations – Subsequent to the Date of Acquisition – Hoyle, Schaefer, Doupnik, Advanced Accounting, 15e

c. ENTRY *C 

EQUITY METHOD No entry is needed to convert the past figures to the equity method since that method has already been applied.



PARTIAL EQUITY METHOD Amortization for the prior years (only 2023 in this case) has not been recorded and must be brought into the consolidation through worksheet entry *C: ENTRY *C

Retained earnings, 1/1/24 (Parent) ...................... 12,000 Investment in Rambis ..................................... 12,000 (To recognize 2023 amortization in consolidated figures. Expense was omitted because of application of partial equity method.) 

INITIAL VALUE METHOD Amortization for the prior years (only 2023 in this case) has not been recorded and must be brought into the consolidation through worksheet entry *C. In addition, only dividend income has been recorded by the parent ($5,000 in 2023). In this prior year, Rambis reported net income of $20,000. Thus, the parent has not recorded the $15,000 income in excess of dividends. That amount must also be included in the consolidation through entry *C: ENTRY *C

Investment in Rambis .......................................... 3,000 Retained earnings, 1/1/24 (Parent) ................ 3,000 (To recognize 2023 unrecognized subsidiary earnings as part of the parent‘s retained earnings. $15,000 net income of subsidiary was not recorded by parent (income in excess of dividends). Amortization expense of $12,000 was not recorded under the initial value method. Note that *C adjustments bring the parent‘s January 1, 2024 Retained Earnings balance equal to that of the equity method. 15.(30 Minutes) (A variety of questions on equity method, initial value method, and partial equity method.) a. An allocation of the acquisition price (based on the fair value of the shares issued) must be made first. Acquisition fair value (consideration paid by Parkovash) Book value equivalency ............................................ Excess of Salerno fair value over book value ......... Excess fair value assigned to specific

Remaining

$135,000 (100,000) $ 35,000

Annual excess

Chapter 03 – Consolidations – Subsequent to the Date of Acquisition – Hoyle, Schaefer, Doupnik, Advanced Accounting, 15e

accounts based on fair value Equipment Software

life $5,000 30,000

amortizations

5 yrs. 10 yrs.

$1,000 3,000 $4,000

Acquisition-date fair value............................................... 2023 Income accrual ....................................................... 2023 Dividends declared by Salerno ............................. 2023 Amortizations (above) ............................................ 2024 Income accrual ....................................................... 2024 Dividends declared by Salerno ............................. 2024 Amortizations .......................................................... Investment in Salerno account balance 12/31/24 ..........

$135,000 110,000 (50,000) (4,000) 130,000 (40,000) (4,000) $277,000

Net income of Parkovash ................................................ Net Income of Salerno ..................................................... Depreciation expense ...................................................... Amortization expense ...................................................... Consolidated net income 2024 ..................................

$240,000 130,000 (1,000) (3,000) $366,000

Equipment balance Parkovash ....................................... Equipment balance Salerno ............................................ Allocation based on fair value (above) .......................... Depreciation for 2023-2024 ............................................. Consolidated equipment—December 31, 2024 ..............

$500,000 300,000 5,000 (2,000) $803,000

Parent's choice of an investment method has no impact on consolidated totals. 15. (continued) d. If the initial value method was applied during 2023, the parent would have recorded dividend income of $50,000 rather than $110,000 (as equity income). Income is, therefore, understated by $60,000. In addition, amortization expense of $4,000 was not recorded. Thus, the January 1, 2024, retained earnings is understated by $56,000 ($60,000 – $4,000). Worksheet Entry *C thus serves to adjust the parent‘s beginning retained earnings to a full accrual basis: Investment in Solerno ............................................... Retained earnings, 1/1/24 (Parkovash) ...............

56,000 56,000

If the partial equity method was applied during 2023, the parent would have failed to record amortization expense of $4,000. Retained earnings are overstated by $4,000 and are corrected through Entry *C:

Chapter 03 – Consolidations – Subsequent to the Date of Acquisition – Hoyle, Schaefer, Doupnik, Advanced Accounting, 15e

Retained earnings, 1/1/24 (Parkovash) .................... Investment in Solerno ..........................................

4,000 4,000

If the equity method had been applied during 2023, consolidated retained earnings would equal the parent's retained earnings. Thus, no adjustment would be necessary. 16.(20 minutes) (Record a merger combination with subsequent testing for goodwill impairment). a. In accounting for the combination, the total fair value of Bruno (consideration transferred) is allocated to each identifiable asset acquired and liability assumed with any remaining excess as goodwill. Cash paid Fair value of shares issued Consideration transferred

$ 198,000 1,500,000 $1,698,000

Consideration transferred (above) Fair value of net assets acquired and liabilities assumed Goodwill recognized in the combination

$1,698,000 1,298,000 $ 400,000

16. (continued): Entry by Arcadia to record assets acquired and liabilities assumed in the combination with Bruno:

Cash 65,000 Receivables 203,000 Inventory 275,000 Patents 531,000 Royalty agreements 580,000 Equipment 215,000 Goodwill 400,000 Accounts payable Long-term liabilities Cash Common stock (Arcadia Co., par value) Additional paid-in capital

111,000 460,000 198,000 100,000 1,400,000

Fair value of reporting unit as a whole Carrying amount of reporting unit's net assets Goodwill impairment loss*

$1,325,000 1,560,000 $ 235,000

*Must be less than $400,000 (carrying amount of goodwill).

17.(10 minutes) (Goodwill impairment testing.)

Chapter 03 – Consolidations – Subsequent to the Date of Acquisition – Hoyle, Schaefer, Doupnik, Advanced Accounting, 15e

a. Goodwill Impairment Step 1 Fair value of reporting unit Carrying amount of reporting unit Goodwill impairment loss*

$1,028 1,094 $ 66

*Must be less than $755 (carrying amount of goodwill).

b. Tangible assets, net Goodwill ($755 carrying amount – $66 impairment loss) Patent Royalty agreement

$ 84 689 -0-0-

18.(10 minutes) (Goodwill impairment) Goodwill Impairment Measurement (R-one and R-two only) Fair value of reporting unit as a whole Carrying amount of reporting unit's net assets Goodwill impairment loss* *Must be less than respective carrying amounts of goodwill.

19.

RU-1

RU-2

$510,000 530,000 $ 20,000

$580,000 610,000 $ 30,000

(30 Minutes) (Consolidation entries for two years. Parent uses equity method.) Fair Value Allocation and Annual Amortization: Acquisition fair value (consideration transferred) .................... $490,000 Book value (assets minus liabilities or total stockholders' equity) ..................................................................................... (400,000) Excess fair value over book value .............................................. $ 90,000 Excess fair value assigned to specific accounts based on individual fair values Land Buildings Equipment Total assigned to specific accounts Goodwill Total

$10,000 40,000 (20,000) 30,000 60,000 $90,000

Remaining Life

Annual excess amortizations

-4 yrs. 5 yrs.

-$10,000 (4,000)

indefinite

-0$6,000

Consolidation Entries as of December 31, 2023 Entry S Common stock—Abernethy ................................. Additional paid-in capital .....................................

250,000 50,000

Chapter 03 – Consolidations – Subsequent to the Date of Acquisition – Hoyle, Schaefer, Doupnik, Advanced Accounting, 15e

Retained earnings—1/1/23 ................................... 100,000 Investment in Abernethy ................................ (To eliminate stockholders' equity accounts of subsidiary)

400,000

Entry A Land ...................................................................... 10,000 Buildings ............................................................... 40,000 Goodwill ................................................................ 60,000 Equipment ....................................................... 20,000 Investment in Abernethy ................................ 90,000 (To recognize allocations attributed to fair value of specific accounts at acquisition date with residual fair value recognized as goodwill). Entry I Equity in subsidiary earnings ............................. 74,000 Investment in Abernethy ................................ 74,000 (To eliminate $80,000 income accrual for 2023 less $6,000 amortization recorded by parent using equity method) 19. (continued) Entry D Investment in Abernethy ..................................... Dividends declared ......................................... (To eliminate intra-entity dividend transfers) Entry E Depreciation expense ........................................... Equipment.............................................................. Buildings .......................................................... (To recognize current year amortization expense)

10,000 10,000

6,000 4,000 10,000

Consolidation Entries as of December 31, 2024 Entry S Common stock—Abernethy ................................ 250,000 Additional paid-in capital ..................................... 50,000 Retained earnings—1/1/24.................................... 170,000 Investment in Abernethy ................................ 470,000 (To eliminate beginning stockholders' equity of subsidiary—the Retained Earnings account has been adjusted for 2023 income and dividends. Entry *C is not needed because equity method was applied.) Entry A Land ...................................................................... Buildings ............................................................... Goodwill ................................................................ Equipment .......................................................

10,000 30,000 60,000 16,000

Chapter 03 – Consolidations – Subsequent to the Date of Acquisition – Hoyle, Schaefer, Doupnik, Advanced Accounting, 15e

Investment in Abernethy ................................ 84,000 (To recognize allocations relating to investment—balances shown here are as of beginning of current year [original allocation less excess amortizations for the prior period]) Entry I Equity in subsidiary earnings ............................. 104,000 Investment in Abernethy ................................ 104,000 (To eliminate $110,000 income accrual less $6,000 amortization recorded by parent during 2024 using equity method) Entry D Investment in Abernethy ..................................... Dividends declared ......................................... (To eliminate intra-entity dividend transfers)

30,000 30,000

Entry E Depreciation expense ........................................... Equipment.............................................................. Buildings .......................................................... 20.

6,000 4,000 10,000

(35 Minutes) (Consolidation entries for two years. Parent uses initial value method.) Acquisition-date allocation and annual excess fair value amortizations: Acquisition date value (consideration paid) ...... $500,000 Book value ............................................................ (400,000) Excess price paid over book value ..................... $100,000 Excess price paid assigned to specific accounts based on fair values Equipment Long-term liabilities Goodwill Total

$ 20,000 30,000 50,000 $100,000

Remaining life

Annual excess amortizations

5 yrs 4 yrs indefinite

$4,000 7,500 -0$11,500

Consolidation entries as of December 31, 2023 Entry S Common stock—Abernethy ................................ 250,000 Additional paid-in capital ..................................... 50,000 Retained earnings—1/1/23 ................................... 100,000 Investment in Abernethy ................................. (To eliminate stockholders' equity accounts of subsidiary) Entry A Equipment .............................................................

400,000

20,000

Chapter 03 – Consolidations – Subsequent to the Date of Acquisition – Hoyle, Schaefer, Doupnik, Advanced Accounting, 15e

Long-term liabilities ............................................. 30,000 Goodwill ................................................................ 50,000 Investment in Abernethy ................................ 100,000 (To recognize allocations determined above in connection with acquisition-date fair values) Entry I Dividend income .................................................. 10,000 Dividends declared ......................................... 10,000 (To eliminate intra-entity dividend declarations recorded by parent as income) Entry E Depreciation expense .......................................... Interest expense.................................................... Equipment ........................................................ Long-term liabilities......................................... (To recognize 2023 amortization expense)

4,000 7,500 4,000 7,500

20. (continued) Consolidation Entries as of December 31, 2024 Entry *C Investment in Abernethy ..................................... 58,500 Retained earnings—1/1/24 (Chapman) .......... 58,500 (To convert parent company figures to equity method by recognizing subsidiary's increase in book value for prior year [$80,000 net income less $10,000 dividend declaration] and excess amortizations for that period [$11,500]) Entry S Common stock—Abernethy ................................ 250,000 Additional paid-in capital ..................................... 50,000 Retained earnings—1/1/24 ................................... 170,000 Investment in Abernethy ................................ 470,000 (To eliminate beginning of year stockholders' equity accounts of subsidiary. The retained earnings balance has been adjusted for 2023 net income and dividends) Entry A Equipment ............................................................. 16,000 Long-term liabilities ............................................. 22,500 Goodwill ................................................................ 50,000 Investment in Abernethy ................................ 88,500 (To recognize allocations relating to investment—balances shown here are as of the beginning of the current year [original allocation less excess

Chapter 03 – Consolidations – Subsequent to the Date of Acquisition – Hoyle, Schaefer, Doupnik, Advanced Accounting, 15e

amortizations for the prior period]) Entry I Dividend income .................................................. 30,000 Dividends declared ......................................... 30,000 (To eliminate intra-entity dividend declarations recorded by parent as income) Entry E Depreciation expense .......................................... Interest expense.................................................... Equipment ........................................................ Long-term liabilities......................................... (To recognize 2024 amortization expense) 21.

4,000 7,500 4,000 7,500

(20 Minutes) (Consolidation entries for two years. Parent uses partial equity method.) Fair value allocation and annual excess amortizations: Abernethy fair value (consideration paid) ............... Book value ................................................................. Excess fair value over book value (all goodwill) ....

$520,000 (400,000) $120,000

Excess amortization (indefinite life for goodwill) ...

-0-

Consolidation Entries as of December 31, 2023 Entry S Common stock—Abernethy ................................ 250,000 Additional paid-in capital ..................................... 50,000 Retained earnings—Abernethy—1/1/23 ............. 100,000 Investment in Abernethy ................................ (To eliminate stockholders' equity accounts of subsidiary)

400,000

Entry A Goodwill ................................................................ 120,000 Investment in Abernethy ................................ 120,000 (To recognize goodwill portion of the original acquisition fair value) Entry I Equity in earnings of subsidiary.......................... 80,000 Investment in Abernethy ................................ 80,000 (To eliminate intra-entity income accrual for the current year based on the parent's usage of the partial equity method) Entry D Investment in Abernethy .....................................

10,000

Chapter 03 – Consolidations – Subsequent to the Date of Acquisition – Hoyle, Schaefer, Doupnik, Advanced Accounting, 15e

Dividends declared ......................................... (To eliminate intra-entity dividend transfers)

10,000

Entry E—Not needed. Goodwill is not amortized. Consolidation Entries as of December 31, 2024 Entry *C—Not needed. Goodwill is not amortized. Entry S Common stock—Abernethy ................................. 250,000 Additional paid-in capital—Abernethy ............... 50,000 Retained earnings—Abernethy—1/1/24 ............. 170,000 Investment in Abernethy ................................ 470,000 (To eliminate beginning of year stockholders' equity accounts of subsidiary—the retained earnings balance has been adjusted for 2023 income and dividends.) 21. (continued) Entry A Goodwill ................................................................ Investment in Abernethy ................................ (To recognize original goodwill balance.)

120,000 120,000

Entry I Equity in earnings of subsidiary.......................... 110,000 Investment in Abernethy ................................ (To eliminate Intra-entity Income accrual for the current year.) Entry D Investment in Abernethy ..................................... Dividends declared ......................................... (To eliminate Intra-entity dividend transfers.)

110,000

30,000 30,000

Equity E—not needed 22.

(45 Minutes) (Variety of questions about the three methods of recording an Investment in a subsidiary for internal reporting purposes.) a. Acquisition-Date Fair-Value Allocation and Annual Amortization: Clay‘s acquisition-date fair value ................... Book value (assets minus liabilities or stockholders' equity) ............................. Fair value in excess of book value ................. Allocation to equipment based on

$510,000 450,000 60,000 Remaining life

Annual excess amortizations

Chapter 03 – Consolidations – Subsequent to the Date of Acquisition – Hoyle, Schaefer, Doupnik, Advanced Accounting, 15e

fair and book value difference Goodwill Total

50,000 $10,000

5 yrs indefinite

EQUITY METHOD Investment Income—2024: Equity accrual (based on Clay's net income) ............. Amortization (above) .................................................... Investment income for 2024 ...............................................

$10,000 -0$10,000

$60,000 (10,000) $50,000

22. (continued) Investment in Clay—December 31, 2024: Consideration transferred for Clay .............................. $510,000 2023: Equity accrual (based on Clay's net Income) .......... 55,000 Excess amortizations (above) ................................... (10,000) Dividends..................................................................... (5,000) 2024: 60,000 Equity accrual (based on Clay's net Income) ........... Excess amortizations ................................................ (10,000) Dividends..................................................................... (8,000) Total ............................................................................... $592,000 INITIAL VALUE METHOD Investment Income—2024: Dividend income ............................................................

$8,000

Investment in Clay—December 31, 2024: Consideration transferred for Clay.................................. $510,000 b. The reported consolidated balances are not affected by the parent‘s investment accounting method. Thus, consolidated expenses ($480,000 or $290,000 + $180,000 + amortizations of $10,000) are the same regardless of whether the equity method, the partial equity method, or the initial value method is applied by Adams. c. The reported consolidated balances are not affected by the parent‘s investment accounting method. Thus, consolidated equipment ($970,000 or $520,000 + $420,000 + allocation of $50,000 – two years of excess depreciation totaling $20,000) is the same regardless of whether the equity method or the initial value method is applied by Adams. d. Adams retained earnings—Equity method Adams retained earnings—1/1/23 ......................................... $860,000 Adams income 2023 ................................................................. 125,000 2023 equity accrual for Clay income ................................. 55,000 3-27 © McGraw Hill LLC. All rights reserved. No reproduction or distribution without the prior written consent of McGraw Hill LLC.

Chapter 03 – Consolidations – Subsequent to the Date of Acquisition – Hoyle, Schaefer, Doupnik, Advanced Accounting, 15e

2023 excess amortization ....................................................... (10,000) Adams retained earnings—1/1/24 ...................................... $1,030,000 Adams retained earnings—Initial value method Adams retained earnings—1/1/23...................................... Adams income 2023............................................................ 2023 dividend income from Clay ....................................... Adams retained earnings—1/1/24......................................

$860,000 125,000 5,000 $990,000

22. (continued) e. INITIAL VALUE METHOD—Entry *C is needed to recognize increase in subsidiary's book value ($55,000 income less 5,000 dividends) and amortization ($10,000) for prior year. Investment in Clay ............................................... Retained earnings, 1/1/24 (parent) .................

40,000 40,000

f. Consolidated worksheet entry S for 2024: Common stock (Clay) .......................................... Retained earnings, 1/1/24 (Clay) .......................... Investment in Clay ..........................................

150,000 350,000 500,000

g. Consolidated revenues (combined) ................... Consolidated expenses (combined plus excess amortization) ...................................... Consolidated net income ..................................... 23.

$640,000 (480,000) $160,000

(15 Minutes) (Consolidated accounts one year after acquisition) Stanza acquisition fair value ($10,000 in stock issue costs reduce additional paid-in capital) .......................... $680,000 Book value of subsidiary (1/1/24 stockholders' equity balances) .......... (480,000) Fair value in excess of book value ................ $200,000 Excess fair value allocated to copyrights Remaining Amortization life based on fair value Goodwill Total

120,000 $ 80,000

a. Consolidated copyrights Penske (book value) ............................................ Stanza (book value) ............................................. Allocation (above) ................................................

6 yrs. indefinite

$20,000 -0$20,000

$900,000 400,000 120,000

Chapter 03 – Consolidations – Subsequent to the Date of Acquisition – Hoyle, Schaefer, Doupnik, Advanced Accounting, 15e

Excess amortization, 2024 ................................... (20,000) Total ..................................................................... $1,400,000 23. (continued) b. Consolidated net income, 2024 Revenues (add book values) ............................... Expenses: Add book values ............................................. Excess amortizations ..................................... Consolidated net income......................................

$700,000 20,000 ......720,000 $380,000

c. Consolidated retained earnings, 12/31/24 Retained earnings 1/1/24 (Penske) ..................... Net income 2024 (above) ..................................... Dividends declared 2024 (Penske) ..................... Total .................................................................

$600,000 380,000 (80,000) $900,000

$1,100,000

Stanza's retained earnings balance as of January 1, 2024, is not included because these operations occurred prior to the acquisition. Stanza's dividends were attributable to Penske and therefore are excluded because they are intra-entity in nature. d. Consolidated goodwill, 12/31/24 Allocation (above) ................................................ 24.

$80,000

(30 Minutes) (Consolidated balances three years after the date of acquisition. Includes questions about parent's method of recording investment for internal reporting purposes.) a. Acquisition-Date Fair Value Allocation and Amortization: Consideration transferred 1/1/22 ................... $600,000 Book value (given) .......................................... (470,000) Fair value in excess of book value ...... 130,000 Remaining Life

Allocation to equipment based on fair and book value difference Goodwill Total

90,000 $40,000

10 yrs. indefinite

Annual excess amortizations

$9,000 -0$9,000

CONSOLIDATED BALANCES 

Depreciation expense = $659,000 (book values plus $9,000 excess depreciation)



Dividends declared = $120,000 (parent balance only. Subsidiary's dividends are eliminated as intra-entity transfer) 3-29

Chapter 03 – Consolidations – Subsequent to the Date of Acquisition – Hoyle, Schaefer, Doupnik, Advanced Accounting, 15e



Revenues = $1,400,000 (add book values)



Equipment = $1,563,000 (add book values plus $90,000 allocation less three years of excess depreciation [$27,000])

24. (continued) 

Buildings = $1,200,000 (add book values)



Goodwill = $40,000 (original residual allocation)



Common Stock = $900,000 (parent balance only)

b. The parent's choice of an investment method has no impact on the consolidated totals. The choice of an investment method only affects the internal reporting of the parent. c. The initial value method is used. The parent's Investment in Subsidiary account still retains the original consideration transferred of $600,000. In addition, the Investment Income account equals the amount of dividends declared by the subsidiary. d. If the partial equity method had been utilized, the investment income account would have shown an equity accrual of $100,000. If the equity method had been applied, the Investment Income account would have included both the equity accrual of $100,000 and excess amortizations of $9,000 for a balance of $91,000. e. Initial value method—Foxx’s retained earnings—1/1/24 Foxx‘s 1/1/24 balance (initial value method was employed) $1,100,000 Partial equity method—Foxx’s retained earnings—1/1/24 Foxx‘s 1/1/24 balance (initial value method) .......................... $1,100,000 2022 net equity accrual for Greenburg ($90,000 – $20,000) 70,000 2023 net equity accrual for Greenburg ($100,000 – $20,000) 80,000 Foxx‘s 1/1/24 retained earnings .................................................... $1,250,000 Equity method—Foxx’s retained earnings—1/1/24 Foxx‘s 1/1/24 balance (initial value method) .............................. $1,100,000 2022 net equity accrual for Greenburg ($90,000 – $20,000) 70,000 2022 excess fair over book value amortization .................. (9,000) 2023 net equity accrual for Greenburg ($100,000 – $20,000) 80,000 2023 excess fair over book value amortization .................. (9,000) Foxx‘s 1/1/24 retained earnings .................................................... $1,232,000 25.

(50 Minutes) (Consolidated totals for an acquisition where parent employs the equity method. Acquisition-date fair value allocation includes long-term debt. Worksheet preparation is a separate requirement.)

Chapter 03 – Consolidations – Subsequent to the Date of Acquisition – Hoyle, Schaefer, Doupnik, Advanced Accounting, 15e

a. Investment in Mathias: Consideration transferred at 1/1/23 ........................................ $5,875,000 Allison‘s equity in Mathias earnings (net of amortization): 2023 ($480,000 – $330,000)........ 150,000 2024 ($960,000 – $330,000)........ 630,000 Post-acquisition earnings net of amortization ................... 780,000 Mathias dividends since acquisition ................................... (75,000) Investment balance at 12/31/24............................................ $6,580,000 Excess acquisition-date fair over book value amortizations: Unpatented technology ($800,000 ÷ 8 years) $ 100,000 Patents ($2,500,000 ÷ 10 years) 250,000 Long-term debt ($100,000 ÷ 5 years) (20,000) Annual excess fair over book value amortization $330,000

Chapter 03 – Consolidations – Subsequent to the Date of Acquisition – Hoyle, Schaefer, Doupnik, Advanced Accounting, 15e

25. continued (part b.) ALLISON CORPORATION AND CONSOLIDATED SUBSIDIARY Consolidation Worksheet For Year Ending December 31, 2024 Income Statement Revenues Cost of goods sold Depreciation expense Amortization expense Interest expense Equity earnings in Mathias Net income Statement of Retained Earnings Retained earnings 1/1 Net income (above) Dividends declared Retained earnings 12/31 Balance Sheet Cash Accounts receivable Inventories Investment in Mathias

Allison (6,400,000) 4,500,000 875,000 430,000 55,000 (630,000) (1,170,000)

Mathias (3,900,000) 2,500,000 277,000 103,000 60,000

(5,340,000) (1,170,000) 560,000 (5,950,000)

(1,955,000) (960,000) 50,000 (2,865,000)

75,000 950,000 1,700,000 6,580,000

143,000 225,000 785,000

Equipment (net) Patents Unpatented technology Goodwill Total assets Accounts payable Long-term debt Common stock Retained earnings 12/31 Total liabilities and equity

3,700,000 95,000 2,125,000 425,000 15,650,000 (500,000) (1,000,000) (8,200,000) (5,950,000) (15,650,000)

2,052,000

Consolidation Entries Debit Credit

E 350,000 E 20,000

Consolidated (10,300,000) 7,000,000 1,152,000 883,000 95,000

I 630,000 (960,000)

(1,170,000) S 1,955,000 D 50,000

D 50,000

S 2,455,000 A 3,545,000 I 630,000

1,450,000

A 2,250,000 A 700,000 A 675,000

E 250,000 E 100,000

4,655,000 (90,000) (1,200,000) (500,000) (2,865,000) (4,655,000)

E 20,000 S 500,000

A 80,000

7,130,000

(5,340,000) (1,170,000) 560,000 (5,950,000) 218,000 1,175,000 2,485,000 -05,752,000 2,095,000 4,175,000 1,100,000 17,000,000 (590,000) (2,260,000) (8,200,000) (5,950,000) (17,000,000)

Chapter 03 – Consolidations – Subsequent to the Date of Acquisition – Hoyle, Schaefer, Doupnik, Advanced Accounting, 15e

26.

(50 Minutes) (Consolidated totals for an acquisition where parent employs the equity method. Worksheet is produced as a separate requirement.) a. Sea Cliff acquisition-date fair value ............... Sea Cliff book value ........................................ Fair value in excess of book value ................

$6,000,000 (2,500,000) $3,500,000

Excess assigned to specific accounts based on fair value

Annual Remaining excess life amortization

Computer software Patented technology Goodwill Total

$1,200,000 2,100,000 200,000 $3,500,000

12 yrs. 7 yrs. indefinite

$100,000 300,000 -0$400,000

b. Equity earnings in Sea Cliff: Because Persoff uses the equity method, the $575,000 "Equity earnings in Sea Cliff" reflects a $975,000 equity accrual (100% of Sea Cliff‘s reported earnings) less $400,000 in excess amortization expense computed above. c. Investment in Sea Cliff: Fair value at 1/3/22 .............................................................. $6,000,000 Persoff's equity in Sea Cliff earnings (net of amortization): 2023....................................................... $500,000 2023....................................................... 540,000 2024....................................................... 575,000 Post-acquisition earnings net of amortization ............ 1,615,000 Sea Cliff dividends since acquisition ........................... (450,000) Investment balance at 12/31/24 ..................................... $7,165,000

Chapter 03 – Consolidations – Subsequent to the Date of Acquisition – Hoyle, Schaefer, Doupnik, Advanced Accounting, 15e

26. continued (part d.) PERSOFF CORPORATION AND CONSOLIDATED SUBSIDIARY Consolidation Worksheet For Year Ending December 31, 2024

Income Statement Revenues Cost of goods sold Depreciation expense Amortization expense Equity earnings in Sea Cliff Net income

Persoff (2,720,000) 1,350,000 275,000 370,000 (575,000) (1,300,000)

Sea Cliff (2,250,000) 870,000 380,000 25,000

Statement of Retained Earnings Retained earnings 1/1 Net income (above) Dividends declared Retained earnings 12/31

(7,470,000) (1,300,000) 600,000 (8,170,000)

(3,240,000) (975,000) 150,000 (4,065,000)

Balance Sheet Current assets Investment in Sea Cliff

490,000 7,165,000

375,000

Consolidation Entries Debit Credit

E 400,000 I 575,000

(975,000)

S 3,240,000 150,000 D

300,000 800,000 100,000 1,835,000 10,690,000

45,000 80,000 0 4,500,000 5,000,000

Liabilities Common stock Retained earnings 12/31 Total liabilities and equity

(520,000) (2,000,000) (8,170,000) (10,690,000)

(135,000) (800,000) (4,065,000) (5,000,000)

(7,470,000) (1,300,000) 600,000 (8,170,000) 865,000

D 150,000

Computer software Patented technology Goodwill Equipment Total assets

Consolidated (4,970,000) 2,220,000 655,000 795,000 0 (1,300,000)

A 1,000,000 A 1,500,000 A 200,000

575,000 I 4,040,000 S 2,700,000 A 100,000 E 300,000 E

S 800,000 7,865,000

7,865,000

-01,245,000 2,080,000 300,000 6,335,000 10,825,000 (655,000) (2,000,000) (8,170,000) (10,825,000)

Chapter 03 – Consolidations – Subsequent to the Date of Acquisition – Hoyle, Schaefer, Doupnik, Advanced Accounting, 15e

27.

(50 Minutes) (Consolidated totals for an acquisition where parent employs the equity method. Worksheet is produced as a separate requirement.) a. Silverstone acquisition-date fair value...................$2,030,000 Silverstone book value .......................................... (1,550,000) Fair value in excess of book value .................. $480,000 Annual Excess assigned to specific accounts based Remaining excess on fair value life amortization Equipment $120,000 8 yrs. $15,000 Royalty agreements 160,000 4 yrs. 40,000 Trademark 50,000 indefinite -0Goodwill 150,000 indefinite -0Total $480,000 $55,000 b. Investment in Silverstone: Fair value at 1/1/23 .................................................................. Palo Verde's equity in Silverstone earnings: 2023: ($175,000 – $55,000) ....................... $120,000 2024: ($375,000 – $55,000) ....................... 320,000 Post-acquisition earnings less excess amortization ........... Silverstone dividends since acquisition............................... Investment balance at 12/31/24 .............................................

$2,030,000

440,000 (70,000) $2,400,000

Chapter 03 – Consolidations – Subsequent to the Date of Acquisition – Hoyle, Schaefer, Doupnik, Advanced Accounting, 15e

27. (continued) part c. PALO VERDE CORPORATION AND CONSOLIDATED SUBSIDIARY Consolidation Worksheet For Year Ending December 31, 2024 Income Statement Sales Cost of goods sold Depreciation expense Amortization expense Equity earnings in Silverstone Net income Statement of Retained Earnings Retained earnings 1/1 Net income Dividends declared Retained earnings 12/31 Balance Sheet Cash Accounts receivable Inventory Investment in Silverstone

Equipment (net) Royalty agreements Trademarks Goodwill Total assets Accounts payable Common stock – Palo Verde Common stock - Silverstone Retained earnings 12/31 Total liabilities and SE

Consolidation Entries Debit Credit

Palo Verde (4,200,000) 2,300,000 495,000 105,000 (320,000) (1,620,000)

Silverstone (2,200,000) 1,550,000 275,000 -0-0(375,000)

(2,900,000) (1,620,000) 150,000 (4,370,000)

(900,000) (375,000) 45,000 (1,230,000)

430,000 693,000 890,000 2,400,000

35,000 75,000 420,000 -0-

6,000,000 115,000 2,500,000 172,000 13,200,000 (330,000) (8,500,000)

1,400,000 -0850,000 -02,780,000 (750,000)

A 105,000 A 120,000 A 50,000 A 150,000

(800,000) (1,230,000) (2,780,000)

S 800,000

(4,370,000) (13,200,000)

E 15,000 E 40,000 I 320,000

S 900,000 45,000 D

D 45,000

2,545,000

1,700,000 S 425,000 A 320,000 I 15,000 E 40,000 E

2,545,000

Consolidated (6,400,000) 3,850,000 785,000 145,000 -0(1,620,000) (2,900,000) (1,620,000) 150,000 (4,370,000) 465,000 768,000 1,310,000 -0-

7,490,000 195,000 3,400,000 322,000 13,950,000 (1,080,000) (8,500,000) (4,370,000) (13,950,000)

Chapter 03 – Consolidations – Subsequent to the Date of Acquisition – Hoyle, Schaefer, Doupnik, Advanced Accounting, 15e

28.

(50 Minutes) (Consolidated totals for an acquisition. Worksheet is produced as a separate requirement.) a. Snowdon acquisition-date fair value .................. Snowdon book value ........................................... Fair value in excess of book value ..................... Excess assigned to specific accounts based on fair value Trademarks Software Equipment Goodwill Total

$100,000 75,000 (30,000) 55,000 $200,000

$550,000 (350,000) $200,000

Remaining life indefinite 5 yrs. 10 yrs. Indefinite

Annual excess amortizations

-0$15,000 (3,000) -0$12,000

If the partial equity method were in use, the Income of Snowdon account would have had a balance of $222,000 (100% of Snowdon's reported income for the period). If the initial value method were in use, the Income of Snowdon account would have had a balance of $80,000 (100% of the dividends declared by Snowdon). The Income from Snowdon balance is an equity accrual of $222,000 (100% of Snowdon‘s reported income) less excess amortizations of $12,000 (as computed above). Thus, the equity method must be in use. b. Students can develop consolidated figures conceptually, without relying on a worksheet or consolidation entries. Thus, part b. asks students to determine independently each balance to be reported by the business combination. 

Revenues = $1,645,000 (the accounts of both companies combined)



Cost of goods sold = 528,000 (the accounts of both companies combined)



Amortization expense = $40,000 (the accounts of both companies and the acquisition-related adjustment of $15,000)



Depreciation expense = $142,000 (the accounts for both companies and the acquisition-related depreciation adjustment of $3,000)



Income from Snowdon = $0 (the balance reported by the parent is removed and replaced with the subsidiary‘s individual revenue and expense accounts)



Net Income = 935,000 (consolidated revenues less expenses)



Retained earnings, 1/1 = $700,000 (only the parent's retained earnings figure is included)



Dividends declared = $142,000 (the subsidiary's dividends were attributable to the parent and, thus, as an intra-entity transfer are eliminated)

Chapter 03 – Consolidations – Subsequent to the Date of Acquisition – Hoyle, Schaefer, Doupnik, Advanced Accounting, 15e



Retained earnings, 12/31 = $1,493,000 (the beginning balance for the parent plus consolidated net income less consolidated [parent] dividends)

28. (continued) 

Cash = $290,000 (the accounts of both companies are added together)



Receivables = $281,000 (the accounts of both companies are combined)



Inventory = $310,000 (the accounts of both companies are combined)



Investment in Snowdon = $0 (the parent‘s balance is removed and replaced with the subsidiary‘s individual asset and liability accounts)



Trademarks = $634,000 (the accounts of both companies are added together plus the 100,000 fair value adjustment)



Software = $60,000 (the initial $75,000 fair value adjustment less $15,000 amortization expense)



Equipment = $1,170,000 (both company‘s balances less the $30,000 fair value adjustment net of $3,000 in depreciation expense reduction)



Goodwill = $55,000 (the original allocation)



Total assets = $2,800,000 (summation of consolidated balances)



Liabilities = $907,000 (the accounts of both companies are combined)



Common stock = $400,000 (parent balance only)



Retained earnings, 12/31 = $1,493,000 (computed above)



Total liabilities and equities = 2,800,000 (summation of consolidated balances)

Chapter 03 – Consolidations – Subsequent to the Date of Acquisition – Hoyle, Schaefer, Doupnik, Advanced Accounting, 15e

28. (Continued) c. KELSEY CORPORATION AND CONSOLIDATED SUBSIDIARY Consolidation Worksheet For Year Ending December 31 Accounts Revenues Cost of goods sold Depreciation expense Amortization expense Income from Snowdon Net income Retained earnings, 1/1 Net income (above) Dividends declared Retained earnings, 12/31 Cash Receivables Inventory Investment in Snowdon Trademarks Software Equipment (net) Goodwill Total assets Liabilities Common stock Retained earnings (above) Total liabilities and equity

Kelsey (1,125,000) 300,000 75,000 25,000 (210,000) (935,000) (700,000) (935,000) 142,000 (1,493,000) 185,000 225,000 175,000 680,000 474,000 -0925,000 -02,664,000 (771,000) (400,000) (1,493,000) (2,664,000)

Snowdon (520,000) 228,000 70,000 -0-0(222,000) (250,000) (222,000) 80,000 (392,000) 105,000 56,000 135,000

Consolidation Entries Debit

Credit (E) 3,000

(E) 15,000 (I) 210,000 (S)250,000 (D) 80,000

(D) 80,000 60,000 -0272,000 -0628,000 (136,000) (100,000) (392,000) (628,000)

(A) 100,000 (A) 75,000 (E) 3,000 (A) 55,000

(S) 350,000 (A) 200,000 (E) 15,000 (A) 30,000

(S)100,000 888,000

888,000

Consolidated Totals (1,645,000) 528,000 142,000 40,000 -0(935,000) (700,000) (935,000) 142,000 (1,493,000) 290,000 281,000 310,000 -0(I) 210,000 634,000 60,000 1,170,000 55,000 2,800,000 (907,000) (400,000) (1,493,000) (2,800,000)

Chapter 03 – Consolidations – Subsequent to the Date of Acquisition – Hoyle, Schaefer, Doupnik, Advanced Accounting, 15e

29.

(60 Minutes) (Consolidation worksheet five years after acquisition with parent using initial value method. Effects of using equity method also included) Acquisition-date fair value allocation and annual amortization: a. Aaron fair value (stock exchanged at fair value) .................................... Book value of subsidiary .................... Excess fair value over book value .....

$470,000 (360,000) $110,000

Excess assigned to specific accounts based on fair values Royalty agreements Trademark Total

Remaining life

$ 60,000 50,000 $110,000

6 yrs. 10 yrs.

Annual excess amortizations

$10,000 5,000 $15,000

The parent company is apparently applying the initial value method: only dividend income is recognized during the current year and the investment account retains its original $470,000 balance. Therefore, both the subsidiary's change in retained earnings during 2020–2024 as well as the amortization for that period must be brought into the consolidation. Aaron's retained earnings January 1, 2024 ........................................$490,000 Retained earnings at acquisition-date ............................................... (230,000) Increase since acquisition-date ..........................................................$260,000 Excess amortization expenses ($15,000 x 4 years) ..................... (60,000) Conversion to equity method for years prior to 2024 (Entry *C) ....................................................................................$200,000 Explanations of consolidation worksheet entries Entry*C: Converts 1/1/24 figures from initial value method to equity method as per computation above. Entry S: Eliminates stockholders' equity accounts of subsidiary as of the beginning of current year. Entry A: Recognizes allocations to royalty agreements and trademark. This entry establishes unamortized balances as of the beginning of the current year. Entry I:

Eliminates intra-entity dividends.

Entry E: Recognizes excess amortization expenses for the current year. See next page for worksheet.

Chapter 03 – Consolidations – Subsequent to the Date of Acquisition – Hoyle, Schaefer, Doupnik, Advanced Accounting, 15e

29. a. (continued) MICHAEL COMPANY AND CONSOLIDATED SUBSIDIARY Consolidation Worksheet For Year Ending December 31, 2024 Consolidation Entries Accounts Revenues Cost of goods sold Amortization expense Dividend income Net income Retained earnings 1/1

Michael (610,000) 270,000 115,000 (5,000) (230,000) (880,000)

Aaron (370,000) 140,000 80,000 -0(150,000)

Net income (above) Dividends declared Retained earnings 12/31 Cash Receivables Inventory Investment in Aaron Co.

(230,000) 90,000 (1,020,000) 380,000 560,000 470,000

(150,000) 5,000 (635,000) $110,000 220,000 280,000 -0-

Copyrights Royalty agreements Trademark Total assets Liabilities Preferred stock Common stock Additional paid-in capital Retained earnings 12/31 Total liabilities and equity

460,000 920,000 -02,900,000 (780,000) (300,000) (500,000) (300,000) (1,020,000) (2,900,000)

340,000 380,000 -01,235,000 (470,000) -0(100,000) (30,000) (635,000) (1,235,000)

Debit

Credit

(E) 15,000 (I) 5,000 (490,000)

(*C) 200,000 (S) 490,000 (I) 5,000

$15,000 (*C) 200,000

(S) 620,000 (A) 50,000

(A) 20,000 (A) 30,000

(E) 10,000 (E) 5,000

(S) 100,000 (S) 30,000 890,000

890,000

Parentheses indicate a credit balance.

Consolidated Totals (980,000) 410,000 210,000 -0(360,000) (1,080,000) -0(360,000) 90,000 (1,350,000) $125,000 600,000 840,000 -0800,000 1,310,000 25,000 3,700,000 (1,250,000) (300,000) (500,000) (300,000) (1,350,000) (3,700,000)

Chapter 03 – Consolidations – Subsequent to the Date of Acquisition – Hoyle, Schaefer, Doupnik, Advanced Accounting, 15e

29. (continued) b. If the equity method had been applied by Michael, four figures on that company's financial records would be different: Equity in Earnings of Aaron, Retained Earnings (both 1/1/24 and 12/31/24), and Investment in Aaron Co. Equity in earnings of Aaron: $135,000 (the parent would accrue 100% of Aaron's $150,000 income but must also recognize $15,000 in amortization expense.) Retained earnings, 1/1/24: $1,080,000 (increases by $200,000—the parent would have recognized the $260,000 increment in the subsidiary's book value during previous years as well as $60,000 in excess amortization expenses for these same four years [see Part a.]) Retained earning, 12/31/24 would be computed as follows: Retained earnings 1/1/24 Net income ($230,000 – 5,000 + 135,000) Dividends declared Retained earnings 12/31/24

$1,080,000 360,000 (90,000) $1,350,000

Investment in Aaron: $800,000 (increases by $330,000—the parent would have recognized the $260,000 increment in the subsidiary's book value during previous years as well as $60,000 in excess amortization expenses for these same four years [see Part a.]. In the current year, net income of $135,000 would have been recognized [see above] along with a reduction of $5,000 for subsidiary dividends declared). c. No Entry *C is needed on the worksheet if the equity method is applied. Both the investment account as well as beginning retained earnings would be stated appropriately. Entry I would have been used to eliminate the $135,000 Equity in Earnings of Aaron from the parent's income statement and from the Investment in Aaron Co. account. Entry D would eliminate the $5,000 current year dividend from Dividends Declared and the Investment in Aaron account balances. d. Consolidated figures are not affected by the investment method used by the parent. The parent company balances would differ and changes would be required in the worksheet entries. However, the figures to be reported for the consolidated entity do not depend on the parent's selection of a method. 30.

(65 Minutes) (Consolidated totals and worksheet five years after acquisition. Parent uses equity method. Includes goodwill impairment.) 3-42 © McGraw Hill LLC. All rights reserved. No reproduction or distribution without the prior written consent of McGraw Hill LLC.

Chapter 03 – Consolidations – Subsequent to the Date of Acquisition – Hoyle, Schaefer, Doupnik, Advanced Accounting, 15e

a. Acquisition-date fair value allocations (given) Land Equipment Goodwill Total

$90,000 50,000 60,000 $200,000

Remaining life -10 yrs. indefinite

Annual excess amortizations -$5,000 -0$5,000

Because Giant uses the equity method, the $135,000 "Equity in Income of Small" reflects a $140,000 equity accrual (100% of Small‘s reported earnings) less $5,000 in amortization expense computed above. b.  Revenues = $1,535,000 (both balances are added together) 

Cost of goods sold = $640,000 (both balances are added)



Depreciation expense = $307,000 (both balances are added along with excess equipment depreciation)



Equity in income of Small = $0 (the parent's Equity in Income of Small balance is removed and replaced with Small's individual revenue and expense accounts)



Net income = $588,000 (consolidated expenses are subtracted from consolidated revenues)



Retained earnings, 1/1/24 = $1,417,000 (the parent‘s balance)



Dividends declared = $310,000 (the parent number alone because the subsidiary's dividends are intra-entity)



Retained earnings, 12/31/24 = $1,695,000 (the parent‘s balance at beginning of the year plus consolidated net income less consolidated dividends declared)



Current assets = $706,000 (both book balances are added together while the $10,000 intra-entity receivable is eliminated)



Investment in Small = $0 (the parent's asset is removed so that Small's individual asset and liability accounts can be brought into the consolidation)



Land = $695,000 (both book balances are added together along with the acquisition-date fair value allocation of $90,000)



Buildings = $723,000 (both book balances are added together)

Chapter 03 – Consolidations – Subsequent to the Date of Acquisition – Hoyle, Schaefer, Doupnik, Advanced Accounting, 15e



Equipment = $959,000 (both book balances are added plus the unamortized portion of the acquisition-date fair value allocation [$50,000 less $25,000 after 5 years of excess depreciation])

30. b. (continued) 

Goodwill = $60,000 (represents the original acquisition-date allocation)



Total assets = $3,143,000 (summation of all consolidated assets)



Liabilities = $1,198,000 (both balances are added together while the $10,000 intra-entity payable is eliminated)



Common stock = $250,000 (parent balance only)



Retained earnings, 12/31/24 = $1,695,000 (see above)



Total liabilities and equity = $3,143,000 (summation of all consolidated liabilities and equity)

c. Worksheet is presented on following page. d. If all goodwill from the Small investment was determined to be impaired, Giant would make the following journal entry on its books: Goodwill impairment loss Investment in Small

60,000 60,000

After this entry, the worksheet process would no longer require an adjustment in Entry (A) to recognize goodwill. The impairment loss would simply carry over to the consolidated income column. The impairment loss would be reported as a separate line item in the operating section of the consolidated income statement.

Chapter 03 – Consolidations – Subsequent to the Date of Acquisition – Hoyle, Schaefer, Doupnik, Advanced Accounting, 15e

30. c. (continued) GIANT COMPANY AND SMALL COMPANY Consolidation Worksheet For Year Ending December 31, 2024 Consolidation Entries Accounts Revenues Cost of goods sold Depreciation expense Equity income of Small Net income

Giant (1,175,000) 550,000 172,000 (135,000) (588,000)

Small (360,000) 90,000 130,000 -0(140,000)

Debit

Retained earnings 1/1 Net income (above) Dividends declared Retained earnings 12/31

(1,417,000) (588,000) 310,000 (1,695,000)

(620,000) (140,000) 110,000 (650,000)

(S) 620,000

398,000 995,000

318,000 -0-

440,000 304,000 648,000 -02,785,000

165,000 419,000 286,000 -01,188,000

(A) 90,000

Liabilities (840,000) Common stock (250,000) Retained earnings (above) (1,695,000) Total liabilities and equity (2,785,000) Parentheses indicate a credit balance.

(368,000) (170,000) (650,000) (1,188,000)

(P) 10,000 (S)170,000

Current assets Investment in Small Land Buildings (net) Equipment (net) Goodwill Total assets

Credit

(E) 5,000 (I) 135,000

(D) 110,000

(A) 30,000 (A) 60,000

1,230,000

(P) 10,000 (S) 790,000

(E) 5,000

1,230,000

Consolidated Totals (1,535,000) 640,000 307,000 -0(588,000) (1,417,000) (588,000) 310,000 (1,695,000) 706,000 -0(A) 180,000 (I) 135,000 695,000 723,000 959,000 60,000 3,143,000 (1,198,000) (250,000) (1,695,000) (3,143,000)

Chapter 03 – Consolidations – Subsequent to the Date of Acquisition – Hoyle, Schaefer, Doupnik, Advanced Accounting, 15e

31.

(45 Minutes) (Consolidated totals and worksheet two years after acquisition. Parent uses initial value method. Includes question comparing initial value and equity methods). a.

12/31/24

Pinnacle

Strata

Sales Cost of goods sold Interest expense Depreciation expense Amortization expense Dividend income Net Income

(7,000,000) 4,650,000 255,000 585,000

(3,000,000) 1,700,000 160,000 350,000 600,000

(50,000) (1,560,000)

(190,000)

Retained earnings 1/1/24 Net income Dividends declared Retained earnings 12/31/24

(5,000,000) (1,560,000) 560,000 (6,000,000)

(1,350,000) (190,000) 50,000 (1,490,000)

Cash Accounts receivable Inventory Investment in Strata

433,000 1,210,000 1,235,000 3,200,000

165,000 200,000 1,500,000

Buildings (net) Licensing agreements Goodwill Total Assets

5,572,000

2,040,000 1,800,000

Accounts payable Long-term debt Common stock - Pinnacle Common stock - Strata Retained earnings 12/31/24 Total Liabilities and OE

350,000 12,000,000 (300,000) (2,700,000) (3,000,000) (6,000,000) (12,000,000)

Consolidation Entries Debit

Credit

Consolidated

(E) 30,000 (E) 20,000 (I) 50,000 (S) 1,350,000

(*C) 240,000 (I) 50,000

(P) 85,000 (*C) 240,000 (A) 270,000 (E) 20,000 (A) 400,000

(S) 2,850,000 (A) 590,000 (E) 30,000 80,000

5,705,000 (715,000) (2,000,000)

(P) 85,000

(1,500,000) (1,490,000) (5,705,000)

(S) 1,500,000 3,945,000

3,945,000

b. Subsidiary income (190,000 – 10,000) ................................................. $180,000 1/1/24 retained earnings (5,000,000 + 240,000) ................................ $5,240,000 Investment in Strata: Initial value basis ......................................................................... $3,200,000 Conversion to equity as of 1/1/24 ............................... 240,000 Net income for 2024 .................................................... 180,000 Dividends for 2024......................................................(50,000) ......... 370,000 Equity method balance 12/31/24 ................................................. $3,570,000

c. The internal method choice for investment accounting has no effect on consolidated financial statements.

(10,000,000) 6,350,000 415,000 965,000 580,000 0 (1,690,000) (5,240,000) (1,690,000) 560,000 (6,370,000) 598,000 1,325,000 2,735,000 0 7,852,000 1,740,000 750,000 15,000,000 (930,000) (4,700,000) (3,000,000) 0 (6,370,000) (15,000,000)

Chapter 03 – Consolidations – Subsequent to the Date of Acquisition – Hoyle, Schaefer, Doupnik, Advanced Accounting, 15e

32.

(30 Minutes) (Determine consolidated accounts and consolidation entries five years after acquisition. Parent applies equity method.) a. Fair value allocation and annual amortization

Land Buildings Equipment Database Total

Allocation Remaining life $20,000 (30,000) 10 yrs. 60,000 5 yrs. 100,000 20 yrs.

Annual excess amortizations $(3,000) 12,000 5,000 $14,000

CONSOLIDATED TOTALS 

Revenues = $850,000 (add the two respective balances)



Cost of goods sold = $380,000 (add the two respective balances)



Depreciation expense = $179,000 (the balances are added and include the excess depreciation net adjustment of $9,000)



Amortization expense = $5,000 (current amortization for database recognized in the acquisition)



Buildings (net) = $625,000 (add the two carrying amounts less the acquisition-date fair value allocation [a $30,000 reduction] after removing 5 years of amortization totaling $15,000)



Equipment (net) = $450,000 (add the two carrying amounts. The acquisition-date fair value allocation is completely amortized at end of current year)



Database = $75,000 ($100,000 original allocation less $25,000 [5 years of amortization])



Common stock = $300,000 (parent company balance only)



Additional paid-in capital = $50,000 (parent company balance only)

b. The method used by the parent is only important in determining the parent's separate account balances (which are given here or are not needed) or consolidation worksheet entries (which are not required in a.)

Chapter 03 – Consolidations – Subsequent to the Date of Acquisition – Hoyle, Schaefer, Doupnik, Advanced Accounting, 15e

32. (continued) c. Consolidation entry S Common stock (Hill) ............................. 40,000 Additional paid-in capital (Hill) ............ 160,000 Retained earnings 1/1 ........................... 600,000 Investment in Hill ............................. 800,000 (To eliminate beginning stockholders' equity of subsidiary) Consolidation entry A Land ....................................................... 20,000 Equipment (net) .................................... 12,000 Database (net) ....................................... 80,000 Buildings (net) ................................. 18,000 Investment in Hill ............................. 94,000 (To recognize unamortized allocation balances as of beginning of current year) Consolidation entry I Investment income ............................... 86,000 Investment in Hill ............................. 86,000 (To remove equity income recognized during year—equity method accrual of $100,000 [based on subsidiary's income] less amortization of $14,000 for the year) Consolidation entry D Investment in Hill .................................. 40,000 Dividends declared .......................... (To remove Intra-entity dividend declarations)

40,000

Consolidation entry E Amortization expense............................ 5,000 Depreciation expense............................ 9,000 Buildings ............................................... 3,000 Equipment......................................... 12,000 Database ........................................... 5,000 (To recognize excess acquisition-date fair-value amortizations for the period) 33.

(30 Minutes) (Determine parent company and consolidated account balances for a bargain purchase combination. Parent applies equity method)

Acquisition-date fair value allocation and annual excess amortization Consideration transferred...................... Chandler book value (given) ................. Technology undervaluation (6 yr. life) ..

$1,183,000 $1,105,000 204,000

Chapter 03 – Consolidations – Subsequent to the Date of Acquisition – Hoyle, Schaefer, Doupnik, Advanced Accounting, 15e

Acquisition-date fair value of net assets Gain on bargain purchase .....................

1,309,000 $(126,000)

Chandler net income .............................. Technology amortization ....................... Equity earnings in Chandler ..................

$(233,000) 34,000 $(199,000)

Fair value of net assets at acquisition-date $1,309,000 Equity earnings from Chandler ............. 199,000 Dividends declared................................. (40,000) Investment in Chandler 12/31/24 ........... $1,468,000 Because a bargain purchase occurred, Chandler‘s net asset fair value replaces the fair value of the consideration transferred as the initial value assigned to the subsidiary on the books of the parent, Brooks.

Chapter 03 – Consolidations – Subsequent to the Date of Acquisition – Hoyle, Schaefer, Doupnik, Advanced Accounting, 15e

33. continued (part b.) Income Statement Revenues Cost of goods sold Gain on bargain purchase Depreciation and amortization expenses Equity earnings in Chandler Net income Statement of Retained Earnings Retained earnings, 1/1 Net income (above) Dividends declared Retained earnings, 12/31 Balance Sheet Current assets Investment in Chandler Trademarks Patented technology Equipment Total assets Liabilities Common stock Retained earnings, 12/31 Total liabilities and equity

Consolidation Entries Debit Credit

Brooks (640,000) 255,000 (126,000)

Chandler (587,000) 203,000 -0-

150,000 (199,000) (560,000)

151,000 -0(233,000)

(E) 34,000 (I) 199,000

335,000 -0(560,000)

(1,835,000) (560,000) 100,000 (2,295,000)

(805,000) (233,000) 40,000 (998,000)

(S) 805,000

(1,835,000) (560,000) 100,000 (2,295,000)

343,000 1,468,000

432,000 -0-

134,000 395,000 693,000 3,033,000 (203,000) (535,000) (2,295,000) (3,033,000)

221,000 410,000 341,000 1,404,000 (106,000) (300,000) (998,000) (1,404,000)

(D) 40,000

Consolidated (1,227,000) 458,000 (126,000)

775,000 (D) 40,000

(A) 204,000

(I) 199,000 (S) 1,105,000 (A) 204,000 (E) 34,000

(S) 300,000 1,582,000

1,582,000

-0355,000 975,000 1,034,000 3,139,000 (309,000) (535,000) (2,295,000) (3,139,000)

Chapter 03 – Consolidations – Subsequent to the Date of Acquisition – Hoyle, Schaefer, Doupnik, Advanced Accounting, 15e

34.

(35 minutes) (Contingent performance obligation and worksheet adjustments for equity and initial value methods.)

a. Investment in Wolfpack, Inc. Contingent performance obligation Cash

500,000 35,000 465,000

b. 12/31/23

Loss from increase in contingent performance obligation 5,000 Contingent performance obligation 5,000

12/31/24

Loss from increase in contingent performance obligation10,000 Contingent performance obligation 10,000

12/31/24

Contingent performance obligation Cash

50,000 50,000

Equity Method Common stock- Wolfpack Retained earnings-Wolfpack Investment in Wolfpack

200,000 180,000

Royalty agreements Goodwill Investment in Wolfpack

90,000 60,000

Equity earnings of Wolfpack Investment in Wolfpack

65,000

Investment in Wolfpack Dividends declared

35,000

Amortization expense Royalty agreements

10,000

380,000

150,000 65,000 35,000 10,000

Initial Value Method Investment in Wolfpack Retained earnings-Branson

30,000

Common stock Retained earnings-Wolfpack Investment in Wolfpack

200,000 180,000

30,000

380,000

Chapter 03 – Consolidations – Subsequent to the Date of Acquisition – Hoyle, Schaefer, Doupnik, Advanced Accounting, 15e

35.

Royalty agreements Goodwill Investment in Wolfpack

90,000 60,000

Dividend income Dividends declared

35,000

Amortization expense Royalty agreements

10,000

150,000 35,000 10,000

(45 Minutes) (Prepare consolidation worksheet five years after acquisition. Parent applies equity method). a. Allocation of Acquisition-Date Fair Value and Determination of Amortization: Bradford‘s acquisition-date fair value Book value of Bradford (acquisition date) Fair value in excess of book value Excess assigned to specific accounts: Land Equipment Formula Total

$10,000 5,000 20,000 $35,000

$140,000 (105,000) $ 35,000 Remaining life – 5 yrs. 20 yrs.

Annual excess amortizations – $1,000 1,000 $2,000

The equity in subsidiary earnings reflects the equity method. The initial value method would have recorded $40,000 (100% of dividend declared) as income while the partial equity method would have shown $68,000 (100% of the subsidiary's income). Under the equity method, a $66,000 income accrual is recognized (100% of reported income less the $2,000 in excess amortization expenses computed above). b. Explanation of Consolidation Entries Found on Worksheet Entry S—Eliminates stockholders' equity accounts of the subsidiary as of the beginning of the current year. Entry A—Recognizes remaining unamortized allocation from acquisition-date fair value adjustments. As of the beginning of the current year, equipment and formula have undergone four years of amortization. Entry I—Eliminates intra-entity income accrual for the current year. Entry D—Eliminates intra-entity dividend transfers. Entry E—Recognizes excess amortization expenses for current year.

Chapter 03 – Consolidations – Subsequent to the Date of Acquisition – Hoyle, Schaefer, Doupnik, Advanced Accounting, 15e

35. (continued) Allen and Subsidiary Consolidated Worksheet for year ended December 31, 2024 Consolidation Entries Accounts Income Statement Revenues Cost of goods sold Depreciation expense Amortization expense Equity in subsidiary earnings Net income Statement of Retained Earnings Retained earnings 1/1 Net income (above) Dividends declared Retained earnings 12/31 Balance Sheet Current assets Investment in Bradford Co.

Allen Co.

Bradford Co.

(485,000) 160,000 130,000 -0(66,000) (261,000)

(190,000) 70,000 52,000 -0-0(68,000)

(659,000) (261,000) 175,500 (744,500)

(98,000) (68,000) 40,000 (126,000)

268,000 216,000

75,000 -0-

Land 427,500 Buildings and equipment (net) 713,000 Formula -0Total assets 1,624,500 Current liabilities (190,000) Common stock (600,000) Additional paid-in capital (90,000) Retained earnings 12/31 (744,500) Total liabilities and equity (1,624,500) Parentheses indicate a credit balance.

58,000 161,000 -0294,000 (103,000) (60,000) (5,000) (126,000) (294,000)

Debit

Credit

(675,000) 230,000 183,000 1,000 -0(261,000)

(E) 1,000 (E) 1,000 (I) 66,000 (S) 98,000 (D) 40,000

(D) 40,000 (A) 10,000 (A) 1,000 (A) 16,000

(S) 163,000 (A) 27,000 (I) 66,000 (E) 1,000 (E) 1,000

(S) 60,000 (S) 5,000 298,000

Consolidated Totals

298,000

(659,000) (261,000) 175,500 (744,500) 343,000 -0495,500 874,000 15,000 1,727,500 (293,000) (600,000) (90,000) (744,500) (1,727,500)

Chapter 03 – Consolidations – Subsequent to the Date of Acquisition – Hoyle, Schaefer, Doupnik, Advanced Accounting, 15e

36.

(20 Minutes) (Consolidated balances three years after acquisition. Parent has applied the equity method.) a. Schedule 1—Acquisition-Date Fair Value Allocation and Amortization Jasmine‘s acquisition-date fair value $206,000 Book value of Jasmine ........................(140,000) Fair value in excess of book value 66,000 Excess fair value assigned to specific accounts based on individual fair values Equipment ................................ Buildings (overvalued) .............. Goodwill ................................... Total .........................................

$54,400 (10,000) $21,600 $66,000

Remaining life 8 yrs. 20 yrs. indefinite

Annual excess amortization $6,800 (500) -0$6,300

Investment in Jasmine Company—12/31/24: Jasmine‘s acquisition-date fair value............................. 2022 Increase in book value of subsidiary .................... 2022 Excess amortizations (Schedule 1) ...................... 2023 Increase in book value of subsidiary .................... 2023 Excess amortizations (Schedule 1) ...................... 2024 Increase in book value of subsidiary .................... 2024 Excess amortizations (Schedule 1) ...................... Investment in Jasmine Company 12/31/24 ...............

$206,000 40,000 (6,300) 20,000 (6,300) 10,000 (6,300) $257,100

b. Equity in subsidiary earnings: Income accrual ................................................................. Excess amortizations (Schedule 1) ............................... Equity in subsidiary earnings ...................................

$30,000 (6,300) $23,700

c. Consolidated net income: Consolidated revenues (add book values) ................... Consolidated expenses (add book values and excess amortization expense) .................................. Consolidated net income ................................................

$414,000 (278,300) $135,700

d. Consolidated equipment: Book values added together .......................................... Acquisition-date fair value allocation ............................ Excess depreciation ($6,800 × 3) ................................... Consolidated equipment ...........................................

$370,000 54,400 (20,400) $404,000

Chapter 03 – Consolidations – Subsequent to the Date of Acquisition – Hoyle, Schaefer, Doupnik, Advanced Accounting, 15e

56. (continued) e. Consolidated buildings: Book values added together .......................................... Acquisition-date fair value allocation............................. Excess depreciation ($500 × 3) ...................................... Consolidated buildings ..............................................

$288,000 (10,000) 1,500 $279,500

Allocation of excess fair value to goodwill ....................

$21,600

Consolidated common stock ..........................................

$290,000

f. g. The parent's $290,000 balance appropriately shows the parent company stockholders‘ contributed capital (the acquired company's common stock will be eliminated each year on the consolidation worksheet). h. Consolidated retained earnings ........................................... $410,000 Tyler's balance of $410,000 is equal to the consolidated total because the equity method has been applied. 37.

(35 minutes) (Consolidation with IPR&D, equity method)

a. Consideration transferred 1/1/23 Increase in GaugeRite‘s retained earnings to 1/1/24 In-process R&D write-off in 2023 Amortizations 2023 Income 2024 Dividends declared 2024 Amortization 2024 Investment balance 12/31/24 b.

$1,980,000 150,000 (44,000) (7,000) 210,000 (25,000) (7,000) $2,257,000

The IPR&D was abandoned in 2023 and the original asset was written off to expense to reflect the absence of future economic benefits. Because the parent applies the equity method, the investment account was reduced by $44,000.

Chapter 03 – Consolidations – Subsequent to the Date of Acquisition – Hoyle, Schaefer, Doupnik, Advanced Accounting, 15e

37. (continued) Procise and Subsidiary GaugeRite Consolidated Worksheet for the year ended December 31, 2024 Accounts Sales Cost of goods sold Depreciation expense Other operating expenses Subsidiary income Net Income Retained earnings 1/1/24 Net Income Dividends declared Retained earnings 12/31/24

12/31/24 Procise (3,500,000) 1,600,000 350,000

12/31/24 GaugeRite (1,000,000) 630,000 130,000

Consolidation Entries Debit Credit

190,000 (203,000) (1,563,000)

30,000 (210,000)

(3,000,000) (1,563,000) 200,000

(800,000) (210,000) 25,000

(4,363,000)

(985,000)

(4,363,000)

228,000 840,000 900,000

50,000 155,000 580,000

278,000 995,000 1,480,000

(E) 7,000

220,000 -0(1,563,000)

(I) 203,000

Cash Accounts receivable Inventory Investment in GaugeRite

2,257,000

Land Equipment (net) Goodwill Total assets

3,500,000 4,785,000 290,000 12,800,000

700,000 1,700,000 -03,185,000

Accounts payable Long-term debt Common stock— Procise Common stock— GaugeRite Retained earnings 12/31/24

(193,000) (3,094,000)

(400,000) (800,000)

(S) 800,000 (D) 25,000

(D) 25,000

(A) 49,000 (A) 230,000

(S)1,800,000 (A) 279,000 (I) 203,000 (E) 7,000

(3,000,000) (1,563,000) 200,000

-0-

4,200,000 6,527,000 520,000 14,000,000 (593,000) (3,894,000)

(5,150,000)

(4,363,000) (12,800,000)

Consolidated (4,500,000) 2,230,000 487,000

(5,150,000) (1,000,000)

(S)1,000,000

(985,000) (3,185,000)

2,314,000

(4,363,000) (14,000,000)

Chapter 03 – Consolidations – Subsequent to the Date of Acquisition – Hoyle, Schaefer, Doupnik, Advanced Accounting, 15e

38.

(45 minutes) (Goodwill impairment, consolidated balances, and worksheet) a. First, a firm has the option to conduct a qualitative assessment of the likelihood that a reporting unit‘s carrying amount is greater than its fair value. If the reporting unit fails the optional qualitative assessment (or if the firm elects to forgo the qualitative assessment), and the carrying amount of a reporting unit exceeds its fair value, then goodwill is considered to be impaired. b. Consideration transferred at 1/1 $120,000,000 Equity in Sherwood‘s earnings: Revenue $12,000,000 Operating expenses (11,800,000) Acquisition-date excess amortization (50,000) 150,000 Dividends from Sherwood (80,000) Investment in Sherwood 12/31 $120,070,000 c. Palisades compares Sherwood‘s total fair value to its carrying amount, as follows: 12/31 Carrying amount (equity method balance) $120,070,000* 12/31 Fair value 110,000,000 Goodwill impairment loss $ 10,070,000 Alternatively: Sherwood 12/31 carrying amount ($77,520,000 – 7,900,000) $ 69,620,000 Plus excess allocation to equipment (net of amortization) 450,000 Plus original goodwill 50,000,000 Consolidated carrying amount of Sherwood at 12/31 $120,070,000

Journal Entry by Palisades: Goodwill impairment loss Investment in Sherwood

10,070,000 10,070,000

d. Combined revenues $ 30,570,000 Combined expenses (including excess amortization) Income before impairment loss Goodwill impairment loss—Sherwood Consolidated net loss

22,200,000 8,370,000 10,070,000 $ 1,700,000

e. Consolidated goodwill = $50,000,000 – $10,070,000 = $39,930,000

Chapter 03 – Consolidations – Subsequent to the Date of Acquisition – Hoyle, Schaefer, Doupnik, Advanced Accounting, 15e

38. f. (continued) Palisades and Sherwood Consolidated Worksheet December 31 Consolidation Entries Accounts

Palisades, Inc. (18,570,000) 10,350,000 (150,000) 10,070,000 1,700,000

Sherwood Co. (12,000,000) 11,800,000 -0-

Retained earnings 1/1 Dividends declared Net loss (income) Retained earnings 12/31

(52,000,000) 300,000 1,700,000 (50,000,000)

(2,000,000) 80,000 (200,000) (2,120,000)

Cash Receivables (net) Investment in Sherwood

175,000 210,000 110,000,000

109,000 897,000 -0-

Broadcast licenses Movie library Equipment (net) Goodwill Total assets

350,000 365,000 131,000,000 -0242,100,000

14,014,000 45,000,000 17,500,000 -077,520,000

Current liabilities Long-term debt Common stock Retained earnings 12/31 Total liabilities and equity

(185,000) (21,915,000) (170,000,000) (50,000,000) (242,100,000)

(650,000) (7,250,000) (67,500,000) (2,120,000) (77,520,000)

Revenues Expenses Equity in Sherwood earnings Impairment loss Net loss (income)

Debit

Credit

(E) 50,000 (I) 150,000 -0-

(200,000) (S) 2,000,000 (D) 80,000

(D) 80,000

(A) 500,000 (A)39,930,000

(S) 69,500,000 (A) 40,430,000 (I) 150,000 (E) 50,000

(S)67,500,000 110,210,000

110,210,000

Consolidated Totals (30,570,000) 22,200,000 -010,070,000 1,700,000 (52,000,000) 300,000 1,700,000 (50,000,000) 284,000 1,107,000 -014,364,000 45,365,000 148,950,000 39,930,000 250,000,000 (835,000) (29,165,000) (170,000,000) (50,000,000) (250,000,000)

Chapter 03 – Consolidations – Subsequent to the Date of Acquisition – Hoyle, Schaefer, Doupnik, Advanced Accounting, 15e

39.

(10 minutes) (Discuss cost savings from alternative goodwill model available to private companies). The primary cost saving from electing to amortize goodwill is the avoidance of an annual goodwill impairment test. The goodwill impairment test requires an assessment of the fair values of every asset and liability in each of the entity‘s reporting units. Because fair values are not uniformly readily available, analyses involving various cash flow or income projection models must be performed. Such analyses can be costly because many private companies must either perform the valuations internally or pay for outside expert valuation services. By amortizing goodwill, a company thus avoids the extra costs involved with annual impairment analyses and recognizes a limited life for its goodwill.

40.

(15 minutes Prepare a consolidated income statement for a private company electing goodwill amortization). Angela Company and Subsidiary Consolidated Income Statement For the year ended December 31, 2024 Sales $10,250,000 Cost of goods sold 5,500,000 Gross profit $4,750,000 Depreciation expense $479,250 Amortization expense* 402,000 Other operating expenses 128,750 1,010,000 Consolidated net income $3,740,000 * Amortization expense Angela Eddy Tech Excess patented technology (5 year life) Goodwill (10 year life) Consolidated amortization expense

$250,000 12,000 30,000 110,000 $402,000

RESEARCH CASE SOLUTION

Jonas recognized several identifiable intangibles from its acquisition of Innovation Plus. Jonas expresses the desire to expense these intangible assets in the acquisition period. 1.

Advise Jonas on the acceptability of its suggested immediate write-off. An intangible asset should not be written down or off in the period of 3-60 © McGraw Hill LLC. All rights reserved. No reproduction or distribution without the prior written consent of McGraw Hill LLC.

Chapter 03 – Consolidations – Subsequent to the Date of Acquisition – Hoyle, Schaefer, Doupnik, Advanced Accounting, 15e

acquisition unless it becomes impaired during that period. Indicate the relevant factors to consider in allocating the values assigned to identifiable intangibles acquired in a business combination. 2.

The accounting for recognized intangible assets is based on its useful life to the reporting entity. An intangible asset with a finite useful life is amortized; an intangible asset with an indefinite useful life is not amortized. The useful life of an intangible asset is the period the asset is expected to contribute to the future cash flows of that entity. Other factors to be considered are legal, regulatory, or contractual provisions, obsolescence, demand, competition, other economic factors, and the level of maintenance expenditures required to obtain the expected future cash flows from the asset (ASC 350-30-35-3).

The price paid by Jonas for Innovation Plus indicates a large amount was paid for goodwill. However, Jonas worries that any goodwill impairment may send the wrong signal to its investors about the wisdom of the acquisition. Jonas thus wishes to allocate all the goodwill to one account called ―enterprise goodwill.‖ In this way, Jonas hopes to minimize the possibility of goodwill impairment because a decline in goodwill in one business unit may be offset by an increase in the value of goodwill in another business unit. Jonas‘ suggested treatment of goodwill is inappropriate. To ensure that goodwill increases in one reporting unit do not offset decreases in others, goodwill acquired in a business combination is allocated across business units that benefit from the goodwill.

Per the FASB ASC (350-20-35-41): For the purpose of testing goodwill for impairment, all goodwill acquired in a business combination shall be assigned to one or more reporting units as of the acquisition date. Goodwill shall be assigned to reporting units of the acquiring entity that are expected to benefit from the synergies of the combination even though other assets or liabilities of the acquired entity may not be assigned to that reporting unit. The total amount of acquired goodwill may be divided among a number of reporting units. The methodology used to determine the amount of goodwill to assign to a reporting unit shall be reasonable and supportable and shall be applied in a consistent manner. Therefore, Jonas‘ desire to minimize the possibility of goodwill impairment should not be a factor in allocating goodwill to reporting units.

Chapter 03 – Consolidations – Subsequent to the Date of Acquisition – Hoyle, Schaefer, Doupnik, Advanced Accounting, 15e

TAPESTRY, INC. IMPAIRMENT ANALYSIS CASE SOLUTION

During fiscal 2020, Tapestry recorded a $210.7 million goodwill impairment charge and a $267.0 million impairment charge to indefinite-lived brand intangible assets for the Stuart Weitzman reporting unit.

According to Business Wire (4/30/2020), In the third quarter of fiscal 2020, the Company recorded $267 million of impairment charges to indefinite-lived brand intangible assets and $210.7million of impairment charges to goodwill for the Stuart Weitzman reporting unit. These charges were as a result of a decline in both current and future expected cash flows, exacerbated by the Covid-19 pandemic, which resulted in a decline in sales driven by closures of a significant portion of stores and traffic declines globally. Tapestry‘s 2020 10-K reported (p. 52) During the third quarter of fiscal 2020, profitability trends continued to decline from those that were expected for the Stuart Weitzman brand. The reduction in both cash from operations and future expected cash flows were exacerbated by the Covid-19 pandemic, which resulted in a decline in sales driven by full and partial closures of a significant portion of our stores globally. As a result of these macroeconomic conditions, the Company concluded that a triggering event had occurred during the third quarter, resulting in the need to perform a quantitative interim impairment assessment over the Company‘s Stuart Weitzman reporting unit and indefinite-lived brand intangible assets.

How did Tapestry reflect the 2020 goodwill impairment in its income statement and cash flow statement?  Income Statement: Operating expense  Cash Flows Statement: Adjustment to reconcile net income to net cash provided by operating activities. Tapestry employs the indirect format for its Consolidated Statement of Cash Flows.

Describe in your own words the goodwill impairment testing performed by Tapestry in 2020. Tapestry records a goodwill impairment if the fair value of a reporting unit exceeds its carrying value. When the carrying value of a reporting unit exceeds its fair value, an impairment charge is recognized for that excess amount. The impairment charge is limited to the carrying amount of goodwill residing in any particular reporting unit. Because Tapestry‘s assessment of the Stuart Weitzman reporting unit showed that its carrying amount exceeded its fair value, the company recorded a goodwill impairment loss. 3-62 © McGraw Hill LLC. All rights reserved. No reproduction or distribution without the prior written consent of McGraw Hill LLC.

Chapter 03 – Consolidations – Subsequent to the Date of Acquisition – Hoyle, Schaefer, Doupnik, Advanced Accounting, 15e

FASB ASC AND IASB RESEARCH CASE GAAP prohibits reversal of impairment losses for goodwill. IFRS also prohibits reversal of impairment losses for goodwill Requirements for goodwill impairment differ under IFRS. First, under IFRS, there is no similar qualitative assessment for goodwill impairment as exists for US GAAP. Under IFRS, goodwill impairment testing uses a one-step approach: The recoverable amount of the CGU (cash-generating unit) or group of CGUs (i.e., the higher of its fair value minus costs to sell and its value in use) is compared with its carrying amount. An impairment loss is recognized in operating results as the excess of carrying over the recoverable amount. The impairment loss is allocated first to goodwill and then pro rata to the other assets of the CGU or group of CGUs to the extent that the impairment exceeds goodwill‘s book value. IAS 36 Impairment of Assets: 90. A cash-generating unit to which goodwill has been allocated shall be tested for impairment annually, and whenever there is an indication that the unit may be impaired, by comparing the carrying amount of the unit, including the goodwill, with the recoverable amount of the unit. If the recoverable amount of the unit exceeds the carrying amount of the unit, the unit and the goodwill allocated to that unit shall be regarded as not impaired. If the carrying amount of the unit exceeds the recoverable amount of the unit, the entity shall recognise the impairment loss in accordance with paragraph 104. 104. An impairment loss shall be recognised for a cash-generating unit (the smallest group of cash-generating units to which goodwill or a corporate asset has been allocated) if, and only if, the recoverable amount of the unit (group of units) is less than the carrying amount of the unit (group of units). The impairment loss shall be allocated to reduce the carrying amount of the assets of the unit (group of units) in the following order: (a) first, to reduce the carrying amount of any goodwill allocated to the cash-generating unit (group of units); and (b) then, to the other assets of the unit (group of units) pro rata on the basis of the carrying amount of each asset in the unit (group of units). These reductions in carrying amounts shall be treated as impairment losses on individual assets and recognised in accordance with paragraph 60.

Chapter 03 – Consolidations – Subsequent to the Date of Acquisition – Hoyle, Schaefer, Doupnik, Advanced Accounting, 15e

Excel Case 1 Solution a. Innovus employs initial value method to account for ChipTech.

Revenues Cost of goods sold Depreciation expense Amortization expense Dividend income Net Income

Innovus (990,000) 500,000 100,000 55,000 (40,000) (375,000)

ChipTech (210,000) 90,000 5,000 18,000 -0(97,000)

Retained earnings 1/1 Net income Dividends declared Retained earnings 12/31 Current assets Investment in ChipTech

(1,555,000) (375,000) 250,000 (1,680,000) 960,000 670,000

(450,000) (97,000) 40,000 (507,000) 355,000

Consolidated Entries Debit

Credit

(E) 20,000 (I) 40,000 (S)450,000

(*C) 60,000 (I) 40,000

Consolidated (1,200,000) 590,000 105,000 93,000 -0(412,000) (1,615,000) (412,000) 250,000 (1,777,000) 1,315,000

(*C) 60,000 (S) 580,000 (A) 150,000

Equipment (net) Trademark Existing technology Goodwill Total assets

765,000 235,000 0 450,000 3,080,000

225,000 100,000 45,000 -0725,000

Liabilities Common stock Additional paid-in capital Retained earnings 12/31 Total liabilities and equity

(780,000) (500,000) (120,000) (1,680,000) (3,080,000)

(88,000) (100,000) (30,000) (507,000) (725,000)

(A) 36,000 (A) 64,000 (A) 50,000

(E) 4,000 (E) 16,000

(S)100,000 (S) 30,000 850,000

850,000

-0990,000 367,000 93,000 500,000 3,265,000 (868,000) (500,000) (120,000) (1,777,000) (3,265,000)

Chapter 03 – Consolidations – Subsequent to the Date of Acquisition – Hoyle, Schaefer, Doupnik, Advanced Accounting, 15e

Excel Case 1 Solution (continued) b. Innovus employs initial value method to account for ChipTech and goodwill is impaired. Consolidation Entries Debit

Revenues Cost of goods sold Depreciation expense Amortization expense Impairment loss Dividend income Net Income

Innovus (990,000) 500,000 100,000 55,000 50,000 (40,000) (325,000)

ChipTech (210,000) 90,000 5,000 18,000 -0(97,000)

(I) 40,000

Retained earnings 1/1 Net income Dividends declared Retained earnings 12/31

(1,555,000) (325,000) 250,000 (1,630,000)

(450,000) (97,000) 40,000 (507,000)

(S)450,000

Current assets Investment in ChipTech

960,000 620,000

355,000

Credit

(E) 20,000

(*C)60,000 (I) 40,000

Consolidated (1,200,000) 590,000 105,000 93,000 50,000 -0(362,000) (1,615,000) (362,000) 250,000 (1,727,000) 1,315,000

(*C) 60,000 (S)580,000 (A)100,000

Equipment (net) Trademark Existing technology Goodwill Total assets Liabilities Common stock Additional paid-in capital Retained earnings 12/31 Total liab. and equity

765,000 235,000 -0450,000 3,030,000

225,000 100,000 45,000 -0725,000

(780,000) (500,000) (120,000) (1,630,000) (3,030,000)

(88,000) (100,000) (30,000) (507,000) (725,000)

(A) 36,000 (A )64,000

(E) 4,000 (E) 16,000

(S)100,000 (S) 30,000 800,000

-0990,000 367,000 93,000 450,000 3,215,000

800,000

(868,000) (500,000) (120,000) (1,727,000) (3,215,000)

Alternatively, the goodwill impairment loss could have been recognized as an adjustment on the worksheet.

Chapter 03 – Consolidations – Subsequent to the Date of Acquisition – Hoyle, Schaefer, Doupnik, Advanced Accounting, 15e

Excel Case 2 Solution Part a: Investment in Wi-Free account balance 12/31/24 Wi-Free‘s acquisition-date fair value Change in Wi-Free‘s retained earnings for 2023 2023 amortization 2023 in-process R&D write-off 2024 reported Wi-Free income 2024 Wi-Free dividend 2024 amortization Balance 12/31/24

$730,000 80,000 (4,500) (75,000) 180,000 (50,000) (4,500) $856,000

Part b: Consolidati on Entries Hi-Speed

Wi-Free

Revenues Cost of goods sold Depreciation expense Amortization expense Equity in subsidiary earnings Net Income

(1,100,000) 625,000 140,000 50,000 (175,500) (460,500)

(325,000) 122,000 12,000 11,000 -0(180,000)

Retained earnings 1/1 Net income Dividends declared Retained earnings 12/31

(1,552,500) (460,500) 250,000 (1,763,000)

(450,000) (180,000) 50,000 (580,000)

Current assets Investment in Wi-Free

1,034,000 856,000

345,000

Equipment (net) Computer software Internet domain name Goodwill Total assets

713,000 650,000 0 -03,253,000

305,000 130,000 100,000 -0880,000

Liabilities Common stock Additional paid-in capital Retained earnings 12/31 Total liab. and equity

(870,000) (500,000) (120,000) (1,763,000) (3,253,000)

(170,000) (110,000) (20,000) (580,000) (880,000)

Debit

(E) 12,000 (I)175,500

Credit

(E) 7,500

(S)450,000 (D) 50,000

(D) 50,000

(E) 7,500 (A)108,000 (A) 65,000

(P) 30,000 (I) 175,500 (S)580,000 (A)150,500 (A) 22,500 (E) 12,000

(P) 30,000 (S)110,000 (S) 20,000 1,028,000

1,028,000

Consolidate d Totals (1,425,000) 747,000 152,000 65,500 -0(460,500) (1,552,500) (460,500) 250,000 (1,763,000) 1,349,000

0 1,018,000 765,000 196,000 65,000 3,393,000 (1,010,000) (500,000) (120,000) (1,763,000) (3,393,000)

Chapter 03 – Consolidations – Subsequent to the Date of Acquisition – Hoyle, Schaefer, Doupnik, Advanced Accounting, 15e

Chapter 3 – Excel Spreadsheet Project PECOS COMPANY AND SUARO COMPANY Consolidated Information Worksheet

Revenues Operating expenses

Pecos

Suaro

(1,052,000) 821,000

(427,000) 262,000

Amortization of intangibles Goodwill impairment loss Income of Suaro

0 0 0

Net income Retained earnings—Pecos, 1/1 Retained earnings—Suaro, 1/1 Net income (above) Dividends declared

(165,000) 0 0 200,000

Retained earnings, 12/31

(201,000) (165,000) 35,000 (331,000)

Cash Receivables Inventory Investment in Suaro

195,000 247,000 415,000

95,000 143,000 197,000 0

Land Equipment (net) Software Other intangibles Goodwill

341,000 240,100 0 145,000 0

85,000 100,000 312,000 0 0

Total assets Liabilities Common stock Retained earnings (above)

932,000 (1,537,100) (500,000)

Total liabilities and equity

(251,000) (350,000) (331,000) (932,000)

Chapter 03 – Consolidations – Subsequent to the Date of Acquisition – Hoyle, Schaefer, Doupnik, Advanced Accounting, 15e

Fair Value Allocation Schedule Acquisition-date fair value 1,450,000 Book value 476,000 Excess fair value over book value 974,000 Amortizations and Write-off 2023

2024

Land

(10,000)

Brand Name Software IPR&D Goodwill

60,000 100,000 300,000 524,000

0 50,000 300,000 0

0 50,000 0 0

Total

974,000 350,000 50,000 Suaro's Retained Earnings Changes 2023 2024 Income Dividends

75,000 0

165,000 35,000

Chapter 03 – Consolidations – Subsequent to the Date of Acquisition – Hoyle, Schaefer, Doupnik, Advanced Accounting, 15e

Chapter 3 - Computer Project Solution PECOS COMPANY AND SUARO COMPANY Consolidated Worksheet For the Year Ended December 31, 2024 EQUITY METHOD Consolidation Entries Pecos Revenues Operating expenses Amortization of intangibles Goodwill impairment loss Income of Suaro

(1,052,000) 821,000 0 0 (115,000)

Suaro

Debit

(427,000) 262,000 0 (E) 0 0 (I)

Consolidated

Credit

Totals (1,479,000) 1,083,000 50,000 0 0

50,000 115,000

Net income

(346,000)

(165,000)

(346,000)

Retained earnings—Pecos, 1/1

0 (201,000) (S) (165,000) 35,000

(655,000)

Retained earnings—Suaro, 1/1 Net income (above) Dividends declared

(655,000) 0 (346,000) 200,000

Retained earnings, 12/31

(801,000)

(331,000)

(801,000)

Cash Receivables Inventory

195,000 247,000 415,000

95,000 143,000 197,000

290,000 390,000 612,000

Investment in Suaro

1,255,000

0 (D)

201,000 (D)

35,000 (S) (A) (I)

35,000

551,000 624,000 115,000

0 (346,000) 200,000

Chapter 03 – Consolidations – Subsequent to the Date of Acquisition – Hoyle, Schaefer, Doupnik, Advanced Accounting, 15e

Land Equipment (net) Software Other intangibles Brand name Goodwill

341,000 240,100 0 145,000 0 0

85,000 100,000 312,000 (A) 0 0 (A) 0 (A)

(A)

10,000

50,000 (E)

50,000

60,000 524,000

416,000 340,100 312,000 145,000 60,000 524,000

Total assets

2,838,100

932,000

3,089,100

Liabilities Common stock Retained earnings (above)

(1,537,100) (500,000) (801,000)

(251,000) (350,000) (S) (331,000)

(1,788,100) (500,000) (801,000)

Total liabilities and equity

(2,838,100)

(932,000)

350,000 1,385,000

1,385,000

Shaded items were provided on the Consolidated Information Worksheet

(3,089,100)

Chapter 03 – Consolidations – Subsequent to the Date of Acquisition – Hoyle, Schaefer, Doupnik, Advanced Accounting, 15e

Chapter 3 – Computer Project Solution PECOS COMPANY AND SUARO COMPANY Consolidated Worksheet For the Year Ended December 31, 2024 PARTIAL EQUITY METHOD Consolidation Entries Pecos Revenues Operating expenses Amortization of intangibles Goodwill impairment loss Income of Suaro Net income

(1,052,000) 821,000 0 0 (165,000) (396,000)

Suaro

Debit

(427,000) 262,000 0 (E) 0 0 (I)

Consolidated

Credit

Totals (1,479,000) 1,083,000 50,000 0 0

50,000 165,000

(165,000)

(346,000)

Retained earnings—Pecos, 1/1

(1,005,000)

0 (*C)

350,000

(655,000)

Retained earnings—Suaro, 1/1 Net income (above) Dividends declared

0 (396,000) 200,000

(201,000) (S) (165,000) 35,000

201,000

0 (346,000) 200,000

Retained earnings, 12/31 Cash Receivables Inventory Investment in Suaro

(D)

35,000

(1,201,000)

(331,000)

(801,000)

195,000 247,000 415,000

95,000 143,000 197,000

290,000 390,000 612,000

1,655,000

0 (D)

35,000 (S) (A) (I) (*C)

551,000 624,000 165,000 350,000

Chapter 03 – Consolidations – Subsequent to the Date of Acquisition – Hoyle, Schaefer, Doupnik, Advanced Accounting, 15e

Land Equipment (net) Software Other intangibles Brand name Goodwill

(A)

10,000

(A)

50,000 (E)

50,000

(A) (A)

60,000 524,000

416,000 340,100 312,000 145,000 60,000 524,000

341,000 240,100 0 145,000 0 0

85,000 100,000 312,000 0 0 0

Total assets

3,238,100

932,000

3,089,100

Liabilities Common stock Retained earnings (above)

(1,537,100) (500,000) (1,201,000)

(251,000) (350,000) (331,000)

(1,788,100) (500,000) (801,000)

Total liabilities and equity

(3,238,100)

(932,000)

(S)

350,000 1,785,000

1,785,000

Shaded items were provided on the Consolidated Information Worksheet

(3,089,100)

Chapter 03 – Consolidations – Subsequent to the Date of Acquisition – Hoyle, Schaefer, Doupnik, Advanced Accounting, 15e

Chapter 3 – Computer Project Solution PECOS COMPANY AND SUARO COMPANY Consolidated Worksheet For the Year Ended December 31, 2024 INITIAL VALUE METHOD Consolidation Entries Pecos Revenues Operating expenses Amortization of intangibles Goodwill impairment loss Income of Suaro

(1,052,000) 821,000 0 0 (35,000)

Suaro (427,000) 262,000 0 (E) 0 0 (I)

Debit

Consolidated

Credit

Totals (1,479,000) 1,083,000 50,000 0 0

50,000 35,000

Net income

(266,000)

(165,000)

Retained earnings—Pecos, 1/1 Retained earnings—Suaro, 1/1 Net income (above) Dividends declared

(930,000) 0 (266,000) 200,000

0 (*C) (201,000) (S) (165,000) 35,000

Retained earnings, 12/31

(996,000)

(331,000)

(801,000)

Cash Receivables Inventory Investment in Suaro

195,000 247,000 415,000 1,450,000

95,000 143,000 197,000 0

290,000 390,000 612,000 0

(346,000) 275,000

(655,000)

201,000

0 (346,000) 200,000

(I)

35,000

(S)

551,000

(A) (*C)

624,000 275,000

Chapter 03 – Consolidations – Subsequent to the Date of Acquisition – Hoyle, Schaefer, Doupnik, Advanced Accounting, 15e

Consolidated Worksheet (continued)

Land Equipment (net) Software Other intangibles Brand name Goodwill

341,000 240,100 0 145,000 0 0

85,000 100,000 312,000 (A) 0 0 (A) 0 (A)

(A)

10,000

50,000 (E)

50,000

60,000 524,000

416,000 340,100 312,000 145,000 60,000 524,000

Total assets

3,033,100

932,000

3,089,100

Liabilities Common stock Retained earnings (above)

(1,537,100) (500,000) (996,000)

(251,000) (350,000) (S) (331,000)

(1,788,100) (500,000) (801,000)

Total liabilities and equity

(3,033,100)

(932,000)

350,000 1,545,000

1,545,000

Shaded items were provided on the Consolidated Information Worksheet

(3,089,100)

Chapter 03 – Consolidations – Subsequent to the Date of Acquisition – Hoyle, Schaefer, Doupnik, Advanced Accounting, 15e

Chapter 3 – Computer Project

4. PECOS COMPANY AND SUARO COMPANY Goodwill Impairment Loss Effects Without

With

Impairment

Common shares outstanding

500,000

Consolidated net income/(loss)

346,000

(178,000)

Consolidated assets, 1/1/24

2,943,100

Consolidated assets, 12/31/24

3,089,100

2,565,100

Consolidated equity, 1/1/24

1,155,000

Consolidated equity, 12/31/24

1,301,000

777,000

Consolidated liabilities

1,788,100

0.69

-0.36

Return on assets

11.47%

-6.46%

Return on equity

28.18%

-18.43%

1.37

2.30

Earnings-per-share

Debt-to-equity

Chapter 03 – Consolidations – Subsequent to the Date of Acquisition – Hoyle, Schaefer, Doupnik, Advanced Accounting, 15e

Chapter 3 – Computer Project Solution PECOS COMPANY AND SUARO COMPANY Consolidated Worksheet For the Year Ended December 31, 2024 EQUITY METHOD – GOODWILL IMPAIRMENT LOSS Consolidation Entries Pecos Revenues Operating expenses Amortization of intangibles Goodwill impairment loss Income of Suaro

(1,052,000) 821,000 0 524,000 (115,000)

Suaro

Debit

(427,000) 262,000 0 (E) 0 0 (I)

Consolidated

Credit

Totals (1,479,000) 1,083,000 50,000 524,000 0

50,000 115,000

Net income

178,000

(165,000)

178,000

Retained earnings—Pecos, 1/1

0 (201,000) (S) (165,000) 35,000

(655,000)

Retained earnings—Suaro, 1/1 Net income (above) Dividends declared

(655,000) 0 178,000 200,000

Retained earnings, 12/31

(277,000)

(331,000)

(277,000)

Cash Receivables Inventory

195,000 247,000 415,000

95,000 143,000 197,000

290,000 390,000 612,000

Investment in Suaro

731,000

0 (D)

201,000 (D)

35,000 (S) (A) (I)

35,000

551,000 100,000 115,000

0 178,000 200,000

Chapter 01 - The Equity Method of Accounting for Investments – Hoyle, Schaefer, Doupnik, Advanced Accounting, 15e

Consolidated Worksheet (continued

Land Equipment (net) Software Other intangibles Brand name Goodwill

341,000 240,100 0 145,000 0 0

85,000 100,000 312,000 0 0 0

(A)

10,000

(A)

50,000 (E)

50,000

(A)

60,000

Total assets

2,314,100

932,000

2,565,100

Liabilities Common stock Retained earnings (above)

(1,537,100) (500,000) (277,000)

(251,000) (350,000) (331,000)

350,000

(1,788,100) (500,000) (277,000)

Total liabilities and equity

(2,314,100)

(932,000)

861,000

861,000 (2,565,100)

(S)

Shaded items were provided on the Consolidated Information Worksheet

416,000 340,100 312,000 145,000 60,000 0

Chapter 04 – Consolidated Financial Statements and Outside Ownership – Hoyle, Schaefer, Doupnik, Advanced Accounting 15e

Part a. of the report should recognize that there is no effect on final consolidated balances from the alternative internal accounting methods, despite differences on the parent‘s trial balances. In part b., students should point to the relation between the parent‘s retained earnings and consolidated retained earnings—observing that the equity method produces identical results and the initial value and partial equity methods require adjustments to the equity method. In part c., students should observe the negative effects on EPS, ROA, and ROE from recognizing a goodwill impairment loss. The effect on the D/E ratio is to decrease the denominator and thus increase the D/E ratio—typically viewed negatively by debtholders and suggesting increased liquidity risk.

CHAPTER 4 CONSOLIDATED FINANCIAL STATEMENTS AND OUTSIDE OWNERSHIP Chapter Outline I.

Outside ownership may be present within any consolidated entity. A. Complete ownership of a subsidiary is not a prerequisite for consolidation—only enough voting shares need be owned so that the acquiring company has the ability to control the decision-making process of the acquired company. B. Any ownership interest in a subsidiary company by a party unrelated to the acquiring company is termed a noncontrolling interest.

II.

Valuation of subsidiary assets and liabilities poses a challenge when a noncontrolling interest is present. A. The accounting emphasis (economic unit concept) is placed on the entire entity that results from the business combination when control has been obtained. The parent company that controls its subsidiary must consolidate 100% of subsidiary assets, liabilities, revenues, and expense are consolidated even when its ownership is less than 100%. B. The consolidated valuation basis for a newly acquired subsidiary is the acquisitiondate fair value of the company (most frequently determined by the consideration transferred and the fair value of the noncontrolling interest); specific subsidiary assets and liabilities are measured at their acquisition-date fair values. C. The noncontrolling interest balance is reported in the parent‘s consolidated financial statements as a component of stockholders' equity.

III.

Consolidations involving a noncontrolling interest—subsequent to the date of acquisition A. Four noncontrolling interest figures are determined for reporting purposes 1. Beginning of year balance sheet amount 2. Net income attributable to noncontrolling interest 3. Dividends declared by subsidiary during the period attributable to the noncontrolling interest 4. End of year balance sheet amount B. Noncontrolling interest balances are accumulated in a separate column in the consolidation worksheet 4-1 © McGraw Hill LLC. All rights reserved. No reproduction or distribution without the prior written consent of McGraw Hill LLC.

Chapter 04 – Consolidated Financial Statements and Outside Ownership – Hoyle, Schaefer, Doupnik, Advanced Accounting 15e

1. The beginning of year figure is entered on the worksheet as a component of Entries S and A 2. The net income attributable to the noncontrolling interest is established by a columnar entry that simultaneously reports the balance in both the consolidated income statement and the noncontrolling interest column 3. Dividends declared to these outside owners are reflected by extending the subsidiary's Dividends declared balance (after eliminating intra-entity transfers) into the noncontrolling interest column as a reduction 4. The end of year noncontrolling interest total is the summation of the three items above and is reported in stockholders' equity. IV.

Step acquisitions A. An acquiring company may make several different purchases of a subsidiary's stock in order to gain control B. Upon attaining control, all of the parent‘s previous investments in the subsidiary are adjusted to fair value and a gain or loss recognized as appropriate C. Upon attaining control, the valuation basis for the subsidiary is established at its total fair value (the sum of the fair values of the controlling and noncontrolling interests) D. Post-control subsidiary stock acquisitions by the parent are considered transactions with current owners of the consolidated entity. Thus such post-control stock acquisitions neither result in gains or losses nor provide a basis for subsidiary asset remeasurement to fair value. The difference between the sale proceeds and the carrying value of the shares sold (equity method) is recorded as an adjustment to the parent‘s additional paid in capital.

Sales of subsidiary stock A. The proper book value must be established within the parent's Investment account so that the sales transaction can be correctly recorded B. The investment balance is adjusted as if the equity method had been applied during the entire period of ownership C. If only a portion of the shares are being sold, the book value of the investment account is reduced using either a FIFO or a weighted-average cost flow assumption D. If the parent maintains control, any difference between the proceeds of the sale and the equity-adjusted book value of the share sold is recognized as an adjustment to additional paid-in capital. E. If the parent loses control with the sale of the subsidiary shares, the difference between the proceeds of the sale and the equity-adjusted book value of the share sold is recognized as a gain or loss. F. Any interest retained by the parent company should be accounted for by either consolidation, the equity method, or the fair value method depending on the influence remaining after the sale. Answer to Discussion Question: Do you think the FASB made the correct decision in requiring consolidated financial statements to recognize all subsidiary‘s assets and liabilities at fair value regardless of the percentage ownership acquired by the parent? As the quotes from the five accounting professionals illustrate, the decision to require the revaluation of 100% of a newly controlled subsidiary‘s assets and liabilities—regardless of

Chapter 04 – Consolidated Financial Statements and Outside Ownership – Hoyle, Schaefer, Doupnik, Advanced Accounting 15e

percentage ownership—was not without some controversy. Students can use the quotes to discuss cost-benefit issues, relevance of capturing the underlying economics, use of hypothetical transactions in financial reporting, potential for abuse, etc. The requirement to value all acquisition date subsidiary assets at 100% fair value thus provides a useful vehicle for the class to discuss the many issues surrounding standard setters‘ decisions. Answer to Discussion Question: DOES GAAP UNDERVALUE POST-CONTROL STOCK ACQUISITIONS? On the date control is established, the new subsidiary‘s valuation basis is established. Subsequent acquisitions of any remaining portions of the noncontrolling interests do not establish a new valuation basis for the subsidiary. In the StepUp case, the new valuation basis for Escalator was established when its 75% controlling interest was acquired. StepUp then increases Escalator‘s consolidated carrying amount as Escalator earns income, not by subsequent purchases of Escalator‘s noncontrolling shares. StepUp‘s payment for its post-control equity acquisition (15%) apparently was in excess of Escalator‘s proportionate carrying amounts. Because these transactions were with owners (not outside parties), no gain or loss is recorded. StepUp reduces its paid-in capital the for excess of the purchase price over the carrying amount. The accounting is similar to retirement of stock for a payment in excess of the company‘s proportionate carrying amount. Margaret Liu may be correct that the current market value of Escalator is $3 million more that its carrying amount. However, GAAP does not, in general, record unrealized increases in a firm‘s market value as increases in reported asset amounts.

Chapter 04 – Consolidated Financial Statements and Outside Ownership – Hoyle, Schaefer, Doupnik, Advanced Accounting 15e

Answers to Questions 1.

"Noncontrolling interest" refers to an equity interest that is held in a member of a consolidated entity by an unrelated (outside) party.

Acquisition method = $220,000 (fair value)

A control premium is the portion of an acquisition price (above currently traded market values) paid by a parent company to induce shareholders to sell a sufficient number of shares to obtain control. The extra payment typically becomes part of the goodwill acquired in the acquisition attributable to the parent company.

Current accounting standards require the noncontrolling interest to appear in the stockholders' equity section. The noncontrolling interest's share of the subsidiary‘s net income is shown as an allocated component of consolidated net income.

The ending noncontrolling interest is determined on a consolidation worksheet by adding the four components found in the noncontrolling interest column: (1) the beginning balance of the subsidiary‘s book value, (2) the noncontrolling interest share of the adjusted acquisition-date excess fair over book value allocation, (3) its share of current year net income, (4) less dividends declared to these outside owners.

Allsports should remove the pre-acquisition revenues and expenses from the consolidated totals. These amounts are attributable to prior ownership and therefore should are not earnings for the current parent company owners.

Following the second acquisition, consolidation is appropriate. Once Tree gains control, the 10% previous ownership is included at fair value as part of the total consideration transferred by Tree in the acquisition.

When a company sells a portion of an investment, it must remove the carrying value of that portion from its investment account. The carrying value is based upon application of the equity method. Thus, if either the initial value method or the partial equity method has been used, Duke must first restate the account to the equity method before recording the sales transaction. The same method is applied to the operations of the current period occurring prior to the time of sale.

Unless control is surrendered, the acquisition method views the sale of subsidiary's stock as a transaction with its owners. Thus, no gain or loss is recognized. The difference between the sale proceeds and the carrying value of the shares sold (equity method) is accounted for as an adjustment to the parent‘s additional paid in capital.

10.

The accounting method choice for the remaining shares depends upon the current relationship between the two firms. If Duke retains control, consolidation is still required. However, if the parent now can only significantly influence the decision-making process, the equity method is applied. A third possibility is Duke may have lost the power to exercise even significant influence. The fair value method then is appropriate.

Chapter 04 – Consolidated Financial Statements and Outside Ownership – Hoyle, Schaefer, Doupnik, Advanced Accounting 15e

Answers to Problems 1.

A At the date control is obtained, the parent consolidates subsidiary assets at fair value ($549,000 in this case) regardless of the parent‘s percentage ownership.

D In consolidating the subsidiary's figures, all intra-entity balances must be eliminated in their entirety for external reporting purposes. Even though the subsidiary is less than fully owned, the parent nonetheless controls it.

B An asset acquired in a business combination is initially valued at 100% acquisition-date fair value and subsequently amortized its useful life. Patent fair value at January 1, 2023................................................... Amortization for 2 years (9 year remaining life) ............................... Patent reported amount December 31, 2024.....................................

$45,000 (10,000) $35,000

Combined revenues ............................................................................. $1,100,000 Combined expenses ................................................................................ (700,000) Excess acquisition-date fair value amortization............................... (15,000) Consolidated net income ........................................................................ $385,000 Less: noncontrolling interest share ($85,000 × 40%) ....................... (34,000) Consolidated net income to Chamberlain Corporation......................... $351,000 7.

C Consideration transferred by Pride ........................................................ $540,000 Noncontrolling interest fair value ...................................................... 60,000 Star acquisition-date fair value ............................................................... $600,000 Star book value ................................................................................... 420,000 Excess fair over book value .................................................................... $180,000 to equipment (8 year remaining life)................................... to unpatented technology (4 year remaining life)..............

$ 80,000 100,000

Amort. $10,000 25,000 $35,000

$783,000 Combined revenues ........................................................................... Combined expenses ............................................................... $545,000 Excess fair value amortization............................................ 35,000 580,000 Consolidated net income ................................................................... $203,000 8.

Under the equity method, consolidated RE = parent‘s RE.

Chapter 04 – Consolidated Financial Statements and Outside Ownership – Hoyle, Schaefer, Doupnik, Advanced Accounting 15e

10.

A Amie, Inc. fair value at July 1, 2024:

11.

12.

13.

30% previously owned fair value (30,000 shares × $5) ................... 60% new shares acquired (60,000 shares × $6)................................ 10% NCI fair value (10,000 shares × $5) ............................................ Acquisition-date fair value ................................................................. Net assets' fair value .......................................................................... Goodwill ..............................................................................................

$150,000 360,000 50,000 $560,000 500,000 $60,000

Fair value of 30% noncontrolling interest on April 1........................ 30% of net income for remainder of year ($240,000 × 30%)............. Noncontrolling interest December 31 ...............................................

$165,000 72,000 $237,000

C Proceeds of $80,000 less $64,000 (⅓ × $192,000) book value = $16,000 Control is maintained so excess proceeds go to APIC.

14.

(20 minutes) (Noncontrolling interest and trademark consolidated balance)

a. Combined 2024 revenues................................................................... $1,300,000 Combined 2024 expenses .................................................................. (800,000) Trademark amortization ..................................................................... (6,000) Patented technology amortization..................................................... (8,000) Consolidated net income .................................................................. $ 486,000

2024 K-Tech net income ($100,000 – $14,000 excess amortizations) Noncontrolling interest percentage................................................... Net income attributable to noncontrolling interest ..........................

86,000 40% $34,400

Acquisition-date (1/1/23) noncontrolling interest fair value............. 40% of 2023 $30,000 K-Tech net income .......................................... 40% of 2023 excess fair value amortization...................................... 2024 net income attributable to NCI (above)..................................... Noncontrolling interest at end of 2024..............................................

$200,000 12,000 (5,600) 34,400 $240,800

French trademark balance ................................................................. K-Tech trademark balance ................................................................. Acquisition-date fair value allocation................................................ Excess fair value amortization for two years.................................... Consolidated trademarks...................................................................

$260,000 200,000 60,000 (12,000) $508,000

Chapter 04 – Consolidated Financial Statements and Outside Ownership – Hoyle, Schaefer, Doupnik, Advanced Accounting 15e

15.

(20 minutes) (Various consolidated balances with a noncontrolling interest)

a. Acquisition-date fair value ($60,000 ÷ 80%) ...................................... Strand's book value ........................................................................... Fair value in excess of book value ...................................................

$75,000 (50,000) $25,000

Excess assigned to inventory (60%) ................................................ Excess assigned to goodwill (40%) .................................................. Park current assets ............................................................................ Strand current assets......................................................................... Excess inventory fair value................................................................ Consolidated current assets..............................................................

$15,000 $10,000 $70,000 20,000 15,000 $105,000

Park noncurrent assets ...................................................................... Strand noncurrent assets .................................................................. Excess fair value to goodwill ............................................................. Consolidated noncurrent assets .......................................................

$90,000 40,000 10,000 $140,000

Park current liabilities ........................................................................ Strand current liabilities..................................................................... Current portion of long-term debt (10%) ........................................... Consolidated current assets..............................................................

$30,000 10,000 (6,000) $34,000

Park noncurrent liabilities.................................................................. Strand noncurrent liabilities .............................................................. Noncurrent portion of long-term debt (90%)..................................... Consolidated current assets..............................................................

$50,000 -054,000 $104,000

Park stockholders' equity .................................................................. Noncontrolling interest at fair value (20% × $75,000)....................... Total stockholders' equity..................................................................

$80,000 15,000 $95,000

16.

(15 minutes) (Compute four elements of noncontrolling interest)

a. Acquisition-date fair value of noncontrolling interest (NCI) ................. $428,000

b. Consolidated net income to NCI: Spring net income Excess amortization licensing agreements ($180,000 ÷ 4 years) Adjusted subsidiary net income Noncontrolling interest percentage Consolidated net income to NCI

172,000 (45,000) 127,000 20% 25,400

c. Dividend allocation to NCI (20% × $50,000)

(10,000)

Chapter 04 – Consolidated Financial Statements and Outside Ownership – Hoyle, Schaefer, Doupnik, Advanced Accounting 15e

d. NCI in Spring 12/31/24

$443,400

16. (Continued) Alternative calculations: NCI share of Spring 1/1/24 book value (20% × $1,700,000) NCI share of acquisition-date fair value allocations: To trademark (20% × $245,000) $49,000 To licensing agreements (20% × $180,000) 36,000 To goodwill (20% × $15,000) 3,000

$340,000

Acquisition-date fair value of Spring NCI..........................................

$428,000

Consolidated net income to NCI........................................................

25,400

Dividend allocation to NCI (20% × $50,000) ......................................

(10,000)

NCI in Spring 12/31/24 ........................................................................

$443,400

$ 88,000

a. b. c. d. 17.

(15 minutes) (Compute consolidated net income and noncontrolling interest)

a. Harrison net income Starr net income Acquisition-date excess fair value amortization Consolidated net income

2023 $220,000 70,000 (8,000) $282,000

2024 $260,000 90,000 (8,000) $342,000

b. Starr fair value .................................................................................... $1,200,000 Fair value of consideration transferred............................................. 1,125,000 Noncontrolling interest fair value ...................................................... $ 75,000 Noncontrolling interest fair value January 1, 2023 (above) ............. 2023 income to NCI ([$70,000 – $8,000] × 10%) ................................ 2023 dividends to NCI ........................................................................ Noncontrolling interest reported value December 31, 2023....... 2024 net income attributable to NCI ([$90,000 – $8,000] × 10%)8,200 2024 dividends to NCI ........................................................................ Noncontrolling interest in Starr at December 31, 2024 .............. 18.

$75,000 6,200 (3,000) 78,200 (3,000) $83,400

(30 minutes) (Consolidated balances, allocation of consolidated net income to controlling and noncontrolling interest, calculation of noncontrolling interest).

a. Stayer’s building:

Carrying amount on Stayer‘s books Excess acquisition-date fair value allocation ($345,000 – $195,000) 2024 excess fair value depreciation ($150,000 ÷ 10 years) Building, net

$175,500 150,000 (15,000) $310,500

Chapter 04 – Consolidated Financial Statements and Outside Ownership – Hoyle, Schaefer, Doupnik, Advanced Accounting 15e

b. Stayer’s technology processes: Acquisition-date fair value (20 year remaining life) 2024 amortization Technology processes 12/31/24

$1,000,000 (50,000) $ 950,000

c. Net income attributable to noncontrolling interest: Stayer‘s reported net income Excess fair value amortization: Technology processes Building ($345,000 – $195,000) ÷ 10 years Stayer‘s adjusted net income Noncontrolling interest percentage Net income attributable to noncontrolling interest

350,000 (50,000) (15,000) 285,000 20% $57,000

d. Controlling interest in consolidated net income: Net income–Johnsonville Net income–Stayer adjusted for excess fair value amortization (see part d below) Consolidated net income Less: net income attributable to noncontrolling interest (see part c above) Net income attributable to Johnsonville Co.

$650,000 285,000 935,000 (57,000) $878,000

-ORJohnsonville‘s separate net income Stayer‘s reported net income Excess fair value amortization: Technology processes Building ($345,000 – $195,000) ÷ 10 years Stayer‘s adjusted net income Johnsonville‘s ownership percentage Net income attributable to Johnsonville Co.

$650,000 350,000 (50,000) (15,000) 285,000 80%

228,000 $878,000

18. (continued)

e. Noncontrolling interest in Stayer: Acquisition-date balance 1/1/24 Total Stayer fair value ($3,000,000 ÷ 80%) $3,750,000 Noncontrolling interest percentage 20% Noncontrolling interest acquisition-date fair value $ 750,000 Net income attributable to noncontrolling interest 57,000 Noncontrolling interest share of Stayer dividends (20% × $50,000) (10,000) Noncontrolling interest in Stayer 12/31/24 $ 797,000 19.

(40 minutes) (Several valuation and income determination questions for a consolidated entity involving a noncontrolling interest.)

a. Business combinations generally are measured at the fair value of the consideration transferred by the acquiring firm plus the acquisition-date fair value of the noncontrolling interest. 4-9 © McGraw Hill LLC. All rights reserved. No reproduction or distribution without the prior written consent of McGraw Hill LLC.

Chapter 04 – Consolidated Financial Statements and Outside Ownership – Hoyle, Schaefer, Doupnik, Advanced Accounting 15e

Patterson‘s consideration transferred ($31.25 × 80,000 shares) ..... $2,500,000 Noncontrolling interest fair value ($30.00 × 20,000 shares)............. 600,000 Soriano‘s total fair value January 1................................................... $3,100,000

b. Each identifiable asset acquired and liability assumed in a business combination is initially reported at its acquisition-date fair value.

c. In periods subsequent to acquisition, the subsidiary‘s assets and liabilities are reported at their book values adjusted for acquisition-date fair value allocations and for subsequent amortization and depreciation on those allocations. Except for certain financial items, the subsidiary‘s assets and liabilities are not continually adjusted for changing fair values.

Soriano‘s total fair value January 1................................................... $3,100,000 Soriano‘s net assets book value ....................................................... 1,290,000 Excess acquisition-date fair value over book value......................... $1,810,000 Adjustments from book to fair values............................................... Buildings and equipment ....................................... (250,000) Trademarks ............................................................. 200,000 Patented technology..................................................... 1,060,000 Unpatented technology .......................................... 600,000 1,610,000 Goodwill .............................................................................................. $200,000

e. Combined revenues ........................................................................... $4,400,000 Combined expenses........................................................................... (2,350,000) Building and equipment excess depreciation .................................. 50,000 Trademark excess amortization ........................................................ (20,000) Patented technology amortization..................................................... (265,000) Unpatented technology amortization ................................................ (200,000) Consolidated net income ................................................................... $1,615,000 19. (continued) To noncontrolling interest: Soriano‘s revenues....................................................................... $1,400,000 Soriano‘s expenses ...................................................................... (600,000) Total excess amortization expenses (above).............................. (435,000) Soriano‘s adjusted net income .................................................... $ 365,000 Noncontrolling interest percentage ownership .......................... 20% Net income attributable to noncontrolling interest..................... $ 73,000 To controlling interest: Consolidated net income ............................................................. $1,615,000 Net income attributable to noncontrolling interest..................... (73,000) Net income attributable to Patterson........................................... $1,542,000 -ORPatterson‘s revenues ............................................................................... $3,000,000

Chapter 04 – Consolidated Financial Statements and Outside Ownership – Hoyle, Schaefer, Doupnik, Advanced Accounting 15e

Patterson‘s expenses ................................................................................ 1,750,000 Patterson‘s separate net income .......................................................... $1,250,000 Patterson‘s share of Soriano‘s adjusted net income (80% × $365,000)................................................................ 292,000 Consolidated net income attributable to Patterson.................... $1,542,000

f. Fair value of noncontrolling interest January 1................................ Net income attributable to noncontrolling interest .......................... Dividends (20% × $30,000) ................................................................. Noncontrolling interest December 31 ...............................................

$ 600,000 73,000 (6,000) $ 667,000

g. If Soriano‘s acquisition-date total fair value was $2,250,000, then a bargain purchase has occurred. Collective fair values of Soriano‘s net assets .......................................... $2,900,000 Soriano‘s total fair value January 1 ............................................................ $2,250,000 Bargain purchase ................................................................................... $ 650,000 The acquisition method requires that the subsidiary assets acquired and liabilities assumed be recognized at their acquisition date fair values regardless of the assessed fair value. Therefore, none of Soriano‘s identifiable assets and liabilities would change as a result of the assessed fair value. When a bargain purchase occurs, however, no goodwill is recognized. 20.

(30 minutes) Step acquisition.

Chapter 04 – Consolidated Financial Statements and Outside Ownership – Hoyle, Schaefer, Doupnik, Advanced Accounting 15e

21.

(20 Minutes) (Determine consolidated income balances, includes a mid-year acquisition)

a. Acquisition-date total fair value ................................. Book value of net assets ............................................. Fair value in excess of book value ............................. Excess fair value assigned to specific accounts based on fair value Patent Land Buildings Goodwill Total

$594,000 (400,000) $194,000

Remaining life 140,000 5 years 10,000 30,000 10 years 14,000 -0$31,000

Consolidated figures following January 1 acquisition date: Combined revenues .................................................................................... Combined expenses .................................................................................... Consolidated net income............................................................................. Net income to noncontrolling interest ([200,000 – 31,000] × 30%)............ Net income attributable to Parker, Inc. .......................................................

Annual excess amortizations $28,000 3,000

$1,500,000 (1,031,000) 469,000 (50,700) $ 418,300

Chapter 04 – Consolidated Financial Statements and Outside Ownership – Hoyle, Schaefer, Doupnik, Advanced Accounting 15e

b. Consolidated figures following April 1 acquisition date: Combined revenues (1) .................................................................................... $1,350,000 Combined expenses (2) ............................................................................... (923,250) Consolidated net income ............................................................................ $ 426,750 Net income attributable to noncontrolling interest (3)............................... (38,025) Net income attributable to Parker, Inc ........................................................ $ 388,725 (1) $900,000 Parker revenues plus $450,000 of post-acquisition Sawyer revenues (2) $600,000 Parker expenses plus $300,000 of post-acquisition Sawyer expenses plus $23,250 amortization expenses for 9 months (3) ($200,000 – 31,000) adjusted subsidiary net income × 30% × ¾ year 22.

(15 minutes) Consolidated figures with noncontrolling interest Fair value of company (given)

$60,000

Book value Fair value in excess of book value to machine ($50,000 – $10,000) to process trade secret

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

÷ 10 = $4,000 per year ÷4 = 2,500 per year $6,500 per year

Consolidated figures: 

Net income attributable to noncontrolling interest = 40%  ($50,000 revenues less $26,500 expenses) = $9,400



End-of-year noncontrolling interest: Beginning balance (40%  $60,000) Net income allocation (from above) Dividend reduction (40%  $5,000) End-of-year noncontrolling interest

$24,000 9,400 (2,000) $31,400



Machine (net) = $45,000 ($9,000 book value plus $40,000 excess allocation less $4,000 excess depreciation for one year).



Process trade secret (net) = $10,000 – $2,500 = $7,500

Chapter 04 – Consolidated Financial Statements and Outside Ownership – Hoyle, Schaefer, Doupnik, Advanced Accounting 15e

23.

(40 minutes) (Worksheet preparation, parent uses equity method, 20% noncontrolling interest, no control premium, first year subsequent to acquisition).

Revenues Cost of goods sold Depreciation expense Amortization expense Equity in income of Stanford Net income

Plaza

Stanford

(1,400,000) 774,000 328,000 -0(280,000) (578,000)

(825,000) 395,750 36,250 28,000 -0(365,000)

Consolidation Entries

NCI

Consolid

(2,225 1,169 36 38

E 5,000 E 10,000 I 280,000

Consolidated net income NCI share of CNI Plaza share of CNI

(70,000)

Retained earnings 1/1 Net income Dividends declared Retained earnings 12/31

(1,275,000) (578,000) 300,000 (1,553,000)

(530,000) (365,000) 50,000 (845,000)

Current assets Investment in Stanford

860,000 1,140,000

432,250 -0-

Tradenames Property and equipment Patents Goodwill Total assets

240,000 1,030,000 -0-

360,000 253,750 104,000

3,270,000

1,150,000

62 1,318 23 23 3,700

(142,000) (300,000) (1,275,000)

(145,000) (120,000) (40,000)

(287 (300 (1,275

Accounts payable Common stock Additional paid-in capital Noncontrolling interest Retained earnings 12/31 Total liabilities and equities

S 530,000

(648 70 (578

D 40,000

10,000

1,292 D 40,000

A 23,000 A 40,000 A 140,000 A 232,000

S 552,000 I 280,000 A 348,000 E 5,000 E 10,000

S 120,000 S 40,000 S 138,000 A 87,000 (225,000)

(1,553,000) (845,000) (3,270,000) (1,150,000)

(1,275 (578 30 (1,553

1,460,000

(285 (1,553 (3,700

Chapter 04 – Consolidated Financial Statements and Outside Ownership – Hoyle, Schaefer, Doupnik, Advanced Accounting 15e

24.

(45 minutes) Noncontrolling interest in the presence of a control premium.

a. Goodwill allocation: Acquisition-date fair value Share of identifiable net assets ($324,000 + $18,000) Goodwill allocation

Parflex $344,000 307,800 $36,200

NCI $36,000 34,200 $1,800

b. Investment in Eagle Initial value Change in Eagle‘s RE ($341,000 – $174,000) × 90% Excess amortization (3 years × $2,000) × 90% Investment in Eagle 12/31/24

$344,000 150,300 (5,400) $488,900

-ORInvestment in Eagle Initial value 2022-2023 change in Eagle‘s RE × 90% ($278,000 – $174,000) × 90% Excess fair value amortization Equity income 2024 (below) Eagle 2024 dividends × 90% Investment in Eagle 12/31/24 Equity in Eagle’s earnings: Eagles reported 2024 net income Excess equipment amortization Adjusted net income Parflex ownership share Equity in Eagle‘s earnings

$344,000 93,600 (3,600) 79,200 (24,300) $488,900 $90,000 (2,000) $88,000 90% $79,200

Chapter 04 – Consolidated Financial Statements and Outside Ownership – Hoyle, Schaefer, Doupnik, Advanced Accounting 15e

24. continued

c. December 31, 2024

Parflex

Eagle

Sales Cost of goods sold

(862,000) (366,000) 515,000 209,000

Depreciation expense Equity in Eagle's earnings Separate company net income

191,200 (79,200)

67,000 0

(235,000)

(90,000)

Adjustments

NCI

(1,228,0 724, E I

2,000 79,200

260,

Consolidated net income to noncontrolling interest to Parflex Corporation

(8,800)

Retained earnings, 1/1 Net income (above) Dividends declared Retained earnings, 12/31

(500,000) (278,000) (235,000) (90,000) 130,000 27,000 (605,000) (341,000)

Cash and receivables Inventory Investment in Eagle

135,000 255,000 488,900

82,000 136,000 0

Property & equipment (net) Goodwill Total assets

964,000

328,000 A1 A2 546,000

Liabilities Common stock NCI 1/1

1,842,900

(722,900) (55,000) (515,000) (150,000)

Retained earnings, 12/31 Total liabilities and equities

S 278,000 24,300

2,700

(605,000) (341,000) (1,842,900) (546,000)

(243,8 8, (235,0

(500,0 (235,0 130, (605,0

217, 391, D

24,300 385,200 S 12,600 A1 36,200 A2 79,200 I 14,000 2,000 E 38,000

1,304, 38, 1,950,

(777,9 (515,0

S 150,000 42,800 S 1,400 A1 1,800 A2 (46,000) (52,100)

NCI 12/31

Consolida

585,500 585,500

(52,1

(605,0 (1,950,0

Chapter 04 – Consolidated Financial Statements and Outside Ownership – Hoyle, Schaefer, Doupnik, Advanced Accounting 15e

25.

(45 minutes) Noncontrolling interest in the presence of a control premium.

a. Consideration transferred by Holland ($8.00 × 60,000 shares) $480,000 Fair value of the noncontrolling interest ($6.50 × 40,000 shares)260,000 Total Zeeland fair value at January 1, 2023 $740,000 Zeeland book value at January 1, 2023 260,000 Excess acquisition-date fair over book value $480,000 To equipment (5-year remaining life) $ 55,000 To patent (10-year remaining life) 285,000 340,000 Goodwill $140,000 Goodwill allocation: Acquisition-date fair value Share (60% and 40%) of identifiable net assets* Goodwill allocation

Holland $480,000 360,000 $120,000

NCI $260,000 240,000 $ 20,000

*Zeeland identifiable net assets at acquisition-date fair value: Current assets $ 14,000 Property and equipment ($268,000 + $55,000) 323,000 Patents ($190,000 + $285,000) 475,000 Liabilities (212,000) Total fair value of net identifiable assets $600,000

b. Investment in Zeeland Initial value Change in Zeeland‘s RE × 60% ($376,500 – $160,000) × 60% Excess amortization ($39,500 × 60% × 2 yrs.) Investment in Zeeland 12/31/24

$480,000 129,900 (47,400) $562,500

-ORInvestment in Zeeland Initial value 2023 change in Zeeland‘s RE × 60% ($296,500 – $160,000) × 60% 2023 excess amortization ($39,500 × 60%) Investment in Zeeland 12/31/23 Equity income 2024 (below) Zeeland 2024 dividends × 60% Investment in Zeeland 12/31/24 Equity in Zeeland’s earnings: Zeelands reported 2024 net income Excess fair value amortizations Adjusted net income Holland ownership share Equity in Zeeland‘s earnings

$480,000 81,900 (23,700) $538,200 42,300 (18,000) $562,500 $110,000 (39,500) $70,500 60% $42,300

Chapter 04 – Consolidated Financial Statements and Outside Ownership – Hoyle, Schaefer, Doupnik, Advanced Accounting 15e

25. continued

c. December 31, 2024

Holland) (640,500) 325,000 80,000 14,000 52,000 (42,300) (211,800)

Sales Cost of goods sold Depreciation expense Amortization expense Other operating expenses Equity income Separate company net income

Zeeland (428,500) 200,000 34,000 21,000 63,500

Consolidation Entries

E 11,000 E 28,500 0

I 42,300

(28,200)

Retained earnings, 1/1 Net income (above) Dividends declared Retained earnings, 12/31

(820,200) (211,800) 50,000 (982,000)

(296,500) (110,000) 30,000 (376,500)

Current assets Investment in Zeeland, Inc

125,000 562,500

81,500 0

Property and equipment (net) Patents Goodwill Total assets

837,000 149,000 0 1,673,500

259,000 147,500

Liabilities Common stock

(371,500) (320,000)

(11,500) (100,000)

S 296,500 D 18,000

12,000

(240,000) 28,200 (211,800) (820,200) (211,800) 50,000 (982,000) 206,500

D 18,000

A1 44,000 A1 256,500 A2 140,000

S 237,900 A1 180,300 A2 120,000 I 42,300 E 11,000 E 28,500

1,129,000 524,500 140,000 2,000,000

488,000

(383,000) (320,000)

S 100,000 S 158,600 A1 120,200 A2 20,000

(982,000) (1,673,500)

Consolidated (1,069,000) 525,000 125,000 63,500 115,500 0

(110,000)

Consolidated net income Noncontrolling interest in CNI Controlling interest net income

Noncontrolling interest Retained earnings, 12/31 Total liabilities and equities

NCI

(376,500) (488,000)

936,800

(298,800)

936,800

(315,000) (982,000) (2,000,000)

Consolidated net income attributable to noncontrolling interest: 2024 Zeeland net income Less: excess depreciation excess amortization Adjusted net income NCI percentage ownership CNI attributable to NCI

26.

$110,000 (11,000) (28,500) $ 70,500 40% $ 28,200

(25 Minutes) (Determine consolidated balances for a step acquisition).

a. Amsterdam fair value implied by price paid by Morey $560,000 ÷ 70% =

$800,000

b. Revaluation gain:

Chapter 04 – Consolidated Financial Statements and Outside Ownership – Hoyle, Schaefer, Doupnik, Advanced Accounting 15e

1/1 equity investment in Amsterdam (book value) 25% net income for 1st 6 months Investment book value at 6/30 Fair value of investment at 6/30 (25% × $800,000) Gain on revaluation to fair value

$178,000 8,750 186,750 200,000 $ 13,250

Goodwill at 12/31: Fair value of Amsterdam at 6/30 Book value at 6/30 (700,000 + [70,000 ÷ 2]) Excess fair value Allocation to goodwill (no impairment)

$800,000 735,000 $ 65,000 $ 65,000

Noncontrolling interest: 5% fair value balance at 6/30 5% subsidiary net income from 6/30 to 12/31 5% subsidiary dividends Noncontrolling interest 12/31

$40,000 1,750 (1,000) $40,750

27.

(30 Minutes) (Reporting the sale of a portion of an investment in a subsidiary.)

a. Posada records an accrual of $7,950 (see computation below) as "Equity Income from Sold Shares of Sabathia" for the January 1, 2024 to October 1, 2024 period which will appear in the 2024 consolidated income statement. The consolidation will continue to include all of Sabathia's accounts but now recognizing a 40% noncontrolling interest. Sabathia fair value 1/1/22 .......................................................... Sabathia book value 1/1/22 ........................................................ Patent ......................................................................................... Remaining life of patent ............................................................ Annual amortization ..................................................................

$1,200,000 (1,130,000) $70,000 5 years $ 14,000

Posada’s share of Sabathia’s net income accruing to shares sold: Sabathia's net income ................................................................ $120,000 Excess patent fair value amortization ....................................... (14,000) Sabathia's adjusted net income................................................. 106,000 Fraction of year held .................................................................. 9/12 Sabathia‘s adjusted net income for 9 months .......................... 79,500 Percentage owned by Posada ................................................... 70% Posada‘s share of Sabathia‘s 9 month net income ................. 55,650 Shares sold—1,000 out of 7,000 ............................................... 1/7 Posada‘s income for shares sold ............................................. $ 7,950

b. As long as control is maintained, the acquisition method considers transactions in the stock of a subsidiary, whether purchases or sales, as transactions in the equity of the consolidated entity. Posada’s investment book value 10/1/24 1/1/24 balance (given—equity method) .....................................

$1,085,000

Chapter 04 – Consolidated Financial Statements and Outside Ownership – Hoyle, Schaefer, Doupnik, Advanced Accounting 15e

Recognition of 1/1/24–10/1/24 period: Income accrual ($120,000 × 70% × ¾).................................. Dividends ($40,000 × 70% × ¾) ........................................... Amortization ($14,000 × 70% × ¾) ....................................... Pre-sale investment book value—10/1/24 .................................

63,000 (21,000) (7,350) $1,119,650

Computation of income effect—sale transaction 10/1/24 book value (above) ........................................................ Portion of investment sold (1,000/7,000 shares) ...................... Book value of investment sold ................................................. Proceeds .................................................................................... Credit to Posada‘s additional paid-in capital ...........................

$1,119,650 1/7 $ 159,950 191,000 $ 31,050

c. Because Posada continues to hold 6,000 shares of Sabathia, control is still maintained and consolidated financial statements would be appropriate with a noncontrolling interest of 40 percent. 28.

(35 Minutes) (Consolidation entries and the effect of different investment methods)

a. From the original fair value allocation, $30,000 is assigned based on the fair value of the patent. With a 5-year remaining life, excess amortization will be $6,000 per year. Because the equity method is in use, no Entry *C is required. Entry S Common stock (Bandmor) .................................... 300,000 Retained earnings, 1/1/24 (Bandmor) ................... 268,000 Investment in Bandmor (70%) ........................... 397,600 Noncontrolling interest in Bandmor, 1/1/24 ...... 170,400 (To eliminate stockholders' equity accounts of subsidiary and recognize outside ownership. Retained earnings figure includes 2022 and 2023 net income and dividends.) Entry A Patent ...................................................................... 18,000 Goodwill .................................................................. 190,000 Investment in Bandmor ..................................... 145,600 Noncontrolling interest in Bandmor (30%).......... 62,400 (To recognize unamortized portions of acquisition-date fair value allocations. No control premium, so goodwill is allocated proportionately. Patent has undergone two years amortization) Entry I Equity in Bandmor earnings ................................. 72,800 Investment in Bandmor ................................... 72,800 (To eliminate intra-entity income balance. Equity accrual of $72,800 [70% × ($110,000 – 6,000 amortization)] has been recorded) Entry D Investment in Bandmor .........................................

42,000

Chapter 04 – Consolidated Financial Statements and Outside Ownership – Hoyle, Schaefer, Doupnik, Advanced Accounting 15e

Dividends declared .......................................... 42,000 (To eliminate current intra-entity dividend transfers—70% of $60,000) Entry E Amortization expense............................................. Patent................................................................. (To recognize amortization for current year)

6,000 6,000

Entry P Accounts payable .................................................. Accounts receivable ........................................ (To eliminate intra-entity payable/receivable balance)

22,000 22,000

28. (continued)

b. If the initial value method had been applied, the parent would have recorded only the subsidiary dividends declared as income rather than an equity accrual. Therefore, Entry *C is needed to adjust the parent's beginning retained earnings for 2024 to the equity method. During 2022 and 2023, the subsidiary reported a total net income of $171,000 but declared dividends of only $83,000. The parent's share of the difference is $61,600 (70% of $88,000 [$171,000 - $83,000]). In addition, the parent‘s 70% share of excess amortization expense for two years must also be included ($8,400 = 2 years × $6,000 per year × 70%). The net amount to be recognized is $53,200 ($61,600 - $8,400). ENTRY *C Investment in Bandmor ......................................... Retained earnings, 1/1/24 ................................

53,200 53,200

c. If the partial equity method had been applied, only the excess amortization expenses for the previous two years would have been omitted from the parent's retained earnings. As shown above, that figure is $8,400 (2 years × $6,000 per year × 70%). ENTRY *C Retained earnings, 1/1/24 ...................................... Investment in Bandmor ...................................

8,400 8,400

d. Net income attributable to noncontrolling interest—2024 [($110,000 – 6,000) × 30%] .....................................

$31,200

Noncontrolling interest (NCI) fair value January 1, 2022 ......... Adjustments to original basis: 2022 NI to noncontrolling interest ...................... $20,700 Dividends to NCI.......................................... (11,700) 2023 2024

NI to noncontrolling interest ...................... Dividends to NCI..........................................

$27,000 (13,200)

Net income to noncontrolling interest ......

$31,200

$210,000

9,000 13,800

Chapter 04 – Consolidated Financial Statements and Outside Ownership – Hoyle, Schaefer, Doupnik, Advanced Accounting 15e

Dividends to NCI.......................................... Noncontrolling interest in Bandmor 12/31/24 .............

(18,000)

13,200 $246,000

–OR– Worksheet adjustment S ............................................................ Worksheet adjustment A............................................................ 2024 net income attributable to noncontrolling interest.......... 2024 dividends to noncontrolling interest ............................... Noncontrolling interest in Bandmor 12/31/24 ........................... 29.

$170,400 62,400 31,200 (18,000) $246,000

(45 Minutes) (Asks about several consolidated balances and consolidation process. Includes the different accounting methods to record investment.)

a. Schedule 1—Fair Value Allocation and Excess Amortizations Consideration transferred by Miller ............... Noncontrolling interest fair value ................... Taylor‘s fair value ............................................ Taylor‘s book value ......................................... Fair value in excess of book value ................ Excess fair value assigned to specific accounts based on fair value Excess fair value assigned to buildings

Goodwill

$664,000 166,000 $830,000 (600,000) 230,000

Remainin life 80,000 20 years

Annual excess amortizations $4,000

$150,000 indefinite

-0-

Total

$4,000

b. $150,000 (see schedule 1 above) c. Entry (S) Common stock (Taylor)............................................. Additional paid-in capital (Taylor) ............................ Retained earnings (Taylor)........................................

300,000 90,000 210,000

Investment in Taylor Company (80%) ................................. Noncontrolling interest in Taylor (20%) ..............................

480,000 120,000

Entry (A)—no control premium Buildings ................................................................... Goodwill .................................................................... Investment in Taylor Company (80%) ................ Noncontrolling interest in Taylor (20%) .............

80,000 150,000 184,000 46,000

d. (1) Equity method

Chapter 04 – Consolidated Financial Statements and Outside Ownership – Hoyle, Schaefer, Doupnik, Advanced Accounting 15e

Income accrual (80%) ......................................... Excess amortization expense ............................ Investment income ........................................

$56,000 (3,200) $52,800

(2) Partial equity method Income accrual (80%) .........................................

$56,000

(3) Initial value method Dividends received (80%) ...................................

$8,000

29. (continued)

e. (1) Equity method Initial fair value paid ............................................ $664,000 Income accrual 2022–2024 ($260,000 × 80%) 208,000 Dividends 2022–2024 ($45,000 × 80%) ............... (36,000) Excess amortizations 2022–2024 ($3,200 × 3) (9,600) Investment in Taylor—12/31/24 .......................... $826,400

(2) Partial Equity Method Investment in Taylor—12/31/24 = $836,000 (initial value paid plus income accrual of $208,000 less dividends of $36,000 [no excess amortizations])

(3) Initial Value Method Investment in Taylor—12/31/24 = $664,000 (original value paid)

f. Using the acquisition method, the allocation will be the total difference ($80,000) between the buildings' book value and fair value. Based on a 20 year remaining life, annual excess amortization is $4,000. Miller book value—buildings .................................................... Taylor book value—buildings ................................................... Allocation ................................................................................... Excess amortizations for 2022–2023 ($4,000 × 2 years) .......... Consolidated buildings account .........................................

$ 800,000 300,000 80,000 (8,000) $1,172,000

g. Acquisition-date fair value allocated to goodwill (see schedule 1 above) ........................................................

$150,000

h. If the parent has been applying the equity method, the stockholders' equity accounts on its books will already represent consolidated totals. The common stock and additional paid-in capital figures to be reported are the parent balances only. As to retained earnings, the equity method will properly record all subsidiary net income and amortization so that the parent balance is also a 4-23 © McGraw Hill LLC. All rights reserved. No reproduction or distribution without the prior written consent of McGraw Hill LLC.

Chapter 04 – Consolidated Financial Statements and Outside Ownership – Hoyle, Schaefer, Doupnik, Advanced Accounting 15e

reflection of the consolidated total. 30.

(20 Minutes) (A variety of consolidated balances-midyear acquisition) Consideration transferred by Karson (cash and contingent consideration) ........................................ Noncontrolling interest fair value ................................................... Reilly‘ fair value (given) ................................................................... Book value of Reilly ......................................................................... Fair value in excess of book value ..................................................

Excess fair value assigned to specific accounts based on fair value Trademarks Goodwill Total

Remaining. life

$1,360,000 340,000 $1,700,000 (1,450,000)* $250,000 Annual excess amortizations

150,000 5 years $100,000 indefinite

*Reilly book value, January 1 (Common stock + APIC + RE) ................................................... Increase in book value: Net income (revenues less cost of goods sold and expenses) .................................$120,000 Dividends ............................................................. (20,000) Change during year ..................................................$100,000 Change during first 6 months of year.................................. Reilly book value, July 1 (acquisition date) .................................... CONSOLIDATION TOTALS:  Sales (1)

$30,000 -0$30,000

$1,400,000

50,000 $1,450,000 $1,050,000



Cost of goods sold (2)

540,000



Operating expenses (3)

265,000



Consolidated net income

$245,000



Net income attributable to noncontrolling interest (4)

$ 9,000

(1) $800,000 Karson revenues plus $250,000 (post-acquisition subsidiary revenue) (2) $400,000 Karson COGS plus $140,000 (post-acquisition subsidiary COGS) (3) $200,000 Karson operating expenses plus $50,000 (post-acquisition subsidiary operating expenses) plus ½ year excess amortization of $15,000 (4) 20% of post-acquisition subsidiary net income less excess fair value amortization [20% × ½ year × (120,000 – 30,000)] = $9,000 

Retained earnings, 1/1 = $1,400,000 (the parent‘s balance because the subsidiary was acquired during the current year)



Trademarks = $935,000 (add the two book values and the excess fair value allocation after taking one-half year excess amortization)

Chapter 04 – Consolidated Financial Statements and Outside Ownership – Hoyle, Schaefer, Doupnik, Advanced Accounting 15e

 31.

Goodwill = $100,000 (the original allocation)

(25 Minutes) (A variety of consolidated questions and balances)

a. Nascent applies the initial value method because the original price of $414,000 is still in the Investment in Sea-Breeze account. In addition, the Investment Income account is equal to 60 percent of the dividends declared by the subsidiary during the year.

b. Consideration transferred in acquisition ................. Noncontrolling interest fair value ............................. Sea-Breeze fair value 1/1/21 ...................................... Sea-Breeze book value 1/1/21 ................................... Excess fair value over book value............................ Excess fair value assigned to specific accounts based on fair value Buildings Equipment Patent Total

60,000 (20,000) 100,000

$414,000 276,000 $690,000 550,000 $140,000

Remaining life

Annual excess amortizations

6 years 4 years 10 years -0-

$10,000 (5,000) 10,000 $15,000

c. If the equity method had been applied, the Investment Income account would show the basic equity accrual less amortization: 60% of (the subsidiary's net income of $90,000 less $15,000 excess fair value amortization) = $45,000.

d. The initial value method recognizes neither the increase in the subsidiary's book value nor the excess amortization expenses for prior years. At the acquisition date, the subsidiary‘s book value was $550,000 as indicated by the assets less liabilities. At the beginning of the current year, the book value of the subsidiary is $780,000 as indicated by beginning stockholders' equity balances. Increase in book value during prior years ($780,000 – $550,000)............................................................ Less excess amortization ......................................................... Net increase in book value......................................................... Ownership .................................................................................. Increase required in parent's retained earnings, 1/1/24 .......... Parent's retained earnings, 1/1/24 as reported ........................ Parent‘s share of consolidated retained earnings, 1/1/24........

$230,000 (45,000) $185,000 60% $111,000 700,000 $811,000

e. Consolidated net income and allocation     

Revenues (add book values) Expenses (add book values and excess amortization) Consolidated net Income Net income attributable to noncontrolling interest ($90,000 – 15,000) × 40% Net income attributable to Nascent, Inc.

$900,000 (635,000) $265,000 30,000 $235,000

Chapter 04 – Consolidated Financial Statements and Outside Ownership – Hoyle, Schaefer, Doupnik, Advanced Accounting 15e

31. (continued)

f. Consolidated buildings, 1/1/21 (subsidiary): Book value............................................................................. Acquisition-date fair-value allocation ................................. Consolidation figure ............................................................

$300,000 60,000 $360,000

g. Consolidated buildings, 12/31/24: Parent's book value ............................................................. Subsidiary's book value ...................................................... Original allocation ................................................................ Amortization ($10,000 × 4 years) ......................................... Consolidated balance ..........................................................

$700,000 200,000 60,000 (40,000) $920,000

Chapter 04 – Consolidated Financial Statements and Outside Ownership – Hoyle, Schaefer, Doupnik, Advanced Accounting 15e

32.

(45 minutes) (Acquisition Method Consolidated Balances)

a. Consolidation Entries December 31, 2024 Revenues Cost of goods sold Depreciation expense Amortization expense Interest expense Equity in Stein Income Separate company net income

Perlman (1,843,000) 1,100,000 125,000 275,000 27,500 (121,500)

Stein (675,000) 322,000 120,000 11,000 7,000

(437,000)

(215,000)

NCI

(E) 80,000 (I)121,500

Consolidated net income To noncontrolling interest To Perlman Company

(13,500)

Retained Earnings 1/1 Net Income Dividends declared Retained Earnings 12/31

(2,625,000) (437,000) 350,000 (2,712,000)

(395,000) (215,000) 25,000 (585,000)

Current Assets Investment in Stein

1,204,000 1,854,000

430,000

Software Buildings and Equipment Copyrights Goodwill Total Assets Accounts Payable Notes Payable NCI in Stein

Common Stock Additional Paid-In Capital Retained Earnings 12/31 Total Liab. and SE

-0931,000 950,000

(S)395,000 (D) 22,500

(450,500) (13,500) (437,000) (2,625,000) (437,000) 350,000 (2,712,000) 1,634,000

(D) 22,500

-0863,000 107,000

2,500

Consolidated (2,518,000) 1,422,000 245,000 366,000 34,500 -0-

(A)720,000

(S)769,500 (A)985,500 (I) 121,500 (E) 80,000

-0-

4,939,000

1,400,000

640,000 1,794,000 1,057,000 375,000 5,500,000

(485,000) (542,000)

(200,000) (155,000)

(685,000) (697,000)

(A)375,000

(S) 85,500 (A)109,500 (900,000) (300,000) (2,712,000) (4,939,000)

(400,000) (60,000) (585,000) (1,400,000)

(S)400,000 (S) 60,000 2,174,000

2,174,000

(195,000) (206,000)

(206,000) (900,000) (300,000) (2,712,000) (5,500,000)

Chapter 04 – Consolidated Financial Statements and Outside Ownership – Hoyle, Schaefer, Doupnik, Advanced Accounting 15e

32. (continued)

Fair value at acquisition date Relative fair values of identifiable net assets 90% and 10% of $1,525,000 (acquisition date recorded fair value plus Software) Goodwill

Controlling Interest $1,710,000 1,372,500

Noncontrolling Interest $190,000 152,500

$337,500

$37,500

b. If the acquisition-date fair value of the noncontrolling interest was $167,500, both goodwill (NCI portion) and the noncontrolling interest balance would be reduced equally by $22,500 as follows: Fair value of Stein Company (1,710,000 + 167,500) $1,877,500 Carrying amount acquired 725,000 Excess fair value 1,152,500 to Software 800,000 to goodwill $352,500 Noncontrolling interest balance beginning of year* Net income attributable to noncontrolling interest Dividends declared to noncontrolling interest Noncontrolling interest end of year * NCI at beginning of year Common stock-subsidiary APIC-subsidiary Retained earnings-subsidiary 1/1 Total Noncontrolling interest percentage Noncontrolling share of subsidiary book value Noncontrolling share of 1/1 Software excess Noncontrolling share of goodwill (below) Noncontrolling interest 1/1

Fair value at acquisition date Relative fair values of identifiable net assets 90% and 10% of $1,525,000 (acquisition date recorded fair value plus Software) Goodwill 33.

$(172,500) (13,500) 2,500 $(183,500) $400,000 60,000 395,000 $855,000 10% 85,500 72,000 15,000 $172,500 Controlling Interest $1,710,000

Noncontrolling Interest $167,500

1,372,500 $ 337,500

152,500 $ 15,000

(60 Minutes) (Consolidation worksheet and income statement with parent using initial value method. Also consolidated balances with a control premium paid by parent.)

a. Fair Value Allocation and Amortization Consideration transferred by Holtz ................................ $576,000 Noncontrolling interest fair value ............................. 144,000

Chapter 04 – Consolidated Financial Statements and Outside Ownership – Hoyle, Schaefer, Doupnik, Advanced Accounting 15e

Devine total fair value 1/1/23........................................... $720,000 Devine book value 1/1/23 ................................................ (326,500) Fair value in excess of book value ................................. $393,500 Remaining life

Excess fair value assigned to specific accounts based on fair value: Building Trademark Goodwill

85,500 64,000 $244,000

Annual excess amortizations

5 years 10 years indefinite

$17,100 6,400 -0$23,500

Explanation of Consolidation Entries Found on Worksheet Entry *C: Convert the parent‘s 1/1/24 retained earnings balance from the initial value method to the equity method. Change in subsidiary RE from 1/1/23 to 1/1/24 ($296,500 – $226,500)................................................. $70,000 Excess amortization for 2023.......................................... 23,500 Adjusted subsidiary RE increase ......................................... $46,500 Percentage ownership by parent.................................... 80% *C conversion entry ............................................................... $37,200 Entry S: Eliminates stockholders' equity accounts of subsidiary while recognizing noncontrolling interest balance (20%) as of the beginning of the current year. Entry A: Recognizes acquisition-date fair value allocations less one year of amortization for building and trademark and increases beginning balance of the noncontrolling interest for its share. Entry I: Eliminates Intra-entity dividends declared by subsidiary and recorded as income by parent. Entry E: Recognizes amortization expense for current year. Columnar entry—Recognizes net income attributable to noncontrolling interest [($97,000 – $23,500) × 20%].

Chapter 04 – Consolidated Financial Statements and Outside Ownership – Hoyle, Schaefer, Doupnik, Advanced Accounting 15e

33. a. (continued) HOLTZ CORPORATION AND DEVINE, INC. Consolidation Worksheet For Year Ending December 31, 2024 Accounts

Holtz Corporation

Devine Inc.

4-30

Consolidation Entries Debit Credit

Noncontrollin g Interest

Consolidated Totals

Chapter 04 – Consolidated Financial Statements and Outside Ownership – Hoyle, Schaefer, Doupnik, Advanced Accounting 15e

Sales Cost of goods sold Operating expenses Dividend income Separate company net income Consolidated net income NI attributable to noncontrolling interest NI attributable to Holtz Corp.

(641,000) 198,000 273,000 (16,000) (186,000)

Retained earnings, 1/1 Net income (above) Dividends declared Retained earnings, 12/31

(762,000) (186,000) 70,000 (878,000)

(296,500) (97,000) 20,000 (373,500)

Current assets Investment in Devine

121,000 576,000

120,500 -0-

Buildings and equipment (net) Trademarks Goodwill Total assets

887,000 149,000 -01,733,000

335,000 236,000 -0691,500

Liabilities Common stock Retained earnings, 12/31 (above) NCI in Devine, 1/1

(535,000) (320,000) (878,000)

(218,000) (100,000) (373,500)

NCI in Devine, 12/31 Total liabilities and equities

(399,000) 176,000 126,000 -0(97,000)

(1,040,000) 374,000 422,500 -0-

(E) 23,500 (I) 16,000

(243,500) (14,700) (S) 296,500

(*C) 37,200 (I) 16,000

(*C) 37,200 (A) 68,400 (A) 57,600 (A)244,000

4,000

1,273,300 436,200 244,000 2,195,000 (753,000) (320,000) (958,000)

(S)100,000

(153,300) (164,000)

(691,500)

843,200

(799,200) (228,800) 70,000 (958,000) 241,500 -0-

(S)317,200 (A)296,000 (E) 17,100 (E) 6,400

(S) 79,300 (A) 74,000 (1,733,000)

14,700 (228,800)

843,200

(164,000) (2,195,000)

Chapter 04 – Consolidated Financial Statements and Outside Ownership – Hoyle, Schaefer, Doupnik, Advanced Accounting 15e

33. (continued) b. HOLTZ CORPORATION AND DEVINE, INC. Consolidated Income Statement For Year Ending December 31, 2024 Sales Cost of goods sold Operating expenses Total expenses Consolidated net income

$1,040,000 $374,000 422,500 796,500 $243,500

To 20% noncontrolling interest To Holtz Corporation

$ 14,700 $228,800

b. Consideration transferred by Holtz for 80% of Devine Noncontrolling interest fair value ($4.76 × 20,000 shares) Devine fair value Fair value of Devine‘s underlying net assets Goodwill

$576,000 95,200 $671,200 476,000 $195,200

If the noncontrolling interest fair value was $4.76 per share at the acquisition date, then goodwill declines to $195,200. The noncontrolling interest total would also decline from $164,000 to $115,200. Worksheet entries (S), (A1) and (A2) assuming a $4.76 noncontrolling interest acquisition-date fair value: (S)

(A1)

(A2)

Common stock-Devine Retained earnings- Devine 1/1 Investment in Devine Noncontrolling interest

100,000 296,500

Buildings and equipment (net) Trademarks Investment in Devine Noncontrolling interest

68,400 57,600

Goodwill Investment in Devine

195,200

317,200 79,300

100,800 25,200 195,200

Controlling Noncontrolling Interest Interest

4-32

Chapter 04 – Consolidated Financial Statements and Outside Ownership – Hoyle, Schaefer, Doupnik, Advanced Accounting 15e

Fair value at acquisition date Relative fair values of identifiable net assets 80% and 20% of $476,000 (acquisition date fair value of net identifiable assets) Goodwill 34.

$576,000

$95,200

380,800 $195,200

95,200 -0-

(40 Minutes) (Determine consolidated balances.) Acquisition-date subsidiary fair value (given)................. $1,003,400 Book value of subsidiary (given) ..................................... (690,000) Fair value in excess of book value .................................. $ 313,400 Allocations to specific accounts based on difference between fair value and book value Land ............................................................................. $225,000 Buildings and equipment ........................................... (24,000) Copyright ..................................................................... 94,000 Notes payable ............................................................. 18,400 313,400 Total .................................................................. -0Annual excess amortizations: Buildings and equipment [$(24,000) ÷ 10 years] Copyright ($94,000 ÷ 20 years) Notes payable ($18,400 ÷ 8 years) Total

$(2,400) 4,700 2,300 $4,600

Consolidated Totals: 

Revenues = $2,079,880 (add the two book values)



Cost of goods sold = $1,206,000 (add the two book values)



Depreciation expense = $283,200 (add the two book values less $2,400 excess adjustment)



Amortization expense = $10,800 (add the two book values plus $4,700 excess adjustment)



Interest expense = $63,600 (add the two book values plus $2,300 excess adjustment)



Equity in income of Sierra = -0- (eliminated so that the individual revenues and expenses of the subsidiary can be included in the consolidated figures)



Consolidated net income = $516,280 (revenues less expenses)



Net income attributable to noncontrolling interest = $44,280 ($226,000 reported subsidiary net income less $4,600 net excess amortization expense multiplied by 20 percent outside ownership)



Net income to Padre Company = $472,000 ($516,280 consolidated net income less noncontrolling interest share of $44,280)



Retained earnings, 1/1 = $1,275,000 (parent company balance only) 4-33

Chapter 04 – Consolidated Financial Statements and Outside Ownership – Hoyle, Schaefer, Doupnik, Advanced Accounting 15e



Dividends declared = $260,000 (parent company balance; subsidiary's declarations to parent are intra-entity, declarations to outside owners decrease noncontrolling interest balance)

34. (continued) 

Retained earnings, 12/31 = $1,487,000 (consolidated balance on 1/1 plus net income to Padre Co. less Padre‘s dividends declared) or simply the parent‘s RE because parent employs the equity method.



Current assets = $1,620,860 (add the two book values)



Investment in Sierra = -0- (eliminated so that the individual assets and liabilities of the subsidiary can be included in the consolidated figures)



Land = $650,000 (add the book values plus the $225,000 excess allocation)



Buildings and equipment (net) = $1,162,800 (add the book values less the $24,000 allocation [asset was overvalued] plus the excess amortization)



Total assets = $3,638,860



Accounts payable = $469,000 (add book values)



Notes payable = $700,900 (add the book values less $18,400 excess allocation plus amortization)



Noncontrolling interest in subsidiary = $231,960 (20% of fair value as of 1/1 [$200,680] plus net income attributable to noncontrolling interest [$44,280] less dividends declared to outside owners [$13,000])



Common stock = $300,000 (parent company balance)



Additional paid-in capital = 450,000 (parent company balance)



Retained earnings, 12/31 = $1,487,000 (computed above)



Total liabilities and equities = $3,638,860

34. (continued)

Chapter 04 – Consolidated Financial Statements and Outside Ownership – Hoyle, Schaefer, Doupnik, Advanced Accounting 15e Consolidation Entries Accounts

Padre

Sierra

Revenues Cost of goods sold Depreciation expense Amortization expense Interest expense Equity in income of Sierra Separate company net income Consolidated net income NI to noncontrolling interest NI to Padre Company Retained earnings 1/1 Net income (above) Dividends declared Retained earnings 12/31 Current assets Investment in Sierra

(1,394,980) 774,000 274,000 -052,100 (177,120) (472,000)

(1,275,000) (472,000) 260,000 (1,487,000) 856,160 927,840

(530,000) (226,000) 65,000 (691,000) 764,700

Land Buildings and equipment (net) Copyright Total assets Accounts payable Notes payable NCI in Sierra 1/1 NCI in Sierra 12/31

360,000 909,000 -03,053,000 (275,000) (541,000)

65,000 275,400 115,900 1,221,000 (194,000) (176,000)

Common stock Additional paid-in capital Retained earnings 12/31 (above) Total liab. and stockholders' equity

(684,900) 432,000 11,600 6,100 9,200 -0(226,000)

Debit

Credit

Noncontrolling Interest

(2,079,880) 1,206,000 283,200 10,800 63,600 -0-

(E) 2,400 (E) 4,700 (E) 2,300 (I) 177,120

(44,280)

(300,000) (450,000) (1,487,000) (3,053,000)

(S) 530,000 (D) 52,000 (D) 52,000

(100,000) (60,000) (691,000) (1,221,000)

(A) 225,000 (E) 2,400 (A) 94,000 (A) 18,400

13,000

(S) 552,000 (I) 177,120 (A) 250,720

(516,280) 44,280 (472,000) (1,275,000) (472,000) 260,000 (1,487,000) 1,620,860

-0650,000 1,162,800 205,200 3,638,860 (469,000) (700,900)

(A) 24,000 (E) 4,700 (E) 2,300 (S) 138,000 (A) 62,680

Consolidated Totals

(200,680) (231,960)

(S) 100,000 (S) 60,000 1,265,920

(231,960) (300,000) (450,000) (1,487,000) (3,638,860)

Chapter 04 – Consolidated Financial Statements and Outside Ownership – Hoyle, Schaefer, Doupnik, Advanced Accounting 15e

35.

(55 Minutes) (Consolidated worksheet)

Consideration transferred by Adams Noncontrolling interest fair value Acquisition-date total fair value Book value of Barstow (CS + RE 12/31/22) Excess fair value over book value Excess fair value assigned to specific accounts based on fair value Land Buildings Equipment Patents Notes payable

$603,000 67,000 $670,000 (460,000) 210,000 Remaining life

$30,000 (20,000) 40,000 50,000 20,000 120,000 $ 90,000

Goodwill Total

Annual excess amortizations

— 10 years 5 years 10 years 5 years

— ($2,000) 8,000 5,000 4,000

indefinite

-0$15,000

Because investment income is exactly 90 percent of Barstow's reported earnings, Adams apparently is applying the partial equity method.

Explanation of Consolidation Entries Found on Worksheet Entry *C—Converts Adams's financial records from the partial equity method to the equity method by recognizing amortization for 2023. Total expense was $15,000 but only 90 percent (or $13,500) applied to the parent. Entry S—Eliminates subsidiary's stockholders' equity while recording noncontrolling interest balance as of January 1, 2024. Entry A—Records unamortized allocation balances as of January 1, 2024. The acquisition method attributes 10 percent of these amounts to the noncontrolling interest. Entry I—Eliminates intra-entity income accrual for 2024. Entry D—Eliminates intra-entity dividend transfers. Entry E—Records amortization expense for current year. Columnar Entry—Recognizes noncontrolling interest's share of consolidated net income as follows: 4-36

Chapter 04 – Consolidated Financial Statements and Outside Ownership – Hoyle, Schaefer, Doupnik, Advanced Accounting 15e

Net income attributable to noncontrolling interest (Columnar Entry) Barstow reported net income ......................................................... Excess amortization expenses 2024 ............................................... Adjusted net income of Barstow .............................................. Noncontrolling interest ownership ................................................. Net income attributable to noncontrolling interest ..................

$120,000 (15,000) $105,000 10% $ 10,500

35. c. and d. (continued) ADAMS CORPORATION AND BARSTOW, INC. Consolidation Worksheet For Year Ending December 31, 2024 Adams Corp.

Barstow Inc.

Debit

Credit

Noncontrolling Interest

Consolidated Totals

Chapter 04 – Consolidated Financial Statements and Outside Ownership – Hoyle, Schaefer, Doupnik, Advanced Accounting 15e

Revenues Cost of goods sold Depreciation expense Amortization expense Interest expense Investment income Separate company net income Consolidated net income NI to noncontrolling interest NI to Adams Corporation

(940,000) 480,000 100,000

(280,000) 90,000 55,000

40,000 (108,000) (428,000)

15,000 -0(120,000)

(E) 6,000 (E) 5,000 (E) 4,000 (I) 108,000

(10,500)

Retained earnings, 1/1

(1,367,000)

(340,000)

Net income Dividends declared Retained earnings, 12/31

(428,000) 110,000 (1,685,000)

(120,000) 70,000 (390,000)

610,000 702,000

250,000

Current assets Investment in Barstow

(1,220,000) 570,000 161,000 5,000 59,000 -0-

(C*) 13,500 (S) 340,000

(1,353,500)

(D) 63,000

(425,000) 10,500 (414,500)

7,000

(414,500) 110,000 (1,658,000) 860,000 -0-

(*C) 13,500 (S) 468,000 (A) 175,500 (I) 108,000

Land Buildings Equipment Patents Goodwill Total assets

380,000 490,000 873,000 -0-03,055,000

150,000 250,000 150,000 -0-0800,000

(A) 30,000 (E) 2,000 (A) 32,000 (A) 45,000 (A) 90,000

Notes payable Common stock Retained earnings, 12/31

(860,000) (510,000) (1,685,000)

(230,000) (180,000) (390,000)

(A) 16,000 (S) 180,000

Total liabilities and stockholders' equity

(E) 4,000

(S) 52,000 (A) 19,500

Noncontrolling interest (3,055,000)

(800,000)

4-38

934,500

560,000 724,000 1,047,000 40,000 90,000 3,321,000

(A) 18,000 (E) 8,000 (E) 5,000

(1,078,000) (510,000) (1,658,000) (71,500) (75,000)

934,500

(75,000) (3,321,000)

Chapter 04 – Consolidated Financial Statements and Outside Ownership – Hoyle, Schaefer, Doupnik, Advanced Accounting 15e

36.

(25 minutes) (Consolidated balances after a mid-year acquisition)

a. Investment account balance indicates the initial value method. Consideration transferred by Gibson............... Noncontrolling interest fair value .................... Davis acquisition-date fair value ...................... Book value of Davis (see below)....................... Fair value in excess of book value .................. Excess fair value assigned to specific accounts based on fair value: Equipment (overvalued) Goodwill Total Amortization for 9 months

$528,000 352,000 880,000 (765,000) $115,000 Annual excess amortizations

Remaining life

(30,000) 5 years $145,000 indefinite

Acquisition-date subsidiary book value: Book value of Davis, 1/1/24 (CS + 1/1 RE) ................... Increase in book value-net income (dividends were declared after acquisition) ............................. Time prior to purchase (3 months) .............................. Book value of Davis, 4/1/24 (acquisition date) ............

$(6,000) -0$(6,000) $(4,500) $740,000 $100,000 × ¼ year

Consolidated income statement: Revenues (1) Cost of goods sold (2) $405,000 Operating expenses (3) 214,500 Consolidated net income Net income attributable to noncontrolling interest (4) Net income to Gibson Company

25,000 $765,000 $825,000 619,500 205,500 31,800 $173,700

(1) $900,000 combined revenues less $75,000 (preacquisition subsidiary revenue) (2) $440,000 combined COGS less $35,000 (preacquisition subsidiary COGS) (3) $234,000 combined operating expenses less $15,000 (preacquisition subsidiary operating expenses) less nine month excess overvalued equipment depreciation reduction of $4,500 (4) 40% of post-acquisition subsidiary net income plus excess amortization

b. Goodwill = $145,000 (original allocation) Equipment = $774,500 (add the two book values less $30,000 reduction to fair value plus $4,500 nine months excess amortization) Common stock = $630,000 (parent company balance only) Buildings = $1,124,000 (add the two book values) Dividends declared = $80,000 (parent company balance only) 37.

(45 minutes) Determine consolidated balance for a mid-year acquisition. 4-39 © McGraw Hill LLC. All rights reserved. No reproduction or distribution without the prior written consent of McGraw Hill LLC.

Chapter 04 – Consolidated Financial Statements and Outside Ownership – Hoyle, Schaefer, Doupnik, Advanced Accounting 15e

a. Consideration transferred by Truman ................ Noncontrolling interest fair value ....................... Atlanta‘s acquisition-date total fair value ........... Book value of Atlanta........................................... Fair value in excess of book value ...................... Excess fair value assigned to specific accounts based on fair value Patent Goodwill Total

$720,000 290,000 $1,010,000 840,000) $ 170,000 Remaining life

Annual exces amortizations

100,000 5 years $ 70,000 indefinite

$20,000 -0$20,000

Controlling Interest $720,000

Noncontrolling Interest $290,000

658,000 $ 62,000

282,000 $ 8,000

b. Goodwill allocation with control premium Fair values at acquisition date Relative fair values of identifiable net assets 70% and 30% of $940,000 (acquisition date book value plus patent = net asset fair value) Goodwill

c. Initial value at acquisition date

Truman‘s share of Atlanta‘s net income for half year ([$120,000 – 20,000 amortization × ½ year] × 70%) Dividends 2024 ($80,000 × ½ year × 70%) Investment account balance 12/31/24

$720,000 35,000 (28,000) $727,000

Chapter 04 – Consolidated Financial Statements and Outside Ownership – Hoyle, Schaefer, Doupnik, Advanced Accounting 15e

37. (continued)

d. Consolidated Worksheet TRUMAN COMPANY AND SUBSIDIARY ATLANTA COMPANY Consolidation Worksheet For Year Ending December 31, 2024

Truman

Atlanta

Revenues (670,000) Operating Expenses 402,000 Net income of subsidiary (35,000) Separate company net income (303,000) Consolidated net income Net income attributable to NCI Net income attributable to Truman

(400,000) 280,000

Retained earnings, 1/1 Net income (above) Dividends declared

(823,000) (303,000) 145,000

(500,000) (120,000) 80,000

Retained earnings 12/31

(981,000)

(540,000)

Current assets Investment in Atlanta

481,000 727,000

390,000

Land Buildings Patent Goodwill Total assets

388,000 701,000

200,000 630,000

Liabilities Common stock Additional paid-in capital Retained earnings 12/31 Noncontrolling interest 7/1

Noncontrolling interest 12/31 Total liab. and equity

Consolidation Entries

(S) 200,000 (E) 10,000 (I) 35,000

Cons. (870,000) 552,000 -0-

(S) 140,000

(120,000) (15,000)

(S) 500,000

(D) 28,000

2,297,000

1,220,000

(816,000) (95,000) (405,000) (981,000)

(360,000) (300,000) (20,000) (540,000)

12,000 145,000 (981,000) 871,000 -0-

(S) 588,000 (I) 35,000 (A1) 70,000 (A2) 62,000

588,000 1,331,000 90,000 70,000 2,950,000

(E) 10,000

(1,176,000) (95,000) (405,000) (981,000)

(S) 300,000 (S) 20,000 (A1) 30,000 (A2) 8,000 (S) 252,000

(1,220,000)

1,263,000

(318,000) 15,000 (303,000) (823,000) (303,000)

(S) 40,000 (D) 28,000

(A1)100,000 (A2) 70,000

(2,297,000)

NCI

(290,000) (293,000)

1,263,000

(293,000) (2,950,000)

Chapter 04 – Consolidated Financial Statements and Outside Ownership – Hoyle, Schaefer, Doupnik, Advanced Accounting 15e

38.

(60 minutes) (Consolidated statements for a step acquisition)

a. Fair value of Scout 1/1/24 (given) Book value of Scout 1/1/24 (CS + APIC + RE) Excess fair value over book value To database (4 year remaining life) To goodwill

$1,750,000 1,300,000 450,000 400,000 $ 50,000

Equity in earnings of Scout 2024 net income (150,000 × 95%) Amortization (100,000 × 95%) Equity in earnings of Scout

$142,500 (95,000) $ 47,500

Revaluation of 15% block to fair value Consideration transferred 2023 net income (100,000 × 15%) 2023 dividends (30,000 × 15%) Book value at 1/1/24 Fair value at 1/1/24 Gain on revaluation

$184,500 15,000 (4,500) 195,000 262,500 $ 67,500

Investment account balance Fair value at 1/1/24 (15% block) Consideration transferred 1/1/24 (80% block) Equity earnings 2024 Net income (95% × 150,000) Database amortization (95,000) Dividends (40,000 × 95%) Investment in Scout 12/31/24

$262,500 1,400,000 142,500 47,500 (38,000) $1,672,000

Chapter 04 – Consolidated Financial Statements and Outside Ownership – Hoyle, Schaefer, Doupnik, Advanced Accounting 15e

38. (Continued)

c. Payne and Scout Consolidation Worksheet For Year Ending December 31, 2024

Consolidation Entries Accounts

Payne Scout Company Company

Debit

Credit

Noncontrolling Consolidated Interest Totals

Chapter 04 – Consolidated Financial Statements and Outside Ownership – Hoyle, Schaefer, Doupnik, Advanced Accounting 15e

Revenues Operating expenses Equity earnings of Scout Gain on revaluation Separate company net income Consolidated net income NI attributable to noncontrolling interest NI attributable to Payne Company Retained earnings, 1/1 Net income Dividends declared Retained earnings 12/31 Current assets Investment in Scout

(931,000) 615,000

(380,000) 230,000

(E)100,000

(1,311,000) 945,000

(47,500)

-0-

(I) 47,500

-0-

(67,500)

-0-

(431,000)

(150,000)

(67,500)

(433,500) (2,500)

2,500

(431,000)

(965,000)

(600,000)

(S) 600,000

(965,000)

(431,000) 140,000

(150,000) 40,000

(1,256,000)

(710,000)

(1,256,000)

288,000

540,000

828,000

1,672,000

-0-

(D) 38,000

2,000

(S)1,235,000

(431,000) 140,000

-0-

(I) 47,500 (A) 427,500 Property, plant, and equipment Patented technology Database Goodwill Total assets Liabilities Common stock Additional paid-in capital Retained earnings 12/31 NCI in Scout, 1/1

826,000

590,000

1,416,000

850,000

370,000

1,220,000

-0-

3,636,000 (1,300,000) (900,000)

-01,500,000 (90,000) (500,000)

(180,000)

(200,000)

(1,256,000)

(710,000)

-0-

(3,636,000)

(1,500,000)

(A) 400,000 (A) 50,000

(E) 100,000

50,000 3,814,000 (1,390,000) (900,000)

(S) 500,000 (S) 200,000

(180,000) (1,256,000) (S) 65,000 (A) 22,500

NCI in Scout, 12/31 Total liab. and stockholders'

300,000

1,935,500

(87,500) (88,000)

1,935,500

(88,000) (3,814,000)

Chapter 04 – Consolidated Financial Statements and Outside Ownership – Hoyle, Schaefer, Doupnik, Advanced Accounting 15e

equity

39.

(60 minutes) (Step acquisition—control previously acquired.)

a. According to the acquisition method, the valuation basis for a subsidiary is established on the date control is obtained, in this case January 1, 2023. Subsequent acquisitions are valued consistent with this initial value after adjusting the investment for subsidiary net income and other changes. Because subsequent acquisitions are considered as transactions in the parent‘s own equity, no gains or losses are recorded. Differences in cash paid and the underlying value are recorded as adjustments to APIC. Fair value of Keane Company 1/1/23 ($573,000 ÷ 60%) Keane net income 2023 Excess fair value amortization for copyright Keane dividends 2023 Initial fair value adjusted to 1/1/24 Percent acquired in step acquisition Value assigned to 30% acquisition Cash paid for the 30% acquisition Credit to APIC from 30% step acquisition *Fair value of Keane Company 1/1/23 ($573,000 ÷ 60%)$955,000 Book value of Keane Company 1/1/23 (given) Excess fair value over book value To copyright (6 year remaining life) To goodwill Entry to record 30% additional investment in Keane: 1/1/24 Investment in Keane 301,500 Cash APIC from step acquisition

$955,000 150,000 (20,000)* (80,000) $1,005,000 30% 301,500 300,000 $ 1,500 810,000 145,000 120,000 $25,000

300,000 1,500

b. Investment in Keane Company 1/1/23 2023 Equity earnings [60% × (150,000 – 20,000)] 2023 Dividends from Keane (60% × $80,000) Additional acquisition of 30% interest 2024 Equity earnings [90% × (180,000 – 20,000)] 2024 Dividends from Keane (90% × $60,000) Investment in Keane Company 12/31/24

$573,000 78,000 (48,000) 301,500 144,000 (54,000) $994,500

39. (continued) part c.

Chapter 04 – Consolidated Financial Statements and Outside Ownership – Hoyle, Schaefer, Doupnik, Advanced Accounting 15e

BRETZ, INC. AND KEANE COMPANY Consolidation Worksheet Year Ending December 31, 2024

Consolidation Entries Accounts Revenues Operating expenses Equity in Keane‘s income Separate company net income Consolidated net income NI attributable to noncontrolling interest NI attributable to Bretz, Inc. Retained earnings, 1/1 Net income (above) Dividends declared Retained earnings, 12/31 Current assets Investment in Keane Company

Trademarks Copyrights Equipment (net) Goodwill Total assets Liabilities Common stock Additional paid-in capital APIC-step acquisition Retained earnings,12/31 Noncontrolling interest 1/1 Noncontrolling interest 12/31 Total liabilities and equities

Bretz, Inc. (402,000) 200,000 (144,000) (346,000)

Keane Co. (300,000) 120,000

Debit

Credit

Noncontrolling Consolidated Interest Totals (702,000) 340,000

(E) 20,000 (I) 144,000

(180,000) (16,000)

(797,000) (346,000) 143,000 224,000 994,500

(500,000) (180,000) 60,000 (1,000,000) 190,000

(S) 500,000 (D) 54,000

(S) 792,000 (D)54,000

106,000 210,000 380,000

600,000 300,000 110,000

1,914,500 (453,000) (400,000) (60,000) (1,500) (1,000,000)

1,200,000 (200,000) (300,000) (80,000)

6,000

(620,000)

(A)100,000

(A) 112,500 (I) 144,000 706,000 590,000 490,000 25,000 2,225,000 (653,000) (400,000) (60,000) (1,500) (1,000,000)

(E) 20,000

(A) 25,000

(S)300,000 (S) 80,000

(620,000) (A) 12,500 (S) 88,000

(1,914,500)

(1,200,000)

1,223,000

(362,000) 16,000 (346,000) (797,000) (346,000) 143,000 (1,000,000) 414,000 0

(100,500) (110,500)

1,223,000

(110,500) (2,225,000)

Chapter 05 – Consolidated Financial Statements – Intra-Entity Asset Transactions – Hoyle, Schaefer, Doupnik, Advanced Accounting, 15e

RESEARCH CASE: U.S. STEEL'S STEP ACQUISITION OF BIG RIVER STEEL (45 minutes) 1. What amounts and components did U.S Steel identify to determine the total consideration for the acquisition of Big River Steel? (in millions) Cash paid (net of cash acquired) $ 625 Fair value of previously held shares 770 U.S. Steel liabilities assumed in the purchase 50 Total acquisition-date fair value $ 1445 2. Prepare a schedule showing the computation of goodwill. Total consideration paid (above and in millions) $1,445 Total identifiable assets acquired Total liabilities assumed Net identifiable assets acquired Goodwill

$3,085 (2,556) 529 $ 916

3. Prior to its acquisition of control, how did U.S. Steel account for its 49.9 percent investment in Big River Steel and why? As noted in U.S. Steel‘s 2021 10-K, ―Prior to the closing of the acquisition on January 15, 2021, U. S. Steel accounted for its 49.9% equity interest in Big River Steel under the equity method as control and risk of loss were shared among the joint venture members.‖ Apparently, prior to January 15, 2021, U.S. Steel had significant influence over Big River Steel, but not control. 4. Upon acquisition of its controlling interest on January 15, 2021, how did U.S. Steel account for the change in fair value of its original 49.9 percent ownership interest in Big River Steel? How was this amount reported in the consolidated financial statements? U.S. Steel revalued its previous equity interest in Big River Steel to its fair value of $770 million as of the date control was obtained and recognized a gain of approximately $111 million. The gain was reported in U.S. Steel‘s consolidated statement of operations as a ―gain on equity investee transactions.‖ RESEARCH CASE: COSTCO’S NONCONTROLLING INTERESTS (40 minutes) 1. How does Costco present the noncontrolling interest in its consolidated financial statements? 

Consolidated Balance Sheet: Noncontrolling interests are listed at $514 million as of August 29, 2021 in the Owners‘ Equity section of the consolidated balance sheet.



Consolidated Income Statement: Net income to noncontrolling interests is reported at $72 million for the year ended August 29, 2021 as an allocated portion of consolidated net income (―Net income including noncontrolling interests‖) on the consolidated statements of income. 5-1

Chapter 05 – Consolidated Financial Statements – Intra-Entity Asset Transactions – Hoyle, Schaefer, Doupnik, Advanced Accounting, 15e



Consolidated Statement of Comprehensive Income: Noncontrolling interests are listed at $93 million for the year ended August 29, 2021 as an allocated portion of consolidated comprehensive income.



Consolidated Statement of Cash Flows has no separate amount listed for the noncontrolling interest, but instead represents the cash flows for the entire economic unit. The consolidated statements of equity show that foreign currency translation adjustments have affected the noncontrolling interest in each of the three years presented. Also stock-based compensation reduced the noncontrolling interest in the 2018-19 fiscal year

2. Explain how Costco‘s presentation of the noncontrolling interest reflects the acquisition method for consolidated entity reporting. The acquisition method emphasizes the inclusion of each entity controlled by the parent as a whole for financial reporting purposes consistent with the economic unit concept. Any outside ownership interests of subsidiaries is then reported as the noncontrolling interest. 

The balance sheet combines all of Costco‘s assets and liabilities for the entire economic unit including all subsidiaries, regardless of ownership. Costco then shows the noncontrolling interest as a separate component of equity.



The income statement likewise combines 100% of the revenues and expenses of the entire economic unit in computing consolidated net income. The income statement then shows the allocation of the consolidated entity‘s net income to the controlling and noncontrolling interests.



The consolidated statement of comprehensive income first combines 100% of its financial statement items for the consolidated entity. It then allocates the consolidated entity‘s comprehensive income to the controlling and noncontrolling interests.



The consolidated statement of cash flows reflects the acquisition method because each of its elements represent cash flows for the combined entity as a whole.

Bardeen ELECTRIC: FASB ASC and IFRS Research Case (75 MINUTES) 1. What is the total consideration transferred by Armstrong to acquire its 80 percent controlling interest in Bardeen? Cash Shares of Armstrong stock Contingency Total consideration transferred

$40,000,000 24,000,000 8,000,000 $72,000,000

The shares of Armstrong stock and the contingency are both measured at their acquisitiondate fair values (ASC 805-30-30-7, ASC 805-30-25-5).

2. What values should Armstrong assign to identifiable assets and liabilities as part of the acquisition accounting? Cash Accounts receivable

$ 425,000 788,000 5-2

Chapter 05 – Consolidated Financial Statements – Intra-Entity Asset Transactions – Hoyle, Schaefer, Doupnik, Advanced Accounting, 15e Land Building Machinery Trademark Research and development asset Accounts payable Total identifiable net asset fair value

3,487,000 16,300,000 39,000,000 7,000,000 11,000,000 (1,500,000) $76,500,000

(ASC 805-20-30-1)

3. What is the acquisition-date value assigned to the 20 percent noncontrolling interest? What are the noncontrolling interest valuation alternatives available under IFRS? Under U.S. GAAP, the acquisition-date noncontrolling interest is measured at its fair value. In this case, there are no readily available market values for the noncontrolling shares so Armstrong has relied on other valuation techniques to arrive at an estimated fair value of $16,500,000. IFRS allows two alternative measures for the noncontrolling interest. The first is identical to the U.S. measure. The second alternative uses the noncontrolling interest percentage of the fair value of the subsidiary‘s identifiable net assets. In this case, the second alternative provides a value of $15,300,000 ($76,500,000 × 20%). 4. Under U.S. GAAP, what amount should Armstrong recognize as goodwill from the acquisition? What alternative valuations are available for goodwill under IFRS? Goodwill under U.S. GAAP (ASC 805-30-30-1) and IFRS alternative 1 (IFRS 3 IN 8): Consideration transferred (above) Acquisition-date noncontrolling interest fair value Acquisition-date value assigned to subsidiary Net identifiable assets acquired at fair value (above) Goodwill

$ 72,000,000 16,500,000 $88,500,000 76,500,000 $ 12,000,000

Goodwill under IFRS alternative 2: Consideration transferred (above) Acquisition-date NCI value assigned (above) Acquisition-date value assigned to subsidiary Net assets acquired fair value (above) Goodwill

$ 72,000,000 15,300,000 $87,300,000 76,500,000 $ 10,800,000

CHAPTER 5 CONSOLIDATED FINANCIAL STATEMENTS—INTRA-ENTITY ASSET TRANSACTIONS Chapter Outline I. II.

The transfer of assets between the companies within a consolidated entity is a common practice. The opportunity for such direct acquisition (especially of inventory) is often the underlying motive for the creation of the combination. Intra-entity inventory transfers A. The individual accounting systems of the two companies will record the transfer as a sale by one party and as a purchase by the other B. Because the transaction was not made with an outside, unrelated party, the sales and purchases balances created by the transfer are eliminated in consolidation (Entry Tl) 5-3 © McGraw Hill LLC. All rights reserved. No reproduction or distribution without the prior written consent of McGraw Hill LLC.

Chapter 05 – Consolidated Financial Statements – Intra-Entity Asset Transactions – Hoyle, Schaefer, Doupnik, Advanced Accounting, 15e

III.

IV.

C. Any transferred inventory retained at the end of the year is recorded at its transfer price which in (many cases) will include an intra-entity gross profit 1. For consolidation purposes, this intra-entity gross profit must be deferred by eliminating the amount from the inventory account on the balance sheet and from the ending inventory figure within cost of goods sold (Entry G). 2. Because transfer effects carry over to the subsequent fiscal period, the intra-entity gross profit must also be removed a second time: from the beginning inventory component of cost of goods sold and from the beginning retained earnings balance (Entry *G). a. The retained earnings figure being adjusted is that of the original seller. b. If the equity method has been applied and the transfer was made downstream (by the parent), the beginning retained earnings account will be correct; therefore, in this one case, the adjustment is to the Investment in Subsidiary account. 3. The consolidation process is designed to shift the profit from the period of transfer into the time period in which the goods are actually sold to unrelated parties or consumed D. Effect of deferral process on the valuation of a noncontrolling interest 1. Official accounting pronouncements permit but do not require deferral of intra-entity profits on the valuation of noncontrolling interest balances 2. This textbook adjusts the noncontrolling interest balances but only if the sale was made upstream from subsidiary to parent. Downstream sales are made by the parent and, thus, are viewed as having no effect on the outside interest. Intra-entity land transfers A. Any gain created by intra-entity land transfers is removed in consolidation each year until the land is sold to an outside party B. For each subsequent consolidation, the recorded value of the land account is reduced to original cost. The intra-entity gain recorded by the seller must also be removed and deferred until the land is sold to an outsider. 1. In the year of transfer, an actual gain account exists within the accounting records of the seller and must be removed. 2. In all later time periods, since the intra-entity gain has become an element of the seller's beginning retained earnings balance, the reduction is made to this equity account. 3. If the land is ever sold to an outside party, the intra-entity gain must be recognized within that time period. Intra-entity transfer of depreciable assets A. As with other intra-entity transfers, any intra-entity gross profit in depreciable assets must be deferred and subsequently recognized (via depreciation expense adjustments) for consolidation purposes to establish appropriate historical cost balances. B. However, the difference between the transfer-based accounting carrying amount and the historical-based carrying amount of the asset will change each year because of the effects of depreciation. The amount of intra-entity gain within retained earnings will also be reduced annually since excess depreciation expense is recognized (and closed into retained earnings) based on the inflated transfer price. C. Consequently, elimination of the intra-entity gain (within retained earnings) and the reduction of the asset value to historical cost will differ from year to year. D. Also within the consolidation process, the recorded depreciation expense must be decreased every period to an amount appropriately based on the asset's original acquisition price. 5-4 © McGraw Hill LLC. All rights reserved. No reproduction or distribution without the prior written consent of McGraw Hill LLC.

Chapter 05 – Consolidated Financial Statements – Intra-Entity Asset Transactions – Hoyle, Schaefer, Doupnik, Advanced Accounting, 15e

Answers to Discussion Questions Earnings Management: By selling goods to special purpose entities that it controlled but did not consolidate, did Enron overstate its earnings? According to the Power‘s Report (Report of Investigation by the Special Investigative Committee of the Board of Directors of Enron Corp.—February 1, 2004) These partnerships—Chewco, LJM1, and LJM2—were used by Enron Management to enter into transactions that it could not, or would not, do with unrelated commercial entities. Many of the most significant transactions apparently were designed to accomplish favorable financial statement results, not to achieve bona fide economic objectives or to transfer risk. (page 4) Assuming Enron controlled LJM2, the activities that produced the $67 million gain and the $20.3 million agency fee were not arm‘s length and thus did not provide a proper basis for recognizing income. What effect does consolidation have on the financial reporting for transactions with controlled entities? In consolidation, all intra-entity profit would have been deferred until the goods were sold to an outside party. Also, the intra-entity note receivable and payable would have been eliminated in consolidation. As noted by Bala Dahran in his February 6, Congressional Testimony Despite their potential for economic and business benefits, the use of SPEs has always raised the question of whether the sponsoring company has some other accounting motivations, such as hiding of debt, hiding of poor-performing assets, or earnings management. Additionally, explosive growth in the use of SPEs led to debates among managers, auditors and accounting standard setters as to whether and when SPEs should be consolidated. This is because the intended accounting effects of SPEs can only be achieved if the SPEs are reported as unconsolidated entities separate from the sponsoring entity. FASB Activity on Variable Interest Entities (VIEs) Fortunately, the FASB‘s ASC Topic 810 explains how to identify an SPE (a type of entity that is often a VIE) that is not subject to control through voting ownership interests, but is nonetheless controlled by another enterprise and therefore subject to consolidation. The entity that controls the SPE is then required to include the assets, liabilities, and results of the activities of the SPE in its consolidated financial statements. What Price Should We Charge Ourselves? Transfer pricing is actually a topic for a managerial accounting discussion. Students, though, need to be aware that managerial and financial accounting do overlap at times. In this illustration, the price set by company officials for this component will affect the specific consolidation procedures needed in the preparation of financial statements for external reporting purposes. Since Slagle owns 100 percent of Harrison's common stock, consolidated net income will not be altered by the transfer pricing decision. All intra-entity transactions as well as intra-entity profits will be removed entirely. However, because the sales are upstream, if a noncontrolling interest had been present, the portion of the subsidiary's net income attributed to these outside owners would be influenced by the markup. Both the noncontrolling interest figure on the balance sheet 5-5 © McGraw Hill LLC. All rights reserved. No reproduction or distribution without the prior written consent of McGraw Hill LLC.

Chapter 05 – Consolidated Financial Statements – Intra-Entity Asset Transactions – Hoyle, Schaefer, Doupnik, Advanced Accounting, 15e

and on the income statement are impacted by the amount of profits that must be deferred in consolidation when transactions are from subsidiary to parent. To the accountant, the easiest approach is to set the transfer price at the seller's cost ($70.00 in this case). No intra-entity profits are created and the consolidation process is less complicated. However, as indicated in the narrative, that price may penalize the seller since no profits are recognized by that profit center. In addition, the buyer will then show artificially inflated income. Thus, some amount of profit is usually built into transfer pricing decisions. Those students who have already completed cost/managerial accounting can be asked to describe the various factors that should influence the establishment of this price. Interaction between accounting courses is beneficial to the students.

Chapter 05 – Consolidated Financial Statements – Intra-Entity Asset Transactions – Hoyle, Schaefer, Doupnik, Advanced Accounting, 15e

Answers to Questions 1.

One reason for the significant volume and frequency of intra-entity transfers is that many consolidated entities are specifically organized so that the companies can provide products for each other. This design is intended to benefit the consolidated entity as a whole because of the economies provided by vertical integration. In effect, more profit can often be generated by the combination if one member is able to buy from another rather than from an outside party. The sales between Barker and Walden totaled $100,000. Regardless of the ownership percentage or the gross profit rate, the $100,000 was simply an intra-entity asset transfer. Thus, within the consolidation process, the entire $100,000 should be eliminated from both the Sales and the Purchases (Inventory) accounts. Sales price per unit ($900,000 ÷ 3,000 units) $ 300 Number of units in Safeco‘s ending inventory × 500 Intra-entity inventory at transfer price $ 150,000 Gross profit rate (0.6 ÷ 1.6) 375 Intra-entity profit in ending inventory $ 56,250 In intra-entity transactions, a transfer price is often established that exceeds the cost of the inventory. Hence, the seller is recording a gross profit on its books that, from the perspective of the consolidated entity as a whole, must be deferred until the asset is consumed or sold to an outside party. Any intra-entity gross profit on merchandise still held by the buyer must be deferred whenever consolidated financial statements are prepared. For the year of transfer, this consolidation procedure is carried out by removing the intra-entity gross profit from the inventory account on the balance sheet and from the ending inventory balance within cost of goods sold. In the year following the transfer (if the goods are resold or consumed), the previously deferred gross profit must be recognized within the consolidation process. Reductions are made on the worksheet to the beginning inventory component of cost of goods sold and to the beginning retained earnings balance of the original seller. The gross profit is thus taken out of last year‘s earnings (retained earnings) and recognized in the current year through the reduction of cost of goods sold. If the transfer was downstream in direction and the parent company has applied the equity method, the adjustment in the subsequent year is made to the Investment in Subsidiary account rather than to retained earnings. On its individual financial records, James, Inc., records a gross profit in the year of transfer. From the viewpoint of the consolidated entity, this gross profit should be recognized in the period in which the products are sold or consumed by Matthews Co. An initial consolidation entry must be made in the year of transfer to defer any gross profit in ending inventory. A second entry must be made in the following time period to allow the gross profit to be recognized in the year when a sale to an outsider takes place. Current accounting pronouncements allow discretion regarding the effect of intra-entity profits in inventory and noncontrolling interest values. This textbook reasons that intraentity profits relate to the seller and to the computation of the seller's income. Therefore, any intra-entity profits created by upstream transfers (from subsidiary to parent) are attributed to the subsidiary. The effects resulting from the deferral and eventual recognition of these intra-entity profits are considered in the calculation of noncontrolling interest balances. In contrast, intra-entity profits from downstream transfers are viewed as relating solely to the parent (as the seller) and, thus, have no effect on the noncontrolling interest. Consolidated financial statements are largely unchanged across downstream versus upstream transfers. Sales and purchases (Inventory) balances created by the transactions are eliminated in total. Any intra-entity gross profits remaining at the end of a fiscal period

Chapter 05 – Consolidated Financial Statements – Intra-Entity Asset Transactions – Hoyle, Schaefer, Doupnik, Advanced Accounting, 15e

10.

11.

get deferred until ultimately sold to an outside party or consumed. The direction of intra-entity transfers (upstream versus downstream) does have one effect on consolidated financial statements. In computing noncontrolling interest balances (if present), the deferral of intra-entity gross profits on upstream sales is taken into account. Downstream sales, however, are attributed to the parent and are viewed as having no impact on the outside interest. The computation of this noncontrolling interest balance depends on the direction of the intra-entity transfers which is not indicated in the question. If the intra-entity gross profits were created by downstream sales from King to Pawn, they relate only to King. The net income attributable to the noncontrolling interest is not affected and would be $11,000 ($110,000 × 10%). In contrast, if the transfers were upstream from Pawn to King, the deferral and recognition of the profits are attributed to Pawn. Pawn's "adjusted" net income would be $80,000 and the noncontrolling interest's share of consolidated net income is reported as $8,000: Pawn's reported net income $110,000 Recognition of prior year intra-entity gross profit 30,000 Deferral of current year intra-entity gross profit (60,000) Pawn's adjusted net income $ 80,000 Outside ownership percentage 10% Net income attributable to noncontrolling interest $ 8,000 The deferral and subsequent recognition of intra-entity profits are allocated to the noncontrolling interest in the same periods as the parent. When one affiliate sells to another affiliate, ownership from the consolidated entity perspective does not change and therefore the underlying profit is deferred. When the purchasing affiliate subsequently sells the inventory to an entity outside the affiliated group, ownership changes, and the intraentity profit may be recognized. Intra-entity profits are not really eliminated, but simply deferred until a sale to an outsider takes place. Several differences can be cited that exist between the consolidated process applicable to inventory transfers and that which is appropriate for land transfers. The total intra-entity Sales balance is offset against Purchases (Inventory) when inventory is transferred but no corresponding entry is needed when land is involved. Furthermore, in the year of the sale, ending intra-entity inventory gross profits are deferred through an adjustment to cost of goods sold, but a specific gross profit account exists (and must be removed) when land has been sold. Finally, intra-entity inventory gross profits are usually expected to be recognized in the year following the transfer. This effect is mirrored in that period by reduction of the beginning inventory figure (within cost of goods sold). For land transfers, however, the intra-entity gain must be repeatedly deferred in each fiscal period for as long as the land continues to be held within the consolidated entity. As long as the land is held by the parent, its recorded value must be reduced to historical cost within each consolidated set of financial statements. In the year of the original transfer, the asset reduction is offset against the subsidiary's recorded gain. For all subsequent years in which the property is held, the credit to the Land account is made against the beginning retained earnings balance of the subsidiary (since the intra-entity gain will have been closed into that account). According to this question, the land is eventually sold to an outside party. The intra-entity gain (which has been deferred in each of the previous years) is recognized by the sale and should be recognized in the consolidated financial statements of this later period. Because the transfer was upstream from subsidiary to parent, the above consolidated entries will also affect any noncontrolling interest balances being reported. Because of the deferral of the intra-entity gross profit, the adjusted net income balances applicable to the subsidiary will be less than the reported values. In the year of resale, however, the 5-8 © McGraw Hill LLC. All rights reserved. No reproduction or distribution without the prior written consent of McGraw Hill LLC.

Chapter 05 – Consolidated Financial Statements – Intra-Entity Asset Transactions – Hoyle, Schaefer, Doupnik, Advanced Accounting, 15e

12.

13.

adjusted net income for consolidation purposes is higher than reported. All noncontrolling interest totals are computed on the adjusted balances rather than the reported figures. Depreciable assets are often transferred between the members of a consolidated entity at amounts in excess of book value. The buyer will then compute depreciation expense based on this inflated transfer price rather than on an historical cost basis. From the perspective of the consolidated entity, depreciation should be calculated solely on historical cost figures. Thus, within the consolidation process for each period, adjustment of the depreciation (that is recorded by the buyer) is necessary to reduce the expense to a cost-based figure. From the viewpoint of the consolidated entity, an intra-entity gain has been created by the transfer and must be deferred in the preparation of consolidated financial statements. This intra-entity gain is closed by the seller into retained earnings necessitating subsequent reductions to that account. In the individual financial records, however, another income effect is created which gradually reduces the overstatement of retained earnings each period. The asset will be depreciated by the buyer based on the inflated transfer price. The resulting expense will be higher than the amount appropriate to the historical cost of the item. Because this excess depreciation is closed into retained earnings annually, the overstatement of the equity account is gradually reduced to a zero balance over the remaining life of the asset.

Chapter 05 – Consolidated Financial Statements – Intra-Entity Asset Transactions – Hoyle, Schaefer, Doupnik, Advanced Accounting, 15e

Answers to Problems 1.

B Merchandise remaining in James‘s inventory $250,000 × 40% = $100,000. Intra-entity gross profit (based on subsidiary's gross profit rate as the seller) $100,000 × 30% = $30,000. James‘s ownership percentage of Carl has no impact on this computation.

C Alpha sales....................................................................................... $ 800,000 Beta sales.................................................................................... 300,000 Intra-entity sales ......................................................................... (100,000) Consolidated sales ....................................................................... $ 1,000,000

B Alpha inventory ......................................................................... $ 95,000 Beta inventory ............................................................................ 88,000 Gross profit in intra-entity inventory (25% gross profit rate × $100,000 × 40%) ........................... (10,000) Consolidated inventory ................................................................... $ 173,000

B Alpha COGS ..................................................................................... $ 600,000 Beta COGS .................................................................................. 180,000 Intra-entity sales elimination ..................................................... (100,000) Gross profit in intra-entity inventory deferral (25% gross profit rate × $100,000 × 40%) ............................. 10,000 Consolidated COGS ........................................................................ $ 690,000

D INTRA-ENTITY GROSS PROFIT, 12/31/23 Intra-entity gross profit ($200,000 – $160,000) ......................... $ 40,000 Inventory remaining at year's end ............................................... 18% Intra-entity gross profit in inventory, 12/31/23 ......................... $ 7,200 INTRA-ENTITY GROSS PROFIT, 12/31/24 Intra-entity gross profit ($350,000 – $297,500) ......................... $ 52,500 Inventory remaining at year's end............................................. 30% Intra-entity gross profit in inventory, 12/31/24 ......................... $15,750 CONSOLIDATED COST OF GOODS SOLD Parent balance............................................................................ $ 607,500 Subsidiary balance ............................................................... 450,000 Remove intra-entity transfer ................................................ (350,000) 5-10 © McGraw Hill LLC. All rights reserved. No reproduction or distribution without the prior written consent of McGraw Hill LLC.

Chapter 05 – Consolidated Financial Statements – Intra-Entity Asset Transactions – Hoyle, Schaefer, Doupnik, Advanced Accounting, 15e

Recognize 2023 deferred gross profit ................................. Defer 2024 intra-entity gross profit....................................... Cost of goods sold .....................................................................

(7,200) 15,750 $ 716,050

B INTRA-ENTITY GROSS PROFIT, 12/31/23 Ending inventory .................................................................... Gross profit rate ($33,000 ÷ $110,000) .................................. Intra-entity gross profit in ending inventory, 12/31/23 ........

$ 40,000 30% $ 12,000

INTRA-ENTITY GROSS PROFIT, 12/31/24 Ending inventory .................................................................. Gross profit rate ($48,000 ÷ $120,000) ................................ Intra-entity gross profit in ending inventory, 12/31/24 ......

$50,000 40% $20,000

NET INCOME ATTRIBUTABLE TO NONCONTROLLING INTEREST Reported net income for 2024 after excess amortization $90,000 Intra-entity gross profit deferred in 2023 ........................... 12,000 Deferral of 2024 intra-entity gross profit ............................ (20,000) Adjusted net income of subsidiary..................................... $82,000 Outside ownership ............................................................... 10% Noncontrolling interest........................................................ $8,200 9.

Individual records after transfer:

12/31/23 Machinery = $40,000 Gain = $10,000 Depreciation expense $8,000 ($40,000 ÷ 5 years) Net effect on income = $2,000 ($10,000 – $8,000) 12/31/24 Depreciation expense = $8,000 Consolidated figures—historical cost: 12/31/23 Machinery = $30,000 Depreciation expense = $6,000 ($30,000 ÷ 5 years) 12/31/24 Depreciation expense = $6,000 Adjustments for consolidation purposes: 2023: $2,000 income is reduced to a $6,000 expense (net income is reduced by $8,000)

Chapter 05 – Consolidated Financial Statements – Intra-Entity Asset Transactions – Hoyle, Schaefer, Doupnik, Advanced Accounting, 15e

2024: $8,000 expense is reduced to a $6,000 expense (net income is increased by $2,000) 10.

D INTRA-ENTITY GAIN Transfer price.............................................................................. Book value (original cost less two years depreciation) .......... Intra-entity gain...........................................................................

$430,400 368,000 $ 62,400

EXCESS DEPRECIATION Annual depreciation based on carrying amount at of intra-entity transfer ($368,000 ÷ 8 years) .................................................................... $46,000 Annual depreciation based on transfer price ($430,400 ÷ 8 years)................................................................ 53,800 Excess depreciation................................................................... $ 7,800 ADJUSTMENTS TO CONSOLIDATED NET INCOME Defer intra-entity gain .............................................................. Remove excess depreciation .................................................. Net reduction in consolidated net income .............................

$ (62,400) 7,800 $ (54,600)

11.

a. Jarel revenues .......................................................................... Suarez revenues ....................................................................... Intra-entity transfers................................................................. Consolidated revenues ............................................................

$300,000 200,000 (100,000) $400,000

Intra-entity gross profit ($100,000 - $80,000)............................ Inventory remaining at year's end............................................. Intra-entity gross profit in ending inventory ............................

$20,000 60% $12,000

CONSOLIDATED COST OF GOODS SOLD Parent balance....................................................................... Subsidiary balance ............................................................... Remove intra-entity transfer ................................................ Defer intra-entity gross profit (above) .................................. Cost of goods sold .....................................................................

$140,000 80,000 (100,000) 12,000 $132,000

c. Consideration transferred........................... Noncontrolling interest fair value .............. Suarez total fair value ................................. Book value of net assets ............................ Excess fair over book value .......................

$260,000 65,000 $ 325,000 (250,000) $ 75,000

Chapter 05 – Consolidated Financial Statements – Intra-Entity Asset Transactions – Hoyle, Schaefer, Doupnik, Advanced Accounting, 15e

Excess fair value to undervalued assets: Equipment ........................... Secret Formulas.................. Total

Remaining Life

Annual Excess Amortizations

$25,000 5 years 50,000 20 years -0-

$ 5,000 2,500 $ 7,500

11. (continued) Jarel expenses............................................................................ Suarez expenses ........................................................................ Excess fair-value amortization .................................................. Consolidated expenses .............................................................

$ 20,000 10,000 7,500 $ 37,500

20% of the beginning book value.............................................. Excess fair value allocation (20% × $75,000) ........................... 20% share of Suarez net income adjusted for amortization (20% × [110,000 – 7,500])............ Ending noncontrolling interest balance ...................................

$ 50,000 15,000

Jarel equipment (net) ................................................................. Suarez equipment (net) .............................................................. Acquisition date excess fair-value allocation .......................... Excess fair-value amortization .................................................. Consolidated equipment............................................................

$ 440,000 300,000 25,000 (5,000) $ 760,000

Combined pre-consolidation inventory balances.................... Intra-entity gross profit ($100,000 – $80,000) .............. $ 20,000 Inventory remaining at year's end.............................. 60% Intra-entity gross profit in ending inventory, 12/31 ................. Consolidated total for inventory ...............................................

$ 260,000

20,500 $ 85,500

12.

(12,000) $ 248,000

(15 Minutes) (Determine selected consolidated balances; includes inventory transfers and an outside ownership.)

Unpatented technology amortization = $78,000 ÷ 4 years = $19,500 per year Intra-entity gross profit ($180,000 – $130,000) ........................ Inventory remaining at year end ............................................... Intra-entity gross profit in ending inventory, 12/31 ................

$ 50,000 10% $ 5,000

CONSOLIDATED TOTALS a. Inventory = $795,000 (add the two book values and subtract the ending intra-entity gross profit of $5,000) 5-13 © McGraw Hill LLC. All rights reserved. No reproduction or distribution without the prior written consent of McGraw Hill LLC.

Chapter 05 – Consolidated Financial Statements – Intra-Entity Asset Transactions – Hoyle, Schaefer, Doupnik, Advanced Accounting, 15e

b. Sales = $1,620,000 (add book values and subtract $180,000 intra-entity transfer) c. Cost of goods sold = $725,000 (add the two book values and subtract the intra-entity transfer and add [to defer] ending inventory intra-entity gross profit) d. Operating expenses = $549,500 (add the two book values and the amortization expense for the period) 12. (continued) e.

Sutter‘s net income........................................................ $100,000 Intra-entity gross profit deferral........................... (5,000) Excess fair value amortization ..................................... (19,500) Adjusted subsidiary net income................................... $75,500 Noncontrolling interest percentage ............................. 10% Net income attributable to noncontrolling interest..... $ 7,550 Gross profit deferral is allocated to the noncontrolling interest because the transfer was upstream from Sutter to Poyer. 13.

(60 minutes) (Downstream intra-entity profit adjustments when parent uses equity method and a noncontrolling interest is present) Consideration transferred by Corgan ................ Noncontrolling interest fair value ...................... Smashing‘s acquisition-date fair value ............. Book value of subsidiary .................................... Excess fair over book value ............................... Excess assigned to covenants........................... Remaining useful life in years ............................ Annual amortization ............................................

$980,000 245,000 1,225,000 950,000 275,000 275,000 ÷ 20 $13,750

2023 Ending Inventory Profit Deferral   

Cost = $100,000 ÷ 1.6 = $62,500 Intra-entity gross profit = $100,000 – $62,500 = $37,500 Ending inventory gross profit = $37,500 × 40% = $15,000

2024 Ending Inventory Profit Deferral   

Cost = $120,000 ÷ 1.6 = $75,000 Intra-entity gross profit = $120,000 – $75,000 = $45,000 Ending inventory gross profit = $45,000  40% = $18,000

13. (continued) a. Investment account:

Chapter 05 – Consolidated Financial Statements – Intra-Entity Asset Transactions – Hoyle, Schaefer, Doupnik, Advanced Accounting, 15e

Consideration transferred, January 1, 2023 Smashing‘s 2023 net income × 80% Covenant amortization (13,750 × 80%) Ending inventory profit deferral (100%) Equity in Smashing‘s earnings 2023 dividends Investment balance 12/31/23 Smashing‘s 2024 net income × 80% Covenants amortization (13,750 × 80%) Beginning inventory profit recognition Ending inventory profit deferral (100%) Equity in Smashing‘s earnings 2024 dividends Investment balance 12/31/24

$980,000 $120,000 (11,000) (15,000) 94,000 (28,000) $1,046,000 $104,000 (11,000) 15,000 (18,000) 90,000 (36,000) $1,100,000

b. 12/31/24 Worksheet Adjustments *G S

I D E TI G 14.

Investment in Smashing Cost of goods sold

15,000

Common stock—Smashing Retained earnings—Smashing Investment in Smashing Noncontrolling interest

700,000 365,000

Covenants Investment in Smashing Noncontrolling interest

261,250

Equity in earnings of Smashing Investment in Smashing

90,000

Investment in Smashing Dividends declared

36,000

Amortization expense Covenants

13,750

Sales Cost of goods sold

120,000

Cost of goods sold Inventory

18,000

15,000

852,000 213,000 209,000 52,250 90,000 36,000 13,750 120,000 18,000

(40 Minutes) (Series of independent questions concerning various aspects of the consolidation process when intra-entity transfers have occurred) a. 5-15 © McGraw Hill LLC. All rights reserved. No reproduction or distribution without the prior written consent of McGraw Hill LLC.

Chapter 05 – Consolidated Financial Statements – Intra-Entity Asset Transactions – Hoyle, Schaefer, Doupnik, Advanced Accounting, 15e

Placid Lake's 2024 net income before effect from Scenic ............ Scenic's reported net income 2024................................................. Amortization expense (given).......................................................... Realization of 2023 intra-entity gross profit (see below)............... Deferral of 2024 intra-entity gross profit (see below).................... Consolidated net income .................................................................

$300,000 110,000 (5,000) 7,200 (16,200) $396,000

2023 Intra-entity gross profit to be recognized in 2024: Intra-entity gross profit on transfers ($90,000 – $54,000) ............. Inventory retained at end of 2023.................................................... Intra-entity gross profit in ending inventory—12/31/23 ............

$36,000 20% $ 7,200

2024 Intra-entity gross profit deferred: Intra-entity gross profit on transfers ($120,000 – $66,000) ........... Inventory retained at end of 2024.................................................... Intra-entity gross profit in ending inventory—12/31/24 ........... b. Noncontrolling interest's share of consolidated net income (upstream sales): Scenic's reported net income 2024.............................................. Amortization of excess fair value to intangibles ........................ 2023 intra-entity gross profit recognized in 2024 (upstream sales).......................................................... 2024 intra-entity gross profit deferred (upstream sales) ........... Scenic's adjusted net income ...................................................... Noncontrolling interest ownership .............................................. Noncontrolling interest share of consolidated net income ....... Placid Lake‘s net income from own operations......................... Placid Lake‘s share of Scenic‘s adjusted NI (80%× $96,000).... Placid Lake‘s share of consolidated net income .......................

$54,000 30% $16,200

$110,000 (5,000) 7,200 (16,200) $96,000 20% $19,200 $300,000 76,800 $376,800

c. Noncontrolling interest's share of consolidated net income (downstream sales): Downstream transfers do not affect the noncontrolling interest. Scenic's reported net income 2024 after amortization.............. Noncontrolling interest ownership ............................................. Net income attributable to noncontrolling interest ...................

$105,000 20% $21,000

Placid Lake‘s net income from own operations......................... Placid Lake‘s share of Scenic‘s adjusted NI (80% × $105,000). Realization of 2023 intra-entity gross profit (see part a.) .......... Deferral of 2024 intra-entity gross profit (see part a.) ............ Net income attributable to controlling interest .......................

$300,000 84,000 7,200 (16,200) $375,000

Chapter 05 – Consolidated Financial Statements – Intra-Entity Asset Transactions – Hoyle, Schaefer, Doupnik, Advanced Accounting, 15e

Inventory—Placid Lake book value ......................................... Inventory—Scenic book value .................................................. Intra-entity gross profit, 12/31/24 (see part a) ......................... Consolidated inventory ............................................................. (Direction of transfer has no impact here)

$140,000 90,000 (16,200) $213,800

Land—Placid Lake‘s book value .............................................. Land—Scenic's book value ...................................................... Elimination of intra-entity gain on land ................................... Consolidated land balance .......................................................

$600,000 200,000 (20,000) $780,000

f. The intra-entity transfer was upstream from Scenic to Placid Lake. Because the transfer occurred in 2023, beginning retained earnings of the seller for 2024 contains the remaining portion of the intra-entity gain. Transfer pricing figures: 2023 Equipment Gain Depreciation expense Income effect Accumulated depreciation 2024 Depreciation expense Accumulated depreciation

= = = = = = =

$80,000 $20,000 ($80,000 – $60,000) $16,000 ($80,000 ÷ 5) $4,000 ($20,000 – $16,000) $16,000 $16,000 $32,000

= = = = =

$100,000 $12,000 ($60,000 ÷ 5 years) $52,000 ($40,000 + $12,000) $12,000 $64,000

Historical cost figures: 2023

2024

Equipment Depreciation expense Accumulated depreciation Depreciation expense Accumulated depreciation

CONSOLIDATION ENTRIES FOR TRANSFERRED EQUIPMENT ENTRY *TA Retained earnings, 1/1/24 (Scenic) ................................... Equipment ($100,000 – $80,000) ....................................... Accumulated depreciation ($52,000 – $16,000) ..........

16,000 20,000 36,000

To change beginning of year figures to historical cost by removing impact of 2023 transactions. Retained earnings reduction removes $4,000 income effect (above) and replaces it with $12,000 depreciation expense for 2023. 14. (continued) ENTRY ED 5-17 © McGraw Hill LLC. All rights reserved. No reproduction or distribution without the prior written consent of McGraw Hill LLC.

Chapter 05 – Consolidated Financial Statements – Intra-Entity Asset Transactions – Hoyle, Schaefer, Doupnik, Advanced Accounting, 15e

Accumulated depreciation ................................................ 4,000 Depreciation expense .................................................. 4,000 To reduce depreciation from transfer price ($16,000) to historical cost of $12,000. This intra-entity transfer was upstream from Scenic to Placid Lake. Thus, income effects are assumed to relate to the original seller (Scenic). Because the sale occurred in 2023, the only effect in 2024 relates to depreciation expense. The expense based on the transfer price is $4,000 higher than the amount based on the historical cost. As an upstream transfer, this adjustment affects Scenic and the noncontrolling interest computations. Transfer price depreciation: $80,000 ÷ 5 yrs. = $16,000 Historical cost depreciation (based on book value): $60,000 ÷ 5 yrs. = $12,000 Net income attributable to noncontrolling interest Scenic's reported net income less excess amortization ......... Reduction of depreciation expense to historical cost figure... Scenic's adjusted net income ................................................... Outside ownership percentage .................................................. Net income attributable to noncontrolling interest ............ 15.

$105,000 4,000 $109,000 20% $ 21,800

(20 Minutes) (Consolidation entries and noncontrolling interest balances affected by inventory transfers.) a. Conversion from Markup on Cost to Gross Profit Rate Markup (given as a percentage of cost) ............................. Convert to gross profit rate [.25  (1.00 + 0.25)] ................. Noncontrolling Interest's Share of Consolidated Net Income Reported net income of subsidiary—2024.......................... 2023 intra-entity gross profit recognized in 2024 ($250,000 × 30% × 20%) .................................................. 2024 intra-entity gross profit deferred ($300,000 × 30% × 20%) .................................................. Adjusted net income of subsidiary—2024 ......................... Outside ownership ............................................................... Net income attributable to noncontrolling interest ............

25% 20% $160,000 15,000 (18,000) $157,000 40% $ 62,800

b. Entry *G Retained earnings, Jan. 1 (subsidiary) ....................... 15,000 Cost of goods sold ............................................... 15,000 To remove intra-entity gross profit from previous year so that it can be recognized in current year.

Chapter 05 – Consolidated Financial Statements – Intra-Entity Asset Transactions – Hoyle, Schaefer, Doupnik, Advanced Accounting, 15e

Entry Tl Sales ............................................................................. 300,000 Cost of goods sold ............................................... To eliminate intra-entity inventory sale and purchase.

300,000

Entry G Cost of goods sold ........................................................18,000 Inventory ................................................................ 18,000 To remove effects of current year intra-entity gross profit in inventory. 16.

(30 Minutes) (Compute selected balances based on three different intra-entity asset transfer scenarios) a. Consolidated Cost of Goods Sold Protrade‘s cost of goods sold................................................. Seacraft‘s cost of goods sold ................................................. Elimination of 2024 intra-entity transfers............................... Recognized gross profit deferred in 2023 (2024 beginning inventory) $52,000 transfer price ÷ 1.6 = $32,500 cost $52,000 – $32,500 = $19,500 intra-entity gross profit....... Deferral of 2024 intra-entity gross profit in ending inventory: $66,000 transfer price ÷ 1.6 = $41,250 cost $66,000 – $41,250 = $24,750 intra-entity gross profit....... Consolidated cost of goods sold............................................ Consolidated Inventory Protrade book value ........................................................... Seacraft book value ............................................................ Defer ending intra-entity gross profit (see above) ........... Consolidated Inventory ......................................................

$410,000 317,000 (134,000)

(19,500)

24,750 $598,250 $370,000 144,000 (24,750) $489,250

Net income attributable to noncontrolling interest: Because all intra-entity sales were downstream, the deferrals do not affect Seacraft. Thus, the noncontrolling interest share is 20% of the $154,000 reported net income (revenues minus cost of goods sold and expenses) or $30,800. b. Consolidated Cost of Goods Sold Protrade book value................................................................. Seacraft book value ................................................................. Elimination of 2024 intra-entity transfers............................... Recognized gross profit deferred in 2023 (2024 beginning inventory)

$410,000 317,000 (104,000)

Chapter 05 – Consolidated Financial Statements – Intra-Entity Asset Transactions – Hoyle, Schaefer, Doupnik, Advanced Accounting, 15e

$45,000 transfer price ÷ 1.6 = $28,125 cost $45,000 – $28,125 = $16,875 intra-entity gross profit ..... (16,875) Deferral of 2024 intra-entity gross profit in ending inventory: $59,000 transfer price ÷ 1.6 = $36,875 cost $59,000 – $36,875 = $22,125 intra-entity gross profit ..... 22,125 Consolidated cost of goods sold ................................................... $628,250 16. b. (continued) Consolidated inventory Protrade book value................................................................... Seacraft book value ................................................................... Defer ending intra-entity gross profit (see above) ................... Consolidated inventory ..............................................................

$370,000 144,000 (22,125) $491,875

Net income attributable to noncontrolling interest Since all intra-entity sales are upstream, the effect on Seacraft's net income must be reflected in the noncontrolling interest computation: Seacraft reported net income.................................................... 2023 intra-entity gross profit recognized in 2024 (above) ...... 2024 intra-entity gross profit deferred until 2025 (above) ....... Seacraft adjusted net income ................................................... Outside ownership percentage .................................................. Net income attributable to noncontrolling interest ..................

$154,000 16,875 (22,125) $148,750 20% $ 29,750

c. Consolidated buildings (net): Protrade‘s buildings .......................................... Seacraft's buildings ........................................... Remove write-up created by transfer ($128,000 – $74,000) ...................................... Remove excess depreciation created by transfer ($54,000 intra-entity gain ÷ 5-year remaining life × 2 years) ............................... Consolidated buildings (net) ...............................

$382,000 181,000 $(54,000)

21,600

(32,400) $530,600

Protrade‘s book value ............................................................... Seacraft's book value ............................................................... Remove excess depreciation on transferred building ($54,000 intra-entity gain ÷ 5 year remaining life) .............. Consolidated expenses .............................................................

$174,000 129,000

Consolidated expenses:

(10,800) $292,200

Chapter 05 – Consolidated Financial Statements – Intra-Entity Asset Transactions – Hoyle, Schaefer, Doupnik, Advanced Accounting, 15e

Net income attributable to noncontrolling interest: Because the transfer was made downstream, it has no effect on the noncontrolling interest. Thus, Seacraft's reported net income ($154,000 computed as revenues minus cost of goods sold and expenses) is used for this computation. The 20 percent outside ownership will be allotted consolidated net income of $30,800 (20% × $154,000). 17.

(15 Minutes) (Prepare consolidated income statement with a wholly-owned subsidiary, includes transfers) a. In this consolidated entity, the direction of the intra-entity transfers (either upstream or downstream) is not important to the consolidated totals. Because Akron controls all of Toledo's outstanding stock, no noncontrolling interest figures are computed. If present, noncontrolling interest balances are affected by upstream sales but not by downstream. For purposes of a 2024 consolidation, the following worksheet entries would affect income statement balances: Entry *G Retained earnings, 1/1/24 (seller) ....... 17,500 Cost of goods sold ......................... 17,500 To remove 2023 intra-entity gross profit from beginning account balances. Gross profit is the 25% gross profit rate ($80,000 ÷ $320,000) multiplied by remaining inventory ($70,000). Entry E Amortization expense........................... 15,000 Patented technology ...................... 15,000 To recognize excess amortization expense for the current period. Entry Tl Sales ...................................................... 320,000 Cost of goods sold ......................... To eliminate intra-entity transfers of inventory during 2024.

320,000

Entry G Cost of goods sold .............................. 12,500 Inventory ......................................... 12,500 To remove 2024 intra-entity gross profit from ending account balances. Gross profit is the 25% gross profit rate ($80,000 ÷ $320,000) multiplied by remaining inventory ($50,000). b. By including the impact of each of these four consolidation entries, the following income statement can be created from the individual account balances:

Chapter 05 – Consolidated Financial Statements – Intra-Entity Asset Transactions – Hoyle, Schaefer, Doupnik, Advanced Accounting, 15e

AKRON, INC. AND CONSOLIDATED SUBSIDIARY Income Statement Year Ending December 31, 2024 Sales..................................................................................... Cost of goods sold.............................................................. Gross profit ................................................................... Operating expenses............................................................ Consolidated net income ............................................. 18.

$1,380,000 575,000 805,000 635,000 $ 170,000

(60 minutes) (Downstream intra-entity asset transfer when parent uses equity method and when a noncontrolling interest is present) a. Investment account: Consideration paid (fair value) 1/1/23 Netspeed‘s reported net income for 2023 $80,000 Database amortization (12,000) Netspeed‘s adjusted net income $68,000 Quickport's ownership percentage 90% Quickport's share of Netspeed‘s net income $61,200 Gain on equipment transfer deferral (3,000) Depreciation adjustment (6 months) 500 Equity in earnings of Netspeed Company, Quickport‘s share of Netspeed‘s dividends (90%) Balance 12/31/23 Netspeed‘s reported net income for 2024 $115,000 Database amortization (12,000) Netspeed‘s adjusted 2024 net income $103,000 Quickport's ownership percentage 90% Quickport's share of Netspeed net income $ 92,700 Depreciation adjustment 1,000 Equity in earnings of Netspeed Company, 2024 Quickport‘s share of Netspeed‘s dividends, 2024 (90%) Balance 12/31/24

$810,000

$58,700 (7,200) $861,500

$93,700 (7,200) $948,000

b. 12/31/24 Worksheet Adjustments *TA Equipment 6,000 Investment in Netspeed 2,500 Accumulated depreciation 8,500 To transfer the intra-entity equipment reduction (as of Jan. 1, 2024) from the Investment account to the equipment and A.D. accounts. S

Common stock—Netspeed

800,000

Retained earnings—Netspeed

112,000

Investment in Netspeed

820,800

Noncontrolling interest

91,200

Database

48,000 5-22

Chapter 05 – Consolidated Financial Statements – Intra-Entity Asset Transactions – Hoyle, Schaefer, Doupnik, Advanced Accounting, 15e

Investment in Netspeed

43,200

Noncontrolling interest

4,800

Equity in earnings of Netspeed

93,700

Investment in Netspeed D

93,700

Investment in Netspeed

7,200

Dividends declared E

7,200

Amortization expense

12,000

Database

12,000

ED Accumulated depreciation

1,000

Depreciation expense 19.

1,000

(20 Minutes) (Consolidation entries for intra-entity equipment transfer.) INDIVIDUAL RECORDS BASED ON TRANSFER PRICE 12/31/22

Equipment = $95,000 Gain on transfer = $45,000 ($95,000 – $50,000) Depreciation expense = $19,000 ($95,000 ÷ 5 years) Accumulated depreciation = $19,000

12/31/23

Depreciation expense $19,000 Accumulated depreciation = $38,000 (2 years)

12/31/24

Effect on retained earnings, 1/1/24 = $7,000 credit balance (gain less two years depreciation) Depreciation expense = $19,000 Accumulated depreciation = $57,000 (3 years)

CONSOLIDATED REPORTING BASED ON HISTORICAL COST 12/31/22

Equipment = $130,000 Depreciation expense = $10,000 ($50,000 ÷ 5 years) Accumulated depreciation = $90,000 ($80,000 + $10,000)

12/31/23

Depreciation expense = $10,000 Accumulated depreciation = $100,000 ($90,000 + $10,000)

12/31/24

Effect on retained earnings, 1/1/24 = ($20,000) (two years depreciation) Depreciation expense = $10,000 Accumulated depreciation = $110,000 ($100,000 + $10,000)

Entry *TA

Retained earnings, 1/1/24 (Padre) ........................... 27,000 Equipment ($130,000 – $95,000) ............................. 35,000 Accumulated depreciation ($100,000 – $38,000) ......

62,000

Chapter 05 – Consolidated Financial Statements – Intra-Entity Asset Transactions – Hoyle, Schaefer, Doupnik, Advanced Accounting, 15e

To adjust to 1/1/24 balances for consolidated entity. Retained earnings adjustment reduces $7,000 credit balance to $20,000 debit balance. Entry ED

Accumulated depreciation .................................................... 9,000 Depreciation expense .................................................

9,000

To remove excess current year depreciation to reflect historical depreciation ($10,000) instead of transfer price ($19,000). Consolidated net income is increased by $9,000 (current year portion of intra-entity gain). 20.

(20 Minutes) (Determine consolidated net income when an intra-entity transfer of equipment occurs. Includes an outside ownership) a. Net income—Ackerman ......................................................... Net income—Brannigan.......................................................... Excess amortization for unpatented technology ................. Remove intra-entity gain on equipment ............................... ($200,000 – $110,000) Remove excess depreciation created by inflated transfer price ($90,000 ÷ 5) ................................. Consolidated net income .......................................................

$300,000 98,000 (4,000) (90,000)

18,000 $322,000

b. $322,000 Net income calculated in (part a.) ......................................... Net income attributable to noncontrolling interest: Net income—Brannigan ......................................... $98,000 Excess amortization ............................................... (4,000) Adjusted net income ............................................... $94,000 NI attributable to the noncontrolling interest ........ 10% (9,400) Consolidated net income to parent company....................... $312,600 c. Net income calculated in (part a.) ......................................... $322,000 NI attributable to noncontrolling interest (see Schedule 1). (2,200) Consolidated net income to parent company....................... $319,800 Schedule 1: Net income attributable to noncontrolling interest (includes upstream transfer) Reported subsidiary net income............................................ Excess amortization ............................................................... Defer intra-entity gain on equipment transfer ..................... Eliminate excess depreciation ($90,000 ÷ 5) ........................ Brannigan's adjusted net income ......................................... Outside ownership ................................................................. Net income attributable to noncontrolling interest ........

$98,000 (4,000) (90,000) 18,000 $22,000 10% $ 2,200

Chapter 05 – Consolidated Financial Statements – Intra-Entity Asset Transactions – Hoyle, Schaefer, Doupnik, Advanced Accounting, 15e

d. Net income 2025—Ackerman ................................................ Net income 2025—Brannigan ................................................ Excess amortization ............................................................... Eliminate excess depreciation stemming from transfer ($90,000 gain ÷ 5 years) (year after transfer) .................. Consolidated net income ....................................................... 21.

320,000 108,000 (4,000) 18,000 $442,000

(35 minutes) (Compute consolidated totals with transfers of both inventory and a building.) Excess Amortization Expenses Equipment $60,000 ÷ 10 years = $ 6,000 per year Franchises $80,000 ÷ 20 years = 4,000 per year Annual excess amortizations $10,000 Intra-entity Gross Profit—Inventory, 1/1/24: Gross profit ($80,000 – $48,000) ........................................... Gross profit rate ($32,000 ÷ $80,000) ....................................

$32,000 40%

Remaining inventory .............................................................. Gross profit rate ..................................................................... Intra-entity gross profit in beginning inventory, 1/1/24 .......

$35,000 40% $ 14,000

Intra-entity Gross Profit—Inventory, 12/31/24: Gross profit ($92,000 – $69,000) ........................................... Gross profit rate ($23,000 ÷ $92,000) ....................................

$23,000 25%

Remaining inventory .............................................................. Gross profit rate ...................................................................... Intra-entity gross profit in ending inventory, 12/31/24 ........

$50,000 25% $12,500

Impact of Intra-Entity Building Transfer: 12/31/23—Transfer price figures Transfer price .................................................................... Gain on transfer ($50,000 – $30,000) ............................... Depreciation expense ($50,000 ÷ 5 years) ...................... Accumulated depreciation ............................................... 12/31/24—Transfer price figures Depreciation expense ....................................................... Accumulated depreciation ............................................... 12/31/23—Historical cost figures Historical cost ................................................................... Depreciation expense ($30,000 book value ÷ 5 years) ... Accumulated depreciation ($40,000 + $6,000) ................ 12/31/24—Historical cost figures Depreciation expense .......................................................

$50,000 20,000 10,000 10,000 10,000 20,000 $70,000 6,000 46,000 6,000

Chapter 05 – Consolidated Financial Statements – Intra-Entity Asset Transactions – Hoyle, Schaefer, Doupnik, Advanced Accounting, 15e

Accumulated depreciation ...............................................

52,000

21. (continued) CONSOLIDATED BALANCES

22.



Sales = $1,008,000 (add the two book values and subtract $92,000 in intraentity transfers)



Cost of Goods Sold = $566,500 (add the two book values and subtract $92,000 in intra-entity purchases. Subtract $14,000 because of the previous year deferred intra-entity gross profit and add $12,500 to defer the current year intra-entity gross profit in ending inventory.)



Operating Expenses = $206,000 (add the two book values and include the $10,000 excess amortization expenses but remove the $4,000 in excess depreciation expense [$10,000 – $6,000] created by building transfer)



Investment Income = $0 (the intra-entity balance is removed because the individual revenue and expense accounts of the subsidiary are included for consolidation)



Inventory = $287,500 (add the two book values and subtract the $12,500 ending intra-entity gross profit)



Equipment (net) = $292,000 (add the two book values and include the $60,000 allocation from the acquisition-date fair value less three years of excess amortizations)



Buildings (net) = $528,000 (add the two book values and subtract the $20,000 intra-entity gain on the transfer after two years of excess depreciation [$4,000 per year])

(35 Minutes) (Prepare consolidation entries for a consolidated entity with intra-entity inventory and equipment transfers; includes an outside ownership.) a. Entry *G Retained earnings, 1/1/24 (Sledge) ............... 2,000 Cost of goods sold ................................... 2,000 To remove intra-entity gross profit from beginning account balances. (40% gross profit rate ($6,000 ÷ $15,000) × remaining inventory ($5,000). Entry *TA Equipment ....................................................... Investment in Sledge .....................................

4,000 2,400

Chapter 05 – Consolidated Financial Statements – Intra-Entity Asset Transactions – Hoyle, Schaefer, Doupnik, Advanced Accounting, 15e

Accumulated depreciation ....................... 6,400 To adjust the equipment balance to original cost ($16,000) and to adjust accumulated depreciation to the consolidated January 1, 2024 balance ($7,000 less $600 extra depreciation in 2023). The $2,400 debit to the Investment account transfers the reduction in the net book value of the transferred equipment to the equipment and A.D. accounts. The Investment account was reduced by $3,000 in 2023 for the original intra-entity gain and increased by $600 in 2023 for the extra depreciation ($3,000 gain ÷ 5 years) through application of the equity method. Entry ED (below) completes the adjustment of A.D. and depreciation expense to their consolidated December 31, 2024 balances. Entry S Common stock (Sledge) ............................................. 120,000 Retained earnings, 1/1/24 (adjusted) (Sledge) .......... 258,000 Investment in Sledge (80%) ................................. 302,400 Noncontrolling interest in Sledge, 1/1/24 (20%).. 75,600 To eliminate subsidiary's stockholders' equity accounts (after adjustment for Entry *G) and recognize noncontrolling interest balance as of January 1, 2024. Entry A Contracts ($60,000 – $3,000 for 2 years) ..................... 54,000 Buildings ($20,000 – $2,000 for 2 years) ..................... 16,000 Investment in Sledge (80%) .................................. 56,000 Noncontrolling interest in Sledge, 1/1/24 (20%).. 14,000 To recognize acquisition-date fair value allocations adjusted for 2 years of amortization (2022 and 2023). 22. (continued) Entry I Equity in income of Sledge .......................................... 10,600 Investment in Sledge ............................................ To remove parent‘s equity method income.

10,600*

*Subsidiary reported net income .............................................................. $20,000 Recognize upstream intra-entity gross profit in beg. inventory .... Intra-entity inventory year-end 2023 (upstream) Gross profit rate ($6,000 ÷ 15,000) Intra-entity gross profit in 2024 beginning inventory

$5,000 .40 $2,000

Defer upstream intra-entity gross profit in ending inventory ......... Intra-entity inventory year-end 2024 (upstream)

2,000

(4,500)

$10,000

Chapter 05 – Consolidated Financial Statements – Intra-Entity Asset Transactions – Hoyle, Schaefer, Doupnik, Advanced Accounting, 15e Gross profit rate ($9,000 ÷ 20,000) Intra-entity gross profit in 2024 ending inventory

.45 $ 4,500

Excess amortization .......................................................................... 2024 adjusted subsidiary net income............................................... Parent‘s ownership percentage ........................................................ Parent‘s share of subsidiary adjusted net income .......................... Depreciation adjustment from 2023 downstream fixed asset sale.

(5,000) $12,500 80% $10,000 600

Intra-entity gain recognition from downstream fixed asset sale: $3,000 intra-entity profit ÷ 5 years = $600 per year.

Parent‘s recorded 2024 equity income from subsidiary.......................... $10,600

Entry E Depreciation expense................................................ Amortization expense................................................ Contracts ($60,000 ÷ 20 years) ............................ Buildings ($20,000 ÷ 10 years) ............................ To recognize 2024 excess amortizations.

2,000 3,000

Entry TI Sales ................................................................................ 20,000 Cost of goods sold ............................................... To eliminate intra-entity inventory transfers during 2024.

3,000 2,000

20,000

Entry G Cost of goods sold .................................................... 4,500 Inventory ............................................................... 4,500 To remove intra-entity gross profit from ending account balances. (45% gross profit rate ($9,000 ÷ $20,000) × remaining inventory ($10,000). 22. (continued) Entry ED Accumulated depreciation ....................................... 600 Depreciation expense ......................................... 600 To eliminate excess depreciation on equipment recorded at transfer price. Expense is being reduced from the recorded amount ($2,400 or $12,000 ÷ 5) to historical cost figure ($1,800 or $9,000 ÷ 5). Also increases consolidated net income to recognize the 2024 portion of the deferred intra-entity gain. b. Net income attributable to noncontrolling interest (2024) Revenues .................................................................................... Cost of goods sold .................................................................... Other expenses .........................................................................

$130,000 (70,000) (40,000)

Chapter 05 – Consolidated Financial Statements – Intra-Entity Asset Transactions – Hoyle, Schaefer, Doupnik, Advanced Accounting, 15e

Excess acquisition-date fair value amortization ..................... Net income adjusted for amortization................................. Gross profit on 2023 upstream inventory transfer recognized in 2024 (Entry *G) ................................... Gross profit on 2024 upstream inventory transfer deferred until 2025 (Entry G)..................................... Adjusted net income of subsidiary—2024 ............................... Outside ownership .................................................................... Net income attributable to noncontrolling interest............ 23.

(5,000) $15,000 2,000 4,500) $12,500 20% $ 2,500

(65 Minutes) (Determine consolidation totals after answering a series of questions about combination and intra-entity inventory transfers) a. Consideration transferred .......................... Noncontrolling interest fair value .............. Subsidiary fair value at acquisition-date.. Book value ................................................... Fair value in excess of book value ............

Excess fair value assignments To building To patented technology Totals

$342,000 38,000 380,000 (326,000) $54,000 Remaining Life

18,000 36,000 -0-

Amortizations Annual Excess

9 yrs. 6 yrs.

$2,000 6,000 $8,000

b. Because Brey sold inventory to Pitino, the transfers are upstream. c.

Gross profit on 2023 transfers ($135,000 – $81,000) .............. Gross profit percentage ($54,000 ÷ $135,000) ........................

$54,000 40%

Inventory remaining, 12/31/23 ................................................... Gross profit percentage ............................................................ Intra-entity gross profit in inventory, Jan. 1, 2024 ..................

$37,500 40% $15,000

Gross profit on 2024 transfers ($160,000 – $92,800) .............. Gross profit percentage ($67,200 ÷ $160,000) ........................

$67,200 42%

Inventory remaining, 12/31/24 ................................................... Gross profit percentage ............................................................ Intra-entity gross profit in inventory, Dec. 31, 2024 ...............

$50,000 42% $21,000

e. Pitino is applying the equity method because the $68,400 equals neither 90% of Brey's reported net income nor 90% of the dividends declared by Brey. Brey‘s reported net income ......................................................

$90,000

Chapter 05 – Consolidated Financial Statements – Intra-Entity Asset Transactions – Hoyle, Schaefer, Doupnik, Advanced Accounting, 15e

Excess fair value amortization.................................................. Recognized gross profit ............................................................ Deferred gross profit ................................................................. Adjusted subsidiary net income ............................................... Ownership .................................................................................. Equity in earnings of Brey ........................................................

(8,000) 15,000 (21,000) $76,000 90% $68,400

Brey‘s adjusted net income (see e.) ........................................ Outside ownership .................................................................... Net income attributable to noncontrolling interest ................

$76,000 10% $ 7,600

23. (continued) g. Investment in Brey (consideration transferred).................. $342,000 Net income of Brey Reported 2022 .................................................. $64,000 2023 ............................................................. 80,000 2024 ............................................................. 90,000 Total............................................................. 234,000 Intra-entity gross profit, 12/31/24(see d.) ....... (21,000) Adjusted net income 2022-2024 ..................... 213,000 Pitino‘s ownership ........................................... 90% 191,700 Excess amortizations ($8,000 × 3 years × 90%).. (21,600) Dividends declared by Brey 2022 ................................................................$19,000 2023 ................................................................23,000 2024 ................................................................ 27,000 Total ..................................................................69,000 Pitino's ownership ............................................. Investment in Brey, 12/31/24 ................................

90%

(62,100) $450,000

h. Entry S Common stock (Brey) .......................................... Retained earnings, 1/1/24 (Brey) (reduced by 1/1/24 intra-entity gross profit) ............................ Investment in Brey (90%) ................................ Noncontrolling interest in Brey (10%) ..

150,000 263,000 371,700 41,300

i. 

Sales revenue = $1,068,000 (total less $160,000 intra-entity sales)



Cost of Goods Sold = $570,000 (add book values less $160,000 in intraentity purchases. Also, adjust for 2023 intra-entity gross profit in inventory [subtract $15,000] and 2024 intra-entity gross profit in inventory 5-30

Chapter 05 – Consolidated Financial Statements – Intra-Entity Asset Transactions – Hoyle, Schaefer, Doupnik, Advanced Accounting, 15e

[add $21,000]) 

Expenses = $260,400 (add book values with $8,000 amortization for excess fair value allocations)



Equity in Earnings of Brey = $0 (intra-entity balance is eliminated because individual revenue and expense accounts of the subsidiary are included in consolidated totals)



Consolidated Net Income = $237,600 (consolidated revenues less COGS and expenses)



Net Income Attributable to Noncontrolling Interest = $7,600 (see f.)



Net Income to Pitino (parent) = $230,000 (consolidated revenues less consolidated cost of goods sold, expenses, and the net income attributable to the noncontrolling interest)

23. (continued) part i. 

Retained Earnings, 1/1 = $488,000 (parent equity method balance)



Dividends Declared = $136,000 (parent balance only)



Retained Earnings, 12/31 = $582,000 (consolidated beginning balance plus net income less dividends declared)



Cash and Receivables = $228,000 (total less $16,000 intra-entity balance)



Inventory = $370,000 (total less ending intra-entity gross profit)



Investment in Brey = $0 (intra-entity balance is eliminated because the individual assets and liabilities of the subsidiary are reported)



Land, Buildings, and Equipment = $1,304,000 (add book values and include a $12,000 net allocation after 3 years of amortization)



Patented Technology = $18,000 (original allocation after 3 years of amortization [$6,000 per year])



Total Assets = $1,920,000 (add consolidated figures)



Liabilities = $773,000 (add book values less $16,000 intra-entity balance)



Noncontrolling Interest in Brey, 12/31 = $50,000 ([10% of subsidiary's book value at beginning of period plus unamortized excess less beginning intra-entity gross profit] plus 10% of the subsidiary's adjusted net income less 10% of subsidiary dividends).



Common Stock = $515,000 (parent balance only)



Retained Earnings, 12/31 = $582,000 (see above)



Total Liabilities and Stockholders' Equity = $1,920,000 (summation)

Chapter 05 – Consolidated Financial Statements – Intra-Entity Asset Transactions – Hoyle, Schaefer, Doupnik, Advanced Accounting, 15e

24.

(20 Minutes) (Computation of selected consolidation balances as affected by downstream inventory transfers) INTRA-ENTITY GROSS PROFIT, 12/31/23: (downstream transfer) Intra-entity gross profit ($120,000 – $72,000) ............... Inventory remaining at year's end ................................ Intra-entity gross profit in inventory, 12/31/23 ..................

$48,000 30% $14,400

INTRA-ENTITY GROSS PROFIT, 12/31/24: (downstream transfer) Intra-entity gross profit ($250,000 – $200,000) ............. Inventory remaining at year's end ................................ Intra-entity gross profit in inventory, 12/31/24 ..................

$50,000 10% $5,000

CONSOLIDATED TOTALS  Sales = $1,150,000 (combine amounts and eliminate intra-entity sales of $250,000) 

25.

Cost of goods sold: Proform's COGS book value ..................................................... ClipRite's COGS book value...................................................... Eliminate intra-entity transfers ................................................ Adjusted gross profit deferred in 2023 .................................... Deferral of 2024 intra-entity gross profit ................................. Cost of goods sold ..............................................................

$535,000 400,000 (250,000) (14,400) 5,000 $675,600



Operating expenses = $210,000 (add the two book values and include intangible amortization for current year)



Dividend income = -0- (intra-entity transfer eliminated in consolidation)



Net income attributable to noncontrolling interest: (impact of transfers is not included because they were downstream) ClipRite reported net income for 2024 ............................... $100,000 Intangible amortization......................................................... (10,000) ClipRite adjusted net income............................................... 90,000 Outside ownership ............................................................... 30% Net income attributable to noncontrolling interest ....... $27,000



Inventory = $985,000 (combine amounts less the $5,000 ending intraentity gross profit)



Noncontrolling interest in subsidiary 30% beginning $950,000 book value ................................... Excess January 1 intangible allocation (30% × $395,000). Net income attributable to noncontrolling interest............ Dividends (30% × $50,000) ................................................... Total noncontrolling interest at 12/31/24 ............................

$285,000 118,500 27,000 (15,000) $415,500

(25 Minutes) (Computation of selected consolidation balances as affected by upstream inventory transfers) 5-32 © McGraw Hill LLC. All rights reserved. No reproduction or distribution without the prior written consent of McGraw Hill LLC.

Chapter 05 – Consolidated Financial Statements – Intra-Entity Asset Transactions – Hoyle, Schaefer, Doupnik, Advanced Accounting, 15e

INTRA-ENTITY GROSS PROFIT, 12/31/23: (upstream transfer) Intra-entity gross profit ($120,000 – $72,000) ............... Inventory remaining at year's end ................................ Intra-entity gross profit in inventory, 12/31/23 .............................

$48,000 30% $14,400

INTRA-ENTITY GROSS PROFIT, 12/31/24: (upstream transfer) Intra-entity gross profit ($250,000 – $200,000) ............. Inventory remaining at year's end ................................ Intra-entity gross profit in inventory, 12/31/24 .............................

$50,000 10% $ 5,000

CONSOLIDATED TOTALS  Sales = $1,150,000 (combine amounts and eliminate intra-entity transfer)  Cost of goods sold: Proform's COGS book value .................................................... $535,000 ClipRite's COGS book value ..................................................... 400,000 Eliminate intra-entity transfers ................................................ (250,000) Recognized gross profit deferred in 2023 ............................... (14,400) Deferral of 2024 Intra-entity gross profit in inventory............. 5,000 Consolidated cost of goods sold ....................................... $675,600  Operating expenses = $210,000 (combine amounts and include intangible amortization for current year)  Dividend income = -0- (intra-entity transfer eliminated in consolidation)  Net income attributable to noncontrolling interest: (impact of transfers is included because they were upstream) ClipRite reported net income for 2024...................................... $100,000 Intangible amortization......................................................... (10,000) 2023 gross profit recognized in 2024 ................................. 14,400 2024 gross profit deferred ................................................... (5,000) ClipRite adjusted net income for 2024 ................................ $99,400 Outside ownership ............................................................... 30% Net income attributable to noncontrolling interest ........... $29,820  Inventory = $985,000 (combine amounts and defer the $5,000 ending intraentity gross profit)  Noncontrolling interest in subsidiary, 12/31/24 30% beginning book value less $14,400 intra-entity gross profit (30% × $935,600)...................... $280,680 Excess intangible allocation (30% × $395,000) .................. 118,500 Net income attributable to noncontrolling interest............ 29,820

26.

Dividends (30% × $50,000) ...........................................................

(15,000)

Total noncontrolling interest at 12/31/24 ............................

$414,000

(75 Minutes) (Determine consolidated balances after impact of upstream Inventory transfers and downstream transfer of building. Parent uses initial value method.) PRELIMINARY COMPUTATIONS Consideration transferred .......................... $657,000 5-33 © McGraw Hill LLC. All rights reserved. No reproduction or distribution without the prior written consent of McGraw Hill LLC.

Chapter 05 – Consolidated Financial Statements – Intra-Entity Asset Transactions – Hoyle, Schaefer, Doupnik, Advanced Accounting, 15e

Noncontrolling interest fair value .................. 73,000 Subsidiary fair value at acquisition-date . 730,000 Book value .................................................. (620,000) Fair value in excess of book value ............ $110,000 Excess fair value assignments Remaining Life to equipment 20,000 4 yrs. to liabilities 40,000 5 yrs. to brand names 50,000 10 yrs. Totals -0-

Annual Excess Amortizations

$5,000 8,000 5,000 $18,000

Determination of subsidiary book value on 1/1/23 Book value, 1/1/24 (based on stockholders' equity accounts) Eliminate net income – 2023 .................................................... Eliminate dividends – 2023 ....................................................... Book value, 1/1/23 ..............................................................

$700,000 (80,000) -0$620,000

Beginning inventory intra-entity gross profit, 12/31/23 (Upstream) Ending Inventory ($145,000 × 30%) ......................................... Gross profit rate (given) ........................................................... Intra-entity gross profit in inventory, 12/31/23 ........................

$43,500 20% $ 8,700

Ending inventory intra-entity gross profit, 12/31/24 (Upstream) Ending Inventory ($160,000 × 40%) ......................................... Gross profit rate (given) ........................................................... Intra-entity gross profit in inventory, 12/31/24 ........................

$64,000 20% $12,800

Building intra-entity gross profit, 1/2/23 (Downstream) Transfer price ............................................................................ Book value ................................................................................. Intra-entity gross profit .............................................................

$25,000 10,000 $15,000

Annual excess depreciation Annual depreciation based on book value ($10,000 ÷ 5 years) Annual depreciation based on transfer price ($25,000 ÷ 5 years) ............................................................... Excess annual depreciation .....................................................

$2,000 5,000 $3,000

26. (continued) Adjustment to buildings to return to historical cost at 1/1/24 Transfer Price Historical Cost Buildings Accumulated depreciation (1/1/24 balance after 1 more year of

$25,000

$100,000

Consolidation Adjustment $75,000

5,000

92,000

87,000

Chapter 05 – Consolidated Financial Statements – Intra-Entity Asset Transactions – Hoyle, Schaefer, Doupnik, Advanced Accounting, 15e

depreciation) Consolidated Totals 

Sales and other Income = $1,240,000 (add the two book values and eliminate the intra-entity transfers)



Cost of goods sold: Moore's book value .................................................................... Kirby's book value ..................................................................... Eliminate intra-entity transfers ................................................. Recognized gross profit deferred in 2023................................. Deferral of 2024 Intra-entity gross profit in inventory.............. Cost of goods sold .....................................................................

$500,000 400,000 (160,000) (8,700) 12,800 $744,100



Operating and interest expenses = $275,000 (add the two book values and include $18,000 amortization for current year but eliminate $3,000 excess depreciation from asset transfer)



Net income attributable to noncontrolling interest = $1,790 (impact of inventory transfers is included because they were upstream but building transfer is omitted because it was downstream)

Reported net income for 2024 ....................................................... Recognized gross profit deferred in 2023 ............................... Deferral of 2024 Intra-entity gross profit in inventory............. Adjusted net income of subsidiary .......................................... Excess fair value amortization.................................................. Adjusted subsidiary net income ............................................... Outside ownership ......................................................................... Net income attributable to noncontrolling interest ................. 

$40,000 8,700 (12,800) $35,900 (18,000) 17,900 10% $ 1,790

Consolidated net income = $220,900 (consolidated sales less consolidated cost of goods sold, expenses, and noncontrolling interest)  To noncontrolling interest = $1,790 (above)  To controlling interest = $219,110

26. (continued) 

Retained earnings, 1/1/24 = $1,025,970 (because the parent uses the initial value method, worksheet entries adjust its retained earnings for changes in subsidiary's book value, excess amortizations, and the impact of intraentity gross profits in previous years)

Moore's reported balance, 1/1/24 ....................................... Impact of building transfer (parent's income was overstated by the $15,000 gain but has been reduced by one prior year of excess depreciation) ........................ Adjustments to convert initial value to equity method:

$990,000

(12,000)

Chapter 05 – Consolidated Financial Statements – Intra-Entity Asset Transactions – Hoyle, Schaefer, Doupnik, Advanced Accounting, 15e

Increase in subsidiary's book value during prior years........................................................................... Excess fair value amortization ..................................... Deferral of 12/31/23 intra-entity gross profit (subsidiary's prior income was overstated) ........... Adjusted increase in book value ............................ Ownership....................................................................... Equity accrual ................................................................ Retained Earnings, 1/1/24 ........................................

$80,000 (18,000) (8,700) 53,300 90% 47,970 $1,025,970

Dividends declared = $130,000 (parent balance only) Retained Earnings, 12/31/24 = $1,115,080 (the beginning balance plus controlling interest share of consolidated net income less dividends declared) Cash and Receivables = $397,000 (add the two book values) Inventory = $371,200 (add the two book values and defer the $12,800 ending intra-entity gross profit) Investment in Kirby = -0- (eliminated for consolidation purposes) Equipment (Net) = $1,030,000 (add the two book values adjusted for excess allocation and amortization) Buildings = $1,725,000 (add the two book values and add the $75,000 impact to return to historical cost as computed above for transfer) Accumulated Depreciation = $384,000 (add the two book values plus adjustment to historical cost ($87,000 at beginning of year less $3,000 excess depreciation for current year) Other Assets = $300,000 (add the two book values) Brand Names = $40,000 (the original $50,000 allocation less two years of amortization at $5,000 per year) Total Assets = $3,479,200 (summation of the consolidated totals) Liabilities = $1,684,000 (add the two book values and subtract the original allocation [$40,000] after two years of amortization [$8,000 per year]) 26. (continued)

Noncontrolling interest 12/31/24 = $80,120 (10 percent of $691,300 adjusted beginning book value [$700,000 less $8,700 deferral of intra-entity gross profit] plus $9,200 share of beginning unamortized excess fair value allocations plus $1,790 net income share) Common Stock = $600,000 (parent balance only) Retained Earnings, 12/31/24 = $1,115,080 (computed above) Total Liabilities and Equities = $3,479,200 (summation of consolidated balances). 5-36 © McGraw Hill LLC. All rights reserved. No reproduction or distribution without the prior written consent of McGraw Hill LLC.

Chapter 05 – Consolidated Financial Statements – Intra-Entity Asset Transactions – Hoyle, Schaefer, Doupnik, Advanced Accounting, 15e

The same consolidation balances can be derived using a worksheet and the following adjusting and eliminating entries: CONSOLIDATION ENTRIES Entry *G Retained earnings, 1/1/24 (Kirby) ....................... 8,700 Cost of goods sold ........................................ (To recognize 2023 deferred gross profit as income in 2024) Entry *TA Building................................................................. Retained earnings, 1/1/24 (Moore) ..................... Accumulated depreciation ............................ (To adjust 1/1/24 balance to historical cost figures)

8,700

75,000 12,000

Entry *C Investment in Kirby ............................................. 47,970 Retained earnings, 1/1/24 (Moore) ................ (To convert from initial value to equity method as follows:) Increase in subsidiary's book value during prior years (income of $80,000) .......................................................... Excess amortization for 2023.............................................. Deferral of 12/31/23 intra-entity gross profit ...................... Recognized increase in subsidiary's book value .............. Ownership ........................................................................... Conversion to equity method (full accrual) adjustment....

87,000

47,970

$80,000 (18,000) (8,700) $53,300 90% $47,970

S Common stock (Kirby) ........................................ 150,000 541,300 Retained earnings, 1/1/24 as adjusted (Kirby) ... 622,170 Investment in Kirby (90%) ............................. Noncontrolling interest in Kirby (10%) ......... 69,130 (To eliminate subsidiary's beginning stockholders' equity accounts and recognize beginning noncontrolling interest balance) 26. (continued)

A Liabilities .............................................................. 32,000 Equipment ............................................................ 15,000 Brand names ....................................................... 45,000 Investment in Kirby ........................................ 82,800 Noncontrolling interest in Kirby (10%) ......... 9,200 (To recognize unamortized balance of excess allocations as of 1/1/24. Figures have been reduced by one year of amortization) Entry I (the subsidiary declared no dividends so no adjustment needed)

Chapter 05 – Consolidated Financial Statements – Intra-Entity Asset Transactions – Hoyle, Schaefer, Doupnik, Advanced Accounting, 15e

E Operating and interest expense.......................... 18,000 Liabilities .............................................................. Equipment............................................................. Brand names ....................................................... (To recognize excess amortization expenses for current year) Tl Sales ..................................................................... Cost of goods sold .............................................. (To eliminate intra-entity transfers for 2024)

160,000

G Cost of goods sold .............................................. Inventory .............................................................. (To defer ending intra-entity inventory gross profit)

12,800

8,000 5,000 5,000

160,000

12,800

EDAccumulated depreciation ................................. 3,000 Depreciation expense ......................................... 3,000 (To adjust depreciation for current year created by transfer of building)

Chapter 05 – Consolidated Financial Statements – Intra-Entity Asset Transactions – Hoyle, Schaefer, Doupnik, Advanced Accounting, 15e

26. continued: Worksheet (not part of requirements) Moore Company and Subsidiary Consolidated Worksheet December 31, 2024 Moore

Kirby

Consolidation Entries

Sales and other income

(800,000)

(600,000)

(TI) 160,000

Cost of goods sold

500,000

400,000

(G) 12,800

NCI

Consolidated (1,240,000)

(G*) 8,700

744,100

(TI)160,000 Op. and interest expenses

100,000

160,000

Separate company income

(200,000)

(40,000)

(E) 18,000

(ED) 3,000

275,000

Consolidated net income

(220,900)

to noncontrolling interest

(1,790)

to Moore Company Retained earnings, 1/1

1,790 (219,110)

(990,000)

(TA*) 12,000 (550,000)

(*C) 47,970

(1,025,970)

(S) 541,300 (G*) 8,700

Net income

(200,000)

Dividends declared

130,000

(1,060,000)

(590,000)

(1,115,080)

Cash and receivables

217,000

180,000

397,000

Inventory

224,000

160,000

Investment in Kirby

657,000

Retained earnings, 12/31

(40,000)

(219,110)

(*C) 47,970

(G) 12,800

371,200

(S) 622,170

(A) 82,800 Equipment (net)

600,000

420,000

(A) 15,000

Buildings

1,000,000

650,000

(TA*) 75,000

Acc. depreciation—buildings

(100,000)

(200,000)

(ED) 3,000

(TA*) 87,000

(384,000)

Brand names

(A) 45,000

(E) 5,000

40,000

Other assets

200,000

100,000

300,000

Total assets

2,798,000

1,310,000

3,479,200

Liabilities

(1,138,000)

(570,000)

(A) 32,000

(600,000)

(150,000)

(S)150,000

Common stock Noncontrolling interest , 1/1

(E) 5,000

1,725,000

(E) 8,000

(1,684,000) (600,000)

(S) 69,130 (A) 9,200

Noncontrolling interest,12/31 Retained earnings, 12/31

1,030,000

(78,330) (80,120)

(1,060,000)

(590,000)

(80,120) (1,115,080)

Chapter 05 – Consolidated Financial Statements – Intra-Entity Asset Transactions – Hoyle, Schaefer, Doupnik, Advanced Accounting, 15e Total liabilities and equity

27.

(2,798,000)

(1,310,000)

1,120,770

(3,479,200)

(55 Minutes) (Investment account balance and consolidated worksheet with downstream inventory transfers when parent uses equity method)

Acquisition-date fair value allocation and excess amortizations a. Consideration transferred................................. $372,000 Noncontrolling interest fair value..................... 248,000 Subsidiary fair value at acquisition-date ........ $620,000 Acquisition-date book value ............................. (320,000) Fair value in excess of book value .................. $300,000 Remaining Annual Excess Excess fair value assignments Life

to patents ..................................... to unpatented technology ......... to trade name ..............................

Amortizations

70,000 10 yrs. 45,000 15 yrs. $185,000 indefinite

$7,000 3,000 -0$10,000

Determination of Investment in Sheridan account balance Consideration transferred ........................... Increase in Sheridan‘s retained earnings 1/1/23 to 1/1/24 [(280,000 – 220,000) × 60%] ..................................... Excess fair value amortization × 60% ............................ 2023 ending inventory profit deferral (100%) ................ Pulaski‘s equity in earnings of Sheridan for 2024*....... Sheridan 2024 dividends declared to Pulaski ............... Investment account balance 12/31/24 ................................

$372,000 $36,000 (6,000) (10,000)

20,000 28,000 (9,000) $411,000

*Sheridan‘s 2024 net income .......................................... Excess fair value amortization ....................................... Adjusted net income ....................................................... Pulaski‘s percentage ownership .................................... Pulaski‘s share of Sheridan‘s adjusted net income ..... 2023 intra-entity inventory profit recognized ................ 2024 intra-entity inventory profit deferred..................... Pulaski‘s equity in earnings of Sheridan.......................

$60,000 (10,000) $50,000 60% $30,000 10,000 (12,000) $28,000

Intra-entity profits (downstream) Intra-entity transfers remaining in inventory Gross profit rate**

2024 $40,000 30% $12,000

2023 $50,000 20% $10,000

**(150,000 – 120,000) ÷ 150,000 = 20% (160,000 – 112,000) ÷ 160,000 = 30%

Chapter 05 – Consolidated Financial Statements – Intra-Entity Asset Transactions – Hoyle, Schaefer, Doupnik, Advanced Accounting, 15e

27. (continued) Sales Cost of goods sold

Pulaski (700,000) 460,000

Sheridan (335,000) 205,000

Consolidation (TI)160,000 (G) 12,000

Entries

NCI

(*G) 10,000

Consolidated (875,000) 507,000

(TI) 160,000 Operating expenses Equity in earnings of Sheridan Separate company net income Consolidated net income to noncontrolling interest to Pulaski, Inc.

188,000

70,000

(28,000)

(80,000)

(E) 10,000

268,000

(I) 28,000

-0-

(60,000)

(100,000) (20,000)

20,000 (80,000)

Retained earnings, 1/1 Net income (above) Dividends declared Retained earnings, 12/31

(695,000)

(280,000)

(80,000)

(60,000)

45,000

15,000

(730,000)

(325,000)

(730,000)

Cash and receivables Inventory Investment in Sheridan

248,000

148,000

396,000

233,000 411,000

129,000 -0-

(S) 280,000

(80,000) (D) 9,000

(D) 9,000 (*G) 10,000

Buildings (net) Equipment (net) Patents (net) Unpatented technology Trade name Total assets Liabilities Common stock Noncontrolling interest 1/1

Noncontrolling interest 12/31 Retained earnings, 12/31

308,000 220,000 -0-

202,000 86,000 20,000

1,420,000

585,000

(390,000) (300,000)

(160,000) (100,000)

(695,000)

(A) 63,000 (A) 42,000

6,000

(G) 12,000 (S) 228,000 (A)174,000 (I) 28,000

350,000 -0-

510,000 306,000 76,000 39,000

(E) 7,000 (E) 3,000 (A)185,000

(268,000) (282,000)

(325,000)

185,000 1,862,000 (550,000) (300,000)

(S) 100,000 (S) 152,000 (A) 116,000

(730,000)

45,000

(282,000) (730,000)

Chapter 05 – Consolidated Financial Statements – Intra-Entity Asset Transactions – Hoyle, Schaefer, Doupnik, Advanced Accounting, 15e Total liabilities and equities

28.

(1,420,000)

(585,000)

899,000

(1,862,000)

Investment balance and worksheet preparation—upstream sales, equity method

a. 2024 net income reported by Sander Excess patent fair value amortization ($350,000 ÷ 5 years) Deferred gross profit for 12/31/24 intra-entity inventory (160,000 × 25%) Recognized gross profit for 1/1/24 intra-entity inventory (125,000 × 28%) Sander‘s net income adjusted To controlling interest (80%) To noncontrolling interest (20%)

$230,000 (70,000) (40,000) 35,000 $155,000 $124,000 $31,000

b. Revenues Cost of goods sold Depreciation expense Amortization expense Interest expense Equity in earnings of Sander Separate company net income Consolidated net income to noncontrolling interest to Plymouth Corp.

Plymouth

Sander

(1,740,000) 820,000

(950,000) 500,000

(TI) 300,000 (G) 40,000

Consolidation Entries

104,000 220,000 20,000 (124,000) (700,000)

85,000 120,000 15,000

(E) 70,000

NCI

Consolidated

(2,390,000) 1,025,000

(TI)300,000 (*G) 35,000

189,000 410,000 35,000 0

(I) 124,000 (230,000) (31,000)

Retained earnings 1/1

(2,800,000)

(345,000)

Net income Dividends declared Retained earnings 12/31

(700,000) 200,000 (3,300,000)

(230,000) 25,000 (550,000)

Cash Accounts receivable Inventory Investment in Sander

535,000 575,000 990,000 1,420,000

115,000 215,000 800,000

(S) 310,000 (*G) 35,000

(2,800,000)

(D) 20,000

(731,000) 31,000 (700,000)

5,000

(700,000) 200,000 (3,300,000) 650,000 790,000 1,750,000

(G) 40,000 (S)968,000 (A)348,000 (I) 124,000

Buildings and equipment Patents Goodwill Total Assets

1,025,000 950,000

863,000 107,000

5,495,000

2,100,000

1,888,000 1,197,000 225,000 6,500,000

Accounts payable Notes payable Noncontrolling interest 1/1

(450,000) (545,000)

(200,000) (450,000)

(650,000) (995,000)

(A) 210,000 (A) 225,000

(E) 70,000

(S)242,000 (A) 87,000

(329,000)

Chapter 05 – Consolidated Financial Statements – Intra-Entity Asset Transactions – Hoyle, Schaefer, Doupnik, Advanced Accounting, 15e Noncontrolling interest 12/31 Common stock APIC Retained earnings 12/31 Total liab. and SE

29.

(355,000) (900,000) (300,000) (3,300,000) (5,495,000)

(800,000) (100,000) (550,000) (2,100,000)

(S) 800,000 (S) 100,000 2,234,000

2,234,000

(355,000) (900,000) (300,000) (3,300,000) (6,500,000)

(50 Minutes) (Prepare consolidation entries for a combination where upstream inventory transfers have occurred as well as downstream equipment transfers. Parent has applied initial value method) Consideration transferred................................. $665,000 Noncontrolling interest fair value .................... 285,000 Subsidiary fair value at acquisition-date ........ $950,000 Book value ......................................................... (800,000) Fair value in excess of book value .................. $150,000 Excess fair value Annual Excess Remaining assignments Amortizations Life to building 50,000 5 yrs. $10,000 to franchise agreements 100,000 10 yrs. 10,000 -0$20,000 Inventory Transfers (Upstream) 2023 gross profit deferred until 2024 ($12,000 × 30%) .................

$3,600

2024 gross profit deferred until 2025 ($18,000 × 30%) .................

$5,400

Equipment Transfer (Downstream) Intra-entity gain as of January 1, 2024: Intra-entity gain on transfer (1/1/23) ........................................ 2023 excess depreciation ($36,000 ÷ 6 yrs.) ........................... Intra-entity gain January 1, 2024 ....................................................

$36,000 (6,000) $30,000

Excess depreciation—2024 ($36,000 ÷ 6 yrs.) ...................................

$6,000

Entry *G Retained earnings, 1/1/24 (Young) .......................... Cost of goods sold ..............................................

3,600

To recognize upstream intra-entity inventory gross profit deferred from previous year. Entry *TA Retained earnings, 1/1/24 (Monica).......................... Equipment ($50,000 – $36,000) ................................ Accumulated depreciation ($50,000 – $6,000) ..

30,000 14,000 44,000

To return equipment accounts to beginning book value based on historical cost and to remove intra-entity gain from beginning retained earnings. 5-43 © McGraw Hill LLC. All rights reserved. No reproduction or distribution without the prior written consent of McGraw Hill LLC.

Chapter 05 – Consolidated Financial Statements – Intra-Entity Asset Transactions – Hoyle, Schaefer, Doupnik, Advanced Accounting, 15e

29. (continued) Entry *C Investment in Young ........................................... Retained earnings, 1/1/24 (Monica) ..............

123,480 123,480

Because the parent uses the initial value method, its retained earnings must be adjusted for the subsidiary's increase in book value less excess amortizations and upstream profits during 2022–2023 as follows. Retained earnings of Young, December 31, 2024 (given) Eliminate income and dividends of Young ($160,000 – $50,000) .................................................. Retained earnings of Young, December 31, 2023 ....... Removal of intra-entity gross profit (Entry *G) ............ Recognized retained earnings of Young, December 31, 2023 .................................................... Retained earnings at date of acquisition ..................... Increase in retained earnings during 2022–2023.......... Ownership percentage ................................................... Income accrual to be recognized .................................. Excess amortization for 2022–2023 ($20,000 × 70%× 2 yrs.) ENTRY *C ADJUSTMENT (above) .................................

$740,000 (110,000) 630,000 (3,600) 626,400 (410,000) 216,400 70% 151,480 (28,000) $123,480

Entry S Common stock (Young) ................................................ 300,000 Additional paid-in capital (Young) ............................... 90,000 Retained earnings, 1/1/24 (Young) (adjusted for *G) ........................................ 626,400 Investment in Young (70%) ................................ 711,480 Noncontrolling interest in Young (30%) . 304,920 To eliminate stockholders' equity accounts of subsidiary and recognize noncontrolling interest; amount of retained earnings was previously reduced by Entry *G. The $626,400 figure is computed above. Entry A Franchise agreement ......................................................... 80,000 Buildings ............................................................................. 30,000 Investment in Young ................................................ 77,000 Noncontrolling interest in Young (30%) ................. 33,000 To recognize amount paid within acquisition price for buildings and the franchise agreement. Balances have been reduced by two years of excess amortizations. 29. (continued) Entry I Dividend income ............................................................

35,000

Chapter 05 – Consolidated Financial Statements – Intra-Entity Asset Transactions – Hoyle, Schaefer, Doupnik, Advanced Accounting, 15e

Dividends declared .................................................... 35,000 To eliminate Intra-entity dividend declarations recorded by parent as income under the initial value method. Entry E Depreciation expense ..................................................... Amortization expense .................................................... Franchise agreement ............................................... Buildings ................................................................... To recognize current year excess amortization expense.

10,000 10,000 10,000 10,000

Entry Tl Sales................................................................................ 90,000 Cost of goods sold .................................................. 90,000 To remove intra-entity inventory transfers made during the current year. Entry G Cost of goods sold ........................................................ 5,400 Inventory.................................................................... 5,400 To defer intra-entity gross profit on 2024 intra-entity inventory transfers (computed above). Entry ED Accumulated depreciation ........................................... 6,000 Depreciation expense .............................................. To remove current year depreciation on transferred item since its historical cost has been fully depreciated. Noncontrolling Interest's Share of Consolidated Net Income Reported net income of Young (given) ............................. Excess fair value amortization .......................................... Recognition of 2023 intra-entity gross profit (Entry *G) .. Deferral of 2024 intra-entity gross profit (Entry G) (upstream) Adjusted net income of Young .......................................... Outside ownership percentage ......................................... Net income attributable to noncontrolling interest ......... 30.

6,000

$160,000 (20,000) 3,600 (5,400) $138,200 30% $ 41,460

(35 Minutes) (Consolidation entries with upstream Inventory transfers and downstream equipment transfers. Parent uses equity method) Entry *G (Same as Entry *G in Problem 29.) Entry *TA Investment in Young ........................................... 30,000 Equipment ............................................................ 14,000 Accumulated depreciation ............................ 44,000 To return equipment account to its book value based on historical cost. Because the parent uses the equity method and the transfer is 5-45 © McGraw Hill LLC. All rights reserved. No reproduction or distribution without the prior written consent of McGraw Hill LLC.

Chapter 05 – Consolidated Financial Statements – Intra-Entity Asset Transactions – Hoyle, Schaefer, Doupnik, Advanced Accounting, 15e

downstream, the intra-entity gain has already been removed from the parent's retained earnings. Thus, the remaining gain is eliminated here from the Investment account rather than from retained earnings. Entry *C (No Entry *C is needed because equity method has been applied.) Entry S (Same as Entry S in Problem 29.) Entry A (Same as Entry A in Problem 29.) Entry I Investment income .............................................. Investment in Young ...................................... To eliminate intra-entity income accrual.

102,740 102,740

Reported net income of Young (given) ................................... Excess fair value amortization ................................................. Recognition of 2023 intra-entity gross profit (Entry *G) ......... Deferral of 2024 intra-entity gross profit (Entry G) (upstream) Adjusted net income of Young ................................................ Outside ownership percentage ................................................ Monica‘s share of Young‘s adjusted net income .................... Depreciation adjustment for asset transfer gain..................... Equity accrual for 2024......................................................... Entry D Investment in Young ........................................... Dividends declared ........................................ To eliminate intra-entity dividend transfers.

$160,000 (20,000) 3,600 (5,400) $138,200 70% $ 96,740 6,000 $102,740

35,000 35,000

Entry E (Same as Entry E in Problem 29.) Entry TI (Same as Entry Tl in Problem 29.) Entry G (Same as Entry G in Problem 29.) Entry ED (Same as Entry ED in Problem 29.) Net income attributable to noncontrolling interest (Same as in Problem 29.) 31.

(60 Minutes) (Consolidation worksheet for combination with upstream inventory transfers and downstream transfer of land. Also asks about transfer of a building. Parent uses partial equity method.) Consideration transferred................................. Noncontrolling interest fair value .................... Subsidiary fair value at acquisition-date ........ Book value ......................................................... Fair value in excess of book value ..................

$570,000 380,000 $950,000 (850,000) $100,000

Chapter 05 – Consolidated Financial Statements – Intra-Entity Asset Transactions – Hoyle, Schaefer, Doupnik, Advanced Accounting, 15e

Excess fair value assignment to trademark

Remaining Life

Annual Excess Amortization

100,000 20 yrs. -0-

$5,000

a. CONSOLIDATION ENTRIES Entry *TL Retained earnings, 1/1/24 (Abbey) ............................... 40,000 Land .................................................................... 40,000 To remove intra-entity gain on Intra-entity downstream transfer of land made in 2023. Entry *G Retained earnings, 1/1/24 (Bellstar) ............................ 10,000 Cost of goods sold ............................................. 10,000 To defer intra-entity upstream Inventory gross profit from 2023 until 2024 ($150,000 − $100,000 = $50,000 total gross profit × 20% inventory remaining = $10,000). Entry *C Retained earnings, 1/1/24 (Abbey) .......................... Investment in Bellstar ........................................

9,000 9,000

Parent is applying the partial equity method as can be seen by the amount in the Equity in earnings of Bellstar Company account (60 percent of the reported balance). Thus, the parent‘s share of amortization of $3,000 ($100,000 divided by 20 years × 60%) must be recognized for the previous year 2023. In addition, the equity accrual recorded by the parent has been based on Bellstar's reported net income. As shown in Entry *G, $10,000 of that reported net income relates to intra-entity ending inventory as of January 1, 2024. Thus, the previous accrual must be reduced by $6,000 to mirror the parent's 60% ownership. The total of the two adjustments being made here is $9,000. 31. (continued) Entry S Common stock (Bellstar) ........................................... 320,000 Additional paid-in capital ............................................. 90,000 Retained earnings, 1/1/24 (Bellstar) (adjusted for Entry *G) ........................................................... 610,000 Investment in Bellstar (60%) ....................... 612,000 Noncontrolling interest in Bellstar, 1/1/24 (40%) 408,000 To remove stockholders' equity accounts of Bellstar and recognize beginning noncontrolling interest. Retained earnings balance has been adjusted in Entry *G. 5-47 © McGraw Hill LLC. All rights reserved. No reproduction or distribution without the prior written consent of McGraw Hill LLC.

Chapter 05 – Consolidated Financial Statements – Intra-Entity Asset Transactions – Hoyle, Schaefer, Doupnik, Advanced Accounting, 15e

Entry A Trademark ..................................................................... 95,000 Investment in Bellstar ....................................... Noncontrolling interest in Bellstar, 1/1/24 (40%)

57,000 38,000

To recognize amount paid within acquisition price for the Trademark. Original balance is adjusted for previous year‘s amortization. Entry I Equity in earnings of Bellstar ...................................... 84,000 Investment in Bellstar ........................................ To eliminate intra-entity income accrual. Entry D Investment in Bellstar................................................... 36,000 Dividends declared ............................................. To eliminate intra-entity (60%) dividend transfers. Entry E Amortization expense............................................... 5,000 Trademark ........................................................... To recognize current period excess amortization expense. Entry P Liabilities ....................................................................... 40,000 Accounts receivable ........................................... To eliminate intra-entity debt. Entry Tl Sales ............................................................................ 200,000 Cost of goods sold ............................................. To eliminate current year intra-entity inventory transfer.

84,000

36,000

5,000

40,000

200,000

31. (continued) Entry G Cost of goods sold ....................................................... 12,000 Inventory .............................................................. 12,000 To defer 2024 intra-entity inventory gross profit in ending inventory. ($200,000 − $140,000 = $60,000 total gross profit × 20% remaining inventory = $12,000). Net income attributable to noncontrolling interest Bellstar reported net income ..................................................... Excess fair value amortization................................................... 2023 Intra-entity gross profit recognized in 2024 (inventory) . 2024 Intra-entity gross profit deferred (inventory) .................. Bellstar adjusted net income 2024 ............................................

$140,000 (5,000) 10,000 (12,000) $133,000

Chapter 05 – Consolidated Financial Statements – Intra-Entity Asset Transactions – Hoyle, Schaefer, Doupnik, Advanced Accounting, 15e

Outside ownership percentage ................................................. Net income attributable to noncontrolling interest ............

40% $ 53,200

Chapter 05 – Consolidated Financial Statements – Intra-Entity Asset Transactions – Hoyle, Schaefer, Doupnik, Advanced Accounting, 15e

31. a. (continued) ABBEY AND BELLSTAR Consolidation Worksheet Year Ending December 31, 2024 Consolidatio n Entries Accounts Sales Cost of goods sold Operating expenses Equity in earnings of Bellstar Separate company net income Consolidated net income To noncontrolling interest To Abbey Company Retained earnings, Abbey, 1/1

Abbey (800,000) 500,000

Bellstar (500,000) 300,000

Debit (TI) 200,000 (G) 12,000

100,000 (84,000) (284,000)

60,000 -0(140,000)

(E) 5,000 (I) 84,000

Credit

Noncontrolli ng Interest

(*G) 10,000 (TI) 200,000

165,000 -0-

(53,200) (1,116,000)

(*TL) 40,000 (*C) 9,000 (620,000) (S) 610,000

Retained earnings, Bellstar, 1/1 Net income (above) Dividends declared Retained earnings, 12/31 Cash Accounts receivable Inventory Investment in Bellstar

(284,000) 115,000 (1,285,000) 177,000 356,000 440,000 726,000

(140,000) 60,000 (700,000) 90,000 410,000 320,000

Land Buildings and equipment (net) Trademark Total assets Liabilities Common stock Additional paid-in capital Retained earnings, 12/31

180,000 496,000 -02,375,000 (480,000) (610,000)

390,000 300,000 -01,510,000 (400,000) (320,000) (90,000) (700,000)

(1,285,000)

(A) 95,000

(333,000) 53,200 (279,800)

(1,067,000) (*G) 10,000

(D) 36,000

Consolidat ed Totals (1,100,000) 602,000

24,000

(P) 40,000 (G) 12,000 (*C) 9,000 (S) 612,000 (I) 84,000 (A) 57,000 (*TL) 40,000 (E) 5,000

(P) 40,000 (S) 320,000 (S) 90,000

(279,800) 115,000 (1,231,800) 267,000 726,000 748,000 -0-

530,000 796,000 90,000 3,157,000 (840,000) (610,000) (1,231,800)

Chapter 05 – Consolidated Financial Statements – Intra-Entity Asset Transactions – Hoyle, Schaefer, Doupnik, Advanced Accounting, 15e

NCI in Bellstar, 1/1

(S) 408,000 (A) 38,000

NCI In Bellstar, 12/31 Total liabilities and equity

(2,375,000)

(1,510,000)

1,551,000

(446,000) (475,200)

1,551,000

(475,200) (3,157,000)

Chapter 05 – Consolidated Financial Statements – Intra-Entity Asset Transactions – Hoyle, Schaefer, Doupnik, Advanced Accounting, 15e

31. (continued)

b. If the intra-entity transfer had been a building rather than land, two adjustments to the consolidation entries would be needed. Entry *TL would be changed and relabeled as Entry *TA and an Entry ED would be added to eliminate the overstatement of depreciation expense for 2024. All other consolidation entries would be the same as shown in Part a. As a downstream transfer, entries *C and S are not affected. Entry *TA Retained earnings, 1/1/24 (Abbey) ................ 36,000 Buildings ........................................................ 40,000 Accumulated depreciation ....................... 76,000 To defer intra-entity gain ($40,000 original amount less one year of excess depreciation at $4,000 per year) as of beginning of year. Entry also returns Buildings account to historical cost (from $100,000 to $140,000) and Accumulated Depreciation account to historical cost (original $80,000 less one year of excess depreciation at $4,000). Because the Buildings account is shown at net value in the information given in this problem, the above entry would probably be made as follows: Entry *TA (Alternative) Retained earnings, 1/1/24 (Abbey) ................ Buildings (net) ..........................................

36,000 36,000

Entry ED Accumulated depreciation ............................ 4,000 Operating (or depreciation) expense ...... 4,000 To remove excess depreciation for current year created by transfer price. Excess depreciation for each year would be $4,000 based on allocating the $60,000 historical cost book value over 10 years ($6,000 per year) rather than the $100,000 transfer price ($10,000 per year). 32.

(40 Minutes) (Prepare consolidation worksheet with intra-entity transfer of inventory and land. No outside ownership exists) a. Stark reported net income.................................................. Patented technology amortization..................................... Beginning inventory gross profit recognized................... Ending inventory gross profit deferred............................. Deferral of land gain on sale .............................................. Equity in Stark‘s earnings ..................................................

$(90,000) 29,000 (13,000) 19,000 16,000 $(39,000)

Chapter 05 – Consolidated Financial Statements – Intra-Entity Asset Transactions – Hoyle, Schaefer, Doupnik, Advanced Accounting, 15e

b. Acquisition-Date Fair Value Allocation Consideration transferred (fair value of shares issued) . Book value of subsidiary.................................................... Fair value in excess of book value ................................... Excess fair over book value assigned to: Trademarks (indefinite life) .......................................... Patented technology ..................................................... Remaining life of patented technology ....................... Annual amortization ...........................................................

$577,000 300,000 $277,000 45,000 $232,000 8 years $ 29,000

Intra-entity Upstream Inventory Gross Profit, 1/1 Intra-entity inventory ($125,000 × 26%) ............................ Gross profit rate ($50,000 ÷ $125,000) .............................. Intra-entity gross profit in inventory, 1/1 ..........................

$32,500 40% $13,000

Intra-entity Upstream Inventory Gross Profit, 12/31 Intra-entity inventory (given) ............................................. Gross profit rate ($70,000 ÷ $140,000) .............................. Intra-entity gross profit in inventory, 12/31.......................

$38,000 50% $19,000

CONSOLIDATION ENTRIES Entry *G Retained earnings 1/1 (Stark) ............................ 13,000 Cost of goods sold ....................................... 13,000 To remove beginning intra-entity gross profit. Amount computed above. Entry S Common stock (Stark) ....................................... 100,000 Additional paid-in capital (Stark) ...................... 50,000 Retained earnings 1/1 (Stark, adjusted) ........... 279,000 Investment in Stark........................................ 429,000 To remove subsidiary stockholders' equity accounts. Retained earnings is adjusted for elimination of upstream intra-entity gross profit in Entry *G. 32. (continued) Entry A Trademarks ......................................................... 45,000 Patented technology .......................................... 203,000 Investment in Stark ....................................... 248,000 To recognize excess fair value allocations as of 1/1. Patented technology is adjusted for one prior year of amortization at $29,000 per year. Entry I Investment income .............................................

39,000

Chapter 05 – Consolidated Financial Statements – Intra-Entity Asset Transactions – Hoyle, Schaefer, Doupnik, Advanced Accounting, 15e

Investment in Stark ....................................... 39,000 To remove intra-entity income accrued by parent using the equity method. Entry D Investment in Stark ....................................... Dividends declared .................................. To eliminate Intra-entity dividends.

25,000 25,000

Entry E Other operating expenses ............................. 29,000 Patented technology ................................ 29,000 To recognize current year amortization expense on patented technology Entry Tl Revenues ....................................................... 140,000 Cost of goods sold .................................. 140,000 To eliminate intra-entity inventory transfer for current year. Entry G Cost of goods sold ........................................ 19,000 Inventory.................................................... 19,000 To defer intra-entity inventory gross profit. Amount is computed above. Entry TL Gain on sale of land ...................................... 16,000 Land .......................................................... 16,000 To remove gain from intra-entity transfer of land during current year. Entry P Accounts payable ......................................... Accounts receivable ................................. To remove intra-entity payable and receivable.

62,000 62,000

32. (continued)

Chapter 05 – Consolidated Financial Statements – Intra-Entity Asset Transactions – Hoyle, Schaefer, Doupnik, Advanced Accounting, 15e

PANTHER AND STARK Consolidation Worksheet Year Ending December 31, 2024

Accounts Revenues Cost of goods sold

Panther (710,000) 305,000

Other operating expenses Gain on sale of land Investment income Net income Retained earnings 1/1

167,000 (16,000) (39,000) (293,000) (367,000)

Net income (above) Dividends declared Retained earnings 12/31 Cash and receivables Inventory Investment in Stark

(293,000) 80,000 (580,000) 102,000 311,000 691,000

Trademarks Land, buildings, and equipment (net) Patented technology Total assets Liabilities Common stock Additional paid-in capital Retained earnings (above) Total liabilities & stockholders‘ equity

638,000 125,000 1,742,000 (462,000) (400,000) (300,000) (580,000) (1,742,000)

Stark (360,000) 189,000 81,000

(90,000) (292,000)

Consolidation Entries Debit Credit (TI) 140,000 (G) 19,000 (TI) 140,000 (*G) 13,000 (E) 29,000 (TL) 16,000 (I) 39,000 (*G) 13,000 (S) 279,000

(90,000) 25,000 (357,000) 154,000 110,000

(D) 25,000

58,000 280,000

(A) 45,000 (A) 203,000

727,000 (220,000) (100,000) (50,000) (357,000) (727,000)

(P) 62,000 (G) 19,000 (S) 429,000 (A) 248,000 (I) 39,000 (TL) 16,000 (E) 29,000

(P) 62,000 (S) 100,000 (S) 50,000 1,020,000

1,020,000

Consolidated Totals (930,000) 360,000 277,000 -0-0(293,000) (367,000) -0(293,000) 80,000 (580,000) 194,000 402,000 -0103,000 902,000 299,000 1,900,000 (620,000) (400,000) (300,000) (580,000) (1,900,000)

Chapter 05 – Consolidated Financial Statements – Intra-Entity Asset Transactions – Hoyle, Schaefer, Doupnik, Advanced Accounting, 15e

33.

(20 minutes) Prepare a consolidated income statement in the presence of intraentity gross profits in beginning and ending inventories. Kelly Company Consolidated Income Statement For the Year Ending December 31, 2024 Sales revenue Cost of goods sold Gross profit Operating expenses Depreciation expense (includes $1,500 excess depreciation) Amortization expense (includes $12,000 excess amortization) Other operating expenses Total operating expense Consolidated net income To the noncontrolling interest To the controlling interest-Kelly

$1,328,000 (644,000) $ 684,000 $115,100 114,900 236,000 $ 466,000 $ 218,000 (14,000) $204,000

Supporting calculations: Kelly sales revenue Helton sales revenue Less: intra-entity sales (2024) Consolidated sales revenue

$962,000 466,000 (100,000) $1,328,000

Kelly COGS Helton COGS Less: intra-entity sales (2024) Plus: intra-entity profit in EI (60%  $50,000) Less: intra-entity profit in BI (40%  $27,500) Consolidated COGS

$515,000 210,000 (100,000) 30,000 (11,000) $644,000

Consideration transferred Noncontrolling interest acquisition-date fair value Helton acquisition-date fair value Helton acquisition-date book value Excess acquisition-date fair over book value To building (12 year remaining life) To patented technology (3 year remaining life)

$285,000 95,000 $380,000 326,000 $ 54,000 $18,000 36,000

Excess building amortization ($18,000  12 years) Excess patented technology amortization ($36,000  3 years) Total excess fair over book value amortization expense

$ 54,000 -0$ 1,500 12,000 $13,500

Helton net income Less: excess fair value amortization expense Plus: intra-entity gross profit in beginning inventory Less: intra-entity gross profit in ending inventory Helton‘s adjusted net income Noncontrolling interest ownership percentage Noncontrolling interest in consolidated net income

$88,500 (13,500) 11,000 (30,000) $56,000 25% $14,000

Chapter 05 – Consolidated Financial Statements – Intra-Entity Asset Transactions – Hoyle, Schaefer, Doupnik, Advanced Accounting, 15e

34.

(50 Minutes) (Determine consolidated totals. Subsidiary has preferred shares outstanding that are equity instruments.) Consideration transferred Skyler‘s book value Excess fair value assigned to intangible asset (10-year life)

$560,000 450,000 $110,000

Annual amortization

$11,000

Ending Intra-entity Gross Profit Ending inventory (at transfer price) .................................... $18,000 Markup ($30,000 ÷ $90,000) ............................................. 33⅓% Deferred gross profit in ending inventory (increase made to cost of goods sold to defer gain) $6,000 Effect of Intra-Entity Equipment Transfer: Transfer price: Recorded value.................................................................. Depreciation expense ($20,000 ÷ 4) ................................. Accumulated depreciation................................................ Gain on sale ($20,000 – $12,000) ......................................

$20,000 $5,000 $5,000 $8,000

Historical cost: Recorded value.................................................................. Depreciation expense ($12,000 ÷ 4) ................................. Accumulated depreciation ($18,000 + $3,000) ................

$30,000 $3,000 $21,000

34. (continued)

Chapter 05 – Consolidated Financial Statements – Intra-Entity Asset Transactions – Hoyle, Schaefer, Doupnik, Advanced Accounting, 15e

Paisley, Inc. and Skyler Corp. Consolidation Worksheet Year Ending December 31 Accounts Sales Cost of goods sold Expenses Gain on sale of equipment Net income Retained earnings, 1/1 Net income Dividends declared Retained earnings, 12/31 Cash Accounts receivable Inventory Investment in Skyler Corp.

Paisley, Inc. (800,000) 528,000 180,000 (8,000)

Skyler Corp. (400,000) 260,000 130,000 -0-

(100,000) (400,000) (100,000) 60,000 (440,000) 30,000 300,000 260,000 560,000

(10,000) (150,000) (10,000) -0(160,000) 40,000 100,000 180,000 -0-

Consolidation Entries Debit Credit (TI) 90,000 (G) 6,000 (TI) 90,000 (E) 11,000 (ED) 2,000 (TA) 8,000 (S) 150,000

(P) 28,000 (G) 6,000 (S) 450,000

Consolidated Totals (1,110,000) 704,000 319,000 -0(87,000) (400,000) (87,000) 60,000 (427,000) 70,000 372,000 434,000 -0-

(A) 110,000 Land, buildings, and equipment Accumulated depreciation Intangible Asset Total assets Accounts payable Long-term liabilities Common stock Additional paid-in capital Retained earnings, 12/31 Total liab. and stockholders‘ equity

680,000

500,000

(TA) 10,000

1,190,000

(180,000)

(90,000)

(ED) 2,000

(TA) 18,000

(286,000)

-01,650,000 (140,000) (240,000) (620,000) (210,000) (440,000) (1,650,000)

-0730,000 (90,000) (180,000) (300,000) -0(160,000) (730,000)

(A) 110,000

(E) 11,000

99,000 1,879,000 (202,000) (420,000) (620,000) (210,000) (427,000) (1,879,000)

(P) 28,000 (S) 300,000

715,000

Chapter 06 – Variable Interest Entities, Intra-Entity Debt, Consolidated Cash Flows, and Other Issues– Hoyle, Schaefer, Doupnik, Advanced Accounting, 15e

34. (continued) CONSOLIDATED TOTALS                      

Sales = $1,110,000 (add book values and eliminate intra-entity transfers) Cost of Goods Sold = $704,000 (add book values, eliminate intra-entity transfers, and eliminate ending intra-entity gain [computed above]) Expenses = $319,000 (add book values and include amortization of intangibles and eliminate $2,000 excess equipment depreciation) Gain on Sale of Equipment = $0 (intra-entity balance is eliminated) Net Income = $87,000 (consolidated revenues less consolidated expenses) Retained Earnings, 1/1 = $400,000 (parent company figure only because subsidiary was not acquired until current year) Dividends Declared = $60,000 (parent balance only) Retained Earnings, 12/31 = $427,000 (consolidated beginning retained earnings plus net income less dividends declared) Cash = $70,000 (add book values) Accounts Receivable = $372,000 (add book values after eliminating intraentity balance) Inventory = $434,000 (add book values after eliminating intra-entity gross profit) Investment in Skyler Corporation = 0 (intra-entity account is eliminated because individual asset and liability accounts of subsidiary are included) Land, Buildings, and Equipment = $1,190,000 (add book values and increase transferred asset from transfer price to historical cost [see above]) Accumulated Depreciation = $286,000 (add book values and adjust balance for transferred asset from transfer price figure to historical cost (see above]) Intangible Asset = $99,000 (original allocations less one year amortization) Total Assets = $1,879,000 (summation of consolidated accounts) Accounts Payable = $202,000 (add book values and remove intra-entity balance) Long-Term Liabilities = $420,000 (add book values) Common Stock = $620,000 (parent balance only) Additional Paid-in Capital = $210,000 (parent balance only) Retained Earnings, 12/31 = $427,000 (computed above) Total Liabilities and Equities = $1,879,000 (summation of consolidated accounts)

34. (continued): Consolidation entries and explanations: Entry S Common Stock (Skyler) ................................................... Retained Earnings, 1/1 ..................................................... Investment in Skyler Corp..........................................

300,000 150,000 450,000

(To eliminate subsidiary stockholder‘s equity accounts.)

Chapter 06 – Variable Interest Entities, Intra-Entity Debt, Consolidated Cash Flows, and Other Issues – Hoyle, Schaefer, Doupnik, Advanced Accounting, 15e

Entry A Intangible Asset ............................................................... Investment in Skyler Corp..........................................

110,000 110,000

(To recognize excess fair value attributed to intangible asset.) Entry E Amortization Expense...................................................... Intangible Asset .......................................................... (To record current year‘s amortization of intangible asset.) Entry P Accounts Payable............................................................. Accounts Receivable.................................................. (To eliminate intra-entity receivable and payable.)

11,000 11,000

28,000 28,000

Entry TA Equipment......................................................................... 10,000 Gain on Sale of Equipment .............................................. 8,000 Accumulated Depreciation......................................... 18,000 (To eliminate effects as of 1/1 created by intra-entity transfer of equipment.) Entry TI Sales.................................................................................. 90,000 Cost of Goods Sold .................................................... (To eliminate intra-entity inventory transfers for the current year.)

90,000

Entry G Cost of Goods Sold .......................................................... 6,000 Inventory ..................................................................... 6,000 (To defer intra-entity gain in inventory remaining at the end of the current year. Markup is 33⅓% [30,000 gross profit ’ 90,000 transfer price] indicating that the ending inventory of 18,000 contains an intra-entity profit of 6,000 [18,000 × 33⅓%].) Entry ED Accumulated Depreciation .............................................. 2,000 Depreciation Expense ................................................ 2,000 (To eliminate excess depreciation resulting from intra-entity gain of 8,000 on transfer of equipment [see Entry TA]. Equipment is being depreciated over a remaining life of four years.) Chapter 5 Excel Case Solution—Example below shows solution for a 60% gross profit rate. Equity in Sweet Water Earnings 2023 reported net 78,000 income El profit (34,200) Amortization (12,600)

Fair Value Allocation Schedule 1/1/2023 Consideration 1,000,000 transferred C.S. 500,000 R.E. 185,000 685,000

Life

Amort.

Tradename

12,600

315,000

Equity earnings

31,200

2024 reported net income BI profit

85,000 34,200

Chapter 06 – Variable Interest Entities, Intra-Entity Debt, Consolidated Cash Flows, and Other Issues– Hoyle, Schaefer, Doupnik, Advanced Accounting, 15e

SweetWater sells to PondBlue

GPR

Inventory remaining

El profit Amortization

(37,800) (12,600)

60%

30%

Equity earnings

68,800

Intra-entity Inventory Transfers (upstream) Sales Inventory Intra. profit 2023 190,000 57,000 34,200 2024 210,000 63,000 37,800

Investment account Cost 1,000,000 Equity 31,200 earnings dividends (25,000)

2023

12/31/23 2024

Consolidation Adjustments RE- SweetWater 34,200 COGS Common stockSweetWater RE-SweetWater Investment in SweetWater

500,000

Tradename Investment in SweetWater I Equity earningsSweetWater Investment in SweetWater D Investment in SweetWater Dividends declared E Amortization expense Tradename IT Sales COGS G COGS Inventory Investment account goes to zero? 0

302,400

1,006,200 Equity earnings dividends

12/31/24

SweetWater dividends 2023 25,000 2024 27,000

34,200

203,800 703,800

68,800 (27,000) 1,048,000

302,400 68,800 68,800 27,000 27,000 12,600 210,000

12,600 210,000

37,800

Analysis and Research—Accounting Information and Salary Negotiations 1. With common control over related enterprises, a consolidated income statement better portrays economic reality. For example, it is likely that the stadium‘s concession and parking revenues would have been less (maybe zero) if the team did not play there. The $2,500,000 rent expense is not an arm‘s length transaction—Reston Rockets Soccer owns 85% of Rockets Stadium. Also given that the $2,500,000 is the only rent revenue, it appears that the stadium is used exclusively for soccer with its fortunes intertwined with the team. Also, the 85% common ownership other stands speaks clearly against the owner‘s assertion that the stadium is ―really a separate business entity.‖

Chapter 06 – Variable Interest Entities, Intra-Entity Debt, Consolidated Cash Flows, and Other Issues – Hoyle, Schaefer, Doupnik, Advanced Accounting, 15e Searching the FASB ASC for ―separate statements‖ and then ―intra-entity‖ yields the following relevant support: There is a presumption that consolidated financial statements are more meaningful than separate financial statements and that they are usually necessary for a fair presentation when one of the entities in the consolidated group directly or indirectly has a controlling financial interest in the other entities. FASB ASC (para. 810-10-10-1). As consolidated financial statements are based on the assumption that they represent the financial position and operating results of a single economic entity, such statements should not include gain or loss on transactions among the entities in the consolidated group. FASB ASC (para. 810-10-451).

Reston Rockets Team and Stadium Consolidated Income Statement Ticket revenues Concession revenue Parking revenue

$3,500,000 875,000 95,000

Ticket expense Promotion expense COGS Depreciation expense Grounds maintenance expense Player salaries Staff salaries and miscellaneous Consolidated net income

$ 30,000 80,000 270,000 190,000 410,000 700,000 465,000

$4,470,000

$2,145,000 $2,325,000

Thus, a good starting point for the salary discussion may be the consolidated net income, followed by some measure of the appropriate rate of return on the stadium facility and market values of the soccer players. 2. Other pertinent factors include

    

Any available comparisons for the market values for the players The market value of any alternative uses for the stadium The amount the owners have invested in the team The amount the owners have invested in the stadium Fair rates of return for the owners‘ investments in the team and the stadium

CHAPTER 6 VARIABLE INTEREST ENTITIES, INTRA-ENTITY DEBT, CONSOLIDATED CASH FLOWS, AND OTHER ISSUES Chapter Outline I.

Variable interest entities (VIEs) A. VIEs typically take the form of a trust, partnership, joint venture, or corporation. In most cases a sponsoring firm creates these entities to engage in a limited and well-defined set of business activities. For example, a business may create a VIE to finance the acquisition of a large asset. The VIE purchases the asset using debt and equity financing, and then leases the asset back to the sponsoring firm. If their activities are strictly limited and the

Chapter 06 – Variable Interest Entities, Intra-Entity Debt, Consolidated Cash Flows, and Other Issues– Hoyle, Schaefer, Doupnik, Advanced Accounting, 15e

asset is pledged as collateral, VIEs are often viewed by lenders as less risky than their sponsoring firms. As a result, such arrangements can allow financing at lower interest rates than would otherwise be available to the sponsor. B. Control of VIEs, by design, sometimes does not rest with its equity holders. Instead, control is exercised through contractual arrangements with the sponsoring firm who becomes the "primary beneficiary" of the VIE. These contracts can take the form of leases, loans, participation rights, guarantees, or other residual interests. Through contracting, the primary beneficiary bears a majority of the risks and receives a majority of the rewards of the entity, often without owning any voting shares. C. An entity whose control rests with a primary beneficiary is addressed by FASB ASC subtopic 810-10 Variable Interest Entities. The following characteristics indicate a controlling financial interest in a variable interest entity. 1. The power to direct the activities that most significantly impact the VIE‘s economic performance 2. The obligation to absorb losses of the VIE that could potentially be significant to the VIE or the right to receive benefits from the VIE that could potentially be significant to the VIE. The primary beneficiary bears the risks and receives the rewards of a variable interest entity and is considered to have a controlling financial interest. D. If a reporting entity has a controlling financial interest in a variable interest entity, it should include the assets, liabilities, and results of the activities of the variable interest entity its consolidated financial statements. E. In reporting periods subsequent to when a primary beneficiary gains control over a VIE, consolidation procedures are similar to that for a voting interest entity. A notable exception in consolidation procedures occurs in accounting for the allocation of consolidated net income across the controlling and noncontrolling interests. Because variable, rather than voting, interests determine profit allocation, the underlying agreements between the primary beneficiary, the VIE, and other related parties must be carefully reviewed to determine net income distribution. II.

Intra-entity debt transactions A. No special difficulty is created when one member of a business combination loans money to another. The resulting receivable/payable accounts as well as the interest income expense balances are identical and can be directly offset in the consolidation process. B. The acquisition of an affiliate's debt instrument from an outside party does require special handling so that consolidated financial statements can be produced. 1. Because the acquisition price will usually differ from the carrying amount of the liability, a gain or loss has been created by an effective retirement which is not recorded within the individual records of either company. 2. Because of the amortization of any associated discounts and/or premiums, the interest income reported by the buyer will not equal the interest expense of the debtor. C. In the year of acquisition, the consolidation process eliminates intra-entity accounts (the liability, the receivable, interest income, and interest expense) while the gain or loss (which produced all of the discrepancies because of the initial difference) is recognized. 1. Although several alternatives exist, this textbook assigns all income effects resulting from the retirement to the parent company, the party ultimately responsible for the decision to reacquire the debt. 2. Any noncontrolling interest is, therefore, not affected by the adjustments utilized to consolidate intra-entity debt.

Chapter 06 – Variable Interest Entities, Intra-Entity Debt, Consolidated Cash Flows, and Other Issues – Hoyle, Schaefer, Doupnik, Advanced Accounting, 15e

D. After the year of effective retirement, all intra-entity accounts must be eliminated again in each subsequent consolidation. However, when the parent uses the equity method, the parent‘s Investment in Subsidiary account is adjusted in consolidation rather than a gain or loss account. If the parent employs an accounting method other than the equity method, then the parent‘s Retained Earnings are adjusted for the prior years‘ income net effects of the effective gain/loss on retirement. 1. The change in retained earnings is needed because a gain or loss was created in a prior year by the effective retirement of the debt, but only interest income and interest expense were recognized by the two parties. 2. The adjustment to retained earnings at any point in time is the original gain or loss adjusted for the subsequent amortization of discounts or premiums. III.

Subsidiary preferred stock A. Subsidiary preferred shares not owned by the parent are a part of noncontrolling interest. B. The fair value of any subsidiary preferred shares not acquired by the parent is added to the consideration transferred along with the fair value of the noncontrolling interest in common shares to compute the acquisition-date fair value of the subsidiary.

IV.

Consolidated statement of cash flows A. Statement is produced from consolidated balance sheet and income statement and not from the separate cash flow statements of the component companies. B. Consolidated net income is the starting point for the cash flow from operating section— including both the parent and noncontrolling interest share. C. Intra-entity cash transfers are omitted from this statement because they do not occur with an outside unrelated party. D. Dividends paid by the subsidiary to the noncontrolling interest are reported as a financing activity.

Consolidated earnings per share A. This computation normally follows the pattern described in intermediate accounting textbooks. For basic EPS, consolidated net income is divided by the weighted-average number of parent shares outstanding. If convertibles (such as bonds or warrants) exist for the parent shares, their weight must be included in computing diluted EPS but only if earnings per share is reduced. 1. The subsidiary's diluted earnings per share are computed first to arrive at (1) an earnings figure and (2) a shares figure. 2. The portion of the shares figure belonging to the parent is computed. That percentage of the subsidiary's diluted earnings is then added to the parent's net income in order to complete the earnings per share computation.

VI.

Subsidiary stock transactions A. If the subsidiary issues new shares of stock or reacquires its own shares as treasury stock, a change is created in the book value underlying the parent's investment account. The increase or decrease should be reflected by the parent as an adjustment to this balance. B. The book value of the subsidiary that corresponds to the parent's ownership is measured before and after the transaction with any alteration recorded directly to the investment account. The parent's additional paid-in capital (or retained earnings) account is normally adjusted although the recognition of a gain or loss is an alternate accounting treatment.

Chapter 06 – Variable Interest Entities, Intra-Entity Debt, Consolidated Cash Flows, and Other Issues– Hoyle, Schaefer, Doupnik, Advanced Accounting, 15e

C. Treasury stock acquired by the subsidiary may also necessitate a similar adjustment to the parent's investment account. In addition, any subsidiary treasury stock is eliminated within the consolidation process. Answer to Discussion Question: Who Lost this $300,000? This case is designed to give life to a theoretical accounting issue: If a subsidiary's debt is retired, should the resulting gain or loss be assigned to the parent or to the subsidiary? The case illustrates that there is no clear-cut solution. This lack of an absolute answer makes financial accounting both intriguing and frustrating. The assignment decision is only necessary in the presence of a noncontrolling interest. Regardless of the ownership level all intra-entity balances are eliminated on the worksheet with a gain or loss recognized. Not until the consolidated net income is allocated across the controlling interest and the noncontrolling interest does the assignment decision have an impact. We assume that financial and operating decisions are made in the best interest of the business entity as a whole. This debt would not have been retired unless corporate officials believed that Penston/Swansan would benefit from the decision. Thus, an argument can be made against any assignment to either separate party. Students should choose and justify one method. Discussion often centers on the following: ▪

▪

Parent company officials made the actual choice that created the book loss. Therefore, assigning the $300,000 to the subsidiary directs the impact of their decision to the wrong party. In effect, the subsidiary had nothing to do with this transaction (as indicated in the case) so that its share of consolidated net income should not be affected by the $300,000 loss. The debt was that of the subsidiary. Because the subsidiary's debt is being retired, all of the $300,000 should be attributed to that party. Financial records measure the results of transactions and the retirement simply culminates an earlier transaction made by the subsidiary. The parent is doing no more than acting as an agent for the subsidiary (as indicated in the case). If the subsidiary had acquired its own debt, for example, no question as to the assignment would have existed. Thus, changing that assignment simply because the parent agreed to be the acquirer is not justified. Both parties were involved in the transaction so that some allocation of the loss is required. If, at the time of repurchase, a discount existed within the subsidiary's accounts, this figure would have been amortized to interest expense (if the debt had not been retired). Thus, the $300,000 loss was accepted now in place of the later amortization. This reasoning then assigns this portion of the loss to the subsidiary. Because the parent agreed to pay more than face value, that remaining portion is assigned to the buyer.

Answers to Questions 1. A variable interest entity (VIE) is a business structure that is designed to accomplish a specific purpose. A VIE can take the form of a trust, partnership, joint venture, or corporation although typically it has neither independent management nor employees. The entity is frequently sponsored by another firm to achieve favorable financing rates.

Chapter 06 – Variable Interest Entities, Intra-Entity Debt, Consolidated Cash Flows, and Other Issues – Hoyle, Schaefer, Doupnik, Advanced Accounting, 15e

2. Variable interests are contractual, ownership, or other pecuniary interests in an entity that change with changes in the entity's net asset value. Variable interests will absorb portions of a variable interest entity's losses or receive portions of the entity's expected residual returns. Variable interests typically are accompanied by contractual arrangements that provide decision making power to the owner of the variable interests. Examples of variable interests include debt guarantees, lease residual value guarantees, participation rights, and other financial interests. 3. The following characteristics are indicative of an enterprise qualifying as a primary beneficiary with a controlling financial interest in a VIE. ▪

The power, through voting rights or similar rights, to direct the activities of an entity that most significantly impact the entity‘s economic performance.

▪

The obligation to absorb losses of the VIE that could potentially be significant to the VIE or the right to receive benefits from the VIE that could potentially be significant to the VIE.

4. Because the bonds were purchased from an outside party, the acquisition price is likely to differ from the carrying amount of the debt in the subsidiary's records. This difference creates accounting challenges in handling the intra-entity transaction. From a consolidated perspective, the debt is retired; a gain or loss is reported with no further interest being recorded. In reality, each company continues to maintain these bonds on their individual financial records. Also, because discounts and/or premiums are likely to be present, these account balances as well as the interest income/expense will change from period to period because of amortization. For reporting purposes, all individual accounts must be eliminated with the gain or loss being reported so that the events are shown from the vantage point of the consolidated entity. 5. If the bonds are acquired directly from the affiliate company, all reciprocal accounts will be equal in amount. The debt and the receivable will be in agreement so that no gain or loss is created. Interest income and interest expense should also reflect identical amounts. Therefore, the consolidation process for this type of intra-entity debt requires no more than the offsetting of the various reciprocal balances. 6. The gain or loss to be reported is the difference between the price paid and the carrying amount of the debt on the date of acquisition. For consolidation purposes, this gain or loss should be recognized immediately on the date of acquisition. 7. Because the bonds are still legally outstanding, they will continue to be found on both sets of financial records. Thus, each account (Bonds Payable, Investment in Bonds, Interest Expense, and Interest Income) must be eliminated within the consolidation process. Any gain or loss on the effective retirement as well as later effects on interest caused by amortization are also included to arrive at an adjustment to the beginning retained earnings (or the Investment account if the equity method is used) of the parent company. 8. The original gain is never recognized within the financial records of either company. Thus, within the consolidation process for the year of acquisition, the gain is directly recorded whereas (for each subsequent year) it is entered as an adjustment to beginning retained earnings (or the Investment account if the equity method is used). In addition, because the carrying amount of the debt and the investment are not in agreement, the interest expense and interest income balances being recorded by the two companies will differ each year

Chapter 06 – Variable Interest Entities, Intra-Entity Debt, Consolidated Cash Flows, and Other Issues– Hoyle, Schaefer, Doupnik, Advanced Accounting, 15e

because of the amortization process. This amortization effectively reduces the difference between the individual retained earnings balances and the total that is appropriate for the consolidated entity. Consequently, a smaller change is needed each period to arrive at the balance to be reported. For this reason, the annual adjustment to beginning retained earnings (or the Investment account if the equity method is used) gradually decreases over the life of the bond. 9. No set rule exists for assigning the income effects from intra-entity debt transactions although several different theories exist and include: (1) assignment of the entire amount to the debtor, (2) assignment of the entire amount to the buyer, and (3) allocation of the gain or loss between the two parties in some manner. This textbook attributes the entire income effect (the $45,000 gain in this case) to the parent company. Assignment to the parent is justified because that party is ultimately responsible for the decision to retire the debt from the public market. The answer to the discussion question included in this chapter analyzes this question in more detail. 10. Subsidiary outstanding preferred shares are part of the noncontrolling interest and are included in the consolidated financial statements at acquisition-date fair value and subsequently adjusted for their share of subsidiary income and dividends. 11. The consolidated cash flow statement is developed from consolidated balance sheet and income statement figures. Thus, the cash flows generated by operating, investing, and financing activities are identified only after the consolidation of these other statements. 12. The noncontrolling interest share of the subsidiary‘s net income is a component of consolidated net income. Consolidated net income then is adjusted for noncash and other items to arrive at consolidated cash flows from operations. Any dividends paid by the subsidiary to these outside owners are listed as a financing activity because an actual cash outflow occurs. 13. An alternative to the normal diluted earnings per share calculation is required whenever the subsidiary has dilutive convertible securities such as bonds or warrants. In this case, the potential impact of the conversion of subsidiary shares must be factored into the overall diluted earnings per share computation. 14. Basic Earnings per Share. The existence of subsidiary convertible securities does not affect basic EPS. The parent‘s basic earnings per share is computed by dividing the parent‘s share of consolidated net income by the weighted average number of parent shares outstanding. Diluted Earnings per Share. The subsidiary's diluted earnings per share is computed by including both convertible items. The portion of the parent's controlled shares to the total shares used in this calculation is then determined. Only this percentage (of the income figure used in the subsidiary's computation) is added to the parent's income in arriving at the parent company‘s diluted earnings per share. 15. Several reasons could exist for a subsidiary to issue new shares of stock to outside parties. First, additional financing is brought into the company by any such sale. Also, stock issuance may be used to entice new individuals to join the organization. Additional management personnel, as an example, might be attracted to the company in this manner. The company could also be forced to sell shares because of government regulation. Many countries require some degree of local ownership as a prerequisite for operating within that country. 6-9 © McGraw Hill LLC. All rights reserved. No reproduction or distribution without the prior written consent of McGraw Hill LLC.

Chapter 06 – Variable Interest Entities, Intra-Entity Debt, Consolidated Cash Flows, and Other Issues – Hoyle, Schaefer, Doupnik, Advanced Accounting, 15e

16. Because the new stock was issued at a price above the subsidiary‘s assigned consolidation value, the overall valuation for Metcalf's stock has been increased. Consequently, the Washburn's investment is increased to reflect this change. To measure the effect, the value of Washburn's investment is calculated both before and after the new issue. Because the increment is the result of a stock transaction, an increase is made to additional paid-in capital. Although the subsidiary's shares (both new and old) are eliminated in the consolidation process, the increase in the parent's APIC (or gain or loss) carries into the consolidated figures. Also, the noncontrolling interest percentage of the subsidiary increases. 17. A stock dividend does not alter the assigned consolidated subsidiary value and, thus, creates no effect on Washburn's investment account or on the consolidated figures. Hence, no entry is recorded by the parent company in connection with the subsidiary's stock dividend. Answers to Problems

1. C 2. B. Vince Company net income.............................................. Less: Porter Company 15% ownership share................. Less: Porter Company 40% participating rights............. Net income attributable to noncontrolling interest ........

$100,000 (15,000) (40,000) $45,000

3. B 4. D 5. A 6. D 7. D Cash flow from operations: Net income ..................................................................... Depreciation................................................................... Trademark amortization ................................................ Increase in accounts receivable................................... Increase in inventory..................................................... Increase in accounts payable....................................... Cash flow from operations ...........................................

$45,000 10,000 15,000 (17,000) (40,000) 12,000

(20,000) $25,000

8. C Cash flow from financing activities: Dividends to parent‘s interest ...................................... Dividends to noncontrolling interest (20%  $5,000).. Reduction in long-term notes payable .................... Cash flow from financing activities .........................

($12,000) (1,000) (25,000) ($38,000)

Chapter 06 – Variable Interest Entities, Intra-Entity Debt, Consolidated Cash Flows, and Other Issues– Hoyle, Schaefer, Doupnik, Advanced Accounting, 15e

9. C 10. C

11. C

12. B

Post-issue subsidiary valuation ($800,000 + $250,000) Arcola‘s new ownership percentage (40,000 ’ 50,000) Arcola‘s share of post-issue subsidiary valuation Arcola‘s pre-issue equity balance Increase to Arcola‘s investment account

$1,050,000 80% $ 840,000 800,000 $ 40,000

Dane‘s income from own operations ........................... Carlton‘s income .......................................................... Eliminate intra-entity interest income.......................... Eliminate intra-entity interest expense........................ Recognize retirement gain on debt ($209,000 – $196,000) Consolidated net income ..............................................

$185,000 105,000 (19,000) 18,000 13,000 $302,000

Mattoon‘s share of consolidated net income.............. Number of Mattoon common shares outstanding...... Mattoon‘s EPS = ($465,000 ’ 100,000 shares).............

$465,000 100,000 $4.65

13. B Ayer net income................................................................ $430,000 Less intra-entity dividends (initial value method) ...... (8,050) Zane reported net income ............................................ Gain on extinguishment of debt ($60,200 – $56,000).. Eliminate interest expense on "retired" debt ($60,200 × 10%) ............................................................. Eliminate interest income on "retired" debt ($56,000 × 12%) ............................................................. Consolidated net income .............................................

$421,950 164,000 4,200 6,020 (6,720) $589,450

14. B 30% of $147,000 subsidiary net income; the intra-entity debt effects are attributed solely to the parent company. 30% x $147,000 = $44,100 15. A For 2024, the adjustment to beginning retained earnings should recognize the gain on the retirement of the debt, the elimination of the 2023 interest expense, and the elimination of the 2023 interest income. Gain on Retirement of Bond: Original carrying amount .............................................. 2020–2022 amortization ($600,000 ÷ 20 yrs. × 3 yrs.) . Carrying amount, January 1, 2024 .............................. Percentage of bonds retired ........................................

$10,600,000 (90,000) $10,510,000 40%

Chapter 06 – Variable Interest Entities, Intra-Entity Debt, Consolidated Cash Flows, and Other Issues – Hoyle, Schaefer, Doupnik, Advanced Accounting, 15e

Carrying amount of retired bonds ............................... Cash received ($4,000,000 × 96.6%) ............................ Gain on retirement of bonds ........................................ Interest Expense on Intra-Entity Debt—2023 Cash interest expense (9% × $4,000,000) ................... Premium amortization ($30,000 per year total × 40% retired portion of bonds) .............................................. Interest expense on intra-entity debt ..........................

$ 4,204,000 3,864,000 $ 340,000 $360,000 (12,000) $348,000

Interest Income on Intra-Entity Debt—2023 Cash interest income (9% × $4,000,000) ..................... Discount amortization (.034 × $4,000,000 ÷ 17 years) Interest income on intra-entity debt ............................

$360,000 8,000 $368,000

Adjustment to 1/1/24 Retained Earnings Recognition of 2023 gain on extinguishment of debt (above)... Elimination of 2023 intra-entity interest expense (above).......... Elimination of 2023 intra-entity interest income (above) ........... Increase in retained earnings, 1/1/24 ...........................................

$340,000 348,000 (368,000) $320,000

Consideration transferred for preferred stock............................ Consideration transferred for common stock............................. Noncontrolling interest fair value for preferred ......................... Noncontrolling interest fair value for common .......................... Acquisition-date fair value ........................................................... Acquisition-date identified net asset fair value ......................... Goodwill ........................................................................................

$ 424,000 3,960,000 1,696,000 440,000 6,520,000 (6,000,000) $ 520,000

16. D

17. B

18. B

Parent‘s reported sales ................................................ Subsidiary's reported sales ......................................... Less: intra-entity transfers .......................................... Sales to outsiders ......................................................... Less: increase in receivables ....................................... Cash generated by sales ..............................................

$480,000 264,000 (57,600) $686,400 (37,300) $649,100

Subsidiary‘s unamortized fair value prior to new share issue (12,000 × $49) ........................................................... Parent's ownership ....................................................... Unamortized subsidiary fair value ..............................

$588,000 100% $588,000

Subsidiary unamortized fair value after issuing new shares (above value plus 3,000 shares at $50 each) Parent's ownership 12,000 ÷ 15,000 shares) ..............

$738,000 80%

Chapter 06 – Variable Interest Entities, Intra-Entity Debt, Consolidated Cash Flows, and Other Issues– Hoyle, Schaefer, Doupnik, Advanced Accounting, 15e

Unamortized subsidiary fair value after stock issue ..

$590,400

Investment in Veritable increases by $2,400 ($590,400 less $588,000). 19.(15 minutes) (Subsidiary stock transactions) a. Because the parent acquired 80 percent of the new shares, its proportional ownership remains the same. Because the amount the parent pays will necessarily equal 80 percent of the increase in the subsidiary's book value, no separate adjustment by the parent is required. b. Adjusted acquisition-date sub. fair value at 1/1/24 Consideration transferred ....................................................... Noncontrolling interest acquisition-date fair value................ Increase in Stuart book value .................................................. Stock issue proceeds ............................................................... Subsidiary valuation basis 1/1/24 ................................................. New parent ownership (32,000 shs. ÷ 50,000 shs.) ..................... Parent‘s post-stock issue ownership balance ............................. Parent's investment account ($592,000 + [80% × 80,000]) .......... Required adjustment —decrease ............................................ c.

Adjusted acquisition-date fair value ($820,000 – $192,000) ....... New parent ownership (32,000 shs. ÷ 32,000 shs.) ..................... Fair value equivalency of parent's ownership ....................... Parent's investment account ($592,000 + [80% × 80,000]) ......... Required adjustment—decrease .............................................

$592,000 148,000 80,000 150,000 970,000 64% $620,800 656,000 $(35,200) $628,000 100% $628,000 656,000 $ (28,000)

20.(10 minutes) (Qualifications of a VIE and consolidation requirements) Apparel Media is a variable interest entity (VIE). The equity holders (the two outside investors) lack ▪

The power, through voting rights or similar rights, to direct the activities of a legal entity that most significantly impact the entity‘s economic performance.

▪

The obligation to absorb the expected losses of the VIE.

▪

The right to receive the expected residual returns of the legal entity.

Consolidation of a VIE is required if a firm has a variable interest that gives the firm a controlling financial interest in the VIE evidenced by ▪

The power to direct the activities of a VIE that most significantly impact the VIE‘s economic performance

Chapter 06 – Variable Interest Entities, Intra-Entity Debt, Consolidated Cash Flows, and Other Issues – Hoyle, Schaefer, Doupnik, Advanced Accounting, 15e

▪

The obligation to absorb losses of the VIE that could potentially be significant to the VIE or the right to receive benefits from the VIE that could potentially be significant to the VIE.

Because (1) Paige has the right to receive the 95% of the revenues generated by the VIE, and (2) Paige‘s losses are not limited by contract, Paige should consolidate Apparel Media. 21.(30 minutes) (VIE Qualifications for Consolidation) a. The purpose of consolidated financial statements is to present the financial position and results of operations of a group of businesses as if they were a single entity. They are designed to provide information useful for making business and economic decisions—especially assessing amounts, timing, and uncertainty of prospective cash flows. Consolidated statements also provide more complete information about the resources, obligations, risks, and opportunities of an enterprise than separate statements. b. An entity qualifies as a VIE and is subject to consolidation if either of the following conditions exist. 1. The total equity at risk is not sufficient to permit the entity to finance its activities without additional subordinated financial support from other parties. 21. (continued) 2. The equity investors in the VIE lack any one of the following three characteristics of a controlling financial interest. •

The power, through voting rights or similar rights, to direct the activities of a legal entity that most significantly impact the entity‘s economic performance.

•

The obligation to absorb the expected losses of the VIE.

•

The right to receive the expected residual returns of the legal entity.

Consolidation of a variable interest entity is required if a firm has a variable interest that gives the firm ▪

The power, through voting rights or similar rights, to direct the activities of an entity that most significantly impact the entity‘s economic performance.

▪

The obligation to absorb a majority of the entity's expected losses if they occur and/or the right to receive a majority of the entity's expected residual returns if they occur

Chapter 06 – Variable Interest Entities, Intra-Entity Debt, Consolidated Cash Flows, and Other Issues– Hoyle, Schaefer, Doupnik, Advanced Accounting, 15e

c. Risks of the construction project that has TecPC has effectively shifted to the owners of the VIE: At the end of the 1st five-year lease term, if the parent opts to sell the facility, and the proceeds are insufficient to repay the VIE investors, TecPC may be required to pay up to 85% of the project's cost--a potential 15% risk. Risks that remain with TecPC ▪

Guarantees of return to VIE investors at market rate, if facility does not perform as expected TecPC is still obligated to pay market rates.

▪

If lease is not renewed, TecPC must either purchase the facility or sell it on behalf of the VIE with a guarantee of Investors' (debt and equity) balances representing a risk of decline in market value of asset

▪

Debt guarantees

d. TecPC possesses the following characteristics of a primary beneficiary: ▪

Direct decision-making ability (end of five-year lease term).

▪

The obligation to absorb the expected losses of the VIE.

▪

The right to receive the expected residual returns of the legal entity.

22.(15 minutes) (Consolidation of variable interest entity.) a. Implied valuation and excess allocation for Valery: Noncontrolling interest fair value Consideration transferred by Petra Total Valery fair value Fair value of Valery‘s net identifiable assets Excess net asset value fair value (bargain purchase)

$60,000 20,000 80,000 105,000 $25,000

Petra recognizes the $25,000 excess net asset fair value as a bargain purchase and records all of Valery‘s assets and liabilities at their individual fair values. Cash $ 20,000 Marketing software 165,000 Computer equipment 40,000 Long-term debt (120,000) Noncontrolling interest (60,000) Gain on bargain purchase (25,000) b. Implied valuation and excess allocation for Valery Noncontrolling interest fair value Consideration transferred by Petra

$60,000 20,000

Chapter 06 – Variable Interest Entities, Intra-Entity Debt, Consolidated Cash Flows, and Other Issues – Hoyle, Schaefer, Doupnik, Advanced Accounting, 15e

Total Valery fair value Fair value of Valery‘s net identifiable assets Goodwill

80,000 55,000 $25,000

When the fair value of a VIE (that is a business) is greater than assessed asset values, all identifiable assets and liabilities are reported at fair values (unless a previously held interest) and the difference is treated as goodwill. Cash Marketing software Computer equipment Goodwill (excess business fair value) Long-term debt Noncontrolling interest

$ 20,000 115,000 40,000 25,000 (120,000) (60,000)

23. (40 minutes) (Acquisition-date consolidation worksheet for a parent and a variable interest entity) Consolidation Entries

Vector 41,000

Capitalized software Computer equipment Communications equipment Research and development asset Patent Unpatented technology Total assets

981,000 1,066,000

156,000 56,000

1,137,000 1,122,000

916,000

336,000

1,252,000

4,024,000

780,000

Long-term debt Common stock-Platform Common stock-Vector Retained earnings Noncontrolling interest

(941,000) (2,660,000)

(616,000)

Total liabilities and equity

(4,024,000)

Cash Investment in Vector

NCI

Consolidate d Balances 102,000

Platform 61,000 1,000,000

S 65,600 A 934,400

A1,960,000

1,960,000 191,000 376,000 6,140,000

191,000 A 376,000

(423,000)

Consideration transferred Noncontrolling interest fair value Acquisition-date fair value Book value Excess fair over book value Research and development asset Unpatented technology

(1,557,000) (2,660,000)

(41,000) (123,000)

S 41,000 S 123,000

(780,000)

2,500,000

(423,000) S 98,400 A 1,401,600 2,500,000

(1,500,000)

$1,000,000 1,500,000 $2,500,000 (164,000) $2,336,000 $1,960,000 376,000

2,236,000 -0-

(1,500,000) (6,140,000)

Chapter 06 – Variable Interest Entities, Intra-Entity Debt, Consolidated Cash Flows, and Other Issues– Hoyle, Schaefer, Doupnik, Advanced Accounting, 15e

24.(35 minutes) (Consolidation of a primary beneficiary and variable interest entity one year after control is obtained) Pikes and Venti Companies Consolidation Worksheet Year Ended December 31, 2024

Revenues Management fee Cost of good sold Other operating expenses Interest income Interest expense Net Income

Consolidatio n Entries

Pikes

Venti

(792,000) (54,000) 621,000 76,000 (21,000) -0(170,000)

(216,000) -089,000 64,000 -039,000 (24,000)

NCI

(F) 54,000 (IE) 21,000 (IE) 21,000

(24,000)

(1,380,000) (170,000) 75,000 (1,475,000)

(40,000) (24,000) -0(64,000)

360,000 300,000 895,000 -0-

73,000 -0527,000 125,000

1,555,000

725,000

(30,000) -0-0(50,000)

(92,000) (300,000) (254,000) (15,000)

Noncontrolling interest Retained earnings 12/31

-0(1,475,000)

-0(64,000)

Total liabilities and equity

(1,555,000)

(725,000)

Current assets Loan receivable from Venti Equipment (net) Trademark Total assets Current liabilities Loan payable to Pikes Other long-term debt Common stock

(1,008,000) -0710,000 86,000 -018,000

(F) 54,000

Consolidated net income to noncontrolling interest to Pikes Retained earnings 1/1 Net income Dividends declared Retained earnings 12/31

Consolid ated

(S) 40,000

(194,000) 24,000 (170,000) (1,380,000) (170,000) 75,000 (1,475,000) 433,000 -01,422,000 145,000

(P) 300,000 (A) 20,000

2,000,000 (122,000) -0(254,000) (50,000)

(P) 300,000 (S) 15,000 (S) 55,000 (A) 20,000 450,000

(75,000)

450,000

Fair value of Venti on January 1, 2024 (date Pikes obtains control) ............... Venti book value—January 1, 2024 ($15,000 common stock + $40,000 RE)... Excess fair over book value................................................................................. To trademark (indefinite life) .........................................................................

(99,000) (1,475,000) (2,000,000)

$75,000 55,000 20,000 20,000 -0-

25.(25 Minutes) (Consolidation entry for three consecutive years to report effects of intra-entity bond acquisition. Straight-line method used. Parent uses equity method) a. Carrying Amount of Bonds Payable, January 1, 2022 6-17 © McGraw Hill LLC. All rights reserved. No reproduction or distribution without the prior written consent of McGraw Hill LLC.

Chapter 06 – Variable Interest Entities, Intra-Entity Debt, Consolidated Cash Flows, and Other Issues – Hoyle, Schaefer, Doupnik, Advanced Accounting, 15e

Carrying amount, January 1, 2020 ............................................... $1,050,000 Amortization—2020–2021 ($5,000 per year [$50,000 premium ÷ 10 years] for two years) ......................... 10,000 Carrying amount of bonds payable, January 1, 2022 .................. $1,040,000 Carrying amount of 40% of bonds payable (intra-entity portion), January 1, 2022 .................................... $416,000 Gain on Retirement of Bonds, January 1, 2022 Purchase price ($400,000 × 96%) ................................................. Carrying amount of liability (computed above) .......................... Gain on retirement of bonds .........................................................

$384,000 416,000 $ 32,000

Carrying Amount of Bonds Payable, December 31, 2022 Carrying amount, January 1, 2022 (computed above) ............... $1,040,000 Amortization for 2022 ..................................................................... 5,000 Carrying amount of bonds payable, December 31, 2022 ............ $1,035,000 Carrying amount 40% bonds payable (intra-entity portion), December 31, 2022 .................................................................... $414,000 Carrying Amount of Investment in Bonds, December 31, 2022 Investment carrying amount, Jan. 1, 2022 (purchase price) ...... Amortization for 2022 ($16,000 discount ÷ 8-yr. rem. life) .......... Carrying amount of investment, December 31, 2022 ................. Intra-entity Interest Balances for 2022 Interest expense: Cash payment ($400,000 × 9%) ............................................... Amortization of premium for 2022 ($5,000 per year × 40% intra-entity portion) .................................................. Intra-entity interest expense ................................................... Interest income: Cash collection ($400,000 × 9%) ............................................. Amortization of discount for 2022 (above) ............................. Intra-entity interest income .....................................................

$384,000 2,000 $386,000

$36,000 2,000 $34,000 $36,000 2,000 $38,000

25. (continued) CONSOLIDATION ENTRY B (2022) Bonds Payable............................................................... 400,000 Premium on Bonds Payable ......................................... 14,000 Interest Income .............................................................. 38,000 Investment in Bonds ................................................ 386,000 Interest Expense ...................................................... 34,000 Gain on Retirement of Bonds.................................. 32,000 (To eliminate accounts stemming from intra-entity bonds [balances computed above] and to recognize gain on the effective retirement of this

Chapter 06 – Variable Interest Entities, Intra-Entity Debt, Consolidated Cash Flows, and Other Issues– Hoyle, Schaefer, Doupnik, Advanced Accounting, 15e

debt.) b. In 2023, because straight-line amortization is used, the interest accounts remain unchanged at $38,000 and $34,000. However, the premium associated with the bond payable as well as the discount on the investment are affected by the $2,000 per year amortization. In addition, the gain now has to be removed from the Investment in Hamilton account. Concurrently, the two interest balances recorded by the individual companies in 2023 are removed from the Investment in Hamilton because they occurred after the intra-entity retirement. Gain of $32,000 plus $34,000 expense removal less $38,000 income elimination yields a $28,000 credit to the investment account. CONSOLIDATION ENTRY *B (2023) Bonds Payable .................................................................... 400,000 Premium on Bonds Payable (net of $2,000 amortization) 12,000 Interest Income .............................................................. 38,000 Investment in Bonds (net of $2,000 amortization) 388,000 Interest Expense ...................................................... 34,000 Investment in Hamilton............................................ 28,000 (To remove intra-entity bond accounts that remain on the individual records of both companies. Both debt and bond investment balances have been adjusted for amortizations. Credit to Investment in Hamilton brings the totals reported by the individual companies [interest income and expense] to the balance of the original gain.) c. As with part b, new premium and discount balances must be determined and then removed. The adjustment made to the Investment in Hamilton takes into account that another year of interest expense ($34,000) and income ($38,000) have been incorporated into the investment account through application of the equity method. 25. (continued) CONSOLIDATION ENTRY *B (2024) Bonds Payable .............................................................. 400,000 Premium on Bonds Payable ........................................ 10,000 Interest Income ............................................................. 38,000 Investment in Bonds ............................................... 390,000 Interest Expense ..................................................... 34,000 Investment in Hamilton............................................ 24,000 (To remove intra-entity bond accounts that remain on the individual records of both companies. Both debt and bond investment balances have been adjusted for amortizations. Credit to Investment in Hamilton brings the totals reported by the individual companies to the balance of the original gain.)

Chapter 06 – Variable Interest Entities, Intra-Entity Debt, Consolidated Cash Flows, and Other Issues – Hoyle, Schaefer, Doupnik, Advanced Accounting, 15e

26.(12 Minutes) (Determine consolidated income statement accounts after acquisition of intra-entity bonds.) ▪

Interest Expense To Be Eliminated = $84,000 × 11% = $9,240

▪

Interest Income To Be Eliminated = $108,000 × 8% = $8,640

▪

Loss To Be Recognized = $108,000 – $84,000 = $24,000

CONSOLIDATED TOTALS ▪

Revenues and Interest Income = $1,051,360 (add the two book values and eliminate interest income on intra-entity bond)

▪

Operating and Interest Expense = $751,760 (add the two book values and eliminate interest expense on intra-entity bond)

▪

Other Gains and Losses = $152,000 (add the two book values)

▪

Loss on Retirement of Debt = $24,000 (computed above)

▪

Net Income = $427,600 (consolidated revenues, interest income, and gains less consolidated operating and interest expense and losses)

27.(30 Minutes) (Consolidation entry for two years to report effects of intra-entity bond acquisition. Effective rate method applied.) a. Loss on Repurchase of Bond Cost of acquisition .................................................. $201,000 Carrying amount ($760,000 × 1/5) .......................... 152,000 Loss on repurchase ................................................ $ 49,000 Interest Balances for 2022 Interest income: $201,000 × 7% .....................................................

$14,070

Interest expense: $152,000 (carrying amount [above]) × 12%.......

$18,240

Investment in Bonds Balance, December 31, 2022 Original cost, 1/1/22 ................................................. $201,000 Amortization of premium: Cash interest ($180,000 × 9%) ........................... $16,200 Effective interest income (above) ..................... 14,070 Investment in Bonds, 12/31/22 ................................

2,130 $198,870

Bonds Payable Balance, December 31, 2022 Carrying amount, 1/1/22 (above) ............................

$152,000

Chapter 06 – Variable Interest Entities, Intra-Entity Debt, Consolidated Cash Flows, and Other Issues– Hoyle, Schaefer, Doupnik, Advanced Accounting, 15e

Amortization of discount: Cash interest ($180,000 × 9%)................................. $16,200 Effective interest expense (above) ................... 18,240 Bonds payable, 12/31/22..........................................

2,040 $154,040

Entry B—12/31/22 Bonds Payable ........................................................ 154,040 Interest Income ........................................................ 14,070 Loss on Retirement of Debt ................................... 49,000 Investment in Bonds .......................................... 198,870 Interest Expense ................................................ 18,240 (To eliminate intra-entity debt holdings and recognize loss on retirement.) b. Interest Balances for 2023 followed by 2024 Interest income: $198,870 (Investment in Bonds balance for the year) × 7% (rounded) .....................

$13,921

Interest expense: $154,040 (liability balance for the year) × 12% (rounded)..................................

$18,485

27. (continued) Investment in Bonds Balance, December 31, 2023 Carrying amount, January 1, 2023 (part a) ............ Amortization of premium: Cash interest ($180,000 × 9%) ........................... Effective interest income (above) ..................... Investment in Bonds balance, December 31, 2023 Bonds Payable Balance, December 31, 2023 Carrying amount, January 1, 2023 (part a) ............ Amortization of discount: Cash interest ($180,000 × 9%) ........................... Effective interest expense (above) ................... Bonds payable balance, December 31, 2023 ........

$198,870 $16,200 13,921

$154,040 $16,200 18,485

Interest Balances for 2024 Interest income: $196,591 (Investment in Bonds .. balance for the year [above]) × 7% (rounded)

2,285 $156,325 $13,761

Interest expense: $156,325 (liability balance for the year [above]) × 12% ............................... Investment in Bonds Balance, December 31, 2024 Carrying amount, January 1, 2024 (above) ........... Amortization of premium: Cash interest ($180,000 × 9%) ........................... Effective interest income (above) .....................

2,279 $196,591

$18,759 $196,591 $16,200 13,761

2,439

Chapter 06 – Variable Interest Entities, Intra-Entity Debt, Consolidated Cash Flows, and Other Issues – Hoyle, Schaefer, Doupnik, Advanced Accounting, 15e

Investment in Bonds balance, December 31, 2024 Bonds Payable Balance, December 31, 2024 Carrying amount, January 1, 2024 (above) ........... Amortization of discount: Cash interest ($180,000 × 9%) ........................... Effective interest expense (above) ................... Bonds payable balance, December 31, 2024 ........

$194,152 $156,325 $16,200 18,759

2,559 $158,884

27. (continued) Adjustment Needed to Investment in Zack for Bond Retirement Loss: Loss on retirement of debt (part a) ........................ Amounts recognized in previous years:

Interest income:

Interest expense:

2022 2023

$(14,070) (13,921)

$(27,991)

2022 2023

$18,240 18,485

36,725

$49,000

8,734

Adjustment needed to Investment in Zack to arrive at consolidated total ..............

$40,266

Entry *B—12/31/24 Bonds Payable ........................................................ Interest Income ........................................................ Investment in Zack .................................................. Investment in Bonds .......................................... Interest Expense ................................................

158,884 13,761 40,266 194,152 18,759

(To eliminate intra-entity bond holdings and adjust the Investment in Zack for the unrecognized loss on retirement. Amounts computed above.) Many of the above amounts can also be determined using amortization tables as shown below. Investment in Bonds Amortization Table: Cash 2022 2023 2024

16,200 16,200 16,200

Interest Revenue

Amortization

14,070 13,921 13,761

2,130 2,279 2,439

Carrying Amount 201,000 198,870 196,591 194,152

Intra-Entity Portion of Bonds Payable Amortization Table: Cash

Interest

Amortization

Carrying

Chapter 06 – Variable Interest Entities, Intra-Entity Debt, Consolidated Cash Flows, and Other Issues– Hoyle, Schaefer, Doupnik, Advanced Accounting, 15e

2022 2023 2024

16,200 16,200 16,200

Expense

Amount

18,240 18,485 18,759

(2,040) (2,285) (2,559)

152,000 154,040 156,325 158,884

28.(35 Minutes) (Consolidation procedures and balances related to intra-entity bonds. Both straight-line and effective interest rate methods are used.) a. Acquisition price of bonds .......................................... Carrying amount of bonds payable (see Schedule 1) ($443,498 × 50%) ...................................................... Loss on retirement .......................................................

$283,550 (221,749) $ 61,801

SCHEDULE 1—Carrying Amount of Bonds Payable

Date 2021 2022 2023

Beg. Year Carrying Amount $435,765 $438,056 $440,623

Effective Interest (12% Rate) $52,292 $52,567 $52,875

Cash Interest $50,000 $50,000 $50,000

Amortization $2,292 $2,567 $2,875

Year-End Carrying Amount $438,056 $440,623 $443,498

b. Investment in Southport Bonds Purchase price—12/31/23 ........................................ Cash interest ($250,000 × 10%) .............................. Effective interest income ($283,550 × 8%) ............ Amortization ....................................................... Investment in Southport bonds, 12/31/24 .............

$25,000 22,684

Bonds Payable Carrying amount—12/31/23 (computed above) .... Cash interest ($500,000 × 10%) .............................. Effective interest expense ($443,498 × 12%) ........ Amortization ....................................................... Bonds payable, 12/31/24 .........................................

$50,000 53,220

$283,550

2,316 $281,234 $443,498

3,220 $446,718

Although not required in the problem, the consolidation entry as of 12/31/24 is as follows. The reduction in retained earnings represents the loss only; no intra-entity interest was recognized in the previous year because the purchase was made on December 31. Entry *B (2024) Bonds Payable ($446,718 × 50%) ........................... Interest Income ........................................................ Retained Earnings, 1/1/24 ....................................... Interest Expense ($53,220 × 50%) .....................

223,359 22,684 61,801 26,610

Chapter 06 – Variable Interest Entities, Intra-Entity Debt, Consolidated Cash Flows, and Other Issues – Hoyle, Schaefer, Doupnik, Advanced Accounting, 15e

Investment in Southport Bonds .......................

281,234

28. (continued) c. Loss on Retirement of Bond Because Southport uses the straight-line method of amortization, the loss on retirement must be computed again. Original issue price—1/1/21 ........................................... Discount amortization (2021–2023) ([$64,237 ÷ 13] × 3 years) Carrying amount 12/31/23 ..............................................

$435,765 14,824 $450,589

Intra-entity portion of bonds payable (50%) ................ Purchase price ............................................................... Loss on retirement .........................................................

$225,294 283,550 $ 58,256

Investment in Southport Bonds Purchase price—12/31/23 .............................................. Premium amortization (2024) ($33,550 ÷ 10) ................ Carrying amount 12/31/24 ........................................

$283,550 (3,355) $280,195

Interest Income Cash interest ($250,000 × 10%) ..................................... Premium amortization (above) ...................................... Intra-entity interest income—2024 ..........................

$25,000 (3,355) $21,645

Bonds Payable Original issue price 1/1/21 .............................................. Discount amortization (2021–2024) [($64,237 ÷ 13) × 4 years] Carrying amount 12/31/24 ........................................ Opus ownership ........................................................ Intra-entity portion—12/31/24 .............................

$435,765 19,765 $455,530 50% $227,765

Interest Expense Cash interest ($250,000 × 10%) ..................................... Discount amortization ([$64,237 ÷ 13] × 1/2) ................ Intra-entity interest expense—2024 .........................

$25,000 2,471 $27,471

The reduction in retained earnings represents the loss only; no intra-entity interest was recognized in the previous year because the purchase was made on December 31. Entry *B (2024) Bonds Payable ........................................................ Interest Income ........................................................ Retained Earnings, 1/1/24 ....................................... Interest Expense ................................................ Investment in Southport Bonds .......................

227,765 21,645 58,256 27,471 280,195

Chapter 06 – Variable Interest Entities, Intra-Entity Debt, Consolidated Cash Flows, and Other Issues– Hoyle, Schaefer, Doupnik, Advanced Accounting, 15e

29.(8 Minutes) (Determine goodwill for an acquisition in which subsidiary has both common stock and preferred stock) Consideration transferred for common stock Consideration transferred for preferred stock Noncontrolling interest in common stock Noncontrolling interest in preferred stock Hepner‘s acquisition-date fair value Book value of Hepner Goodwill

$1,600,000 630,000 400,000 270,000 $2,900,000 2,500,000 $ 400,000

30.(30 Minutes) (Consolidation entries with subsidiary cumulative preferred stock.) a. The preferred shares are entitled to the specified cumulative dividend. Thus, the noncontrolling interest's share of the subsidiary's income equals $160,000 or 8 percent of the preferred stock's par value. b. Acquisition-Date Fair Value Allocation and Amortization Consideration transferred ............................................. Noncontrolling interest fair value (preferred shares) .. Acquisition-date fair value of Smith .............................. Book value ...................................................................... Franchises ...................................................................... Period of amortization ................................................... Annual amortization ....................................................... Investment in Smith Account, December 31, 2024 Consideration transferred, January 1, 2024 ................. Equity accrual (income remaining for common stock after preferred stock dividend) ..................................... Dividends collected ($360,000 total less $160,000 paid to preferred shareholders) .................................... Amortization for 2024 (above) ....................................... Investment in Smith account, December 31, 2024 .......

$14,040,000 2,000,000 16,040,000 (16,000,000) $.40,000 40 years $1,000 $14,040,000 290,000 (200,000) (1,000) $14,129,000

c. Consolidation Entries Entry S and A combined Preferred Stock (Smith) ..................................... 2,000,000 Common Stock (Smith) ...................................... 4,000,000 Retained Earnings, 1/1/24 (Smith) .................... 10,000,000 Franchises .......................................................... 40,000 Investment in Smith....................................... 14,040,000 Noncontrolling Interest in Smith, Inc ........... 2,000,000 (To eliminate subsidiary stockholders‘ equity, record excess fair values, and record outside ownership of subsidiary's preferred stock at fair value) 30. c. (continued) 6-25 © McGraw Hill LLC. All rights reserved. No reproduction or distribution without the prior written consent of McGraw Hill LLC.

Chapter 06 – Variable Interest Entities, Intra-Entity Debt, Consolidated Cash Flows, and Other Issues – Hoyle, Schaefer, Doupnik, Advanced Accounting, 15e

Entry I

Equity Income of Smith ..................................... 289,000 Investment in Smith ....................................... 289,000 (To eliminate equity accrual made in connection with common stock [$290,000] along with excess amortization recorded by parent.)

Entry D Investment in Smith ........................................... 200,000 Dividends Declared ........................................ 200,000 (To remove intra-entity dividend declarations made on common stock [see computation above].) Entry E

Amortization Expense ........................................ 1,000 Franchises ...................................................... 1,000 (To recognize amortization of franchises for current year [see computation above].)

31.(15 Minutes) (The effect that various events have on a consolidated statement of cash flows.) ▪

Sale of building. The $44,000 in cash received from the sale is listed as a cash inflow within the company's investing activities. If the company is using the direct method in presenting cash flows from operating activities, the $12,000 gain is not presented. However, if the indirect method is used, the gain (a positive) must be eliminated from net income by a subtraction.

▪

Intra-entity inventory transfers. Because these transactions do not occur with any parties outside of the business combination, they are not reflected in the consolidated statement of cash flows.

▪

Dividend paid by the subsidiary. The $27,000 payment to the parent is eliminated in consolidated statements and is not a cash outflow from the consolidated entity. The remaining $3,000 payment to the noncontrolling interest is reported as a cash outflow from a financing activity.

▪

Amortization of intangible asset. This $16,000 noncash expense appears in the consolidated income statement. If the combined companies are using the direct method to present cash flows from operating activities, this expense is not presented. If the indirect method is used, the expense must be removed by adding it back to consolidated net income.

▪

Decrease in accounts payable. Cash payments have reduced this liability balance during the period. If the direct method is used to present cash flows from operating activities, the change is added to cost of goods sold as one step in deriving the cash paid during the period for inventory (an outflow). If the indirect method is applied, the decrease is subtracted from net income in arriving at the net cash generated from operating activities during the period.

32.(20 Minutes) (Determine cash flows from operations for a consolidated entity.)

Chapter 06 – Variable Interest Entities, Intra-Entity Debt, Consolidated Cash Flows, and Other Issues– Hoyle, Schaefer, Doupnik, Advanced Accounting, 15e

DIRECT METHOD Cash revenues (add book values, eliminate intra-entity transfers, and add decrease in accounts receivable) ................................ $648,000 Cash inventory purchases (add book values, eliminate intra-entity transfers, defer intra-entity gains, add increase in inventory, and add decrease in accounts payable) ................... (370,000) Depreciation and amortization (omit as noncash expenses)......... -0Other expenses (add book values) .................................................. (40,000) Gain on sale of equipment (omit because this is an investing activity) -0Equity in earnings of Knight (intra-entity so not included) ........... -0Net cash flow from operating activities ................................ $238,000 INDIRECT METHOD Consolidated net income (computed below) .................................. Adjustments: Depreciation and amortization .............................................. Gain on sale of equipment .................................................... Increase in inventory ............................................................. Decrease in accounts receivable .......................................... Decrease in accounts payable .............................................. Net cash flow from operating activities ..........................

$216,000 61,000 (30,000) (11,000) 8,000 (6,000) $238,000

Consolidated Net Income = $206,200 + 9,800 = $216,000 or computation below: Revenues (add book values and subtract intra-entity transfers) $640,000 Cost of goods sold (add book values, less intra-entity transfers adjusted for deferral and subsequent recognition of intra-entity gain) ............................................ (353,000) Depreciation and amortization (add book values plus amortization from excess fair value allocations) ................ (61,000) Other expenses (add book value) .............................................. (40,000) Gain on sale of equipment .......................................................... 30,000 Consolidated net income ....................................................... $216,000 33.(30 Minutes) (Compute basic and diluted earnings per share for a parent and its 100 percent owned subsidiary, both with convertible bonds.) Basic EPS—Porter Company: Porter's reported net income .................................. Street's reported net income .................................. Amortization expense ............................................. Consolidated net income (all to Porter) ............ Porter shares outstanding ................................. Basic earnings per share ($270,000 ÷ 60,000) .......

$150,000 130,000 (10,000) $270,000 60,000 $4.50

Diluted EPS—Street Company Street earnings after amortization .......................... $120,000 Shares outstanding ................................................. 30,000 6-27 © McGraw Hill LLC. All rights reserved. No reproduction or distribution without the prior written consent of McGraw Hill LLC.

Chapter 06 – Variable Interest Entities, Intra-Entity Debt, Consolidated Cash Flows, and Other Issues – Hoyle, Schaefer, Doupnik, Advanced Accounting, 15e

Basic earnings per share (120,000 ÷ 30,000) ......... Street's earnings assuming conversion of its bonds ($120,000 + $24,000 interest saved net of tax) . Street's shares assuming conversion of its bonds (30,000 + 10,000) ................................................. Diluted earnings per share (144,000 ÷ 40,000) ......

$4.00 $144,000 40,000 $3.60

Because diluted earnings per share is less than basic earnings per share, the convertible bonds are dilutive and should be included. Porter’s share of Street’s diluted earnings: Total shares assuming Street bond conversion ... Shares owned by Porter .......................................... Porter's ownership percentage (30,000 ÷ 40,000) . Street's earnings for diluted EPS (above) ............. Porter's ownership percentage ............................... Earnings attributed to Porter company ................. Porter’s earnings and shares for diluted EPS: Porter's separate net income ................................. Street‘s income applicable to Porter (above)......... Interest saved (net of tax) on assumed conversion of Porter's bonds ............................ Diluted earnings to Porter........................................ Porter shares outstanding ....................................... Additional shares from assumed bond conversion Diluted shares ..........................................................

40,000 30,000 75% $144,000 75% $108,000 $150,000 108,000 32,000 $290,000 60,000 8,000 68,000

Consolidated income statement EPS amounts for Porter Company: Basic earnings per share (above) ........................... $4.50 Diluted earnings per share ($290,000 ÷ 68,000) .... $4.26 34.(15 Minutes) (Compute diluted EPS. Subsidiary has stock warrants outstanding) Figures For Sonston's Diluted EPS Net Income ......................................................................... Shares outstanding ........................................................... Assumed conversion of stock warrants .......................... Repurchase of treasury stock with proceeds of stock Warrants (10,000 × $10 = $100,000 ÷ $20) ........................ Shares for diluted earnings per share computation ........

$200,000 40,000 10,000 (5,000)

5,000 45,000

Shares controlled by Primus: 40,000 + (20% of 5,000) = . 41,000 Percentage of total held by Primus: 41,000 ÷ 45,000 = 91% (rounded) Income to be included in parent‘s diluted EPS = $200,000 × 91% = $182,000 Parent’s Diluted Earnings Per Share:

Chapter 06 – Variable Interest Entities, Intra-Entity Debt, Consolidated Cash Flows, and Other Issues– Hoyle, Schaefer, Doupnik, Advanced Accounting, 15e

Net income – Primus ......................................................... Net income included from Sonston .................................. Earnings for diluted EPS .............................................. Outstanding shares of Primus ....................................

$600,000 182,000 $782,000 100,000

PARENT‘S DILUTED EARNINGS PER SHARE = $782,000 ’ 100,000 = $7.82 35.(15 Minutes) (Compute diluted EPS. Subsidiary has convertible bonds.) Figures for Echo's diluted EPS: Net income ......................................................................... Interest (net of tax) saved from assumed conversion .... Earnings for diluted earnings per share ..........................

$290,000 63,200 $353,200

Shares outstanding Assumed conversion of bonds Subsidiary shares for parent‘s share of diluted earnings

80,000 20,000 100,000

Shares controlled by Bravo = 80,000 ÷ 100,000 = 80% Income to be included in parent‘s diluted EPS = $353,200 × 80% = $282,560 Earnings for parent’s diluted earnings per share: Net income— Bravo............................................................ Dividends to Bravo 's preferred stock .............................. Net Income included from Echo (above) ......................... Earnings for diluted EPS...............................................

$480,000 (15,000) 282,560 $747,560

PARENT‘S DILUTED EARNINGS PER SHARE = $747,560 ’ 80,000 = $9.35 (rounded) 36.(8 Minutes) (Effect of subsidiary stock issuance to public at a price above reported value per share) Equity method investment prior to Ricardo share issue. Parent's ownership percentage ......................................... Fair value ownership equivalency..................................... Adjusted subsidiary fair value after new share issue (above value plus 10,000 shares at $15.75 each) ....... Parent's ownership (40,000 ÷ 50,000 shares) .................. New ownership adjusted fair value ...................................

$490,000 100% $490,000 $647,500 80% $518,000

Investment in Ricardo should be increased by $28,000 ($518,000 less $490,000) 37.(20 Minutes) (Effects of two different stock issuances by subsidiary.) a. Prior to the issuance of the new shares, Albuquerque owns an 80% interest in Marmon (16,000 shares out of 20,000 shares). The adjusted acquisitiondate fair value is $840,000 ($600,000 + $150,000 + $90,000). After the stock 6-29 © McGraw Hill LLC. All rights reserved. No reproduction or distribution without the prior written consent of McGraw Hill LLC.

Chapter 06 – Variable Interest Entities, Intra-Entity Debt, Consolidated Cash Flows, and Other Issues – Hoyle, Schaefer, Doupnik, Advanced Accounting, 15e

issue, the adjusted acquisition-date fair value of the subsidiary will increase by $235,000 (the price of the stock) to $1,075,000. Albuquerque' ownership, however, will only be 64% (16,000 ’ 25,000). The investment‘s equity method balance before stock issue is $672,000 (600,000 + [$90,000 × 80%]). The book value underlying Albuquerque' investment is now $688,000 (64% of $1,075,000) so that a $16,000 increase is recorded by the parent. Investment in Marmon ............................................ Additional Paid-In Capital .................................

16,000 16,000

37. (continued) b. Albuquerque's adjusted acquisition-date fair value is $840,000 (see above) prior to the issuance of the new shares. The 4,000 additional shares increase subsidiary's total value by $132,000 (the price of the stock) to $972,000. Albuquerque' ownership decreases to 2/3 (16,000 shares out of a total of 24,000) for a fair value equivalency of $648,000. Reducing the $672,000 (see a.) to $648,000 requires a $24,000 decrease to the parent‘s APIC. Additional Paid-In Capital ....................................... Investment in Marmon .......................................

24,000 24,000

38.(55 Minutes) (Prepare consolidation entries following a subsidiary stock issue to outside parties.) Initially, Aronsen owns 18,000 shares (or 90%) of Siedel's outstanding shares (the total number of shares can be determined by dividing the subsidiary's common stock account by the $10 per share par value). After issuing 4,000 additional shares, the parent must prepare an adjustment to reflect the change in its share of the subsidiary‘s unamortized acquisition-date fair value. Because that entry has not been recorded, it is included on the consolidation worksheet as Entry C1 (labeled in this manner as a correction). Other consolidation procedures follow as described in previous chapters. Excess Acquisition-Date Fair Value Allocation and Amortization Fair value (consideration transferred plus NCI fair value) ...... Acquisition-date book value....................................................... Fair value in excess of book value ............................................ Allocated to land based on fair value ........................................ Allocated to copyrights based on fair value ............................. Life of copyrights ....................................................................... Annual amortization ...................................................................

$649,000 (480,000) $169,000 89,000 $ 80,000 16 yrs $ 5,000

Adjustment for Stock Transaction Adjusted acquisition-date fair value of subsidiary on new issue date ($649,000 + $90,000 + $152,000) ... Adjusted parent ownership (18,000 shares ÷ 24,000 shares)

$891,000 75%

Chapter 06 – Variable Interest Entities, Intra-Entity Debt, Consolidated Cash Flows, and Other Issues– Hoyle, Schaefer, Doupnik, Advanced Accounting, 15e

Parent‘s post-issue equity method value at 1/1/24 .... $668,250 Equity method balance before new subsidiary stock issue Consideration transferred ............................................. 584,100 Increase in book value (90% × $100,000) ....................... 90,000 Copyright amortization ($5,000 × 2 years × 90%) ........ (9,000) 665,100 Required increase (Entry C1) ............................................ $ 3,150 38. (continued) Consolidation worksheet entries: Entry *C Investment in Siedel......................................................... 81,000 Retained Earnings, 1/1/24 (Aronsen) ...................... 81,000 (To convert 1/1/24 balance to full accrual [$100,000 less two year‘s amortization expense $5,000 × 2] × 90%) Entry C1 Investment in Siedel........................................................... 3,150 Additional Paid-In Capital (Aronsen) ...................... 3,150 (To record adjustment for subsidiary stock transaction; computation shown above.) Entry S Common Stock (Siedel) ................................................. 240,000 Additional Paid-In Capital (Siedel) ................................ 112,000 Retained Earnings, 1/1/24 (Siedel) ................................ 380,000 Investment in Siedel (75%) ...................................... Noncontrolling Interest in Siedel, 1/1/24 (25%) ......

549,000 183,000

(To eliminate subsidiary stockholders' equity accounts against Investment account and to recognize noncontrolling interest. Stockholders‘ equity balances have been adjusted for increase in book value during 2022–2023 and the issuance by the subsidiary of 4,000 shares of stock on 1/1/24.) Entry A Land .................................................................................. 89,000 Copyrights ........................................................................ 70,000 Investment in Siedel (75%)....................................... 119,250 Noncontrolling Interest (25%) ................................. 39,750 (To recognize acquisition price allocated to land and copyrights. Copyrights balance has been reduced for 2022–2023 amortization to arrive at 1/1/24 balance. NCI now reflects 25% of the unamortized 1/1/24 balance.) Entry I Dividend Income .............................................................. 15,000

Chapter 06 – Variable Interest Entities, Intra-Entity Debt, Consolidated Cash Flows, and Other Issues – Hoyle, Schaefer, Doupnik, Advanced Accounting, 15e

Dividends Declared .................................................. 15,000 (To eliminate intra-entity dividends recorded by parent as income [75% × $20,000].) Entry E Amortization Expense........................................................ 5,000 Copyrights................................................................. (To recognize current year amortization.)

5,000

39. (50 Minutes) (Prepare consolidation worksheet for business combination. Intraentity bond acquisition is made during the current year.) Acquisition-date fair-value allocation and amortization: Equipment Trademarks

$30,000 $40,000

10-year life 20-year life

$3,000 annual amortization $2,000 annual amortization

As indicated in the problem, the parent is applying the partial equity method. Hence an Entry *C must be recorded on the worksheet to convert the recorded figures (amortization is needed for the three years prior to 2024) to equity balances: Amortization expense ($5,000 × 3 years) = ............ $15,000 (Entry *C) Deferred gross profit in ending inventory (downstream): Ending balance ......................................................... Markup ($20,000 ÷ $100,000) .................................... Intra-entity gross profit to be eliminated ................

$10,000 20% $ 2,000

(Entry G)

Loss on extinguishment of bonds: Carrying amount at date of repurchase ....................... Percentage repurchased ............................................... Equivalent carrying amount .......................................... Amount paid ................................................................... Loss on extinguishment of bonds ................................

$282,000 50% $141,000 145,500 $ 4,500

(Entry B)

Amortization during 2024 changed the carrying amount of the bond payable from $282,000 to $288,000 (found in the balance sheet) and the investment from $145,500 to $147,000. This amortization also affects interest income and expense accounts. Entry A reflects remaining values after three years of amortizations.

Chapter 06 – Variable Interest Entities, Intra-Entity Debt, Consolidated Cash Flows, and Other Issues– Hoyle, Schaefer, Doupnik, Advanced Accounting, 15e

39.(continued) Pavin and Stabler Consolidation Worksheet Year Ending December 31, 2024

Accounts

Pavin

Consolidation Entries Debit

Stabler

Consolidated Totals Credit

Chapter 06 – Variable Interest Entities, Intra-Entity Debt, Consolidated Cash Flows, and Other Issues – Hoyle, Schaefer, Doupnik, Advanced Accounting, 15e Revenues ........................................... Cost of goods sold ............................. Expenses ........................................... Interest expense—bonds ................... Interest income—bond investment .... Loss on extinguishment of bonds ...... Equity in income of Stabler ................ Net income...................................

(740,000) 455,000 125,000 36,000 -0-0(123,000) (247,000)

Retained earnings, 1/1/24 .................. Retained earnings, 1/1/24 .................. Net income (above) ............................ Dividends declared............................. Retained earnings, 12/31/24 ..............

(345,000) (247,000) 155,000 (437,000)

(361,000) (123,000) 61,000 (423,000)

Cash and receivables......................... Inventory ............................................ Investment in Stabler .........................

217,000 175,000 613,000

35,000 87,000 -0-

Investment in Pavin bonds ................. Land, buildings, and equipment (net) .................................................... Trademarks ........................................ Total assets ................................. Accounts payable ............................... Bonds payable ................................... Discount on bonds ............................. Common stock ................................... Retained earnings (above)................. Total liabilities and stockholders‘ equity

(505,000) 240,000 158,500 -0(16,500) -0-0(123,000)

(TI) (G) (E)

100,000 2,000 5,000

(B) (B) (I)

16,500 4,500 123,000

(*C) (S)

15,000 361,000

(TI)

100,000

(B)

18,000

61,000 33,000 2,000 15,000 481,000 55,000 123,000 147,000 3,000

219,000 260,000

2,000

32,000 1,315,000

(A)

21,000

-0810,000

(A)

34,000

(E)

(167,000) (100,000) -0(120,000) (423,000) (810,000)

(P) (B)

33,000 150,000

(S)

120,000

-0245,000

147,000 541,000

-01,250,000 (225,000) (300,000) 12,000 (300,000) (437,000) (1,250,000)

61,000

(B) 1,046,000

6-34

(330,000) -0(237,000) 155,000 (412,000)

(D) (P) (G) (*C) (S) (A) (I) (B) (E)

(D)

(1,145,000) 597,000 288,500 18,000 -04,500 -0(237,000)

6,000 1,046,000

-0-0804,000

(359,000) (250,000) 6,000 (300,000) (412,000) (1,315,000)

Chapter 07 - Consolidated Financial Statements—Ownership Patterns and Income Taxes – Hoyle, Schaefer, Doupnik, Advanced Accounting, 15e

40.(45 Minutes) (Prepare consolidation entries after intra-entity bond acquisition.) a. Allocation of Acquisition-date Excess Fair Value Consideration transferred $312,000 Noncontrolling interest fair value 208,000 Acquisition-date fair value $520,000 Book value acquired 300,000 Fair value in excess of book value $220,000 Excess allocated to patents based on fair value Trademarks

Remaining Life 90,000 12 years $130,000 10 years Total

Annual Excess Amortizations $7,500 13,000 $20,500

CONSOLIDATION ENTRIES Entry *TL Investment in Sandra .................................................... 7,000 Land .......................................................................... 7,000 (To eliminate intra-entity gain created by previous intra-entity transfer. Investment is adjusted here because transfer was downstream and equity method has been applied by parent. Thus, retained earnings have already been corrected.) Entry *G Retained Earnings 1/1/24 (Sandra) .............................. 8,000 Cost of Goods Sold ................................................. 8,000 (To remove intra-entity inventory gross profit from prior year recognize the profit in the current year. Amount is computed as shown below.) Intra-entity profit—2023 ................................................ $25,000 Transfer price—2023 ..................................................... $125,000 Markup ($25,000 ÷ $125,000) ........................................ 20% Recognized gain from 1/1/24 inventory ($40,000 × 20%) ........................................................ $8,000 Entry S Common Stock (Sandra) ................................................... 100,000 Retained Earnings, 1/1/24 (Sandra) (adjusted for Entry *G) ....................................................... 292,000 Investment in Sandra (60%) .................................... 235,200 Noncontrolling Interest in Sandra (40%) ................ 156,800 (To eliminate Sandra's stockholders' equity accounts and to record beginning of year balance for noncontrolling interest.) 40. a. (continued)

Chapter 07 - Consolidated Financial Statements—Ownership Patterns and Income Taxes – Hoyle, Schaefer, Doupnik, Advanced Accounting, 15e

Entry A Patents ............................................................................ 75,000 Trademarks ......................................................................... 104,000 Investment in Sandra ............................................... 107,400 Noncontrolling Interest ........................................... 71,600 (To recognize unamortized balances as of 1/1/24 of amounts allocated within original acquisition price. Allocations have been reduced by two years of amortizations.) Entry I Equity income of Sandra ............................................... 5,064 Investment in Sandra .......................................... (To eliminate intra-entity equity income accrual) Sandra‘s income................................................................... $25,000 Excess amortizations ................................................... (20,500) 2023 intra-entity inventory gross profit .................. 8,000 2024 intra-entity inventory gross profit (see Entry G) (7,500) Accrual-based income.............................................. $5,000 Paiton‘s ownership percentage ............................... 60% Paiton‘s share of Sandra‘s net income ................... $3,000 Intra-entity interest income...................................... (1,873) Intra-entity interest expense .................................... 1,283 Gain on effective retirement of parent‘s bonds ..... 2,654* Equity in earnings of Sandra ................................... $5,064

5,064

* $21,386 bond liability – $18,732 repurchase price (amounts given in problem)

Entry D Investment in Sandra .................................................... Dividends Declared .................................................. (To eliminate intra-entity dividend declaration.) Entry E Amortization Expense ................................................... Patents....................................................................... Trademarks ............................................................... (To recognize current year amortization expense.)

2,400 2,400

20,500 7,500 13,000

Entry P Accounts Payable ......................................................... 60,000 Accounts Receivable ............................................... 60,000 (To remove intra-entity debt created by inventory transfers.) 40. a. (continued) Entry B Bonds Payable .............................................................. Premium on Bonds Payable .........................................

20,000 1,069

Chapter 07 - Consolidated Financial Statements—Ownership Patterns and Income Taxes – Hoyle, Schaefer, Doupnik, Advanced Accounting, 15e

Interest Income .............................................................. 1,873 Investment in Paiton‘s Bonds ................................. 19,005 Interest Expense ...................................................... 1,283 Gain on Retirement of Bonds .................................. 2,654 (To eliminate effect created by bond acquisition and recognize the related retirement gain [$21,386 – $18,732]. Amounts are calculated below.)

Investment Liability

Carrying Amount (given)

Effective Interest

$18,732 $1,873(10%) 21,386 1,283 (6%)

Cash Excess Year-End Interest Amortizations Carrying (8%) Amount $1,600 1,600

$273 317

$19,005 21,069

Entry Tl Sales .................................................................................... 120,000 Cost of Goods Sold (or purchases) ........................ 120,000 (To eliminate intra-entity transfers made during current year.) Entry G Cost of Goods Sold ....................................................... 7,500 Inventory.................................................................... 7,500 (To defer intra-entity profits in ending inventory as calculated below): Intra-entity profit ............................................................... $ 30,000 Transfer price 2024 ........................................................... $ 120,000 Markup ($30,000 ÷ $120,000) ............................................ 25% Intra-entity gross profit in ending inventory ($30,000 × 25%) $7,500 b. Sandra's reported net income for 2024 ............................ Excess fair value amortization .......................................... 2023 intra-entity gross profit recognized in 2024 (Entry *G) 2024 deferred intra-entity gross profit (Entry G) .............. Sandra's realized net income for 2024............................... Noncontrolling interest ownership ................................... Net income attributable to noncontrolling interest ..........

$25,000 (20,500) 8,000 (7,500) $5,000 40% $2,000

Noncontrolling interest, 1/1/24 (Entries S and A) ............ NCI‘s share of Sandra's net income (above) .................... NCI‘s share of Sandra's dividends ($4,000 × 40%) .......... Noncontrolling interest, 12/31/24 .......................................

$228,400 2,000 (1,600) $228,800

40. (continued) c. The balances in the individual records as of December 31, 2025 pertaining to the Intra-entity bonds are as follows:

Chapter 07 - Consolidated Financial Statements—Ownership Patterns and Income Taxes – Hoyle, Schaefer, Doupnik, Advanced Accounting, 15e

Investment Liability

Beginning Carrying Amount (see part a.)

$19,005 21,069

Effective Interest

Cash Excess Interest Amortizations (8%)

$1,901 (10%) 1,264 (6%)

$1,600 1,600

$301 336

Year-End Carrying Amount $19,306 20,733

The adjustment to recognize the original gain by the parent can be computed as follows: Original gain on retirement (see part a) ............................ Interest income recorded on investment in 2024 (see part a) ..................................................................... Interest expense recorded on liability in 2024 (see part a) ..................................................................... Required increase as of January 1, 2025 ......................... Entry *B (as of December 31, 2025) Bonds Payable ............................................................... Premium on Bonds Payable ......................................... Interest Income .............................................................. Investment in Sandra ............................................... Investment in Paiton‘s bonds ................................. Interest Expense ......................................................

$2,654 $1,873 1,283

590 $2,064

20,000 733 1,901 2,064 19,306 1,264

(To remove accounts pertaining to intra-entity bonds. "Investment in Sandra" is adjusted here rather than retained earnings because equity method is used and the gain is attributed to the parent.) 41. (50 Minutes) (Prepare consolidation entries for intra-entity preferred stock and bonds. Determine specified account balances. Preferred stock is a debt instrument.) a. Consideration transferred for common stock................... $552,800 Consideration transferred for preferred stock.................. 65,000 Noncontrolling interest in common stock......................... 138,200 Noncontrolling interest in preferred stock ........................ 34,000 Lisa‘s acquisition-date fair value ....................................... $790,000 Book value of Lisa............................................................... 750,000 Excess assigned to franchises .......................................... $ 40,000 CONSOLIDATION ENTRIES 1/1/23 Entry S and A combined: Preferred Stock (Lisa) ...................................................

100,000

Chapter 07 - Consolidated Financial Statements—Ownership Patterns and Income Taxes – Hoyle, Schaefer, Doupnik, Advanced Accounting, 15e

Common Stock (Lisa) ................................................... Retained Earnings, 1/1/23 (Lisa) .................................. Franchises ..................................................................... Investment in Lisa-Common Stock ......................... Investment in Lisa-Preferred Stock......................... Noncontrolling Interest in Lisa, Inc .........................

200,000 450,000 40,000 552,800 65,000 172,200

(To eliminate subsidiary stockholders‘ equity, record excess acquisitiondate fair values, and record outside ownership of subsidiary's preferred and common stock at acquisition-date fair values.) b. Acquisition price of bonds, 1/2/23 ................................ Carrying amount of ½ bonds payable acquired) .......... (44,175) Loss on extinguishment of debt .............................. Interest income—Mona ($53,310 × 8%) ......................... (rounded) Interest expense—Lisa ($44,175 × 14%) ....................... (rounded) Investment in bonds of Lisa (carrying amount): Carrying amount—date of acquisition, 1/2/23 ........ Cash interest ($50,000 × 10%) .................................. Effective interest (above) .......................................... Investment in Bonds of Lisa (carrying amount as of 12/31/23) ........................

$53,310 $9,135 $4,265 $6,185 $53,310

$5,000 4,265

735 $52,575

41. b. (continued) Bonds payable (carrying amount) Carrying amount—date of acquisition, 1/2/23 ........ Cash interest ($50,000 × 10%) .................................. Effective interest (above) .......................................... Bonds payable (carrying amount as of 12/31/23) CONSOLIDATION ENTRY B—December 31, 2023 (all figures computed above) Bonds Payable .......................................................... Interest Income (or other revenues) ........................ Loss on Retirement of Bonds .................................. Discount on Bonds Payable ($50,000 – $45,360) Interest Expense ................................................... Investment in Bonds of Lisa ...............................

$44,175 $5,000 6,185

1,185 $45,360

50,000 4,265 9,135 4,640 6,185 52,575

c. December 31, 2023 book values based on historical cost figures: Cost of fixed assets ............................................................. $100,000 Depreciation expense ($40,000 book value over a 10-year life) ............................................................. 4,000

Chapter 07 - Consolidated Financial Statements—Ownership Patterns and Income Taxes – Hoyle, Schaefer, Doupnik, Advanced Accounting, 15e

Accumulated depreciation (including current expense) .....................................................................

64,000

December 31, 2023 book values based on transfer price: Cost of fixed assets ........................................................ $120,000 Depreciation expense (10-year life) .............................. 12,000 Accumulated depreciation ............................................. 12,000 Gain on transfer of fixed assets ($120,000 – $40,000) book value .............................. 80,000 CONSOLIDATION ENTRY TA—December 31, 2023 Gain on Transfer of Fixed Assets (to remove) ............. Accumulated Depreciation ($64,000 – $12,000)....... Depreciation Expense ($12,000 – $4,000)................. Fixed Assets ($120,000 – $100,000)..........................

80,000 52,000 8,000 20,000

41. (continued) d. Original allocation to franchises (given) ...................... Amortization at $1,000/year (2023–2024) ................. Consolidated franchises—12/31/24 .........................

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

Fixed assets (book values): Mona, Inc...................................................................... $1,100,000 Lisa Co. ...................................................................... 800,000 Reduction necessitated by intra-entity sale ($120,000 transfer price reduced to $100,000 original cost) (see part c) .......................................... (20,000) Consolidated fixed assets—12/31/24......................... $1,880,000 Accumulated depreciation (book values): Mona, Inc......................................................................... $300,000 Lisa Co. ...................................................................... 200,000 Increase needed to eliminate intra-entity sale ($60,000 accumulated depreciation at time of transfer less excess depreciation expense [$12,000 - $4,000] for 2023 and 2024) ...................... 44,000 Consolidated Acc. Depr.—12/31/24 .............................. $544,000 Expenses (book values): Mona, Inc ............................................................... Lisa Co. ................................................................. Recognition of amortization on franchises ............. Elimination of interest expense on intercompany debt ($45,360 [see part b] × 14%) (rounded).......

$220,000 120,000 1,000 (6,350)

Chapter 07 - Consolidated Financial Statements—Ownership Patterns and Income Taxes – Hoyle, Schaefer, Doupnik, Advanced Accounting, 15e

Elimination of excess depreciation from intra-entity transfer of fixed assets ($12,000– $4,000) ................................................. (8,000) Consolidated expenses ................................................. $326,650 42.(35 Minutes) (Prepare statement of cash flows for a business combination.) (Note: before working this problem, students may wish to review the statement of cash flows in an intermediate accounting textbook.) BOLERO COMPANY AND CONSOLIDATED SUBSIDIARY RIVERA Consolidated Statement of Cash Flows Year Ending December 31, 2024 CASH FROM OPERATING ACTIVTIES Consolidated net income ................................................ Adjustment from accrual to cash: Depreciation and amortization ................................. Gain on sale of building ............................................ Decrease in accounts receivable ............................. Increase in inventory ................................................ Decrease in accounts payable ................................. Net cash flow from operating activities ........................ CASH FLOWS FROM INVESTING ACTIVITIES Sale of building ............................................................... Purchase of equipment (given) ...................................... Net cash flow from investing activities ....................

$250,000 120,000 (30,000) 20,000 (150,000) (50,000) $160,000 $70,000 (205,000)

CASH FLOWS FROM FINANCING ACTIVITIES Dividends paid ................................................................ $(112,000) Issuance of bonds .......................................................... 110,000 Issuance of common stock ............................................ 67,000 Net cash flow from financing activities ................... Net increase in cash during 2024 ....................................... Cash, January 1, 2024 ......................................................... Cash, December 31, 2024 ....................................................

(135,000)

65,000 90,000 90,000 $180,000

The above statement uses the indirect method for computing cash flows from operations. 42. (continued) Development of Cash Flow Balances via Direct Method OPERATING ACTIVITIES

Chapter 07 - Consolidated Financial Statements—Ownership Patterns and Income Taxes – Hoyle, Schaefer, Doupnik, Advanced Accounting, 15e

Cash collected from customers (consolidated revenues plus the decrease in accounts receivable) ............................ Cash Purchases (consolidated COGS plus increase in inventory plus decrease in accounts payable) ............................................... Interest expense (the consolidated balance) .............................. Cash flows from operating activities ........................................... INVESTING ACTIVITIES Sale of building ($40,000 book value sold at a $30,000 gain)..... Purchase of equipment (given in problem) ................................. Cash flows from investing activities ............................................ FINANCING ACTIVITIES Dividends paid by parent (the consolidated balance) ............... Dividends paid by subsidiary (amount paid to noncontrolling interest—20%) ................................................ Issuance of bonds ........................................................................ Issuance of common stock by the parent (increase in common stock and additional paid-in capital) ...................... Cash flows from financing activities............................................

$1,050,000 (850,000) (40,000) $ 160,000 $ 70,000 (205,000) $(135,000) $(110,000) (2,000) 110,000 67,000 $ 65,000

43.(40 Minutes) (Compute basic and diluted earnings per share. Subsidiary has stock warrants outstanding and convertible debt.) Basic EPS—Amarillo, Inc. Consolidated net income to parent ..................................... Amarillo‘s preferred dividends ........................................... Earnings applicable to Amarillo‘s basic EPS ...............

$284,000 (40,000) $244,000

Amarillo's outstanding common shares ............................

50,000

Basic earnings per share ($244,000 ÷ 50,000) ........................

$4.88

Diluted EPS—Amarillo, Inc. Subsidiary earnings and shares for Amarillo’s diluted EPS calculation: Saltillo net income after amortization ................................. $105,000 Interest saved assuming conversion of bonds (net of tax) ........................................................................ 22,000 Net income applicable to diluted EPS ................................ $127,000 Shares outstanding ............................................................. Assumed conversion of bonds ........................................... Subsidiary shares applicable to diluted EPS ....................

30,000 10,000 40,000

Shares controlled by parent ................................................

24,000

Chapter 07 - Consolidated Financial Statements—Ownership Patterns and Income Taxes – Hoyle, Schaefer, Doupnik, Advanced Accounting, 15e

Portion owned by parent (24,000 ÷ 40,000) ........................

60%

Net income applicable to parent—diluted EPS (60% × $127,000) .............................................................

$76,200

Amarillo’s income and shares for diluted EPS calculation: Amarillo‘s separate net income ........................................... $200,000 Net income of Saltillo to parent (computed above) .......... 76,200 Preferred dividends (assumed converted) ........................ -0Earnings applicable to diluted EPS .................................... $276,200 Amarillo's outstanding common shares ............................ 50,000 Assumed conversion of preferred stock (10,000 × 2 shares) .......................................................... 20,000 Shares applicable to diluted EPS ....................................... 70,000 Diluted earnings per share ($276,200 ÷ 70,000) .................. $3.95(rounded) 44.(30 minutes) (Consolidated Cash Flow Statement with current year business combination) Plaster Inc. and Subsidiary Stucco Company Consolidated Statement of Cash Flows For the year ended 12/31/24 CASH FLOW FROM OPERATING ACTIVITIES Consolidated net income Depreciation expense Amortization expense Decrease in accounts receivable (net of acquisition) Increase in inventory (net of acquisition) Decrease in accounts payable (net of acquisition) Net cash flow provided by operating activities

$274,000 187,500 8,750 3,600 (102,000) (8,000)

89,850 $363,850

CASH FLOW FROM INVESTING ACTIVITIES Purchase of Stucco Company assets (net of cash acquired) Net cash flow used in investing activities

(856,000)

CASH FLOW FROM FINANCING ACTIVITIES Issue long-term debt Dividends Net cash flow provided by financing activities

$692,000

800,000 (108,000)

Increase in cash 1/1/24 to 12/31/24

$199,850

Beginning cash, 1/1/24 Ending cash, 12/31/24

43,000 $242,850

Chapter 07 - Consolidated Financial Statements—Ownership Patterns and Income Taxes – Hoyle, Schaefer, Doupnik, Advanced Accounting, 15e

Excel Case–Intra-entity Bonds Bonds with a stated rate of 11% sold to yield 12% Eff. Yield 12%

2022 2023 2024 2025 2026 2027 2028 2029 2030 2031

1,000,000.00 110,000.00 943,497.77 946,717.50 950,323.60 954,362.43 958,885.93 963,952.24 969,626.51 975,981.69 983,099.49 991,071.43 1,000,000.00

0.32197 5.65022 113,219.73 113,606.10 114,038.83 114,523.49 115,066.31 115,674.27 116,355.18 117,117.80 117,971.94 118,928.57

321,973.24 621,524.53 943,497.77 110,000.00 110,000.00 110,000.00 110,000.00 110,000.00 110,000.00 110,000.00 110,000.00 110,000.00 110,000.00

Consolidated Worksheet Entry 12/31/24 Bonds Payable 954,362.43 Interest Income 117,523.20 Loss on Retirement 0.00 Gain on Retirement Investment in Bonds Interest Expense

46,299.01 911,547.79 114,038.83

Bonds retired by affiliate on 1/1/24 at

904,024.59

Eff. Yield 13%

2024 2025 2026 2027 2028 2029 2030 2031

1,000,000.00 110,000.00 904,024.59 911,547.79 920,049.00 929,655.37 940,510.57 952,776.95 966,637.95 982,300.88 1,000,000.00

0.37616 4.79877 117,523.20 118,501.21 119,606.37 120,855.20 122,266.37 123,861.00 125,662.93 127,699.12

376,159.86 527,864.73 904,024.59 110,000.00 110,000.00 110,000.00 110,000.00 110,000.00 110,000.00 110,000.00 110,000.00

56,502.23 3,219.73 3,606.10 4,038.83 4,523.49 5,066.31 5,674.27 6,355.18 7,117.80 7,971.94 8,928.57 56,502.23

95,975.41 7,523.20 8,501.21 9,606.37 10,855.20 12,266.37 13,861.00 15,662.93 17,699.12 95,975.41

RESEARCH CASE: STATEMENT OF CASH FLOWS

Chapter 07 - Consolidated Financial Statements—Ownership Patterns and Income Taxes – Hoyle, Schaefer, Doupnik, Advanced Accounting, 15e

Pfizer, Inc. shows the following in its 2021 Consolidated Statement of Cash Flows: •

Pfizer employs the indirect method of accounting for operating cash flows starting with net income and then reconciling through adjustments to ―Net cash provided by operating activities.‖

•

Pfizer includes in its determination of net cash provided by operating activities other changes in assets and liabilities, net of acquisitions and divestitures. These other changes are included ―net‖ so as not to distort the effects of accounts receivable and other accounts balance obtained from current year acquisitions. For example, including accounts receivable from a business combination would cause an increase in accounts receivable that did not result from sales. Such a change in accounts receivable would thus not affect cash provided by operating activities.

•

Cash paid for business acquisitions (net of cash acquired) is shown as an investing activity.

•

The net income used in the operating cash flow section of the statement of cash flows is the net income before allocation to noncontrolling interests. Because the statement of cash flows accounts for the year-to-year difference in cash on the consolidated balance sheet, all income to the consolidated entity (both controlling and noncontrolling interests) must be included.

•

Pfizer shows a $10.861 billion acquisition (net of cash acquired) in the 2019 column of its consolidated statements of cash flows. The cash outflow was related to Pfizer‘s acqusition of Array, a commercial stage biophamaceutical company.

Financial Reporting Research and Analysis Case The number of potential solutions is large. Searches in Lexis-Nexis, Edgar, etc. will produce numerous examples of consolidations of VIEs. For example, Walt Disney Company discloses the assets and liabilities of its consolidated VIEs Hong Kong Disneyland, Shanghai Disney Resort, and others as follows: The following table summarizes the carrying amounts of the International Theme Parks‘ assets and liabilities included in the Company‘s consolidated balance sheets as of October 2, 2021 and October 3, 2020 (amounts in millions): 2021

2020

Chapter 07 - Consolidated Financial Statements—Ownership Patterns and Income Taxes – Hoyle, Schaefer, Doupnik, Advanced Accounting, 15e

Cash and cash equivalents Other current assets Total current assets Parks, resorts and other property Other assets Total assets

$ 287 95 382 6,928 176 $ 7,486

$ 372 91 463 6,720 191 $ 7,374

Current liabilities Borrowings - long-term Other long-term liabilities Total liabilities

$ 473 1,331 422 $ 2,226

$ 486 1,213 403 $ 2,102

CHAPTER 7 CONSOLIDATED FINANCIAL STATEMENTS—OWNERSHIP PATTERNS AND INCOME TAXES Chapter Outline I.

Indirect subsidiary control A. Control of subsidiary companies within a business combination is often of an indirect nature; one subsidiary possesses the stock of another rather than the parent having direct ownership. 1. These ownership patterns may be developed specifically to enhance control or for organizational purposes. 2. Such ownership patterns may also result from the parent company's acquisition of a company that already possesses subsidiaries. B. One of the most common corporate structures is the parent-child-grandchild configuration where each subsidiary in turn owns one or more subsidiaries. C. The consolidation process is altered somewhat when indirect control is present. 1. The worksheet entries are effectively doubled by each corporate ownership layer but the concepts underlying the consolidation process are not changed. 2. Calculation of the accrual-based income of a subsidiary recognizing the consolidated relationships is an important step in an indirect ownership structure. a. The determination of accrual-based income figures is needed for equity income accruals as well as for the computation of noncontrolling interest balances. b. Any company within the business combination that is in both a parent and a subsidiary position must recognize the equity income accruing from its subsidiary before computing its own income.

II.

Indirect subsidiary control-connecting affiliation A. A connecting affiliation exists whenever two or more companies within a business combination hold an equity interest in another member of that organization. B. Despite this variation in the standard ownership pattern, the consolidation process is essentially the same for a connecting affiliation as for a parent-child-grandchild organization. C. Once again, any company in both a parent and a subsidiary position must recognize an appropriate equity accrual in computing its own income.

Chapter 07 - Consolidated Financial Statements—Ownership Patterns and Income Taxes – Hoyle, Schaefer, Doupnik, Advanced Accounting, 15e

III.

Mutual ownership A. A mutual affiliation exists whenever a subsidiary owns shares of its parent company. B. Parent shares held by a subsidiary are accounted for by the treasury stock approach. 1. The cost paid to acquire the parent's stock is reclassified within the consolidation process to a treasury stock account and no income is accrued. 2. The treasury stock approach is popular in practice because of its simplicity and is now required by the FASB Codification.

IV.

Income tax accounting for a business combination—consolidated tax returns A. A consolidated tax return can be prepared for all companies comprising an affiliated group. Any other companies within the business combination file separate tax returns. B. A domestic corporation may be included in an affiliated group if the parent company (either directly or indirectly) owns at least 80 percent of the voting stock of the subsidiary as well as 80 percent of each class of its nonvoting stock. C. The filing of a consolidated tax return provides several potential advantages to the members of an affiliated group. 1. Intra-entity profits are not taxed until goods are sold to outsiders or consumed within the consolidated group. 2. Intra-entity dividends are not taxed (although these distributions are nontaxable for all members of an affiliated group whether a consolidated return or a separate return is filed). 3. Losses of one affiliate can be used to reduce the taxable income earned by other members of the group. D. Income tax expense—effect on noncontrolling interest valuation 1. If a consolidated tax return is filed, an allocation of the total expense must be made to each of the component companies to arrive at the adjusted income figures that serve as a basis for noncontrolling interest computations. 2. Income tax expense is frequently assigned to each subsidiary based on the amounts that would have been paid on separate returns.

Income tax accounting for a business combination—separate tax returns A. Members of a business combination that are foreign companies or that do not meet the 80 percent ownership rule (as described above) must file separate income tax returns. B. Companies in an affiliated group can elect to file separate tax returns. Deferred income taxes are often recognized when separate returns are filed due to temporary differences stemming from intra-entity gains and losses as well as intra-entity dividends.

VI.

Temporary tax differences can stem from the creation of a business combination A. The tax basis of a subsidiary's assets and liabilities may differ from their consolidated values (which is based on the fair value on the date the combination is created). B. If additional taxes will result in future years (for example, if the tax basis of an asset is lower than its consolidated value so that future depreciation expense for tax purposes will be less), a deferred tax liability is created by a combination. C. The deferred tax liability is then written off (creating a reduction in tax expense) in future years so that the net expense recognized (a lower number) matches the combination's book income (a lower number due to the extra depreciation of the consolidated value).

VII.

Operating loss carryforwards A. Net operating losses recognized by a company can be used to reduce taxable income indefinitely (a carryforward) subject to 80 percent of any future year‘s taxable income.

Chapter 07 - Consolidated Financial Statements—Ownership Patterns and Income Taxes – Hoyle, Schaefer, Doupnik, Advanced Accounting, 15e

B. If one company in a newly created combination has a tax carryforward, the future tax benefits are recognized as a deferred income tax asset. C. However, a valuation allowance must also be recorded to reduce the deferred tax asset to the amount that is more likely than not to be realized. Answers to Questions 1. A parent-child-grandchild relationship is a specific type of ownership configuration often encountered in business combinations. The parent possesses the stock of one or more companies. At least one of these subsidiaries holds a majority of the voting stock of its own subsidiary. Each subsidiary controls other subsidiaries with the chain of ownership going on indefinitely. The parent actually holds control over all of the companies within the business combination despite having direct ownership in only its own subsidiaries. 2. In a business combination having an indirect ownership pattern, at least one company is in both a parent and a subsidiary position. To calculate the accrual-based income earned by that company, a proper recognition of the equity income accruing from its own subsidiary must initially be made. Structuring the income calculation in this manner is necessary to ensure that all earnings are properly included by each company. 3. Able—100% of income accrues to the consolidated entity (as parent company). Baker—70% (percentage of stock owned by Able). Carter—56% (80% of stock owned by Baker multiplied by the 70% of Baker controlled by Able). Dexter—33.6% (60% of stock owned by Carter multiplied by the 80% of Carter controlled by Baker multiplied by the 70% of Baker owned by Able). 4. When an indirect ownership is present, the quantity of consolidation entries will increase, perhaps significantly. An additional set of entries is included on the worksheet for each separate investment. Furthermore, the determination of accrual-based net income figures for each subsidiary must be computed in a precise manner. For any company in both a parent and a subsidiary position, equity income accruals are recognized prior to the calculation of that company's accrual-based net income. The accrual-based net income total is significant because it serves as the basis for noncontrolling interest calculations as well as the equity accruals to be recognized by that company's parent. 5. In a connecting affiliation, two (or more) companies within a business combination own shares in a third member. A mutual ownership, in contrast, exists whenever a subsidiary possesses an equity interest in its own parent. 6. In accounting for a mutual ownership, U.S. GAAP requires the treasury stock approach. The treasury stock approach presumes that the cost of the parent shares should be reclassified as treasury stock within the consolidation process. The subsidiary is viewed, under this method, as an agent of the parent. Thus, the shares are accounted for as if the parent had actually made the acquisition. 7. According to present tax laws, an affiliated group can be comprised of all domestic corporations in which a parent holds 80 percent ownership. More specifically, the parent must own (directly or indirectly) 80 percent of the voting stock of the corporation as well as at least 80 percent of each class of nonvoting stock.

Chapter 07 - Consolidated Financial Statements—Ownership Patterns and Income Taxes – Hoyle, Schaefer, Doupnik, Advanced Accounting, 15e

8. Several basic advantages are available to combinations that file a consolidated tax return. First, intra-entity profits are not taxed until the goods are sold to outside customers or consumed within the consolidated group. For companies with large amounts of intra-entity transactions, the deferral of intra-entity gains causes a delay in the making of significant tax payments. Second, losses incurred by one company can be used to reduce or offset taxable income earned by other members of the affiliated group. In addition, intra-entity dividends are not taxable but that exclusion applies to the members of an affiliated group regardless of whether a consolidated or separate tax return is filed. Members of a business combination may be forced to file separate tax returns. Foreign corporations, for example, must always file separately. Domestic companies that do not meet the 80 percent ownership rule are also required to file in this manner. Furthermore, companies that are in an affiliated group may still elect to file separately. If all companies within the combination are profitable and few intra-entity transactions are carried out, little advantage may accrue from preparing a consolidated return. With a separate filing, a subsidiary has more flexibility as to accounting methods as well as its choice of a fiscal year-end. 9. The allocation of income tax expense among the component companies of a business combination has a direct bearing on adjusted income totals and, therefore, noncontrolling interest calculations. Obviously, the more expense that is assigned to a particular company the less income is attributed to that concern. Income tax expense can be allocated based on the income totals that would have been reported by various companies if separate tax returns had been filed or on the portion of taxable income derived from each company. 10. In filing a separate tax return (assuming that the two companies do not qualify as members of an affiliated group), the parent must include as income the dividends received from the subsidiary. For financial reporting purposes, however, income is accrued based on the ownership percentage of the adjusted income of the subsidiary. Because income is frequently recognized by the parent prior to when it receives a dividend (when it is subject to taxation), deferred income taxes must be recognized. Either the parent or the subsidiary might also have to record deferred income taxes in connection with any intra-entity gain on assets that remain within the consolidated entity. On a separate tax return, such gains are reported at the time of transfer while for financial reporting purposes they are appropriately deferred until the goods are sold to outside customers or consumed within the consolidated group. Once again, a temporary difference is created which necessitates the recognition of deferred income taxes. 11. If the consolidated value of a subsidiary‘s assets exceeds their tax basis, depreciation expense in the future will be less on the tax return than is shown for external reporting purposes. The reduced expense creates higher taxable income and, thus, increases taxes. Therefore, the difference in values dictates an anticipated increase in future tax payments. This deferred liability is recognized at the time the combination is created. Subsequently, when actual tax payments do arise, the deferred liability is written off rather than recognizing expense based solely on the current liability. In this manner, the expense is shown at a lower figure, one that is matched with reported income (which is also a lower balance because of the extra depreciation). Recognition of this deferred liability at date of acquisition also reduces the net amount attributed to the subsidiary's assets and liabilities in the initial allocation process. Therefore,

Chapter 07 - Consolidated Financial Statements—Ownership Patterns and Income Taxes – Hoyle, Schaefer, Doupnik, Advanced Accounting, 15e

the residual asset (goodwill) is increased by the amount of any liability that must be recognized. 12. A net operating loss carryforward allows the company to reduce future taxable income subject to 80 percent of any future year‘s taxable income. Thus, a benefit may possibly be derived from the carryforward but that benefit is based on Wilson‘s (the subsidiary) ability to generate future taxable income for offset against the carryforward. To reflect the potential tax reduction, a deferred income tax asset is recorded for the total amount of anticipated benefit. However, because of the uncertainty, unless the receipt of this benefit is more likely than not to be received, a valuation allowance must also be recorded as a contra account to the asset. The valuation allowance may be for the entire amount or just for a portion of the asset. 13. At the date of acquisition, the valuation allowance was $150,000. As a contra asset account, recognition of this amount reduced the net assets attributed to the subsidiary and, hence, increased the recording of goodwill (assuming that the price did not indicate a bargain purchase). If the valuation allowance is subsequently reduced to $110,000, the net assets have increased by $40,000. This change is reflected by a decrease in income tax expense. Answers to Problems

1. D 2. B 3. A 4. C 5. C 6. C 7. D

Sapphire's accrual-based income: Operating income ............................................................................. $210,000 Defer intra-entity gain .................................................................. (50,000) Sapphire's accrual-based income ............................................. $160,000 Emerald's accrual-based income: Operating income ............................................................................. $228,000 Investment Income (90% of Sapphire‘s accrual income).......... 144,000 Emerald's accrual-based income .............................................. $372,000 Diamond's accrual-based income: Operating income ............................................................................. $348,000 Investment income (80% of Emerald's accrual income)........... 297,600 Diamond's accrual-based income ............................................. $645,600

Chapter 07 - Consolidated Financial Statements—Ownership Patterns and Income Taxes – Hoyle, Schaefer, Doupnik, Advanced Accounting, 15e

8. C Stang's accrual-based income: Operating income......................................................................... Defer intra-entity gain .................................................................. Stang's accrual-based income .............................................. Outside ownership....................................................................... Net income attributable to noncontrolling interest..............

$240,000 (50,000) $190,000 30% $ 57,000

Belvista's accrual-based income: Operating income......................................................................... Defer intra-entity gain .................................................................. Investment income (70% of Stang's accrual-based income).... Beltran's accrual-based income ............................................ Outside ownership....................................................................... Net income attributable to noncontrolling interest..............

$305,000 (18,000) 133,000 $420,000 30% $ 126,000

Total net income attributable to noncontrolling interest = ($57,000 + $126,000) = $183,000 9. A Stark's operating income.................................................................. Dividend income from Arryn ............................................................ Stark's income ................................................................................... Outside ownership ............................................................................ Noncontrolling interest .....................................................................

$78,000 18,000 $96,000 5% $ 4,800

Equity income (75% of $425,000) ..................................................... Dividend income (75% of $105,000) ................................................. Tax difference............................................................................... Dividends received deduction upon eventual distribution (65%) Temporary portion of tax difference........................................... Tax rate............................................................................................... Deferred income tax liability .......................................................

$318,750 78,750 $240,000 (156,000) $ 84,000 21% $ 17,640

Intra-Entity Gross Profit: Total gross profit.......................................................................... Portion still held ........................................................................... Intra-entity gross profit in inventory ..................................... Tax rate............................................................................................... Deferred tax asset ........................................................................

$50,000 20% $ 10,000 21% $ 2,100

10. B

11. C

12. A Recognition of this gross profit is not required on a consolidated tax return. 13. B

Chapter 07 - Consolidated Financial Statements—Ownership Patterns and Income Taxes – Hoyle, Schaefer, Doupnik, Advanced Accounting, 15e

Because fair value of the subsidiary's assets exceeds the tax basis by $40,000, a deferred tax liability of $8,400 (21%) must be recorded. Goodwill is then computed as follows: Consideration transferred.................................... Fair value............................................................... Deferred tax liability ............................................. Goodwill ................................................................

(8,400)

$401,600 $355,000 346,600 $ 55,000

14.(30 Minutes) (Series of reporting and consolidation questions pertaining to a parent-child-grandchild combination. Includes intra-entity inventory gains) a. Consideration transferred (by Aspen) .......................... Noncontrolling interest fair value.................................. Birch‘s business fair value ............................................ Book value....................................................................... Trade name...................................................................... Life ................................................................................... Annual amortization .......................................................

$288,000 72,000 360,000 (300,000) $ 60,000 30 years $ 2,000

14. (continued) Consideration transferred for Cedar (by Birch) ........... Noncontrolling interest fair value.................................. Cedar‘s business fair value ........................................... Book value....................................................................... Trade name...................................................................... Life ................................................................................... Annual amortization .......................................................

$104,000 26,000 $130,000 (100,000) $30,000 30 years $ 1,000

Investment in Birch

$288,000

Birch's reported income-2022

$40,000

Amortization expense

(2,000)

Accrual-based income

$38,000

Aspen‘s percentage ownership

80%

Equity accrual-2022

$30,400

Dividends received 2022

(8,000)

Birch's reported income-2023

$60,000

Amortization expense

(2,000)

Chapter 07 - Consolidated Financial Statements—Ownership Patterns and Income Taxes – Hoyle, Schaefer, Doupnik, Advanced Accounting, 15e

Income from Cedar [80% × ($10,000 –$1,000)] Accrual-based income

7,200 $65,200

Aspen‘s percentage ownership

80%

Equity accrual-2023

$52,160

Dividends received from Birch 2023

(16,000)

Investment in Birch, December 31, 2023

$346,560

Note: Dividends declared by Cedar (payable to Birch) do not affect Aspen‘s Investment account. b. Consolidated sales (total for the companies) Consolidated expenses (total for the companies) Total amortization expense (see a.) Consolidated net income for 2024

$1,298,000 (1,025,000) (3,000) $ 270,000

c. Noncontrolling interest in income of Cedar Revenues less expenses Excess amortization Accrual-based income Noncontrolling interest percentage Noncontrolling interest in income of Cedar

$30,000 (1,000) $29,000 20%

Noncontrolling interest in income of Birch: Revenues less expenses $65,000 Excess amortization (2,000) Equity in Cedar income [(30,000-1,000) × 80%] 23,200 Accrual-based net income of Birch—2024 $86,200 Outside ownership 20% NCI share of 2024 consolidated income

$5,800

$17,240 $23,040

14. (continued) d. 2023 Adjusted net income of Birch (prior to accounting for intra-entity gross profit) (see a) 2022 Transfer-gross profit recognized in 2023 2023 Transfer-gross profit to be recognized in 2024 2023 Accrual-based net income - Birch

$65,200 10,000 (16,000) $59,200

2024 Adjusted net income of Birch (prior to accounting

Chapter 07 - Consolidated Financial Statements—Ownership Patterns and Income Taxes – Hoyle, Schaefer, Doupnik, Advanced Accounting, 15e

for intra-entity gross profit) (see c.) 2023 Transfer-gross profit recognized in 2024 2024 Transfer-gross profit to be recognized in 2025 2024 Accrual-based net income—Birch

$86,200 16,000 (25,000) $77,200

15.(15 minutes) (Income and noncontrolling interest with mutual ownership.) a. Consideration transferred by Uncle ......................... Noncontrolling interest fair value............................. Nephew‘s business fair value ................................... Book value.................................................................. Intangible assets........................................................ Life .............................................................................. Amortization expense (annual).................................

$500,000 125,000 $625,000 600,000 $25,000 10 years $2,500

Net income reported by Nephew—2024................... Amortization expense (above) .................................. Accrual-based income............................................... Uncle's ownership percentage ................................. Net income of subsidiary recognized by Uncle.......

$50,000 (2,500) 47,500 80% $38,000

b. To the outside owners, the $6,000 intra-entity dividends ($20,000 × 30%) declared by Uncle are viewed as income because the book value of Nephew increases. Thus, the noncontrolling interest's share of income is computed as follows: Nephew‘s accrual-based income (above) $47,500 Dividends declared by Uncle to Nephew 6,000 Income to outside owners $53,500 Noncontrolling interest percentage 20% Noncontrolling interest share of Nephew‘s net income $ 10,700 16.(35 Minutes) (Consolidated net income for a parent-child-grandchild combination.) a. Boulder's operating income Rock's operating income Stone's operating income Amortization expense–Boulder's investment in Rock Amortization expense–Rock's investment in Stone Consolidated net income

$245,000 85,000 150,000 (22,000) (8,000) $450,000

b. Stone's operating income Amortization expense (on Rock's investment) Stone's accrual-based net income

$150,000 (8,000) $142,000

Chapter 07 - Consolidated Financial Statements—Ownership Patterns and Income Taxes – Hoyle, Schaefer, Doupnik, Advanced Accounting, 15e

Outside ownership 25% Noncontrolling interest in Stone's income Rock's operating income $ 85,000 Amortization expense (on Boulder's investment) (22,000) Equity accrual from ownership of Stone ($142,000 × 75%) 106,500 Rock's accrual-based net income $169,500 Outside ownership 10% Noncontrolling interest in Rock's net income Total net income attributable to noncontrolling interests

$35,500

$16,950 $52,450

Reconciliation: Boulder‘s operating income $245,000 Boulder‘s share of Rock‘s operating income (90% × $85,000) 76,500 Boulder‘s share of Stone‘s operating income (90% × 75% × $150,000) 101,250 Boulder‘s share of Rock‘s excess amortization (90% × $22,000) (19,800) Boulder‘s share of Stone‘s excess amortization (90% × 75% × $8,000) (5,400) Controlling interest in consolidated net income $397,550 Net income attributable to noncontrolling interest 52,450 Consolidated net income $450,000 17.(30 Minutes) (Consolidated net income figures for a connecting affiliation) INTRA-ENTITY GROSS PROFIT: Cleveland ($12,000 remaining inventory × 25% markup) = Wisconsin ($40,000 remaining inventory × 30% markup) =

$3,000 $12,000

NONCONTROLLING INTERESTS: CLEVELAND: Operating income (sales minus cost of goods sold and expenses)................................................................................. Defer intra-entity gross profit (above)......................................... Accrual-based net income—Cleveland ................................. Outside ownership........................................................................ Noncontrolling interest in Cleveland's net income ..............

$60,000 (3,000) $57,000 20% $11,400

WISCONSIN: Operating income (sales minus cost of goods sold and expenses).......................................................................... Defer intra-entity gross profit (above)......................................... Investment income (60% of Cleveland's accrual-based income of $57,000) .................................................................. Accrual-based net income—Wisconsin ................................ Outside ownership........................................................................ Noncontrolling interest in Wisconsin's net income .............

$110,000 (12,000) 34,200 $132,200 10% $ 13,220

TOTAL NONCONTROLLING INTERESTS: $24,620 ($11,400 + $13,220)

Chapter 07 - Consolidated Financial Statements—Ownership Patterns and Income Taxes – Hoyle, Schaefer, Doupnik, Advanced Accounting, 15e

CONSOLIDATION TOTALS ▪ Sales = $1,590,000 (add the three book values and eliminate intra-entity transfers of $40,000 and $100,000) ▪ Cost of goods sold = $1,015,000 (add the three book values, eliminate intraentity transfers of $40,000 and $100,000, and defer [add] intra-entity gains of $3,000 and $12,000) ▪ Expenses = $200,000 (add the three book values) ▪ Dividend income = -0- (eliminated for consolidation purposes) ▪ Consolidated net income = $375,000 (consolidated revenues less consolidated cost of goods sold and expenses) ▪ Net income attributable to noncontrolling interest = $24,620 (above) ▪ Net income attributable to Baxter Company = $350,380 (consolidated net income less noncontrolling interest share) 18.(12 Minutes) (Acquisition accounting for a subsidiary‘s operating loss carryforward) a. Consideration transferred 1/1/24 Fair value of identifiable assets acquired: Software licensing agreements Deferred tax asset from NOL (21% × $155,000) Fair value of net identifiable assets acquired Goodwill

$1,120,000 $900,000 32,550 932,550 $187,450

b. Consideration transferred 1/1/24 Fair value of identifiable assets acquired: Software licensing agreements Deferred tax asset from NOL (.21 × $155,000) Valuation allowance for NOL Fair value of net identifiable assets acquired Goodwill

$1,120,000 $900,000 32,550 (32,550) 900,000 $220,000

19.(25 Minutes) (Tax expense with separate tax returns for a combination.) a. CONSOLIDATED TOTALS ▪ Sales = $790,000 (add the two book values and eliminate the $110,000 intraentity transfer) ▪ Cost of goods sold = $340,000 (add the book values, eliminate intra-entity transfers of $110,000, recognize [subtract] $30,000 deferred gross profit from 2024, and defer [add] $40,000 intra-entity gross profit into 2025) ▪ Operating expenses = $234,000 (add the two book values) ▪ Dividend income = -0- (eliminated for consolidation purposes) ▪ Consolidated net income = $216,000 (Revenues less expenses) ▪ Net income attributable to noncontrolling interest = $18,000 (20 percent of

Chapter 07 - Consolidated Financial Statements—Ownership Patterns and Income Taxes – Hoyle, Schaefer, Doupnik, Advanced Accounting, 15e

▪

reported Income of $100,000 plus $30,000 gross profit deferred from 2024 less $40,000 gross profit deferred into 2025) Net income attributable to Abajo Company = $198,000

b. On separate returns, the intra-entity gross profits in inventories are reported as taxable income. Because Arriba owns 80 percent of Abajo's stock, the dividends are tax-free and no deferred tax liability is necessary on the undistributed income. DUE TO GOVERNMENT: (separate returns) ARRIBA: Income (without dividend income) ............................................. Tax rate ......................................................................................... Currently payable to government .........................................

$126,000 21% $ 26,460

ABAJO: Reported income........................................................................... Tax rate ......................................................................................... Currently payable to government .........................................

$100,000 21% $ 21,000

Total income tax payable: Current = $47,460 ($26,460 + $21,000). Taxable income is not reduced by the intra-entity gross profit. Therefore, the gross profit is recognized for tax purposes but not for book purposes and this temporary difference results in a deferred tax asset of $2,100 ($10,000 × 21%). CONSOLIDATED INCOME TAX EXPENSE: Income tax liability ($26,460 + $21,000) = $47,460 less deferred tax asset ($2,100) = income tax expense $45,360. Otherwise stated as: Arriba has a tax expense of $26,460 and Abajo has a tax expense of $18,900 ($21,000 payable - $2,100 deferred tax asset). Income tax expense on the consolidated income statement is $45,360. 20.(45 Minutes) (Computation of income tax expense and the related payable balances) a. $136,500 ($650,000 × 21%) The affiliated group is taxed on its operating income of $650,000 ($500,000 – $90,000 + $240,000; the net intra-entity gross profit is deferred on a consolidated return). The intra-entity income and dividends are not relevant because the entity files a consolidated return. b. $136,500 ($650,000 × 21%) The affiliated group is taxed on its operating income of $650,000 (the net intraentity gross profit is deferred on a consolidated return). The intra-entity income

Chapter 07 - Consolidated Financial Statements—Ownership Patterns and Income Taxes – Hoyle, Schaefer, Doupnik, Advanced Accounting, 15e

and dividends are not relevant if a consolidated return is filed. The percentage ownership does not affect the figures on a consolidated return. c. $155,400 ($50,400 + $105,000) Rowen would pay $50,400 or 21% of its $240,000 operating income. Marta would pay $105,000 or 21% of its $500,000 operating income. The intra-entity gross profit is not deferred when separate returns are filed. Intra-entity dividends are not taxable because the parties qualify as an affiliated group even though the affiliates file separate returns. Answer (c.) differs from (a.) and (b.) because tax on the $90,000 intra-entity gross profit in inventory (21% or $18,900) is paid immediately. 20. (continued) d. Marta‘s operating income $500,000 Dividends received net of 65% deduction ($80,000 × 70% × 35%)............................................... Taxable income ............................................................... Tax rate ............................................................................ Marta‘s income tax payable ......................................

19,600 $519,600 21% $109,116

Marta‘s deferred taxes: Intra-entity gross profit in ending inventory ................ Tax rate ............................................................................ Marta‘s deferred tax asset ........................................

$90,000 21% $18,900

Rowen‘s income before income tax .............................. Less: income tax (21%) .................................................. Rowen net income .......................................................... Less: dividends paid ...................................................... Undistributed income ..................................................... Marta‘s ownership percentage ...................................... Marta‘s share of undistributed income ......................... Less: dividends-received deduction (65%) .................. Income eventually taxable to Marta............................... Tax rate ............................................................................ Marta‘s deferred tax liability .....................................

$240,000 50,400 $189,600 80,000 $109,600 70% $ 76,720 49,868 $ 26,852 21% $ 5,639

Entry on Marta’s books: Deferred Tax Asset Income Tax Expense Deferred Tax Liability Tax Payable

18,900 95,855

Entry on Rowen’ books: Income Tax Expense (21% × $240,000) Tax Payable

50,400

5,639 109,116

50,400

Chapter 07 - Consolidated Financial Statements—Ownership Patterns and Income Taxes – Hoyle, Schaefer, Doupnik, Advanced Accounting, 15e

Consolidated tax expense = $95,855 + $50,400 = $146,255 e. $109,116 (see part d. above) Marta owes $105,000 on its operating income ($500,000 × 21%) because the intra-entity gross profit in ending inventory cannot be deferred. Marta also owes $4,116 from the dividends received ($56,000 × 35% × 21%). The difference between Marta‘s $109,116 payment and the $95,855 tax expense in (d.) is created by the premature payment of the tax (a deferred tax asset) on the intra-entity inventory gross profit ($90,000) less the deferred tax liability on the parent's net equity accrual ($76,720) in excess of dividends received ($49,868). 21.(20 Minutes) (Comparison of income tax expense and payable on separate and consolidated tax returns.) a. Consolidated Return—2024 Abbey income 2024 (sales less expenses) ........................... Benjamin income 2024 (sales less expenses)...................... 2023 deferred intra-entity gross profit .................................. 2024 deferred intra-entity gross profit .................................. Taxable income ....................................................................... Tax rate .................................................................................... Income tax payable.................................................................

$300,000 100,000 120,000 (150,000) $370,000 21% $ 77,700

Because no temporary differences exist in this problem, the income tax expense would also be $77,700. The intra-entity gross profit is not taxed until the goods are sold to an outside customer or consumed within the consolidated group. Dividend income is not important because the group files a consolidated return. b. Separate Returns—2024 On its separate tax return, Abbey will report taxable income of $300,000—the intra-entity inventory gross profits cannot be deferred. The dividends would not be taxable because Benjamin still meets the criteria to be a member of an affiliated group. A consolidated return is not a requirement for these dividends to be excluded. Thus, income taxes payable by Abbey would be $63,000 ($300,000 × 21%). To determine the income tax expense for Abbey, the two temporary differences must be taken into account: Taxable income ...................................................................... Intra-entity gross profit taxed in 2023 although recognized in 2024 ................................................. Intra-entity gross profit in inventory taxed in 2024.............. 2024 net income subject to taxation .................................... Tax rate ................................................................................... Income tax expense ...............................................................

$300,000 120,000 (150,000) $270,000 21% $ 56,700

Chapter 07 - Consolidated Financial Statements—Ownership Patterns and Income Taxes – Hoyle, Schaefer, Doupnik, Advanced Accounting, 15e

The $6,300 difference between the expense and the payable is the tax effect on the net intra-entity gross profit ($30,000 × 21%). Benjamin will have an expense and payable of $21,000 ($100,000 × 21%). Consolidated income tax expense is $77,700 ($56,700 + $21,000). Consolidated income tax payable is $84,000 ($63,000 + $21,000). 22. 45 Minutes) (Comparison of income tax expense and payable on separate and consolidated tax returns. Includes question on mutual ownership and the conventional approach.) a. Total income tax expense is $84,056. Because of the level of ownership, separate returns must be filed. Intra-entity gross profits are taxed immediately as are intra-entity dividends. Because the intra-entity inventory gross profits are deferred on the consolidated financial statements, Boxwood's expense would be $18,060 or 21% of $86,000 in net income ($100,000 + $18,000 – $32,000). Lake's income subject to taxation includes its $300,000 in operating income plus $40,764 in income accruing from its investment in Boxwood (60% of the after-tax income of $67,940 [$86,000 – $18,060]). Income tax expense for Lake is computed as follows: Operating income .................................................... Equity income .......................................................... Taxable portion ........................................................ Income eventually subject to taxation ................... Tax rate ...................................................................... Income tax expense Lake (rounded) ....................... Income tax expense Boxwood (above) ................... Total income tax expense ....................................... -ORLake‘s operating income.......................................... Dividends received net of 65% deduction ($10,000 × 60% × 35%)......................................... Taxable income ......................................................... Tax rate ...................................................................... Lake‘s income tax payable ................................. Boxwood‘s income before income tax.................... Less: income tax (21%) ............................................ Boxwood‘s net income............................................. Less: dividends paid ................................................ Undistributed income ............................................... Lake‘s ownership percentage.................................. Lake‘s share of undistributed income .................... Less: dividends-received deduction (65%) ............

$300,000 $40,764 35%

14,267 $314,267 21% $ 65,996 18,060 $ 84,056

$300,000 2,100 $302,100 21% $63,441 $ 86,000 (18,060) $ 67,940 (10,000) $ 57,940 60% $ 34,764 (22,597)

Chapter 07 - Consolidated Financial Statements—Ownership Patterns and Income Taxes – Hoyle, Schaefer, Doupnik, Advanced Accounting, 15e

Income eventually taxable to Lake .......................... Tax rate ...................................................................... Lake‘s deferred tax liability (rounded) ............... Income tax expense Lake ................................... Income tax expense Boxwood (above).............. Total income tax expense ........................................

$ 12,167 21% $ 2,555 $ 65,996 18,060 $ 84,056

22. (continued) Entry on Lake’s books: Income Tax Expense Deferred Tax Liability Tax Payable

65,996 2,555 63,441

Entry on Boxwood’s books: Income Tax Expense Deferred Tax Asset Tax Payable

18,060 2,940 21,000

b. Boxwood will pay $21,000 ($100,000 × 21%) because separate returns are filed. Lake, however, will pay its taxes based on dividends received rather than on the equity accrual. A deferred income tax liability would be established for the difference. Lake's payment for the current year is computed as follows: Operating income ..................................................... Dividend income (60% × $10,000) ........................... $6,000 Taxable portion (net of 65% dividends received deduction) 35% Income currently taxable.......................................... Tax rate ...................................................................... Income tax payable—Lake ....................................... Income tax payable—Boxwood (above) ................. Total income tax payable .........................................

$300,000 2,100 $302,100 21% $ 63,441 21,000 $ 84,441

The $385 difference ($84,441 – $84,056) between the expenses in a. and the payable in b. is created by the following two effects: Deferred income tax liability on equity income accrual not yet taxed ($67,940 – $10,000) × 60% = $34,764 × 35% × 21%) ........... $2,555 Deferred income tax asset on net intra-entity gross profit ($32,000 – $18,000 = $14,000 × 21%) ................................... 2,940 Net decrease in expense ........................................................... $ 385 c. Because a consolidated tax return is filed, intra-entity gross profits in ending inventory are deferred as for external reporting purposes. Dividend income is not taxable. Lake's operating income .......................................................... $300,000

Chapter 07 - Consolidated Financial Statements—Ownership Patterns and Income Taxes – Hoyle, Schaefer, Doupnik, Advanced Accounting, 15e

Boxwood's operating income ............................................... Prior year intra-entity gross profit in ending inventory...... Current year intra-entity gross profit in ending inventory . Income subject to taxation (and currently taxable) ............ Tax rate ................................................................................... Income tax expense...............................................................

100,000 18,000 (32,000) $386,000 21% $ 81,060

23.(30 Minutes) (Computation of income tax expense and income tax payable on consolidated and separate tax returns.) a. Operating income ..................................................................... $450,000 Tax rate ................................................................................... 21% Taxes to be paid ......................................................................... $ 94,500 The affiliated group would be taxed on its operating income of $450,000 (the $50,000 intra-entity gain is deferred). Intra-entity income and dividends are not relevant because a consolidated return is filed. b. Total taxes to be paid are $105,000. Robertson would have to pay $42,000 or 21% of its $200,000 operating income. Garrison would pay $63,000 or 21% of its $300,000 operating income. The intra-entity gain is not deferred because separate returns are filed. Intra-entity dividends are not taxable because the parties still qualify as an affiliated group even though separate returns are filed. c. Robertson must report an income tax expense of $42,000 or 21% of its $200,000 operating income. Garrison records its expense based on the revenue recognized during the period. Thus, the expense is computed on an operating income of $250,000 (the net intra-entity gain is not recognized in this period) along with equity income from Robertson of $110,600 (70% of that company's $158,000 after-tax income). Garrison will record an income tax expense of $52,500 in connection with the operating income ($250,000 × 21%) and $8,129 resulting from its equity income ($110,600 × 35% × 21%). Total expense to be reported amounts to $102,629 for Garrison and Robertson ($42,000 + $52,500 + $8,129). d. Garrison will pay $63,000 in connection with its operating income ($300,000 × 21%) and $2,205 because of the dividends received from Robertson. Garrison will receive $30,000 in dividends based on its 60% ownership. Of this total, only $10,500 (35%) is taxable. Thus, at a 21% rate, the tax on the dividends would amount to $2,205 ($10,500 × 21%). The total income taxes payable by Garrison is $65,205 ($63,000 + $2,205). 24.(10 Minutes) (Impact on goodwill of assets with a different tax vs. book value.) a. The assets and liabilities of Oxford (the subsidiary) will be consolidated at their

Chapter 07 - Consolidated Financial Statements—Ownership Patterns and Income Taxes – Hoyle, Schaefer, Doupnik, Advanced Accounting, 15e

individual net fair values ($658,000). However, both the buildings and equipment have a tax basis that is lower than fair value. Thus, for tax purposes, future depreciation expense will be lower on the tax return so that taxable income will exceed book income. The higher taxable income (anticipated in the future) creates a deferred tax liability at the time the combination is created. Tax Basis Buildings Equipment Total temporary difference Tax rate Deferred tax liability

$221,000 160,000

Temporary Difference

Fair Value $276,000 233,000

$ 55,000 73,000 $128,000 21% $ 26,880

b. Consequently, Oxford's accounts will be consolidated as follows: (parentheses indicate a credit balance) Accounts receivable ...................................................... Inventory......................................................................... Land ................................................................................ Buildings ........................................................................ Equipment ...................................................................... Liabilities ........................................................................ Deferred tax liability....................................................... Assigned to specific accounts ..................................... Acquisition consideration.............................................

$153,000 141,000 136,000 276,000 233,000 (281,000) (26,880) 631,120 850,000

Excess assigned to goodwill ........................................

$218,880

c. 25.(55 Minutes) (Consolidation worksheet for a parent-child-grandchild combination. Includes intra-entity inventory transfers. Affiliates use equity method.) The following computations are needed before the consolidation worksheet is prepared: calculation of the deferred gross profits in beginning and ending inventory.

Chapter 07 - Consolidated Financial Statements—Ownership Patterns and Income Taxes – Hoyle, Schaefer, Doupnik, Advanced Accounting, 15e

Beginning Intra-entity Gross Profit (Beta) (January 1, 2024 Inventory Balance)

Transfer Price (goods remaining) = Cost + .25 Cost $60,000 = 1.25 Cost $48,000 = Cost $12,000 is intra-entity gross profit

Ending Intra-entity Gross Profit (Beta) (December 31, 2024 Inventory Balance)

Transfer Price (goods remaining) = Cost + .25 Cost $90,000 = 1.25 Cost $72,000 = Cost $18,000 is intra-entity gross profit

CONSOLIDATION ENTRIES Entry *G Retained Earnings, 1/1/24 (Beta)................................ 12,000 Cost of Goods Sold ............................................... 12,000 (To recognize income on intra-entity inventory transfers made in previous year but not resold until current year as per above computation.) Entry S1 Common Stock (Cade) .....................................................150,000 Retained Earnings, 1/1/24 (Cade) ....................................150,000 Investment in Cade (80%) ..................................... 240,000 Noncontrolling Interest in Cade Common Stock (20%) 60,000 (To eliminate Cade's stockholders' equity against the corresponding investment balance and to recognize noncontrolling interest in common stock.) Entry S2 Common Stock (Beta)................................................. 310,000 Retained Earnings, 1/1/24 (Beta) (adjusted by Entry *G)................................................. 578,000 Investment in Beta (70%) ...................................... 621,600 Noncontrolling Interest in Beta (30%) .................. 266,400 (To eliminate Beta's stockholders' equity against corresponding investment balance and to recognize noncontrolling interest.) 25. (continued) Entry A Buildings...................................................................... Franchise Contracts ................................................... Trademarks.................................................................. Equipment .............................................................. Investment in Beta ................................................. Noncontrolling Interest in Beta ............................

54,000 32,000 140,000 10,000 151,200 64,800

Chapter 07 - Consolidated Financial Statements—Ownership Patterns and Income Taxes – Hoyle, Schaefer, Doupnik, Advanced Accounting, 15e

(To allocate excess payment made in connection with purchase of Beta shown above. Amortization for 2022 and 2023 has been taken into account in determining the January 1, 2024 value for each account.) Entry I1 Income of Cade ........................................................... 56,000 Investment in Cade ................................................ 56,000 (To eliminate intra-entity income accrued by both Acme and Beta during the year.) Entry I2 Income of Beta .................................................................105,000 Investment in Beta ................................................. 105,000 (To eliminate intra-entity income accrued by Acme during the year.) Entry D1 Investment in Cade ..................................................... Dividends declared (80%) (Cade) ......................... (To eliminate effects of intra-entity dividend payments.) Entry D2 Investment in Beta ...................................................... Dividends declared (70%) (Beta) .......................... (To eliminate effects of intra-entity dividend payments.)

40,000 40,000

67,200 67,200

Entry E Operating Expenses ................................................... 2,000 Equipment.................................................................... 5,000 Franchise Contracts .............................................. 4,000 Buildings ................................................................ 3,000 (To record 2024 amortization of excess payment made in connection with acquisition of Beta Company.) Entry TI Sales and Other Revenues ..............................................200,000 Cost of Goods Sold ............................................... (To eliminate intra-entity inventory sales for the current year.)

200,000

25. (continued) Entry G Cost of Goods Sold..................................................... Inventory................................................................. (To defer intra-entity gross profit in ending inventory.)

18,000 18,000

Noncontrolling Interest in Net Income of Cade:

Chapter 07 - Consolidated Financial Statements—Ownership Patterns and Income Taxes – Hoyle, Schaefer, Doupnik, Advanced Accounting, 15e

Reported net income .................................................. Outside ownership...................................................... Noncontrolling interest in Cade net income .............

$70,000 20% $14,000

Noncontrolling Interest in Net Income of Beta: Reported operating income........................................ Equity income of Cade ($70,000 × 40%) .................... Excess amortization ................................................... Recognition of 2023 gross profit (Entry *G).............. Deferral of 2024 intra-entity gross profit (Entry G)... Accrual-based net income.......................................... Outside ownership...................................................... Noncontrolling interest in net income of Beta..........

$130,000 28,000 (2,000) 12,000 (18,000) $150,000 30% $ 45,000

Chapter 07 - Consolidated Financial Statements—Ownership Patterns and Income Taxes – Hoyle, Schaefer, Doupnik, Advanced Accounting, 15e

25. (continued) ACME CORPORATION AND CONSOLIDATED SUBSIDIARIES Consolidation Worksheet December 31, 2024

Accounts Sales and other revenue Cost of goods sold Operating expenses Income of Beta Company Income of Cade Company Net income Consolidated net income Net income attributable to noncontrolling interest (Beta) Net income attributable to noncontrolling interest (Cade) Net income attributable to Acme Corporation Retained earnings, 1/1: —Acme Corporation —Beta Company —Cade Company Net Income Dividends declared —Acme Corporation —Beta Company —Cade Company Retained earnings, 12/31 Cash and receivables Inventory

Acme Corp. (900,000) 551,000

Beta Company (700,000) 300,000

Cade Company (300,000) 140,000

219,000 (105,000) (28,000) (263,000)

270,000

90,000

(28,000) (158,000)

(70,000)

Consolidation Entries Debit (TI) 200,000 (G) 18,000 (E) (I2) (I1)

Credit (*G) (TI)

Noncontrollin g Interest

12,000 200,000

2,000 105,000 56,000

581,000 -0-0(45,000)

(322,000) 45,000

(14,000)

14,000 (263,000)

(808,800) (590,000) (263,000)

(158,000)

(150,000) (70,000)

(*G) (S2) (S1)

(808,800) -0-

12,000 578,000 150,000

-0(263,000)

100,000 96,000 (971,800) 220,000 390,200

Investment in Beta Company

Consolidated Balance (1,700,000) 797,000

(652,000) 334,000 320,000

50,000 (170,000) 67,000 103,000

810,600

(D2)

67,200

(D2) (D1)

67,200 40,000

(G)

18,000

(S2) (I2)

621,600 105,000

28,800 10,000

100,000 -0-0(971,800) 621,000 795,200 -0-

Chapter 07 - Consolidated Financial Statements—Ownership Patterns and Income Taxes – Hoyle, Schaefer, Doupnik, Advanced Accounting, 15e Investment in Cade Company

128,000

Buildings Equipment Land Trademarks Franchise Contracts Total assets Liabilities Noncontrolling interest in Cade Noncontrolling interest in Beta Noncontrolling interest in subsidiary companies Common stock

385,000 310,000 180,000

320,000 130,000 300,000

Retained earnings (above) Total liabilities and equities

2,423,800 (632,000)

1,532,000 (570,000)

144,000 88,000 16,000

54,000 5,000

(A) (S1) (I1) (E) (A)

151,200 240,000 56,000 3,000 10,000

140,000 32,000

(E)

4,000

(S1)

60,000

(S2)

266,400

(A)

64,800

(D1)

40,000

(A) (E) (A) (A)

-0900,000 523,000 496,000 140,000 28,000 3,503,200 (1,300,000)

418,000 (98,000)

(820,000)

(310,000)

(150,000)

(971,800) (2,423,800)

(652,000) (1,532,000)

(170,000) (418,000)

(S1) (S2)

(60,000)

(331,200) (411,400)

150,000 310,000 1,919,200

1,919,20 0

Parentheses indicate a credit balance.

(411,400) (820,000) (971,800) (3,503,200)

Chapter 07 - Consolidated Financial Statements—Ownership Patterns and Income Taxes – Hoyle, Schaefer, Doupnik, Advanced Accounting, 15e

26.(20 Minutes) (Consolidation entries for a mutual holding business combination) a. Acquisition Allocation and Amortization Consideration transferred............................................. Noncontrolling interest fair value................................. Lowly‘s business fair value .......................................... Book value acquired...................................................... Trademarks .................................................................... Annual amortization (20-year life) ................................

$420,000 280,000 700,000 (600,000) $100,000 $ 5,000

CONSOLIDATION ENTRIES Entry *C Investment in Lowly ......................................................... 117,000 Retained Earnings, 1/1/24 (Mighty) ............................ 117,000 (To accrue income to parent during the previous years as measured by increase in book value [$200,000 × 60%] and amortization expense of $3,000 [$5,000 × 60%] for the previous year.) Entry S1 Common Stock (Lowly) .........................................................300,000 Retained Earnings, 1/1/24 (Lowly) ........................................500,000 Investment in Lowly (60%) ......................................... 480,000 Noncontrolling Interest in Lowly 1/1/24 (40%) .......... 320,000 (To eliminate subsidiary stockholders' equity accounts against investment account and to recognize noncontrolling interest ownership.) Entry S2 Treasury Stock .......................................................................240,000 Investment in Mighty .................................................. (To reclassify cost of parent shares as treasury stock.)

240,000

Entry A Trademarks ....................................................................... 95,000 Investment in Lowly.................................................... 57,000 Noncontrolling Interest in Lowly 1/1/24 (40%) .......... 38,000 (To recognize unamortized portion of acquisition-date excess fair value.) Entry E Amortization Expense...................................................... Trademarks.................................................................. (To record trademarks amortization expense for 2024.)

5,000 5,000

Net income attributable to noncontrolling interest = $14,000 [40% × ($40,000 – $5,000)] 27.(80 Minutes) (Prepare consolidation worksheet for a parent-child-grandchild 7-35 © McGraw Hill LLC. All rights reserved. No reproduction or distribution without the prior written consent of McGraw Hill LLC.

Chapter 07 - Consolidated Financial Statements—Ownership Patterns and Income Taxes – Hoyle, Schaefer, Doupnik, Advanced Accounting, 15e

combination. Also asks about income taxes paid on both a separate and a consolidated return) a. Acquisition-Date Allocation and Amortization Consideration transferred for Short............................. Noncontrolling interest fair value................................. Short business fair value .............................................. Short book value............................................................ Copyright ........................................................................ Life .................................................................................. Annual amortization ......................................................

$344,000 86,000 $430,000 (380,000) $ 50,000 5 years $ 10,000

Consideration transferred for Martin ........................... Noncontrolling interest fair value................................. Martin business fair value ............................................. Martin book value .......................................................... Licensing agreements ................................................... Life .................................................................................. Annual amortization ......................................................

$720,000 80,000 $800,000 740,000 $ 60,000 12 years $ 5,000

Short's adjusted 2024 net income Short's separate 2023 net income Excess copyright amortization 2023 intra-entity EI profit deferral (.5 × $70,000 × 20%) Short's adjusted 2023 net income Percentage owned by Martin

$344,000 $120,000 (10,000) (7,000) $103,000 80%

Short's separate 2024 income Excess copyright amortization Intra-entity BI profit recognition (.5 × $70,000 × 20%) Intra-entity EI profit deferral (.5 × $80,000 × 20%) Short's adjusted 2023 net income Percentage owned by Martin Investment in Short 12/31/24

$100,000 (10,000) 7,000 (8,000) $ 89,000 80%

Consideration transferred by Gomez for Martin Martin's separate 2023 net income Martin's share of Short's 2023 net income Martin's 2023 net income Excess licensing agreement amortization Martin's adjusted 2023 net income Percentage owned by Gomez Equity in earnings of Martin 2023

$720,000 $172,600 82,400 255,000 (5,000) $250,000 90%

Martin's 2024 net income (includes share of Short's 2024 net income)

82,400

71,200 $497,600

225,000 $205,000

Chapter 07 - Consolidated Financial Statements—Ownership Patterns and Income Taxes – Hoyle, Schaefer, Doupnik, Advanced Accounting, 15e

Excess licensing agreement amortization Martin's adjusted 2024 net income Percentage owned by Gomez Equity in earnings of Martin 2024 Investment in Martin 12/31/24

(5,000) $200,000 90% 180,000 $1,125,000

b. CONSOLIDATION ENTRIES Entry *G Retained Earnings, 1/1/24 (Short) ................................... 7,000 Cost of Goods Sold..................................................... 7,000 (To give effect to intra-entity gross profit deferral from 2023. Amount is calculated based on normal 50% markup [found from Income Statement] multiplied by $14,000 retained inventory [20% of $70,000]) Entry S1 Common Stock (Short) .................................................... 200,000 Retained Earnings, 1/1/24 (Short, as adjusted by Entry *G) ................................................................. 293,000 Investment in Short (80%)..................................... 394,400 Noncontrolling Interest in Short (20%) ................ 98,600 (To eliminate stockholders' equity accounts of subsidiary [Short] against corresponding balance in investment account and to recognize noncontrolling interest ownership.) 27. (continued) Entry S2 Common Stock (Martin) ........................................................300,000 Retained Earnings, 1/1/24 (Martin) .......................................695,000 Investment in Martin (90%) ................................... 895,500 Noncontrolling Interest in Martin (10%) ............... 99,500 (To eliminate stockholders‘ equity accounts of subsidiary Martin against corresponding balance in investment account and to recognize noncontrolling interest ownership.) Entry A1 Copyright........................................................................... 40,000 Investment in Short ............................................... 32,000 Noncontrolling Interest in Short (20%) ................ 8,000 (To recognize January 1, 2024 unamortized portion of acquisition price assigned to Short‘s copyright.) Entry A2 Licensing agreements...................................................... Investment in Martin .............................................. Noncontrolling Interest in Martin..........................

55,000 49,500 5,500

Chapter 07 - Consolidated Financial Statements—Ownership Patterns and Income Taxes – Hoyle, Schaefer, Doupnik, Advanced Accounting, 15e

(To recognize January 1, 2024 unamortized portion of acquisition price assigned to Martin‘s licensing agreements.) Entry E Operating Expenses......................................................... 15,000 Copyright................................................................ 10,000 Licensing agreements ........................................... 5,000 (To recognize amortization expense for 2024—$10,000 in connection with Martin's investment in Short and $5,000 in connection with Gomez‘s investment in Martin.) Entry Tl Sales .................................................................................. 80,000 Cost of Goods Sold ............................................... (To eliminate intra-entity inventory transfers made during 2024.)

80,000

Entry G Cost of Goods Sold .......................................................... 8,000 Inventory (current assets)..................................... 8,000 (To defer intra-entity gross profit on ending inventory—$16,000 × 50% markup.) 27. (continued) Noncontrolling Interest in Short's Net Income 2024 Reported net income ............................................... $100,000 Copyright amortization .................................................... (10,000) Recognition of 2023 deferred gross profit (*G).............. 7,000 Deferral of 2024 intra-entity gross profit (G) .................. (8,000) Accrual-based net income 2024 ...................................... $89,000 Outside ownership ........................................................... 20% Noncontrolling interest in Short's net income ............... $17,800 Noncontrolling Interest in Martin's Net Income 2024 Reported net income ............................................... $205,000 License agreements amortization................................... (5,000) Accrual-based net income—2024 ................................... $200,000 Outside ownership ........................................................... 10% Noncontrolling interest in Martin's net income.............. $ 20,000

Chapter 07 - Consolidated Financial Statements—Ownership Patterns and Income Taxes – Hoyle, Schaefer, Doupnik, Advanced Accounting, 15e

27. (continued) GOMEZ COMPANY AND CONSOLIDATED SUBSIDIARIES Consolidation Worksheet December 31, 2024

Accounts

Gomez Company

Martin Company

Short Company

Consolidation Entries Debit

Credit

Noncontrolling Interest

Consolidate d Balances

Chapter 07 - Consolidated Financial Statements—Ownership Patterns and Income Taxes – Hoyle, Schaefer, Doupnik, Advanced Accounting, 15e

Sales and other revenues Cost of goods sold

(900,000) 480,000

(600,000) 320,000

(500,000) 250,000

(Tl) (G)

80,000 8,000

Operating expenses Equity earnings of Martin Equity earnings of Short Separate company net income Consolidated net income Net income attributable to NCI (Short) Net income attributable to NCI (Martin) Net income attributable to Gomez Company Retained earnings-Gomez 1/1 Retained earnings-Martin 1/1 Retained earnings-Short 1/1

100,000 (180,000)

146,200

150,000

(71,200) (205,000)

(100,000)

(E) (I) (I)

15,000 180,000 71,200

Net Income (above) Dividends declared Retained earnings, 12/31 Cash and receivables Inventory Investment in Martin Company

(500,000) 128,000 (1,297,000) 120,000 118,000 1,125,000

(500,000)

(*G) (TI)

411,200 -0-0(537,800) 17,800

(20,000)

20,000

(925,000) (695,000) (300,000)

Investment in Short Company

Retained earnings, 12/31 (above) Noncontrolling interest Short, 1/1

(17,800)

(500,000)

(205,000) -0(900,000) 95,000 210,000

(S2) (*G) (S1)

(925,000) -0-0-

695,000 7,000 293,000

(100,000) -0(400,000) 88,000 192,000

(G) (S2)

(I) (A1)

8,000 895,50 0 180,00 0 49,500 394,40 0 71,200 32,000

(E) (E)

10,000 5,000

(I)

Land, buildings, & equipment (net) Copyright License agreements Total assets Liabilities Common stock

(1,920,000) 971,000

7,000 80,000

(A2) (S1)

497,600

849,000

736,000

(500,000) 128,000 (1,297,000) 303,000 512,000 -0-

-0-

520,000

2,212,000 (415,000) (500,000)

1,538,600 (338,600) (300,000)

800,000 (200,000) (200,000)

(1,297,000)

(900,000)

(400,000)

Noncontrolling interest in Martin, 1/1

(A1) (A2)

40,000 55,000

(S1) (S2)

200,000 300,000

2,105,000 30,000 50,000 3,000,000 (953,600) (500,000) (1,297,000)

(S1) (A1) (S2)

98,600 8,000 99,500

(106,600)

(A2)

5,500

(105,000)

Chapter 07 - Consolidated Financial Statements—Ownership Patterns and Income Taxes – Hoyle, Schaefer, Doupnik, Advanced Accounting, 15e

Noncontrolling interests total 12/31 Total liabilities and equities

(249,400) (2,212,000)

(1,538,600)

(800,000)

1,944,20 0

1,944,2 00

(249,400) (3,000,000)

Chapter 10 – Translation of Foreign Currency Financial Statements – Hoyle, Schaefer, Doupnik, Advanced Accounting, 15e

27. (continued) c. Gomez's separate reported pre-tax income ............................ Martin's separate reported pre-tax income.............................. Dividend income (none collected)............................................ Intra-entity gains (no transfers) ................................................ Amortization expense................................................................ Taxable income .......................................................................... Tax rate ....................................................................................... Income tax payable....................................................................

$320,000 133,800 -0-0(15,000) $438,800 21% $92,148

Short's reported pre-tax income............................................... (Intra-entity gross profits in ending inventory are not deferred on a separate tax return.) Tax rate ....................................................................................... Income tax payable....................................................................

$100,000

21% $21,000

e. (1) Because Martin owns 80% of Short's stock, intra-entity dividends are nontaxable. Thus, no temporary difference is created by Short's failure to pay a dividend. (2) Short's intra-entity gross profits in ending inventory are recognized in one time period for financial reporting purposes and in a different time period for tax purposes. This temporary difference increases taxable income by $1,000 over reported income: 2024 Intra-entity gross profit taxed in 2024 ............................. 2023 Intra-entity gross profit taxed previously in 2023 .......... Increase in taxable income ...................................................... Tax rate ...................................................................................... Deferred income tax asset ........................................................

$8,000 (7,000) $1,000 21% $ 210

Income Tax Expense: Gomez and Martin—payable (part c) .................................. Short—payable (part d) ....................................................... Total taxes to be paid—2024 ............................................... Prepayment (asset) (above)................................................. Income tax expense 2024.....................................................

$92,148 21,000 $113,148 (210) $112,938

Because a single 21% tax rate is used, income tax expense can also be computed by multiplying consolidated net income (prior to noncontrolling interest reduction) of $537,800 (part b.) by the 21% tax rate to obtain $112,938. Income tax expense ....................................................................112,938 Deferred tax asset.................................................................. 210 10-1 © McGraw Hill LLC. All rights reserved. No reproduction or distribution without the prior written consent of McGraw Hill LLC.

Chapter 07 - Consolidated Financial Statements—Ownership Patterns and Income Taxes – Hoyle, Schaefer, Doupnik, Advanced Accounting, 15e

Income tax payable ..........................................................

113,148

28.(40 Minutes) (Series of questions about a business combination and its income tax reporting) a. Equity method. "Income of Syber" is 80% of Syber's reported total, adjusted for excess acquisition-date fair value amortization and intra-entity profit adjustments. Also, Parson‘s recognition of ―Income of Syber‖ equals its share of consolidated net income and Parson‘s retained earnings equal consolidated retained earnings. b. $12,000. Reduction is evidenced by a $338,000 figure reported for consolidated inventory rather than the $350,000 total for the two companies. c. $37,500. Consolidated operating expenses have increased by $2,500, evidently the annual amortization. Because a 15-year life is assumed by the combination, the amount originally allocated to trademarks must have been $37,500. d. $120,000. Decrease shown in consolidated sales account. e. Upstream. ―Net income attributable to the noncontrolling interest" is $18,700. Because this amount is not equal to 20% of Syber's reported net income less excess amortization ($100,000 – $2,500), accrual-based net income must have been adjusted for intra-entity gross profits in inventories. Subsidiary net income is only adjusted to show the effects of upstream transfers. f. 20,000. For both receivables and liabilities, the consolidated total is $20,000 less than the sum of the two companies. g. $8,000. Consolidated cost of goods sold is decreased by $120,000 (to $780,000) in eliminating intra-entity sales. The increase of $12,000 created by the ending intra-entity gross profit (see part b.) would then leave a $792,000 balance. Because $784,000 is the ending balance reported for consolidated cost of goods sold, an $8,000 intra-entity gross profit must have been deferred from the previous year. 28. (continued) h. This figure is computed as follows: Book value of subsidiary—1/1 .............................................. $370,000 Intra-entity gross profit in beg. inventory (see above) ....... (8,000) Adjusted book value.............................................................. $362,000 Excess allocation at 1/1......................................................... 35,000 Subsidiary valuation basis 1/1.............................................. 397,000 Noncontrolling interest percentage ..................................... 20% Noncontrolling interest 1/1 ................................................... Noncontrolling interest in Syber's income

McGraw-Hill/Irwin 10-2

$79,400

Chapter 10 – Translation of Foreign Currency Financial Statements – Hoyle, Schaefer, Doupnik, Advanced Accounting, 15e

(as reported)........................................................................... Noncontrolling interest in Syber's dividends ($30,000 × 20%) ...................................................................... Ending noncontrolling interest.............................................

18,700 (6,000) $92,100

i. For a consolidated return, intra-entity gross profits in ending inventory are deferred as in the consolidated statements. At a 21% rate, both the expense and payable would be $61,635. Income tax expense............................................................... Income tax payable ..........................................................

61,635 61,635

Consolidated Taxable Income: Sales .................................................................................. Cost of goods sold ........................................................... Operating expenses ......................................................... Taxable income ...........................................................

$1,280,000 (784,000) (202,500) $ 293,500

j. On a separate return, Parson would report its operating income of $200,000 leading to a tax expense and payable of $42,000. Because of the level of ownership, intra-entity dividend (or investment) income is omitted. Income Tax Expense ............................................................. Income Tax Payable .........................................................

42,000 42,000

On a separate return, Syber would report $100,000 operating income for a payable of $21,000. The intra-entity gross profits in inventory are accounted for in different time periods in the financial statements, thus, a temporary difference is created. The beginning inventory gross profit of $8,000 was taxed in the previous year rather than currently. The current intra-entity inventory gross profit of $12,000 is taxed now rather than next year; the tax paid this year on the net $4,000 ($840) is a prepayment. Income Tax Expense ............................................................. Deferred Income Tax Asset................................................... Income Tax Payable .........................................................

20,160 840

Syber's entry can also be computed as follows: Reported income ......................................................................... Intra-entity gross profit from previous year recognized currently Deferral of current intra-entity gross profit in inventory.......... Accrual-based net income .......................................................... Tax rate......................................................................................... Income tax expense .................................................................... Taxes payable .............................................................................. Deferred tax asset.............................................................................

21,000 $100,000 8,000 (12,000) $96,000 21% $20,160 21,000 $ 840

29.(45 Minutes) Develop worksheet entries that were used to consolidate the 10-3 © McGraw Hill LLC. All rights reserved. No reproduction or distribution without the prior written consent of McGraw Hill LLC.

Chapter 07 - Consolidated Financial Statements—Ownership Patterns and Income Taxes – Hoyle, Schaefer, Doupnik, Advanced Accounting, 15e

financial statements of a parent-child-grandchild combination. Affiliates use the equity method to account for their investments. Entry *G Retained Earnings, 1/1/24 (Bond).................................... 15,000 Cost of Goods Sold..................................................... 15,000 (To recognize intra-entity gross profit in inventory in 2023 [amount provided].) Entry S1 Common Stock (Cole) ...........................................................100,000 Retained Earnings, 1/1/24 (Cole) ..........................................100,000 Investment in Cole (70%)............................................ 140,000 Noncontrolling Interest in Cole (30%) ....................... 60,000 (To eliminate stockholders' equity accounts of Cole against parent's Investment account and to recognize outside ownership.) 29. (continued) Entry S2 Common Stock (Bond) ..........................................................120,000 Retained Earnings, 1/1/24 (Bond, as adjusted) ...................378,000 Investment in Bond (80%) .......................................... 398,400 Noncontrolling Interest in Bond (20%) ...................... 99,600 (To eliminate stockholders' equity accounts of Bond [as adjusted as Entry *G and Entry *C1] against corresponding balance in Investment account and to recognize outside ownership.) Entry A Copyrights..............................................................................222,500 Investment in Bond ..................................................... 90,000 Investment in Cole ...................................................... 77,000 Noncontrolling Interest in Bond ................................ 22,500 Noncontrolling Interest in Cole.................................. 33,000 (To recognize January 1, 2024 unamortized copyrights, 2 years amortization recorded on first investment but only one year for second.) Entry I1 Income of Subsidiary ............................................................127,800 Investment in Bond ..................................................... 127,800 (To eliminate intra-entity income accrual found on Allen's records.) Entry I2 Income of Subsidiary ....................................................... 42,000 Investment in Cole ...................................................... 42,000 (To eliminate intra-entity income accrual found on Bond's records.)

McGraw-Hill/Irwin 10-4

Chapter 10 – Translation of Foreign Currency Financial Statements – Hoyle, Schaefer, Doupnik, Advanced Accounting, 15e

Entry D1 Investment in Bond .......................................................... Dividends Declared (Bond) ........................................ (To eliminate intra-entity dividends.) Entry D2 Investment in Cole............................................................ Dividends Declared (Cole).......................................... (To eliminate intra-entity dividends.)

32,000 32,000

35,000 35,000

Entry E Operating Expenses......................................................... 16,250 Copyrights ................................................................... 16,250 (Current year amortization, $6,250 on first acquisition and $10,000 on second.) 29. (continued) Entry Tl Sales .......................................................................................200,000 Cost of Goods Sold..................................................... (To eliminate intra-entity inventory transfer.) Entry G Cost of Goods Sold .......................................................... 22,000 Inventory ...................................................................... (To defer ending intra-entity gross profit on intra-entity transfers.)

200,000

22,000

Noncontrolling Interest in Cole's Income: Reported income.................................................................... Excess fair value amortization.............................................. Accrual-based income........................................................... Outside ownership ................................................................ Net income attributable to noncontrolling interest.............

$70,000 (10,000) 60,000 30% $18,000

Noncontrolling Interest in Bond's Net Income: Reported operating income ............................................. Equity income investment in Cole (70% × $60,000)....... Amortization expense ...................................................... 2023 intra-entity inventory gross profit deferral ............ 2024 intra-entity inventory gross profit deferral ............ Accrual-based income—Bond (2024) ............................. Outside ownership ........................................................... Net income attributable to noncontrolling interest .......

$131,000 42,000 (6,250) 15,000 (22,000) $159,750 20% $ 31,950

Noncontrolling interest in Bond Company Noncontrolling interest, 1/01/24 (Entry S2) .................... Noncontrolling interest, 1/01/24 (Entry A) ......................

$99,600 22,500

Chapter 07 - Consolidated Financial Statements—Ownership Patterns and Income Taxes – Hoyle, Schaefer, Doupnik, Advanced Accounting, 15e

Noncontrolling interest in Bond‘s income (above)........ Dividends declared to noncontrolling interest ($40,000 × 20%)............................................................ Noncontrolling interest in Bond, 12/31/24.................

(8,000) $146,050

Noncontrolling interest in Cole Company Noncontrolling interest, 1/01/24 (Entry S1) .................... Noncontrolling interest in Cole‘s income (above) ......... Noncontrolling interest, 1/01/24 (Entry A) ...................... Dividends declared to NCI ($50,000 × 30%).................... Noncontrolling interest in Cole, 12/31/24 ..................

$60,000 18,000 33,000 (15,000) $96,000

31,950

Chapter 7 Excel Case Solution

Highpoint Middlebury Lowton

Operating income

Dividends declared

$425,000 $340,000 $250,000

$200,000 $150,000 $ 75,000

Ownership percentages Highpoint-->Middlebury Middlebury-->Lowton

Excess amortizations $20,000 $25,000

95% 80%

Middlebury's share of Lowton net income: Lowton operating income Excess amortization Accrual based income Middlebury ownership percentage Equity income from Lowton

$250,000 (25,000) $225,000 80% $180,000

Highpoint's share of Middlebury income: Middlebury operating income Equity income from Lowton Excess amortization Middlebury accrual-based net income Highpoint ownership percentage Highpoint's share of reported net income

$340,000 180,000 (20,000) $500,000 95% $475,000

Controlling interest in net income Highpoint's operating income Equity earnings in Middlebury and Lowton Highpoint‘s net income

$425,000 475,000 $900,000

Comparison

McGraw-Hill/Irwin 10-6

Chapter 10 – Translation of Foreign Currency Financial Statements – Hoyle, Schaefer, Doupnik, Advanced Accounting, 15e

Consolidated net income (operating incomes less amortizations) Net income attributable to noncontrolling interests (20% × $225,000 plus 5% × $500,000) Net income attributable to Highpoint Company

$970,000 70,000 $900,000

Difference between Highpoint‘s net income and controlling interest in consolidated net income = -0RESEARCH CASE: CONSOLIDATED TAX EXPENSE At www.thecoca-colacompany.com the 2021 annual 10-K Note 14 provides detailed footnote disclosures for consolidated income tax. The excerpt below shows a portion of the footnote relating to deferred tax assets, liabilities, and carryforwards. From Note 14: Income Taxes The tax effects of temporary differences and carryforwards that give rise to deferred tax assets and liabilities consist of the following (in millions): December 31, Deferred tax assets: Property, plant and equipment Trademarks and other intangible assets Equity method investments (including translation adjustment) Derivative financial instruments Other liabilities Benefit plans Net operating/capital loss carryforwards Other Gross deferred tax assets Valuation allowances Total deferred tax assets Deferred tax liabilities: Property, plant and equipment Trademarks and other intangible assets Equity method investments (including translation adjustment) Derivative financial instruments Other liabilities Benefit plans Other Total deferred tax liabilities Net deferred tax liabilities

2021

2020

$ 36 1,910 595 215 1,255 670 280 377 5,338 (401) $ 4,937

$ 44 2,214 580 523 1,401 893 320 391 6,366 (406) $ 5,960

$ (721) (1,783) (1,619) (500) (315) (527) (164) $ (5,629) $ (692)

$ (837) (1,661) (1,533) (435) (402) (321) (144) $ (5,333) $ 627

As of December 31, 2021 and 2020, we had net deferred tax assets of $0.7 billion and $1.4 billion, respectively, located in countries outside the United States. As of December 31, 2021, we had $2,313 million of loss carryforwards available to reduce future taxable income. Loss carryforwards of $849 million must be utilized within the next five years, and the remainder can be utilized over a period greater than five years.

Chapter 07 - Consolidated Financial Statements—Ownership Patterns and Income Taxes – Hoyle, Schaefer, Doupnik, Advanced Accounting, 15e

SEGMENT AND INTERIM REPORTING Chapter Outline I.

FASB Accounting Standards Codification Topic 280, Segment Reporting (FASB ASC 280), provides current guidance on segment reporting. A. ASC 280 follows a management approach in which segments are based on the way that management disaggregates the enterprise for making operating decisions; these are referred to as operating segments. B. Operating segments are components of an enterprise which meet three criteria. 1. Engage in business activities and earn revenues and incur expenses. 2. Operating results are regularly reviewed by the chief operating decision-maker to assess performance and make resource allocation decisions. 3. Discrete financial information is available from the internal reporting system. C. Once operating segments have been identified, three quantitative threshold tests are then applied to identify segments of sufficient size to warrant separate disclosure. Any segment meeting even one of these tests is separately reportable. 1. Revenue test—segment revenues, both external and intersegment, are 10 percent or more of the combined revenue, external and intersegment, of all reported operating segments. 2. Profit or loss test—segment profit or loss is 10 percent or more of the greater (in absolute terms) of the combined reported profit of all profitable segments or the combined reported loss of all segments incurring a loss. 3. Asset test—segment assets are 10 percent or more of the combined assets of all operating segments. D. Several general restrictions on the presentation of operating segments exist. 1. Separately reported operating segments must generate at least 75 percent of total (consolidated) sales made by the company to outside parties. 2. Ten is suggested as the maximum number of operating segments that should be separately disclosed. If more than ten are reportable, the company should consider combining some operating segments. E. Information to be disclosed by operating segment. 1. General information about the operating segment including factors used to identify operating segments and the types of products and services from which each segment derives its revenues. 2. Segment profit or loss and the following components of profit or loss. a Revenues from external customers. b Revenues from transactions with other operating segments. c Interest revenue and interest expense (reported separately). d Depreciation, depletion, and amortization expense. e Other significant noncash items included in segment profit or loss. f Unusual items. g Income tax expense or benefit. 3. Total segment assets and the following related items. a Investment in equity method affiliates. b Expenditures for additions to long-lived assets.

II.

Enterprise-wide disclosures. A. Information about products and services. 1. Additional information must be provided if operating segments have not been

McGraw-Hill/Irwin 10-8

Chapter 10 – Translation of Foreign Currency Financial Statements – Hoyle, Schaefer, Doupnik, Advanced Accounting, 15e

determined based on differences in products and services, or if the enterprise has only one operating segment. 2. In those situations, revenues derived from transactions with external customers must be disclosed by product or service. B. Information about geographic areas. 1. Revenues from external customers and long-lived assets must be reported for (a) the domestic country, (b) all foreign countries in which the enterprise has assets or derives revenues, and (c) each individual foreign country in which the enterprise has material revenues or material long-lived assets. 2. U.S. GAAP does not provide any specific guidance with regard to determining materiality of revenues or long-lived assets; this is left to management‘s judgment. C. Information about major customers. 1. The volume of sales to a single customer must be disclosed if it constitutes 10 percent or more of total sales to unaffiliated customers. 2. The identity of the major customer need not be disclosed. III.

International Financial Reporting Standards (IFRS) also provide guidance with respect to segment reporting. A. IFRS 8, ―Operating Segments,‖ is based on U.S. GAAP. Major differences between IFRS 8 and U.S. GAAP are: 1. IFRS 8 requires disclosure of total assets and total liabilities by operating segment if these are regularly reported to the chief operating decision maker. U.S. GAAP requires disclosure of segment assets but does not require disclosure of segment liabilities. 2. IFRS 8 specifically includes intangibles in the scope of ―non-current assets‖ to be disclosed by geographic area. Authoritative accounting literature (FASB ASC) indicates that ―long-lived assets‖ to be disclosed by geographic area excludes intangibles. 3. U.S. GAAP requires an entity with a matrix form of organization to determine operating segments based on products and services. IFRS 8 allows such an entity to determine operating segments based on either products and services or geographic areas.

IV.

To provide investors and creditors with more timely information than is provided by an annual report, the U.S. Securities and Exchange Commission (SEC) requires publicly traded companies to provide financial statements on an interim (quarterly) basis. A. Quarterly statements need not be audited.

FASB Accounting Standards Codification Topic 270, Interim Reporting (FASB ASC 270) requires companies to treat interim periods as integral parts of an annual period rather than as discrete accounting periods in their own right. A. Generally, interim statements should be prepared following the same accounting principles and practices used in the annual statements. B. However, several items require special treatment for the interim statements to better reflect the expected annual amounts. 1. Revenues are recognized for interim periods in the same way as they are on an annual basis. 2. Interim statements should not reflect the effect of a LIFO liquidation if the units of beginning inventory sold are expected to be replaced by year-end; inventory should not be written down to a lower market value if the market value is expected to recover above the inventory's cost by year-end; and planned variances under a standard cost system should not be reflected in interim statements if they are expected to be absorbed by year-end. 10-9 © McGraw Hill LLC. All rights reserved. No reproduction or distribution without the prior written consent of McGraw Hill LLC.

Chapter 07 - Consolidated Financial Statements—Ownership Patterns and Income Taxes – Hoyle, Schaefer, Doupnik, Advanced Accounting, 15e

3. Costs incurred in one interim period but associated with activities or benefits of multiple interim periods (such as advertising and executive bonuses) should be allocated across interim periods on a reasonable basis through accruals and deferrals. 4. Income tax related to ordinary income should be computed at an estimated annual effective tax rate. VI.

FASB ASC 270 provides guidance for reporting changes in accounting principles made in interim periods. A. Unless impracticable to do so, an accounting change is applied retrospectively, that is, prior period financial statements are restated as if the new accounting principle had always been used. B. When an accounting change is made in other than the first interim period, information for the interim periods prior to the change should be reported by retrospectively applying the new accounting principle to these pre-change interim periods. C. If retrospective application of the new accounting principle to interim periods prior to the change of change is impracticable, the accounting change is not allowed to be made in an interim period but may be made only at the beginning of the next fiscal year.

VII.

Many companies provide summary financial statements and notes in their interim reports. A. U.S. GAAP imposes minimum disclosure requirements for interim reports. 1. Sales or gross revenues, provision for income taxes, net income, and comprehensive income. 2. Basic and diluted earnings per share. 3. Seasonal revenues and expenses. 4. Significant changes in estimates or provisions for income taxes. 5. Disposal of a business segment and unusual items. 6. Contingent items. 7. Changes in accounting principles or estimates. 8. Significant changes in financial position. B. In addition, the U.S. SEC requires a reconciliation of changes in stockholders‘ equity. C. Disclosure of balance sheet and cash flow information is encouraged but not required. If not included in the interim report, significant changes in the following must be disclosed: 1. Cash and cash equivalents. 2. Net working capital. 3. Long-term liabilities. 4. Stockholders' equity.

VIII.

Four items of information must also be disclosed by operating segments in interim financial statements: revenues from external customers, intersegment revenues, segment profit or loss, and, if there has been a material change since the annual report, total assets.

IX.

IAS 34, ―Interim Financial Reporting,‖ provides guidance in IFRS with respect to interim financial statements. A. Unlike U.S. GAAP, IAS 34 requires each interim period to be treated as a discrete accounting period in terms of the amounts to be recognized. As a result, expenses that are incurred in one quarter are expensed in that quarter even though the expenditure benefits the entire year. And there is no accrual in earlier quarters for expenses expected to be incurred later in the year.

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Answer to Discussion Question: How Does a Company Determine Whether a Foreign Country is Material? ASC 250-10-S99 (SAB Topic 1.M, Assessing Materiality, originally issued by the SEC as Staff Accounting Bulletin (SAB) 99, ―Materiality‖), warns financial statement preparers that reliance on a simple numerical rule of thumb, such as 5% of net income, is not sufficient in assessing materiality. In Paragraph QC 11 of Statement of Financial Accounting Concepts (SFAC) 8, the FASB stated the essence of the materiality aspect of relevance as follows: The omission or misstatement of an item in a financial report is material if, in light of surrounding circumstances, the magnitude of the item is such that it is probable that the judgment of a reasonable person relying upon the report would have been changed or influenced by the inclusion or correction of the item. Further, ASC 250-10-S99 reminds companies that both quantitative and qualitative factors should be considered in determining materiality. With respect to segment reporting, ASC 250-10-S99 states: The materiality of a misstatement may turn on where it appears in the financial statements. For example, a misstatement may involve a segment of the registrant's operations. In that instance, in assessing materiality of a misstatement to the financial statements taken as a whole, registrants and their auditors should consider not only the size of the misstatement but also the significance of the segment information to the financial statements taken as a whole. ―A misstatement of the revenue and operating profit of a relatively small segment that is represented by management to be important to the future profitability of the entity" is more likely to be material to investors than a misstatement in a segment that management has not identified as especially important. In assessing the materiality of misstatements in segment information - as with materiality generally - situations may arise in practice where the auditor will conclude that a matter relating to segment information is qualitatively material even though, in his or her judgment, it is quantitatively immaterial to the financial statements taken as a whole. Thus, in addition to quantitative factors, such as the relative percentage of total revenues generated in an individual foreign country, companies should consider qualitative factors as well. Qualitative factors that might be relevant in assessing the materiality of a specific foreign country include: the growth prospects in that country and the level of risk associated with doing business in that country. There are competing arguments for the FASB establishing a significance test for determining material foreign countries. On one hand, such a quantitative materiality test flies in the face of the warning provided in ASC 250-10-S99 and SFAC 8. For example, a ―10% of total revenue or longlived asset test‖ might give companies an excuse to avoid reporting individual countries that would be material for qualitative reasons. Assume that from one year to the next a company increases its revenues in China from 2% of total revenues to 6% of total revenues. Although 6% of total revenues would not meet a 10% test, the relatively large increase in total revenues generated in China could be material in that it could affect an investor‘s assessment of the company‘s future prospects. This company might be reluctant to disclose information about its revenues in China because of potential competitive harm. 10-11 © McGraw Hill LLC. All rights reserved. No reproduction or distribution without the prior written consent of McGraw Hill LLC.

Chapter 07 - Consolidated Financial Statements—Ownership Patterns and Income Taxes – Hoyle, Schaefer, Doupnik, Advanced Accounting, 15e

On the other hand, one could argue that if the FASB were to establish a relatively low disclosure threshold of, say, ―5% of total revenues,‖ that many countries that financial statement users would deem to be of significance would be disclosed regardless of whether they are deemed material for quantitative or for qualitative reasons. However, it could also result in disclosures being provided that are not material, i.e., that are not capable of influencing decisions made by financial statement users.

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Answers to Questions 1. Consolidation presents the account balances of a business combination without regard for the individual component units that comprise the organization. Thus, no distinction can be drawn as to the financial position or operations of the separate enterprises that form the corporate structure. Without a method by which to identify the various individual operations, financial analysis cannot be well refined. 2. The word disaggregated refers to a whole that has been broken apart. Thus, disaggregated financial information is the data of a reporting unit that has been broken down into components so that the separate parts can be identified and studied. 3. According to the FASB, the objective of segment reporting is to provide information to help users of financial statements: a better understand the enterprise‘s performance, b better assess its prospects for future net cash flows, and c make more informed judgments about the enterprise as a whole. 4. Defining segments on the basis of a company‘s organizational structure removes much of the flexibility and subjectivity associated with defining industry segments under prior standards. In addition, the incremental cost of providing segment information externally should be minimal because that information is already generated for internal use. Analysts should benefit from this approach because it reflects the risks and opportunities considered important by management and allows the analyst to see the company the way it is viewed by management. This should enhance the analyst‘s ability to predict management actions that can significantly affect future cash flows. 5. An operating segment is defined as a component of an enterprise: a that engages in business activities from which it earns revenues and incurs expenses, b whose operating results are regularly reviewed by the chief operating decision maker to assess performance and make resource allocation decisions, and c for which discrete financial information is available. 6. Two criteria must be considered in this situation to determine an enterprise‘s operating segment. If more than one set of organizational units exists, but there is only one set for which segment managers are held responsible, that set constitutes the operating segments. If segment managers exist for two or more overlapping sets of organizational units, the organizational units based on products and services are defined as the operating segments. 7. The Revenue Test. An operating segment is separately reportable if its total revenues amount to 10 percent or more of the combined total revenues of all operating segments. The Profit or Loss Test. An operating segment is separately reportable if its profit or loss is 10 percent or more of the greater (in absolute terms) of the combined profits of all profitable segments or the combined losses of all segments reporting a loss. The Asset Test. An operating segment is separately reportable if its assets comprise 10 percent or more of combined assets of all operating segments. 8. For reportable operating segments, the following information must be disclosed: 10-13 © McGraw Hill LLC. All rights reserved. No reproduction or distribution without the prior written consent of McGraw Hill LLC.

Chapter 07 - Consolidated Financial Statements—Ownership Patterns and Income Taxes – Hoyle, Schaefer, Doupnik, Advanced Accounting, 15e

a. General information about the operating segment:  Factors used to identify reportable operating segments.  Types of products and services from which each operating segment reported derives its revenues. b. Segment profit or loss and each of the following if it is included in the measure of segment profit or loss reviewed by, or it is otherwise regularly provided to, the chief operating decision maker:  Revenues from external customers.  Revenues from transactions with other operating segments.  Interest revenue and interest expense (reported separately); net interest revenue may be reported for finance segments if this measure is used internally for evaluation.  Depreciation, depletion, and amortization expenses.  Other significant noncash items included in segment profit or loss.  Unusual items.  Income tax expense or benefit.  Equity in the net income of investees accounted for by the equity method. c. Total segment assets and the following related items:  Investment in equity method affiliates.  Expenditures for additions to long-lived assets. 9. If operating segments are not based upon products or services, or a company has only one operating segment, then revenues from sales to unaffiliated customers must be disclosed for each of the company‘s products and services. 10. Information must be provided for the domestic country, for all foreign countries in which the company generates revenue or holds assets, and for each foreign country in which the company generates a material amount of revenues or has a material amount of assets. 11. Two items of information must be reported for the domestic country, for all foreign countries in total, and for each foreign country in which the company has material operations: (1) revenues from external customers, and (2) long-lived assets. 12. The minimum number of countries to be reported separately is one: the domestic country. If no single foreign country is material, then all foreign countries would be combined and two lines of information would be reported; one for the United States and one for all foreign countries. U.S. GAAP does not provide any guidelines related to the maximum number of countries to be reported. 13. The existence of a major customer and the related amount of revenues must be disclosed when sales to a single customer are 10 percent or more of consolidated sales. 14. U.S. GAAP requires disclosure of a measure of segment assets, but does not require disclosure of a measure of segment liabilities. IFRS 8 requires disclosure of total assets and total liabilities by segment if such a measure is regularly provided to the chief operating decision maker 15. U.S. publicly traded companies are required to prepare quarterly financial reports to provide investors and creditors with relevant information on a more timely basis than is provided by an annual report.

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16. Companies are required to follow an "integral" approach in which each interim period is considered to be an integral part of an annual accounting period, rather than a "discrete" accounting period in its own right. For several items, the integral approach requires deviation from the general rule that the same accounting principles used in preparing annual statements should also be used in preparing interim statements. 17. Cost of goods sold should be adjusted in the interim period to reflect the cost at which the liquidated inventory is expected to be replaced, thus avoiding the effect of the LIFO liquidation on interim period income. 18. Income tax expense related to interim period income is determined by estimating the effective tax rate for the entire year. That rate is then applied to the cumulative pre-tax income earned to date to determine the cumulative income tax to be recognized to date. The amount of income tax recognized in the current interim period is the difference between the cumulative income tax to be recognized to date and the income tax recognized in prior interim periods. 19. When an accounting change occurs in other than the first interim period, information for the pre-change interim periods should be reported based on retrospective application of the new accounting principle. If retrospective application of the new accounting principle to pre-change interim periods is not practicable, the accounting change may be made only at the beginning of the next fiscal year. 20. The following minimum information must be disclosed in an interim report: a Sales or gross revenues, provision for income taxes, net income, and comprehensive income. b Earnings per share. c Seasonal revenues and expenses. d Significant changes in estimates or provisions for income taxes. e Disposal of a component of an entity and unusual or infrequently occurring items. f Contingent items. g Changes in accounting principles or estimates. h Significant changes in the following items of financial position: 1. Cash and cash equivalents. 2. Net working capital. 3. Long-term liabilities. 4. Stockholders' equity. 21. Four items of segment information are required to be included in interim reports: revenues from external customers, intersegment revenues, segment profit or loss, and total assets if there has been a material change in assets from the last annual report. 22. 22. Under IAS 34, an annual bonus paid in the fourth quarter of the year would be recognized fully in that quarter. There would be no accrual of an estimated bonus expense in the first three quarters of the year. Under U.S. GAAP, the annual bonus would be estimated at the beginning of the year and a portion of the estimated bonus would be accrued as expense in each of the first three quarters.

Chapter 07 - Consolidated Financial Statements—Ownership Patterns and Income Taxes – Hoyle, Schaefer, Doupnik, Advanced Accounting, 15e

Answers to Problems 1. D 2. C 3. A 4. C 5. B 6. D 7. C 8. A 9. B 10. D 11. D The test to verify that a sufficient number of segments are being disclosed is based on revenues generated from unaffiliated customers (outside sales). The four segments that are to be separately disclosed have outside sales of $780,000 out of a total for the company of $1,010,000. Since this portion is 77.2 percent of the company‘s total, the 75 percent criterion established by U.S. GAAP has been met.

12. B 13. A 14. C 15. C With regard to major customers, U.S. GAAP (FASB ASC 280) only requires disclosure of the total amount of revenues from each such customer and the identity of the operating segment or segments reporting the revenues.

16. D 17. D 18. A 19. C

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20. D 21. C If there has been a material change from the last annual report, total assets, but not individual assets, for each operating segment must be disclosed.

22. B Under U.S. GAAP, the company should report property tax expense of $25,000 in each quarter of the year. Under IFRS, the company should report the entire property tax expense of $100,000 in the second quarter of the year.

23.(5 minutes) (Determine quantitative threshold under revenue test for reportable segments) A segment is separately reportable when its total revenues (external and intersegment) are 10% or more of the combined revenue (internal and external) of all operating segments. Revenues generated by corporate headquarters are ignored in determining combined segment revenues. Sales to outsiders Intersegment sales Combined segment revenues 10% criterion Minimum

$29,000 3,000 $32,000 x 10% $ 3,200

Any segment with total revenues of $3,200 or more is separately reportable.

24.(5 minutes) (Determine quantitative threshold for disclosure of a major customer) Revenues from a single customer must be disclosed if the amount of revenue generated from that customer is 10 percent or more of consolidated sales. Consolidated sales only includes sales to outsiders; intersegment sales are eliminated. Consolidated sales (combined sales to outsiders) 10% criterion Minimum

$422,000 × 10% $ 42,200

A single customer must be identified as a ―major customer‖ if sales to that customer are $42,200 or more.

25.(5 minutes) (Determine reportable segments under the profit or loss test) Total operating losses of $580,000 (B and D) are larger than total operating profits of $400,000 (A, C, E and F). Thus, based on the 10 percent criterion, any segment with a profit or loss of $58,000 or more must be separately disclosed. Other than E, each segment meets this threshold.

Chapter 07 - Consolidated Financial Statements—Ownership Patterns and Income Taxes – Hoyle, Schaefer, Doupnik, Advanced Accounting, 15e

Revenue Test Combined segment revenues 10% criterion Minimum Segments meeting test—U, V, W

$35,000,000 × 10% $ 3,500,000

Profit or Loss Test Total segment profits of $4,500,000 (U, V, X, Y, Z) is larger than the total segment loss of $1,000,000 (W). Therefore, this test is applied based on total combined segment profits. Combined segment profits 10% criterion Minimum Segments meeting test—U, V, W, X Asset Test Combined segment assets 10% criterion Minimum Segments meeting test—U, V, X, Y

$4,500,000 × 10% $ 450,000

$43,000,000 × 10% $ 4,300,000

Five segments pass at least one of the quantitative threshold tests and therefore are reportable: U, V, W, X, Y

27. (5 minutes) (Determine expense amounts to be recognized in interim period) Depreciation Bonus

$120,000 × 1/4 $200,000 × 1/4

= =

$30,000 50,000 $80,000

The company should report a total of $80,000 for these two expenses in its quarterly income statement for the three months ended March 31.

28.(10 minutes) (Determine income tax expense to be recognized in interim period)

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First Quarter Income before income tax in first quarter Estimated annual income tax rate

$ 1,000,000 × 30%

Income tax expense

$ 300,000

Second Quarter Income before income tax in first quarter

$ 1,000,000

Income before income tax in second quarter Year-to-date income before income tax Estimated annual income tax rate Year-to-date income tax expense

1,200,000 $ 2,200,000 × 32% $ 704,000

Income tax expense recognized in first quarter Income tax expense recognized in second quarter

300,000 $ 404,000

29.(5 minutes) (Determine bonus expense to be recognized in interim period) Because the company is able to estimate the amount that will be paid as year-end bonuses, it should accrue one-fourth of the estimated amount in each of the first three quarters of the year. Thus, for the first quarter ending on March 31, the company should report a bonus expense of $200,000, calculated as follows: $800,000 × 1/4 = $200,000

Bonus expense

30.(10 minutes) (Prepare journal entry for payment of property taxes and determine amount of property tax expense to be recognized in interim period)

a Property tax expense ................................... Prepaid property taxes ................................. Cash.........................................................

150,000 450,000 600,000

b Property tax expense for the quarter ending March 31: $600,000 × 1/4 = $150,000

31.(20 minutes) (Determine COGS in interim period under LIFO with LIFO liquidation) a Under LIFO, the 9,500 units actually sold are assumed to be 8,000 units purchased during the quarter at $40 per unit, plus 1,500 units of beginning inventory that cost $20 per unit. The total amount of COGS recorded in the quarter ended March 31 is calculated as follows: 8,000 units × $40 = 1,500 units × $20 = 9,500 units

$320,000 30,000 $350,000

b If the company expects to replace the units of beginning inventory that are sold by year-end, the 9,500 units actually sold are assumed to be 8,000 units purchased during the quarter for $40 per unit, plus 1,500 units expected to be purchased by 10-19 © McGraw Hill LLC. All rights reserved. No reproduction or distribution without the prior written consent of McGraw Hill LLC.

Chapter 07 - Consolidated Financial Statements—Ownership Patterns and Income Taxes – Hoyle, Schaefer, Doupnik, Advanced Accounting, 15e

year-end for $45 per unit. The total amount of COGS recorded in the quarter ended March 31 is calculated as follows: 8,000 units × $40 = 1,500 units × $45 = 9,500 units

$320,000 67,500 $387,500

32.(10 minutes) (Apply the Profit or Loss Test to Determine Reportable Operating Segments) Calculation of profit or loss.

Revenues from Outsiders Autos Trucks SUVs Motorcycles Total

Intersegment Revenues

$4,000,000 + 3,500,000 + 2,600,000 + 900,000 +

Operating Expenses

$ 100,000 – 200,000 – -0- – 50,000 –

$3,600,000 = 4,000,000 = 2,000,000 = 1,020,000 =

Profit

Loss

$ 500,000 600,000 0 $1,100,000

$300,000 70,000 $370,000

Any segment with an absolute amount of profit or loss greater than or equal to $110,000 (10% × $1,100,000) is separately reportable. Based on this test, Autos, Trucks and SUVs must be reported separately.

33.(25 minutes) (Apply the Three Tests Necessary to Determine Reportable Operating Segments) Revenue Test (numbers in thousands)

Segment

Revenues

Plastics Metals Lumber Paper Finance Total

Percentage

$ 6,842 2,561 870 572 243 $11,088

61.7% 23.1% 7.8% 5.2% 2.2% 100.0%

(reportable) (reportable)

Profit or Loss Test (numbers in thousands)

Segment

Revenues

Expenses

Plastics Metals Lumber Paper Finance Total

$ 6,842 2,561 870

$ 4,290 1,793 1,132 572 133

243

Profit $2,552 768 682 110 $3,430

Loss $

(reportable) (reportable)

262 110 $372

Since $3,430 is larger in absolute terms than $372, it will serve as the basis for testing.

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Chapter 10 – Translation of Foreign Currency Financial Statements – Hoyle, Schaefer, Doupnik, Advanced Accounting, 15e

Each of the profit or loss figures will be compared to $343 (10% × $3,430). Asset Test (numbers in thousands)

Segment

Assets

Plastics Metals Lumber Paper Finance Total

Percentage

$1,588 3,599 524 834 885 $7,430

21.4% 48.4% 7.1% 11.2% 11.9% 100.0%

(reportable) (reportable) (reportable) (reportable)

The plastics, metals, paper, and finance segments meet at least one of the three tests and therefore are reportable.

34.(20 minutes) (A Variety of Computational Questions about Operating Segment and Major Customer Testing)

a Total revenues (including intersegment revenues) amount to $4,200,000. Minimum revenues for required disclosure are 10% or $420,000.

b Disclosure of operating segments is considered adequate only if the separately reported segments have sales to unaffiliated customers that comprise 75% or more of total consolidated sales. In this situation that requirement is met. Red, Blue, and Green have total sales to outsiders of $3,137,000 (or 86%) of total consolidated sales of $3,666,000. Thus, disclosure of these three segments would be adequate.

c Major customer disclosure is based on a level of sales to unaffiliated customers of at least 10% or $366,600 ($3,666,000 × 10%).

d This test is based on the greater (in absolute terms) of profits or losses. In this problem, the total profit of Red, Blue, Green, and White ($1,971,000) is greater than the total loss of Pink and Black ($316,000). Therefore, any segment with a profit or loss of $197,100 or more (10% × $1,971,000) is reportable. Using this standard, Red, Blue, Black, and White are of significant size.

35.(25 minutes) (Apply the three tests necessary to determine reportable operating segments and determine whether a sufficient number of segments is reported) Revenue Test (numbers in thousands)

Segment

Revenues

Books Computers Maps Travel Finance Total

$ 205 936 455 432 184 $2,212

Percentage 9.3% 42.3% (reportable) 20.6% (reportable) 19.5% (reportable) 8.3% 100.0%

Profit or Loss Test (numbers in thousands)

Chapter 07 - Consolidated Financial Statements—Ownership Patterns and Income Taxes – Hoyle, Schaefer, Doupnik, Advanced Accounting, 15e

Segment

Revenues

Expenses

Books Computers Maps Travel Finance Total

$ 205 936 455 432 184 $2,212

$ 218 899 400 284 132 $1,933

Profit

Loss $ 13

$ 37 55 148 52 $292

$ 13

(reportable) (reportable) (reportable (reportable)

This test is based on the greater (in absolute amount) of total profit from profitable segments or total loss from segments with a loss. In this case, any segment with profit or loss greater than or equal to $29,200 (10% × $292,000) is separately reportable. Asset Test (numbers in thousands)

Segment Books Computers Maps Travel Finance Total

Assets $ 206 1,378 248 326 1,240 $3,398

Percentage 6.1% 40.5% (reportable) 7.3% 9.6% 36.5% (reportable) 100.0%

Test for Sufficient Number of Segments Being Reported Four of the company‘s segments (computers, maps, travel, and finance) meet at least one of the tests carried out above. To determine whether a sufficient number of segments is being reported, revenues from unaffiliated parties for these four segments must comprise at least 75% of total consolidated revenues. Consolidated revenues (sales to outside parties and interest income-external) for the company amount to $1,644. These four segments do make up over 75% (actually $1,463 or 89%) of this total. Therefore, this company is presenting disaggregated information for enough of its segments.

Segment

Sales to Outsiders

Computers Maps Travel Finance Total

$ 696 416 314 37 $1,463

36.(15 minutes) (Apply materiality tests adopted by a company to determine countries to be reported separately) Revenue Test (sales to unaffiliated parties) United States Spain Italy Greece Total

McGraw-Hill/Irwin 10-22

$4,500,000 175,000 600,000 450,000 $5,725,000

78.60% 3.06% 10.48% 7.86% 100.00%

Chapter 10 – Translation of Foreign Currency Financial Statements – Hoyle, Schaefer, Doupnik, Advanced Accounting, 15e

Long-lived Asset Test United States Spain Italy Greece Total

$2,200,000 91,000 150,000 100,000 $2,541,000

86.58% 3.58% 5.90% 3.94% 100.00%

Only Italy meets the revenue materiality test, and no foreign country meets the longlived asset test. Italy‘s revenues must be reported separately from the other foreign countries. But all of foreign countries can be combined for reporting long-lived assets.

37.(30 minutes) (Allocate costs incurred in one quarter that benefit the entire year and determine income tax expense

a Determination of Income by Quarter -- Estimated Annual Tax Rate 25% 1st Quarter Sales

2nd Quarter

3rd Quarter

4th Quarter

$1,300,000

$1,560,000

$1,820,000

$2,080,000

Cost of goods sold

(430,000)

(510,000)

(580,000)

(630,000)

Administrative costs

(190,000)

(225,000)

(230,000)

(240,000)

Advertising costs

(25,000)

Executive bonuses

(19,000)

Provision for bad debts

(16,000)

Annual maintenance costs

(18,000)

Pre-tax income

$ 602,000

$ 747,000

$ 932,000

$1,132,000

Income tax*

(150,500)

(186,750)

(233,000)

(283,000)

Net income

$ 451,500

$ 560,250

$ 699,000

$ 849,000

* Calculation of income tax by quarter: 1st Quarter

2nd Quarter

3rd Quarter

4th Quarter

Pre-tax income this quarter

$ 602,000

$ 747,000

$ 932,000

$1,132,000

Cumulative pre-tax income

$ 602,000

$1,349,000

$2,281,000

$3,413,000

Estimated income tax rate

× 25%

$ 150,500

$ 337,250

$ 570,250

$ 853,250

150,500

337,250

570,250

$ 186,750

$ 233,000

$ 283,000

Cumulative income tax to be recognized to date Cumulative income tax recognized in earlier periods Income tax this quarter

$ 150,500

b Determination of Income by Quarter -- Change in Estimated Annual Tax Rate (from 25% to 22%)

1st Quarter

2nd Quarter

3rd Quarter

4th Quarter

Chapter 07 - Consolidated Financial Statements—Ownership Patterns and Income Taxes – Hoyle, Schaefer, Doupnik, Advanced Accounting, 15e

Pre-tax income

$ 602,000

$ 747,000

$ 932,000

$1,132,000

Income tax*

(150,500)

(186,750)

(164,570)

(249,040)

Net income

$ 451,500

$ 560,250

$ 767,430

$ 882,960

1st Quarter

2nd Quarter

3rd Quarter

4th Quarter

$ 602,000 $ 602,000 × 25%

$ 747,000 $1,349,000 × 25%

$ 932,000 $2,281,000 × 22%

$1,132,000 $3,413,000 × 22%

$ 150,500

$ 337,250

$ 501,820

$750,860

$ 150,500

150,500 $ 186,750

337,250 $ 164,570

501,820 $ 249,040

* Calculation of income tax by quarter:

Pre-tax income this quarter Cumulative pre-tax income Estimated income tax rate Cumulative income tax to be recognized to date Cumulative income tax recognized in earlier periods Income tax this quarter

38.(20 minutes) (Treatment of accounting change made in other than first interim period) Retrospective application of the FIFO method results in the following restatements of income for 2023 and the first quarter of 2024:

1st Q.

2nd Q.

2023 3rd Q.

4th Q.

2024 1st Q

Sales

$10,000

$12,000

$14,000

$16,000

$18,000

Cost of goods sold (FIFO) Operating expenses Income before income taxes Income taxes (25%) Net income

3,800 2,000 4,200 1,050 $ 3,150

4,600 2,200 5,200 1,300 $ 3,900

5,200 2,600 6,200 1,550 $ 4,650

6,000 3,000 7,000 1,750 $ 5,250

7,400 3,200 7,400 1,850 $ 5,550

Net income in the second quarter of 2024 is $5,700 [$20,000 – 9,000 – 3,400 = $7,600 – 1,900 (25%) = $5,700]. The accounting change is reflected in the second quarter of 2024, with year-to-date information, and comparative information for similar periods in 2023 as follows:

Three Months Ended June 30 2023 2024 Net income Net income per common share

$3,900 $3.90

$5,700 $5.70

Six Months Ended June 30 2023 2024 $7,050 $7.05

$11,250 $11.25

39.(20 minutes) (LIFO liquidation in interim report) Determination of Cost-of-Goods-Sold and Gross Profit

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The actual cost of goods sold is: 400,000 units @ $24 25,000 units @ $18

$9,600,000 450,000 $10,050,000

Sales (425,000 units @ $36) Cost-of-goods-sold 400,000 units @ $24 25,000 units @ $25 (replacement cost) Gross profit

$15,300,000 $9,600,000 625,000

10,225,000 $ 5,075,000

Journal Entries to Record Sales and Cost-of-Goods-Sold Dr. Cash or Accounts Receivable ........................... 15,300,000 Cr. Sales Revenue .............................................. 15,300,000 To recognize sales revenue. Dr. Cost-of-goods-sold ............................................ 10,225,000 Cr. Inventory ....................................................... 10,050,000 Excess of Replacement Cost over Historical Cost of LIFO Liquidation ................................................................ 175,000 To record cost-of-goods-sold with historical cost of $10,050,000 and an excess of replacement cost over historical cost for beginning inventory liquidated of $175,000 (($25 – $18) × 25,000 units). Develop Your Skills Research Case 1—Segment Reporting (60 minutes) This assignment requires the student to select a company and find the note on operating segments in that company‘s annual report. The responses to this assignment will depend upon the company selected by the student for analysis. Research Case 2—Interim Reporting (60 minutes) This assignment requires students to select a company, find the most recent quarterly report for that company, and then determine whether the company provides the minimum disclosure required as listed in the text. The responses to this assignment will depend upon the company selected by the student for analysis. Research Case 3—Comparability of Geographic Area Information (60 minutes) This assignment requires students to find the note on geographic areas in each company's annual report and then prepare a report describing the comparability of this information. In preparing this assignment, students will see the different formats used by companies in providing this information, and the different levels of detail on geographic areas provided. The comparability of this information will change depending upon the most recent annual report available on the company‘s website. The following comparison based upon the 2020 annual reports (Forms 10K) represents the type of analysis students might perform in solving this assignment. Geographic Areas Reported by Three Pharmaceutical Companies

JnJ (AR, p. 82)

Merck (10-K, p. 134)

Pfizer (10-K, p. 105)

Chapter 07 - Consolidated Financial Statements—Ownership Patterns and Income Taxes – Hoyle, Schaefer, Doupnik, Advanced Accounting, 15e

U.S. Europe W. Hemisphere excl. US) Asia Pacific, Africa -

U.S. Europe, Middle East, Africa Latin America China Japan Asia/Pacific (other) Other

U.S. Developed Europe Developed Rest of World Emerging Markets -

The only geographic area that can be directly compared across these three pharmaceutical companies is the United States. Only Merck reports individual countries (China and Japan) other than the U.S. Issues that could be discussed include different quantitative thresholds used by companies in determining what is a material country, and the fact that disclosure of geographic areas aggregated above the individual country level (e.g., Europe, E/ME/A, Latin America, Emerging Markets) is not required. One can assume that neither Johnson & Johnson nor Pfizer has a material amount of revenues or longlived assets in any single country. Nonetheless, these companies voluntarily provide information on a more aggregated, regional basis (e.g., Europe, Developed Europe). Merck provides information for a combination of both individual countries and aggregated regional area (e.g., E/ME/A, Latin America). Pfizer has perhaps the most different basis for determining geographic areas, focusing on developed vs. emerging markets. Evaluation Case—Operating Segment Disclosures (60 minutes) 1. Two questions must be considered in evaluating CHIC‘s operating segment disclosures: (a) have reportable operating segments been appropriately determined, e.g., is it appropriate to combine the Helicopters and Ships divisions into one segment designated as Other, and (b) are the disclosures provided for each segment in compliance with FASB ASC Topic 280, Segment Reporting? With respect to question (a), ASC 280 allows (but does not require) segments to be combined if they have essentially the same business activities in essentially the same economic environments. In determining whether business activities and environments are similar, management must consider these aggregation criteria: 1. 2. 3. 4. 5.

The nature of the products and services provided by each operating segment. The nature of the production process. The type or class of customer. The distribution methods. If applicable, the nature of the regulatory environment.

Segments must be similar in each and every one of these areas to be combined. The facts of this case indicate that the types of customers and method used to distribute products differ across the four divisions, and each division must comply with

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industry-specific regulations. Thus, the Helicopters and Ships divisions may not be combined into one reportable segment on the basis of having essentially the same business activities in essentially the same economic environments. The Helicopters and Ships divisions still could be combined into a single Other category if neither division meets any of the quantitative thresholds for disclosure as a separate segment. Revenue test: Total segment revenues are $11,171,005; thus, any segment with more than $1,117,100 in sales is separately reportable.  Automobiles, Trucks, and Helicopters meet this threshold. Profit (loss) test: Total segment profits of $ 1,686,700 ($881,292 + $456,530 + $348,878) exceed total segment losses of $58,879, thus any segment with profit or loss greater than $168,670 is separately reportable.  Automobiles, Trucks, and Helicopters meet this threshold. Evaluation Case (continued) Asset test: Total segment assets are $9,993,830, thus any segment with assets greater than $999,383 is separately reportable.  All four segments, including Ships, meet this threshold. As a result of applying these tests, each division must be reported as a separate segment; combining Helicopters and Ships into one segment does not comply with ASC 280. With respect to question (b), Note X. Operating Segments prepared by CHIC‘s accountant fails to disclose information for the Helicopters and Ships segments separately. Note X. also fails to separately disclose revenues from sales to outside parties and revenues from intersegment sales, as well expenditures for additions to long-lived assets and depreciation and amortization. Interest expense and income taxes need not be disclosed by segment because these items are not reported by segment to the chief operating decision maker. CHIC‘s accountant also has neglected to provide a reconciliation of segment amounts to consolidated totals. Evaluation Case (continued) 2. The disclosures required under ASC 280 could be provided in the following manner: Operating Segments Segment profit (loss)*

Automobiles $ 881,292

Trucks $ 456,530

Helicopters $ 348,878

Ships $ (58,879)

Sales to outside parties

4,007,304

3,796,432

1,411,235

1,003,809

Intersegment sales

644,243

307,982

-0-

Depreciation and amortization

180,345

170,976

97,638

58,617

3,987,776

3,209,078

1,587,006

1,209,970

349,776

365,543

276,655

23,695

Segment assets Expenditures for long-lived assets

Chapter 07 - Consolidated Financial Statements—Ownership Patterns and Income Taxes – Hoyle, Schaefer, Doupnik, Advanced Accounting, 15e

Reconciliation of Segment Results to Consolidated Totals Revenues: Total segment revenues

$11,171,005

Elimination of intersegment revenues

952,225

Total consolidated revenues

$10,218,780

Profit or loss: Total segment operating profit before depreciation and amortization

$ 1,627,821

Unallocated amounts: Depreciation and amortization

(507,576)

Interest expense

(130,655)

Total consolidated income before income taxes

$ 989,590

Assets: Total segment assets

$ 9,993,830

Unallocated corporate headquarters assets

1,008,988

Total consolidated assets

$11,002,818

Accounting Standards Case 1 —Segment Reporting (15 minutes) Source of guidance: FASB ASC 280-10-55-2: Segment Reporting; Overall; Implementation Guidance and Illustrations; Operating Segments - Equity Method Investees ASC 280-10-55-2 states ―An equity method investee could be considered an operating segment, if, under the specific facts and circumstances being considered, it meets the definition of an operating segment, even though the investor has no control over the performance of the investee.‖ Thus, in response to the questions asked in the case: (a) an equity method investment can be treated as an operating segment for financial reporting purposes, (b) under the conditions that it meets the definition of an operating segment, that is, (1) it engages in business activities from which it recognizes revenues and incurs expenses, (2) the chief operating decision maker regularly reviews its operating results to assess performance and make resource allocation decision, and (3) its discrete financial information is available. Accounting Standards Case 2—Interim Reporting (15 minutes) Source of guidance: FASB ASC 270-10-50-6: Interim Reporting; Overall; Disclosure;

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Contingencies FASB ASC 270-10-50-6 states: ―Contingencies and other uncertainties that could be expected to affect the fairness of presentation of financial data at an interim date shall be disclosed in interim reports in the same manner required for annual reports.‖ Thus, Caplan should disclose the lawsuit in its interim report, but only if the possible loss is material. FASB ASC 270-10-50-6 provides guidance on this issue, indicating that the materiality of a contingency should be judged in relation to annual financial statements. Analysis Case 1—Walmart Interim and Segment Reporting (60 minutes) 1. Assess the seasonal nature of Walmart‘s sales and operating income for the company as a whole and by operating segment. Net sales for the quarter ended January 31 can be determined for each operating segment and for the company as a whole (labeled as Company Total) by subtracting the amounts reported in the three quarterly reports from the annual amounts reported in Note 13 Segments and Disaggregated Revenue. (amounts in millions) Net Sales Fiscal Year Ended January 31 Quarter Ended April 30 Quarter Ended July 31 Quarter Ended October 31 Quarter Ended January 31

Walmart U.S. $ 369,963 88,743 93,282 88,353 $ 99,585

Walmart International $ 121,360 29,766 27,167 29,554 $ 34,873

Sam's Club $ 63,910 15,163 16,375 15,845 $ 16,527

Company Total $ 555,233 133,672 136,824 133,752 $ 150,985

(amounts in millions) Operating Income Fiscal Year Ended January 31 Quarter Ended April 30 Quarter Ended July 31 Quarter Ended October 31 Quarter Ended January 31

Walmart U.S. $ 19,116 4,302 5,057 4,589 $ 5,168

Walmart International $ 3,660 806 812 1,078 $ 964

Sam's Club $ 1,906 494 592 431 $ 389

Company Total $ 24,682 5,602 6,461 6,098 $ 6,521

These results show the seasonal nature of the company‘s net sales with a significantly larger amount of net sales generated by the company as a whole (labeled Company Total) in the quarter ended January 31 than in the other quarters. This is not surprising given that this quarter includes the holiday season. These results also show the seasonal nature of net sales for each of the company‘s segments, with the largest amount of net sales generated by each segment in the quarter ended January 31 than in the other quarters. Consistent with the largest amount of net sales being made in the quarter ended January 31, the company as a whole (labeled as Company Total) also generates the 10-29 © McGraw Hill LLC. All rights reserved. No reproduction or distribution without the prior written consent of McGraw Hill LLC.

Chapter 07 - Consolidated Financial Statements—Ownership Patterns and Income Taxes – Hoyle, Schaefer, Doupnik, Advanced Accounting, 15e

greatest amount of operating income in that quarter. This result is driven by the Walmart U.S. segment only, which generates more operating income in the quarter ended January 31 than in the other three quarters. In contrast, Walmart International‘s most profitable quarter is the quarter ended October 31, and Sam‘s Club‘s most profitable quarter is the quarter ended Analysis Case 1 (continued) July 31. In fact, Sam‘s Club generates less operating income in the quarter ended January 31 than in the other three quarters. 2. Assess Walmart’s profitability (operating income/net sales and operating income/total assets) by quarter and by segment. By Quarter: Operating profit margin (Operating income/Net sales) by quarter can be determined by using the Company Total amounts reported in the table above. Amounts in millions Company Total

Fiscal Year Ended January 31, 2021 Apr 30

Jul 31

Oct 31

Jan 31

Operating income

$ 5,602

$ 6,461

$ 6,098

$ 6,521

Net sales Operating income/Net sales

133,672 4.19%

136,824 4.72%

133,752 4.56%

150,985 4.32%

These results indicate that operating profit margin is relatively stable across the four quarters of the year, with the quarter ended July 31 being most profitable and the quarter ended April 30 being least profitable. By Segment: Information provided in Note 13 Segments and Disaggregated Revenue can be used to assess profitability in terms of operating profit margin (Operating income/Net sales) and operating return on assets (Operating income/Total assets) by segment.

(amounts in millions) Segments Operating income (loss) Net sales Operating income/Net Sales

Fiscal year ended January 31, 2021 Walmart Walmart Sam‘s U.S. International Club $ 19,116 $ 3,660 $ 1,906 369,963 121,360 63,910 5.17% 3.02% 2.98%

Operating income (loss) Total assets Operating income/Total assets

$ 19,116 113,490 16.84%

$ 3,660 109,445 3.34%

$ 1,906 13,415 14.21%

Analysis Case 1 (continued) These results indicate that Walmart U.S. is the most profitable segment for Walmart,

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Inc., in terms of both operating profit margin (5.17%) and operating return on assets (16.84%). Although Walmart International‘s operating income margin (3.02%), compares favorably to that of Sam‘s Club, the International segment‘s operating return on assets is very low (3.34%) compared to the other segments. [Operating return on assets must be interpreted with caution, however, because the ending balance in Total Assets is used in the denominator of the ratio rather than the average amount of Total Assets for the year. Walmart International‘s operating return on assets (3.34%) would be understated, for example, if a significant portion of Total Assets was acquired late in the year.] Analysis Case 2—Apple Inc. Operating Segment Information (60 minutes) 1. Identify the countries and/or regions that are included in each of Apple‘s reportable segments. Americas: North and South America. Europe: European countries, as well as India, the Middle East, and Africa. Greater China: China, Hong Kong, and Taiwan. Japan: Japan. Rest of Asia Pacific: Australia and Asian countries not included in other reportable segments, i.e., Asian countries other than India, Middle East, China, Hong Kong, Taiwan, and Japan. 2. Percentage of total segment net sales Americas Europe Greater China Japan Rest of Asia Pacific Total

2020 45.37% 25.00% 14.68% 7.80% 7.13% 100.00%

2019 2018 44.93% 42.20% 23.17% 23.50% 16.79% 19.56% 8.27% 8.18% 6.84% 6.55% 100.00% 100.00%

Percentage of total segment operating income Americas Europe Greater China Japan Rest of Asia Pacific Total

2020 41.34% 24.30% 16.73% 10.17% 7.46% 100.00%

2019 2018 40.84% 38.63% 22.33% 22.11% 18.88% 21.88% 10.90% 10.53% 7.07% 6.85% 100.00% 100.00%

Segment operating income as a percentage of segment net sales (operating profit margin)

2020

2019

2018

Chapter 07 - Consolidated Financial Statements—Ownership Patterns and Income Taxes – Hoyle, Schaefer, Doupnik, Advanced Accounting, 15e

Americas Europe Greater China Japan Rest of Asia Pacific Percentage change in segment net sales Americas Europe Greater China Japan Rest of Asia Pacific

30.29% 32.30% 37.86% 43.32% 34.75%

30.02% 31.84% 37.16% 43.56% 34.04%

31.10% 31.97% 38.01% 43.71% 35.51%

2019 to 2020 2018 to 2019 6.54% 4.30% 13.85% –3.42% –7.72% –15.91% –0.41% –1.04% 10.15% 2.19%

Analysis Case 2 (continued) Percentage change in segment operating income Americas Europe Greater China Japan Rest of Asia Pacific

2019 to 2020 7.47% 15.50% –5.98% –0.96% 12.44%

2018 to 2019 0.67% -3.81% –17.78% –1.38% –2.04%

3. Discuss whether you believe Apple should attempt to expand its operations in a particular segment to increase net sales and operating income. Operating profit margins have been remarkably stable within each segment over the period 2018-2020, but vary considerably in magnitude across segments. The data show that Apple generates a much higher operating profit margin in Japan than other parts of the world. Japan contributes a relatively small amount to total net sales and operating income, which might mean that there is potential to grow sales in this segment. Year-to-year changes in sales and income have been relatively flat in Japan. However, Japan is only one country and the market might be relatively saturated with Apple products. Greater China has the second highest operating profit margin among Apple‘s segments and is a much larger market than Japan. But, in recent years, Apple‘s sales and income in this segment have declined by larger percentage amounts than in any other segment. Greater China might be a segment Apple should focus on – at a minimum the company might strive to return to the level of sales that it generated in 2018. 4. List any additional information you would like to have to conduct your analysis. It would be useful to have an estimate of the number of potential customers in each of the areas covered by Apple‘s operating segments. This number is a function of the number of inhabitants in each segment area, their average age, the amount of income individuals have to spend on Apple products, the extent to which cell phone and internet services are available, as well as other issues. This information would help Apple determine which segment markets might already be saturated with Apple products and where there could be additional demand. An understanding of the reason that sales have declined in Greater China would be important in trying to develop a strategy to regain sales in that segment.

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Data with respect to sales and operating profit by product lines (e.g., iPhone vs. Mac vs. iCloud) in the various segments could be useful. Analysis Case 2 (continued) Also, country or at least sub-segment information with respect to sales and profits could be useful. For example, was the increase in sales in Europe from 2019 to 2020 more attributable to Western Europe, Eastern Europe, Scandinavia, or elsewhere? Was the decrease in sales in Greater China more due to China, Hong Kong, or Taiwan than to the other countries? Which countries or regions were most responsible for sales growth in the Americas and Rest of Asia Pacific segments? Where has sales growth been lagging in these segments?

CHAPTER 9 FOREIGN CURRENCY TRANSACTIONS AND HEDGING FOREIGN EXCHANGE RISK Chapter Outline I.

In today‘s global economy, a great many companies deal in currencies other than their reporting currencies. A. Merchandise may be imported or exported with prices stated in a foreign currency. B. For reporting purposes, foreign currency balances must be stated in terms of the company‘s reporting currency by multiplying it by an exchange rate. C. Accountants face two questions in restating foreign currency balances. 1. What is the appropriate exchange rate for restating foreign currency balances? 2. How are changes in the exchange rate accounted for? D. Companies often engage in foreign currency hedging activities to avoid the adverse impact of exchange rate changes. E. Accountants must determine how to properly account for these hedging activities.

II.

Foreign exchange rates are determined in the foreign exchange market under a variety of different currency arrangements. A. Exchange rates can be expressed in terms of the number of U.S. dollars to purchase one foreign currency unit (direct quotes) or the number of foreign currency units that can be obtained with one U.S. dollar (indirect quotes). B. Foreign currency trades can be executed on a spot or forward basis. 1. The spot rate is the price at which a foreign currency can be purchased or sold today. 2. The forward rate is the price today at which foreign currency can be purchased or sold sometime in the future. 3. Forward exchange contracts provide companies with the ability to ―lock in‖ a price today for purchasing or selling currency at a specific future date. C. Foreign currency options provide the right but not the obligation to buy or sell foreign currency in the future, and therefore are more flexible than forward contracts.

III.

FASB ASC 830, Foreign Currency Matters, prescribes accounting rules for foreign currency transactions. A. Export sales denominated in foreign currency are reported in U.S. dollars at the spot exchange rate at the date of the transaction. Subsequent changes in the exchange rate until collection of the receivable are reflected through a restatement of the foreign currency account receivable with an offsetting foreign exchange gain or loss reported in income. 10-33 © McGraw Hill LLC. All rights reserved. No reproduction or distribution without the prior written consent of McGraw Hill LLC.

Chapter 07 - Consolidated Financial Statements—Ownership Patterns and Income Taxes – Hoyle, Schaefer, Doupnik, Advanced Accounting, 15e

This is known as a two-transaction perspective, accrual approach. B. The two-transaction perspective, accrual approach also is used in accounting for foreign currency payables. Receivables and payables denominated in foreign currency create an exposure to foreign exchange risk; this is the risk that changes in the exchange rate over time will result in a foreign exchange gain or loss. IV.

FASB ASC 815, Derivatives and Hedging, governs the accounting for derivative financial instruments and hedging activities including the use of foreign currency forward contracts and foreign currency options. A. The fundamental requirement is that all derivatives must be carried on the balance sheet at their fair value. Derivatives are reported on the balance sheet as assets when they have a positive fair value and as liabilities when they have a negative fair value. B. U.S. GAAP provides guidance for hedges of the following sources of foreign exchange risk: 1. foreign currency denominated assets and liabilities. 2. unrecognized foreign currency firm commitments. 3. forecasted foreign currency transactions. 4. net investments in foreign operations (covered in Chapter 10). C. Companies prefer to account for hedges in such a way that the gain or loss from the hedge is recognized in net income in the same period as the loss or gain on the risk being hedged. This approach is known as hedge accounting. Hedge accounting for foreign currency derivatives may be applied only if three conditions are satisfied: 1. the derivative is used to hedge either a cash flow exposure or fair value exposure to foreign exchange risk, 2. the derivative is highly effective in offsetting changes in the cash flows or fair value related to the hedged item, and 3. the derivative is properly documented as a hedge. D. Hedge accounting is allowed for hedges of two different types of exposure: cash flow exposure and fair value exposure. Hedges of (1) foreign currency denominated assets and liabilities, (2) foreign currency firm commitments, and (3) forecasted foreign currency transactions can be designated as cash flow hedges. Hedges of (1) and (2) also can be designated as fair value hedges. Accounting procedures differ for the two types of hedges. E. For cash flow hedges of foreign currency denominated assets and liabilities, at each balance sheet date: 1. Adjust the hedged asset or liability to fair value based on changes in the spot exchange rate, and a foreign exchange gain or loss is recognized in net income. 2. Adjust the derivative hedging instrument to fair value (resulting in an asset or liability reported on the balance sheet), with the counterpart recognized as a change in Other Comprehensive Income (OCI). 3. Recognize a foreign exchange gain or loss on the hedging instrument equal in amount but of opposite sign to the foreign exchange gain or loss on the hedged asset or liability in net income, with the counterpart in OCI; the net effect is to offset the gain or loss on the hedged asset or liability. 4. Recognize a portion of (a) the original forward points (discount or premium) on the forward contract (if a forward contract is the hedging instrument) or (b) the original time value of the option (if an option is the hedging instrument) in net income with the counterpart reported in OCI. F. For fair value hedges of foreign currency denominated assets and liabilities, at each balance sheet date: 1. Adjust the hedged asset or liability to fair value based on changes in the spot

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exchange rate, and recognize a foreign exchange gain or loss in net income. 2. Adjust the derivative hedging instrument to fair value (resulting in an asset or liability reported on the balance sheet), with the counterpart recognized as a foreign exchange gain or loss in net income. G. Under fair value hedge accounting for hedges of foreign currency firm commitments:

1. the gain or loss on the hedging instrument is recognized currently in net income, and 2. the change in fair value of the firm commitment is also recognized currently in net income. This accounting treatment requires (1) measuring the fair value of the firm commitment, (2) recognizing the change in fair value in net income, and (3) reporting the firm commitment on the balance sheet as an asset or liability. A decision must be made whether to measure the fair value of the firm commitment through reference to (a) changes in the spot exchange rate or (b) changes in the forward rate.

H. Cash flow hedge accounting is allowed for hedges of forecasted foreign currency transactions. For hedge accounting to apply, the forecasted transaction must be probable (likely to occur). The accounting for a hedge of a forecasted transaction differs from the accounting for a hedge of a foreign currency firm commitment in two ways:

1. Unlike the accounting for a firm commitment, there is no recognition of the forecasted transaction or gains and losses on the forecasted transaction. 2. The hedging instrument (forward contract or option) is reported at fair value, but because there is no gain or loss on the forecasted transaction to offset against, changes in the fair value of the hedging instrument are not reported as gains and losses in net income. Instead they are reported in other comprehensive income. On the projected date of the forecasted transaction, the cumulative change in the fair value of the hedging instrument is transferred from accumulated other comprehensive income (balance sheet) to net income. V.

IFRS is very similar to U.S. GAAP with respect to the accounting for foreign currency transactions and hedging of foreign exchange risk. A. IAS 21 requires the use of a two-transaction perspective in accounting for foreign currency transactions with unrealized foreign exchange gains and losses accrued in net income in the period of exchange rate change. B. IAS 39 allows hedge accounting for foreign currency hedges of recognized assets and liabilities, firm commitments, and forecasted transactions when documentation requirements and effectiveness tests are met. Hedges are designated as cash flow or fair value hedges. C. One difference between IFRS and U.S. GAAP relates to the type of financial instrument that can be designated as a foreign currency hedge. Under U.S. GAAP, generally only derivative financial instruments can be used as hedges, whereas IFRS is more flexible in allowing non-derivative financial instruments to be designated as hedging instruments in a foreign currency hedge.

Chapter 07 - Consolidated Financial Statements—Ownership Patterns and Income Taxes – Hoyle, Schaefer, Doupnik, Advanced Accounting, 15e

Answer to Discussion Question DO WE HAVE A GAIN OR WHAT? This discussion question demonstrates the differing kinds of information provided through application of current accounting rules for foreign currency transactions and derivative financial instruments. The Ahnuld Corporation could have received $200,000 [$2.00 × 100,000 tchecks] from its export sale to Tcheckia if it had required immediate payment. Instead, Ahnuld allows its customer six months to pay. Given the future exchange rate of $1.70, Ahnuld would have received only $170,000 if it had not entered into the forward contract. This would have resulted in a decrease in cash inflow of $30,000. In accordance with current accounting standards, the decrease in the value of the tcheck receivable is recognized as a foreign exchange loss of $30,000. This loss represents the cost of extending credit to the foreign customer if the tcheck receivable is left unhedged. However, rather than leaving the tcheck receivable unhedged, Ahnuld sells tchecks forward at a price of $180,000. Because the future spot rate turns out to be only $1.70, the forward contract provides a benefit, increasing the amount of cash received from the export sale by $10,000. In accordance with current accounting standards, the change in the fair value of the forward contract (from zero initially to $10,000 at maturity) is recognized as a forward contract asset of $10,000. The carrying amount of this asset reflects the cash flow benefit from having entered into the forward contract, and is the appropriate basis for evaluating the performance of the foreign exchange risk manager. (Students should be reminded that the forward contract will not always improve cash inflow. For example, if the future spot rate were $1.85, the forward contract would result in $5,000 less cash inflow than if the transaction were left unhedged.) Note that the benefit from entering into the forward contract is not directly recognized as a gain in net income. The net impact on income resulting from the fluctuation in the value of the tcheck is a loss of $20,000. Clearly, Ahnuld forgoes $20,000 in cash inflow by allowing the customer time to pay for the purchase, and the net foreign exchange loss resulting from amortization of the original forward contract discount and reported in net income correctly measures this. The $20,000 loss is useful to management in assessing whether the sale to the retailer in Tcheckia generated an adequate profit margin, but it is not useful in assessing the performance of the foreign exchange risk manager. The fair value of the forward contact asset (or liability) is a relevant measure for evaluating the performance of foreign exchange risk managers. This is true for both fair value and cash flow hedges.

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Answer to Discussion Question IS BITCOIN A FOREIGN CURRENCY? Digital currency (or cryptocurrency) does not exist in physical form (neither as paper money nor as coins) and it is not issued by a government (which is known as fiat currency). Therefore, to directly answer the first question posed, Bitcoin does not have the traditional characteristics of foreign currency. So, what type of asset is cryptocurrency and, more importantly, how should cryptocurrency transactions be accounted for? U.S. GAAP does not directly address the accounting for cryptocurrency (such as Bitcoin), and the FASB thus far has decided not to add a project on digital assets to its agenda. (IFRS standards also are silent with regard to the accounting for cryptocurrency.) Therefore, companies with cryptocurrency must either refer to existing GAAP that is indirectly relevant or follow nonauthoritative guidance in determining the most appropriate accounting treatment. The Association of International Certified Public Accountants1 (Association) released a practice aid in 2020 concluding that, in general, cryptocurrency should be treated as an indefinite-lived intangible asset. That is, cryptocurrency should be initially measured at cost and then subjected to annual impairment testing. (Several large accounting firms, including Deloitte and KPMG, concur with this conclusion.) Following the Association‘s guidance, the receipt of cryptocurrency as part of a sales transaction should be treated as a form of noncash consideration in accordance with FASB ASC 606, ―Revenue from Contracts with Customers.‖ Under that treatment, the amount recognized as sales revenue and the initial cost of the cryptocurrency is equal to the fair value of the cryptocurrency at the contract inception. Thus, if Copanema Manufacturing Co. delivered product to Motonaka Corp. on, for example, September 20, 2021 in exchange for 10 Bitcoins, the company would have recognized sales revenue and an intangible asset in the amount of $447,000 (given that the market price for 1 Bitcoin on September 20, 2021 was $44,700) on that date. The journal entry would be: Bitcoin intangible asset Sales revenue

447,000 447,000

Assuming that Copanema kept the 10 Bitcoins as an investment, rather than selling them immediately for U.S. dollars, the company would treat its Bitcoin investment as an indefinite-lived intangible asset. As such, the Bitcoin asset would be tested for impairment at least annually. If the fair value of the Bitcoin asset should fall below its carrying value, an impairment loss would be recognized. Increases in the fair value of the Bitcoin asset would be ignored. 1

The Association of International Certified Public Accountants, Accounting for and Auditing of Digital Assets, 2020, available at https://us.aicpa.org. The Association of International Certified Public Accountants (Association) was formed in 2017 by the American Institute of Certified Public Accountants (AICPA) in the United States and the Chartered Institute of Management Accountants (CIMA) in the United Kingdom. The Association working group that developed this practice aid included individuals from the Big Four and other large public accounting firms, the U.S. Government Accountability Office (GAO), and Coinbase.

Chapter 07 - Consolidated Financial Statements—Ownership Patterns and Income Taxes – Hoyle, Schaefer, Doupnik, Advanced Accounting, 15e

Answer to Discussion Question IS BITCOIN A FOREIGN CURRENCY? (continued) But what if Copanema delivered product to Motonaka on September 20, 2021, and received payment of 10 Bitcoins two weeks later on October 4, 2021? How should the right to receive a digital asset in the future be accounted for? The Association‘s practice aid suggests that in this situation, companies might need to consider guidance in FASB ASC 815, ―Derivatives and Hedging.‖ Following that approach, the Bitcoin account receivable would be accounted for as a derivative financial instrument. However, hedge accounting would not apply because there is nothing being hedged. In this scenario, on September 20, 2021, Copanema would recognize sales revenue and a Bitcoin account receivable at its fair value of $447,000. The journal entry would be: Accounts receivable (Bitcoin) Sales revenue

447,000 447,000

On September 30, the company would make accounting adjustments to prepare its third quarter 2021 interim report. On that date, Bitcoin had decreased in market value to $43,200 per unit. In accordance with ASC 815, treating the Bitcoin account receivable as if it were a derivative financial instrument, Copanema would restate the Bitcoin account receivable to its fair value of $432,000 and recognize a loss of $15,000 in third quarter 2021 net income, as follows: Loss due to decease in fair value of Bitcoin 15,000 Accounts receivable (Bitcoin) 15,000 On October 4, Bitcoin had a market value of $48,200 per unit. On that date, when Copanema received 10 Bitcoins, it would derecognize the Bitcoin account receivable of $432,000, recognize a Bitcoin intangible asset at its fair value of $482,000, and record a gain in fourth quarter 2021 net income of $50,000. The relevant journal entry is: Bitcoin intangible asset 482,000 Accounts receivable (Bitcoin) 432,000 Gain due to increase in fair value of Bitcoin 50,000 In total, a net gain on the Bitcoin account receivable of $35,000 ($482,000 - $447,000) would be recognized in 2021 net income. When all is said and done, following the Association‘s guidance, the cryptocurrency (Bitcoin) account receivable would be accounted for in exactly the same fashion as a foreign currency account receivable. A decrease in the fair value of the cryptocurrency results in the recognition of a loss, and an increase in the fair value of the cryptocurrency results in the recognition of a gain. Only the titles of the accounts used in recording journal entries is likely to be different from the accounting for foreign currency.

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Chapter 10 – Translation of Foreign Currency Financial Statements – Hoyle, Schaefer, Doupnik, Advanced Accounting, 15e

Answers to Questions 1. Under the two-transaction perspective, an export sale (import purchase) and the subsequent collection (payment) of cash are treated as two separate transactions to be accounted for separately. The idea is that management has made two decisions: (1) to make the export sale (import purchase), and (2) to extend credit in foreign currency to the foreign customer (obtain credit from the foreign supplier). The income effect from each of these decisions should be reported separately. 2. Under the two transaction, accrual approach, foreign currency receivables resulting from export sales are revalued at the end of accounting periods using the current spot rate. An increase in the value of a receivable will be offset by reporting a foreign exchange gain in net income, and a decrease will be offset by a foreign exchange loss. Foreign exchange gains and losses are accrued (i.e., recognized in net income) even though they have not yet been realized. 3. Foreign exchange gains and losses are created by two factors: having foreign currency exposures (foreign currency receivables and payables) and changes in exchange rates. Appreciation of the foreign currency will generate foreign exchange gains on receivables and foreign exchange losses on payables. Depreciation of the foreign currency will generate foreign exchange losses on receivables and foreign exchange gains on payables. 4. The accounting for a foreign currency borrowing involves keeping track of two foreign currency payables—the note payable and interest payable. As both the face value of the borrowing and accrued interest represent foreign currency liabilities, both are exposed to foreign exchange risk and can give rise to foreign currency gains and losses. 5. Hedging is the process of eliminating exposure to foreign exchange risk so as to avoid potential losses from fluctuations in foreign exchange rates. In addition to avoiding possible losses, companies hedge foreign currency denominated assets and liabilities, foreign currency firm commitments, and forecasted foreign currency transactions to introduce an element of certainty into the future cash flows resulting from foreign currency activities. Hedging involves establishing a price today at which foreign currency can be sold or purchased at a future date. 6. A party to a foreign currency forward contract is obligated to deliver one currency in exchange for another at a specified future date, whereas the owner of a foreign currency option can choose whether to exercise the option and exchange one currency for another or not. 7. Hedges of foreign currency denominated assets and liabilities are not entered into until a foreign currency transaction (import purchase or export sale) has taken place. Hedges of firm commitments are made when a purchase order is placed or a sales order is received, before a transaction has taken place. Hedges of forecasted transactions are made at the time a future foreign currency purchase or sale can be anticipated, even before an order has been placed or received. 8. Foreign currency options have an advantage over forward contracts in that the holder of the option can choose not to exercise the option if the future spot rate turns out to be more advantageous. Forward contracts, on the other hand, can lock a company into an unnecessary loss (or a reduced gain). The disadvantage associated with foreign currency options is that a premium must be paid up front even though the option might never be 10-39 © McGraw Hill LLC. All rights reserved. No reproduction or distribution without the prior written consent of McGraw Hill LLC.

Chapter 07 - Consolidated Financial Statements—Ownership Patterns and Income Taxes – Hoyle, Schaefer, Doupnik, Advanced Accounting, 15e

exercised. 9. An enterprise is required to recognize all derivative financial instruments as assets or liabilities on the balance sheet and measure them at fair value. 10. The fair value of a foreign currency forward contract is determined by reference to changes in the forward rate over the life of the contract. Theoretically, this amount should be discounted to its present value. Three pieces of information are needed to determine the fair value of a forward contract at any point in time during its life: (a) the contracted forward rate when the forward contract is entered into, (b) the current forward rate for a contract that matures on the same date as the forward contract entered into, and (c) a discount rate; typically, the company‘s incremental borrowing rate. (For simplicity, discounting can be ignored when the difference between the discounted and undiscounted fair value of a forward contract is immaterial.) The manner in which the fair value of a foreign currency option is determined depends on whether the option is traded on an exchange or has been acquired in the over the counter market. The fair value of an exchange-traded foreign currency option is its current market price quoted on the exchange. For over the counter options, fair value can be determined by obtaining a price quote from an option dealer (such as a bank). If dealer price quotes are unavailable, the company can estimate the value of an option using the modified BlackScholes option pricing model. Regardless of who does the calculation, principles similar to those in the Black-Scholes pricing model will be used in determining the value of the option. 11. Hedge accounting is defined as recognizing gains and losses on the hedging instrument in the same period as the recognition of gains and losses on the hedged item. 12. For hedge accounting to apply, the forecasted transaction must be probable (likely to occur), the hedge must be highly effective in offsetting fluctuations in the cash flow associated with the foreign currency risk, and the hedging relationship must be properly documented. 13. A foreign currency derivative can be considered to be highly effective as a hedge if the critical terms of the hedging instrument match those of the hedged item. Critical terms are the currency type, currency amount, and settlement date. 14. In both cases, (1) sales revenue (or the cost of the item purchased) is determined using the spot rate at the date of sale (or purchase), and (2) the hedged asset or liability is adjusted to fair value based on changes in the spot exchange rate with a foreign exchange gain or loss recognized in net income. For a cash flow hedge, the forward contract is adjusted to fair value (resulting in an asset or liability reported on the balance sheet), with the counterpart recognized in Other Comprehensive Income (OCI). A foreign exchange gain or loss on the hedging instrument is then recognized in net income to offset the foreign exchange gain or loss on the hedged item, with the counterpart recognized in OCI; the net effect is to offset any gain or loss on the hedged asset or liability. If the forward points (discount or premium) have been excluded in assessing hedge effectiveness, an amount is recognized in net income for the current period‘s allocation of the original discount or premium on the forward contract, with the counterpart reported in OCI.

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For a fair value hedge, the forward contract is adjusted to fair value (resulting in an asset or liability reported on the balance sheet), with the counterpart recognized as a foreign exchange gain or loss in net income. If the forward points (discount or premium) have been excluded in assessing hedge effectiveness, an adjustment is made to the previously recognized net foreign exchange gain or loss to reflect the current period's allocation of forward contract discount or premium to net income, with the counterpart reported in OCI. 15. In both cases, the derivative hedging instrument (forward contract or option) is reported on the balance sheet at fair value as an asset or liability. In accounting for a hedge of foreign currency firm commitment, a ―firm commitment‖ also must be reported on the balance sheet at fair value as an asset or liability. In accounting for a forecasted foreign currency transaction, there is no additional asset or liability reported on the balance sheet. 16. In accounting for a cash flow hedge, the change in the fair value of the foreign currency option is reported in Other Comprehensive Income (OCI). In accounting for a fair value hedge, the change in the fair value of the foreign currency option is reported as a foreign exchange gain or loss in net income.

Chapter 07 - Consolidated Financial Statements—Ownership Patterns and Income Taxes – Hoyle, Schaefer, Doupnik, Advanced Accounting, 15e

Answers to Problems 1. C

(Foreign exchange gain/loss on foreign currency transaction) An import purchase causes a foreign currency payable to be carried on the books. If the foreign currency depreciates, the dollar value of the foreign currency payable decreases, yielding a foreign exchange gain. 2. D (Method of accounting for foreign currency transactions) Current accounting standards require a two-transaction perspective, accrual approach. 3. A (Foreign exchange gain/loss on foreign currency transaction) Foreign exchange gains related to foreign currency import purchases are treated as a component of income before income taxes. If there is no foreign exchange gain in operating income, then the purchase must have been denominated in U.S. dollars or there was no change in the value of the foreign currency from October 1 to December 1. 4. B (Calculate foreign exchange gain/loss on foreign currency transaction) The dollar value of the LCU receivable has increased from $110,000 at December 31, 2023 to $120,000 at February 15, 2024. This increase of $10,000 should be reported as a foreign exchange gain in 2024. 5. C (Calculate foreign exchange gain/loss on foreign currency borrowing) The decrease in the dollar value of the euro note payable represents a foreign exchange gain. In this case a $5,000 gain would have been accrued in 2023 and a $10,000 gain will be reported in 2024. 6. B (Foreign exchange gain/loss on foreign currency transaction) A foreign currency payable will generate a foreign exchange loss when the foreign currency increases in dollar value. A foreign currency receivable will generate a foreign exchange loss when the foreign currency decreases in dollar value. Hence, the correct combination is yuan (increase) and peso (decrease).

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7. B (Calculate foreign exchange gain/loss) The merchandise purchase results in a foreign exchange gain of $10,000, the difference between the U.S. dollar equivalent at the date of purchase and at the date of settlement. The increase in the dollar equivalent of the note‘s principal results in a foreign exchange loss of $20,000. The net foreign exchange loss is $10,000 ($10,000 gain - $20,000 loss). 8. A (Forward contract cash flow hedge of foreign currency denominated asset/liability) The Thai baht is selling at a discount (spot rate exceeds forward rate). The exporter will receive fewer dollars as a result of selling the baht forward than if the baht had been received and converted into dollars on June 1. Thus, the discount results in a foreign exchange loss for the exporter. 9. A (Foreign currency borrowing) The accounting for a foreign currency borrowing typically will include interest expense, foreign exchange gain or loss on the note payable, and foreign exchange gain or loss on accrued interest payable, but not interest income. 10. C (Date to enter into hedge of forecasted foreign currency transaction) A hedge of a forecasted foreign currency import purchase is entered into on the date on which the company forecasts the purchase of goods from a foreign supplier. 11. D (Conditions for hedge accounting to be used) Foreign currency forward contracts are not purchased in a foreign currency market, but generally are negotiated with a bank. 12. B (Excluded component in assessing hedge effectiveness)

Chapter 07 - Consolidated Financial Statements—Ownership Patterns and Income Taxes – Hoyle, Schaefer, Doupnik, Advanced Accounting, 15e

Components of a hedging instrument that may be excluded in assessing hedge effectiveness are forward points on a forward contract and time value of an option. 13. B (Hedge documentation) The financial institution that is the counterparty to a foreign currency forward contract need not be disclosed in hedge documentation. 14. C (Discount on forward contract) A forward contract discount that is excluded from hedge effectiveness assessment should be amortized to net income (as a foreign exchange gain or loss) on a straight-line basis over the life of the contract. 15.(5 minutes) (Determine amount at which machinery should be capitalized under forward contract fair value hedge of foreign currency firm commitment) Machinery should be capitalized on February 15, when it is received, at the amount of U.S. dollars paid to acquire FC100,000. Because a forward contract to purchase FC has been entered into with a forward rate of $1.23 per FC, the company pays $123,000 (FC 100,000 × $1.23) for FC 100,000. Therefore, $123,000 is the amount at which the machinery should be capitalized. 16.(5 minutes) (Determine the fair value of a forward contract) The forward contract is reported on the December 31 balance sheet as an asset. On December 1, the company contracted to purchase pesos at $0.094 per peso. If it had waited until December 31 to enter into the forward contract it would have contracted to purchase pesos at $0.098 per peso, which is $0.004 more per peso. Therefore, the forward contract has a positive fair value and is an asset. The undiscounted fair value of the forward contract on December 31 is $4,000 [($0.098 – $0.094) × 1,000,000]. Venice Company should report the forward contract on its December 31, 2023, balance sheet as a $4,000 asset. 17.(15 minutes) (Calculate foreign exchange gain or loss on foreign currency transaction; determine impact on net income from forward contract fair value hedge of foreign currency denominated asset/liability) a. The 10 million won receivable has changed in U.S. dollar value from $35,000 at 12/1/23 (10 mn won × $0.0035) to $33,000 (10 mn won × $0.0033) at

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12/31/23. The won receivable will be written down by $2,000 and a foreign exchange loss of $2,000 will be reported in 2023 income. b. The fair value of the forward contract on December 31, 2023 is a positive $2,000, the difference between the amount to be received from the forward contract actually entered into, $34,000 ($0.0034 × 10 million won), and the amount that could be received by entering into a forward contract on December 31, 2023 that matures on March 31, 2025, $32,000 ($0.0032 × 10 million won). On December 31, 2023, Brandt Corp. will recognize a $2,000 foreign exchange gain on the forward contract and a foreign exchange loss of $2,000 on the won receivable. The discount on forward contract is $1,000 [($0.0035 - $0.0034) × 10 million won], which will be amortized at the rate of $250 per month [$1,000 / 4 month life of forward contract]. A foreign exchange loss of $250 will be recognized on December 31, 2023. The net impact on 2023 net income is a decrease of $250. 18.(20 minutes) (Forward contract cash flow hedge of forecasted foreign currency transaction) Note: The forward contract includes a premium of $10,000 [($0.12 − $0.10) × 500,000 kroner] that will be recognized in net income as an adjustment (increase) to Cost of Goods Sold. The journal entries are as follows: 3/1 No journal entries 5/31 Other Comprehensive Income (OCI) Forward Contract [($0.12 − $0.115) × 500,000 kroner] (To recognize the forward contract as a liability with a corresponding debit to OCI)

2,500

Cost of Goods Sold Other Comprehensive Income (OCI) (To recognize the forward contract premium in net income as an adjustment to COGS)

10,000

Foreign Currency (NOK) Forward Contract Cash (To record settlement of the forward contract through payment of $60,000 and record the

57,500 2,500

2,500

10,000

60,000

Chapter 07 - Consolidated Financial Statements—Ownership Patterns and Income Taxes – Hoyle, Schaefer, Doupnik, Advanced Accounting, 15e

foreign currency received as an asset at fair value: NOK 500,000 × $0.115) Inventory Foreign Currency (NOK) (To record the purchase of inventory)

57,500

Cost of Goods Sold Inventory (To record COGS when inventory is sold)

57,500

Accumulated Other Comprehensive Income (AOCI) 7,500 Cost of Goods Sold (To close to COGS the amount in AOCI [$10,000 – 2,500] related to the forward contract)

7,500

18. (continued) a. In the current year‘s net income, the company should report cost of goods sold of $60,000: ($10,000 + $57,500 − $7,500) b. In the current year‘s net income, the company should not report any foreign exchange gain or loss. 19.(20 minutes) (Option cash flow hedge of forecasted foreign currency transaction) Date 4/15 6/15

Fair Value $1,000 $2,5001 1

Intrinsic Value $0 $2,500

Time Value $1,000 $ 0-

Change in Time Value - $1,000

($1.025 − $1.00) × 100,000 pounds = $2,500

Journal Entries 4/15 Foreign Currency Option 1,000 Cash To record the purchase of a foreign currency option.

1,000

6/15 Foreign Currency Option 1,500 OCI 1,500 To adjust the carrying value of the option to its fair value with a corresponding credit to OCI [$2,500 - $1,000]. Cost of Goods Sold 1,000 OCI 1,000 To recognize the change in the time value of the option as a decrease in net

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income with a corresponding credit to OCI [$1,000 - $0]. Foreign Currency (pounds) 102,500 Cash 100,000 Foreign Currency Option 2,500 To record the exercise of the foreign currency option – receipt of 100,000 pounds (with fair value of $102,500) in exchange for $100,000. Inventory 102,500 Foreign Currency (pounds) To record the purchase of inventory and payment of 100,000 pounds.

102,500

Cost of Goods Sold 102,500 Inventory To record a decrease in inventory and cost of goods sold.

102,500

AOCI2

2,500

Cost of Goods Sold 2,500 To close AOCI related to the option as an adjustment to net income (decrease in COGS). 2

After closing OCI, AOCI has a credit balance of $2,500.

19. (continued) a. The net amount Shandra Corporation recognizes as Cost of Goods Sold is $101,000 ($1,000 + $102,500 - $2,500), which is equal to the net cash outflow for inventory. b. Because this is a hedge of a forecasted foreign currency transaction, no foreign exchange gain or loss is recognized. 20.(20 minutes) (Option fair value hedge of a foreign currency firm commitment) a. Journal entries in 2023. 9/1/23 Foreign Currency Option Cash

2,000 2,000

12/31/23 Foreign Currency Option Foreign Exchange Gain or Loss Foreign Exchange Gain or Loss Firm Commitment [($0.79 – $0.80) × 100,000 = $1,000]

300 300 1,000 1,000

Chapter 07 - Consolidated Financial Statements—Ownership Patterns and Income Taxes – Hoyle, Schaefer, Doupnik, Advanced Accounting, 15e

Net impact on 2023 net income: Net foreign exchange gain (loss) Total decrease in net income

$(700) $(700)

b. Journal entries in 2024 3/1/24 Foreign Currency Option Foreign Exchange Gain or Loss

700 700

Foreign Exchange Gain or Loss 2,000 Firm Commitment [($0.77 – $0.80) × 100,000 = $3,000 – $1,000 = $2,000] Foreign Currency (AUD) Sales

77,000

Cash Foreign Currency (AUD) Foreign Currency Option

80,000

Firm Commitment Sales

3,000

Net impact on 2024 net income: Sales Net foreign exchange gain (loss) Total increase in net income

2,000

77,000 77,000 3,000 3,000 $80,000 (1,300) $78,700

20. (continued) c. The net increase or decrease in cash flow from purchasing the foreign currency option is determined as follows: Net cash inflow with option ($80,000 – $2,000) Cash inflow without option (at spot rate of $0.77) Net increase in cash inflow

$78,000 77,000 $ 1,000

21.(20 minutes) Forward contract fair value hedge of a foreign currency firm commitment) a. One way to determine the net impact on net income in the quarter ended June 30 is to prepare the relevant journal entries: 6/1

No journal entries

6/30

Forward Contract Foreign Exchange Gain or Loss

McGraw-Hill/Irwin 10-48

2,400 2,400

Chapter 10 – Translation of Foreign Currency Financial Statements – Hoyle, Schaefer, Doupnik, Advanced Accounting, 15e

($2,400 – $0) Foreign Exchange Gain or Loss Firm Commitment

2,400 2,400

Net impact on second quarter net income is $0. b. One way to determine the net impact on net income in the quarter ended September 30 is to prepare the relevant journal entries: 7/31

Foreign Exchange Gain or Loss Forward Contract [Fair value of Forward Contract is (($0.240 – $0.236) × 500,000) = $2,000; $2,000 – $2,400 = $400]

400

Firm Commitment Foreign Exchange Gain or Loss

400

Foreign Currency (TRY) Sales [500,000 lira × $0.236]

118,000

Cash [500,000 × $0.240] Foreign Currency (TRY) Forward Contract

120,000

Firm Commitment Sales

118,000 118,000 2,000 2,000 2,000

Impact on third quarter net income is: Sales increases by $120,000. c. The net increase or decrease in cash flow from entering into the forward contract hedge is determined as follows: Cash inflow with forward contract [500,000 lira × $0.24] Cash inflow without forward contract [500,000 lira × $0.236] Net increase in cash flow from forward contract

$120,000 118,000 $ 2,000

22.(20 minutes) (Option cash flow hedge of a forecasted foreign currency transaction) The journal entries to account for this option cash flow hedge of a forecasted foreign currency transaction are: 11/1/23 Foreign Currency Option Cash

1,500 1,500

Chapter 07 - Consolidated Financial Statements—Ownership Patterns and Income Taxes – Hoyle, Schaefer, Doupnik, Advanced Accounting, 15e

Other Comprehensive Income (OCI) Foreign Currency Option

400 400

Cost of Goods Sold 4001 Other Comprehensive Income (OCI) 400 (To recognize the change in the option‘s time value in net income as an adjustment to cost of goods sold) 1

The change in the option‘s time value from 11/1/23 to 12/31/23 is $400, explained as follows. The option‘s strike price of $0.0015 per CLP exceeds the spot rate of $0.0013 on 12/31/23. Therefore, the option has zero intrinsic value on 12/31/23, and the option‘s fair value of $1,100 on 12/31/20 is solely attributable to time value. The change in fair value of the option from $1,500 at 11/1/23 to $1,100 at 12/31/20 is solely due to change in time value. Impact on 2023 net income: Debit to COGS decreases income by $400. 2/1/24 Foreign Currency Option Other Comprehensive Income (OCI)

900 900

Cost of Goods Sold Other Comprehensive Income (OCI)

1,100

Foreign Currency (CLP) [20,000,000 × $0.0016] Cash [20,000,000 × $0.0015] Foreign Currency Option

32,000

Raw Materials Inventory Foreign Currency (CLP)

32,000

Accumulated Other Comprehensive Income (AOCI) Cost of Goods Sold

2,000

1,100 30,000 2,000 32,000 2,000

22. (continued) 3/31/24 Cost of Goods Sold Raw Materials Inventory

32,000 32,000

Impact on 2024 net income: Net debit to COGS decreases income by $31,100 [$1,100 − $2,000 + $32,000]. 23.(10 minutes) (Foreign currency payable – import purchase) a. The decrease in the dollar value of the crown payable from November 1 (100,000 × $0.754 = $75,400) to December 31 (100,000 × $0.742 = $74,200) is

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recorded as a $1,200 foreign exchange gain in 2023. b. The increase in the dollar value of the crown payable from December 31 ($74,200) to January 15 (100,000 × $0.747 = $74,700) is recorded as a $500 foreign exchange loss in 2024. 24.(10 minutes) (Foreign currency receivable – export sale) a. The rial receivable decreases in U.S. dollar value from (50,000 × $1.05) $52,500 at December 20 to $51,000 (50,000 × $1.02) at December 31, resulting in a foreign exchange loss of $1,500 in 2023. b. The further decrease in U.S. dollar value of the rial receivable from $51,000 at December 31 to $49,000 (50,000 × $0.98) at January 10 results in an additional $2,000 foreign exchange loss in 2024. 25.(10 minutes) (Foreign currency receivable – export sale) 9/15 9/30

10/15

Accounts Receivable (crowns) [100,000 × $0.60] Sales

60,000

Accounts Receivable (crowns) Foreign Exchange Gain or Loss [100,000 × ($0.66 – $0.60)]

6,000

Foreign Exchange Gain or Loss Accounts Receivable (crowns) [100,000 × ($0.62 – $0.66)]

4,000

Cash Accounts Receivable (crowns)

62,000

60,000 6,000

4,000

62,000

26.(10 minutes) (Foreign currency payable – import purchase) 12/15/23 12/31/23

1/25/24

Inventory 14,000 Accounts Payable (schillings) [50,000 × $0.28]

14,000

Foreign Exchange Gain or Loss Accounts Payable (schillings) [50,000 × ($0.30 – $0.28)]

1,000 1,000

Foreign Exchange Gain or Loss Accounts Payable (schillings) [50,000 × ($0.33 – $0.30)]

1,500

Accounts Payable (schillings) Cash

16,500

1,500 16,500

27.(15 minutes) (Determine U.S. dollar balance for foreign currency transactions)

Chapter 07 - Consolidated Financial Statements—Ownership Patterns and Income Taxes – Hoyle, Schaefer, Doupnik, Advanced Accounting, 15e

Inventory and Cost of Goods Sold are reported at the spot rate at the date the inventory was purchased. Sales are reported at the spot rate at the date of sale. Accounts Receivable and Accounts Payable are reported at the spot rate at the balance sheet date. Cash is reported at the spot rate when collected and the spot rate when paid. a. Inventory [100,000 pesos × $0.10 × 40% unsold] ...................................... $4,000 b. COGS [100,000 pesos × $0.10 × 60% sold] ................................................ $6,000 c. Sales [80,000 pesos × $0.12]....................................................................... $9,600 d. Accounts Receivable [80,000 – 70,000 = 10,000 pesos × $0.15] .............. $1,500 e. Accounts Payable [100,000 – 60,000 = 40,000 pesos × $0.15] ................. $6,000 f. Cash [(70,000 × $0.13) – (60,000 × $0.14)] ..................................................... $700 28.(25 minutes) (Prepare journal entries for a foreign currency borrowing) 4/1/23 10/1/23 12/31/23

Cash Note Payable (euro) [500,000 × $1.10]

550,000

Interest Expense [500,000 × 5% × 6/12 × $1.20] Cash

15,000

Interest Expense [500,000 × 5% × 3/12 × $1.24] Interest Payable (euro)

7,750

550,000 15,000 7,750

Foreign Exchange Gain or Loss 70,000 Note Payable (euro) [500,000 × ($1.24 - $1.10)]

70,000

28. (continued) 3/31/24

Interest Expense [500,000 × 5% × 3/12 × $1.28] Interest Payable (euro) Foreign Exchange Gain or Loss [500,000 × 5% x 3/12 × ($1.28 – $1.24)] Cash [500,000 × 5% × 6/12 × $1.28] Note Payable (euro) Foreign Exchange Gain or Loss [500,000 × ($1.28 - $1.24)] Cash [500,000 × $1.28]

8,000 7,750 250 16,000 620,000 20,000 640,000

29.(20 minutes) (Determine income effect of foreign currency payable – import purchase) a. Spindler, Inc. has an account payable of BRL 320,000. On the date that this liability was created (September 1, 2023), it had a U.S. dollar value of $73,600 (BRL 320,000 × $0.230). On December 1, 2023, when the liability is paid, the U.S. dollar value has decreased to $70,400 (BRL 320,000 × $0.220). The decrease in the U.S. dollar value of the BRL account payable creates a

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foreign exchange gain of $3,200 ($73,600 – $70,400) in 2023. b. Spindler, Inc. has an account payable of BRL 320,000. On the date that this liability was created (December 1, 2023), it had a U.S. dollar value of $70,400 (BRL 320,000 × $0.220). On December 31, 2023, the U.S. dollar value has risen to $76,800 (BRL 320,000 × $0.240). The increase in the U.S. dollar value of the BRL account payable creates a foreign exchange loss of $6,400 ($76,800 – $70,400) in 2023. On March 1, 2024, when the liability is paid, the U.S. dollar value has decreased to $72,000 (BRL 320,000 × $0.225). The decrease in the U.S. dollar value of the BRL account payable creates a foreign exchange gain of $4,800 ($76,800 – $72,000) in 2024. c. Spindler, Inc. has an account payable of BRL 320,000. On the date that this liability was created (September 1, 2023), it had a U.S. dollar value of $73,600 (BRL 320,000 × $0.230). On December 31, 2023, the dollar value has risen to $76,800 (BRL 320,000 × $0.240). The increase in the U.S. dollar value of the BRL account payable creates a foreign exchange loss of $3,200 ($76,800 – $73,600) in 2023. By March 1, 2024, when the liability is paid, the U.S. dollar value has decreased to $72,000 (BRL 320,000 × $0.225) creating a foreign exchange gain of $4,800 ($76,800 – $72,000) to be reported in 2024. 30.(30 minutes) (Foreign currency borrowing) a. 9/30/23

12/31/23

Cash 100,000 Note Payable (CNY) [1,000,000 × $0.10] (To record the note and conversion of CNY 1 million into U.S.$ at the spot rate.) Interest Expense 525 Interest Payable (CNY) [1,000,000 × 2% × 3/12 = CNY 5,000 × $0.105 spot rate] (To accrue interest for the period 9/30 – 12/31/23.) Foreign Exchange Gain or Loss 5,000 Note Payable (CNY) [CNY 1 mn × ($0.105 – $0.10)] (To revalue the note payable at the spot rate of $0.105 and record a foreign exchange loss.)

9/30/24

Interest Expense [CNY 15,000 × $0.12] Interest Payable (CNY) Foreign Exchange Gain or Loss [CNY 5,000 × ($0.12 – $0.105)]

100,000

525

5,000

1,800 525 75

Chapter 07 - Consolidated Financial Statements—Ownership Patterns and Income Taxes – Hoyle, Schaefer, Doupnik, Advanced Accounting, 15e

Cash [CNY 20,000 × $0.12] (To record the first annual interest payment, record interest expense for the period 1/1 – 9/30/24, and record a foreign exchange loss on the interest payable accrued at 12/31/23.) 12/31/24

12/31/24

9/30/25

Interest Expense 625 Interest Payable (CNY) [CNY 5,000 × $0.125] (To accrue interest for the period 9/30 – 12/31/24.) Foreign Exchange Gain or Loss 20,000 Note Payable (CNY) [CNY 1 mn × ($0.125 – $0.105)] (To revalue the note payable at the spot rate of $0.125 and record a foreign exchange loss.) Interest Expense [CNY 15,000 × $0.15] 2,250 Interest Payable (CNY) 625 Foreign Exchange Gain or Loss [CNY 5,000 × ($0.15 – $0.125)] 125 Cash [CNY 20,000 × $0.15] (To record the second annual interest payment, record interest expense for the period 1/1 – 9/30/25, and record a foreign exchange loss on the interest payable accrued at 12/31/24.) Note Payable (CNY) 125,000 Foreign Exchange Gain or Loss 25,000 Cash [CNY 1 mn × $0.15] (To record payment of the CNY 1 million note.)

2,400

625

20,000

3,000

150,000

b. The ―effective borrowing rate‖ on the loan can be determined by summing the total interest expense and foreign exchange losses in U.S. dollars related to the loan and comparing this with the U.S. dollar amount borrowed: 2023 Interest expense Foreign exchange loss Total 2024 Interest expense Foreign exchange loss Total 2025 Interest expense Foreign exchange loss

McGraw-Hill/Irwin 10-54

$ 525 5,000 $5,525 / $100,000 = 5.525% for 3 months 5.525% × 12/3 = 22.1% for 12 months $ 2,425 20,075 $22,500 / $100,000 = 22.5% for 12 months $ 2,250 25,125

Chapter 10 – Translation of Foreign Currency Financial Statements – Hoyle, Schaefer, Doupnik, Advanced Accounting, 15e

Total

$27,375 / $100,0000 = 27.38% for 9 months 27.38% × 12/9 = 36.5% for 12 months

Because of appreciation in the value of the Chinese yuan, the effective annual borrowing rate ranges from 22.1% – 36.5%. Alternatively, the average effective borrowing rate on this loan can be calculated by comparing the cash inflows in U.S.$ and cash outflows in U.S.$ as follows: Cash outflows: Interest ($2,400 + $3,000) Principal Cash inflow: Borrowing Net cash outflow $100,000

$ 5,400 150,000 $155,400 $(100,000) $ 55,400

on a loan that originally generated

Ignoring compounding, this results in an average effective interest rate of approximately 27.7% per year [($55,400 / $100,000) = 55.4% over two years; 55.4% / 2 years = 27.7% per year]. 31.(40 minutes) (Forward contract hedge of foreign currency receivable) The dinar is selling at a premium in the forward market (forward rate > spot rate). The forward contract includes a premium of $1,200 [($2.775 − $2.70) × 16,000 dinars]. The premium will be amortized as an increase to net income over the life of the forward contract at the rate of $400 per month [$1,200 / 3 months]. a. Cash Flow Hedge Date

Journal Entry

12/1/23

Accounts Receivable (dinars) Sales To record sales revenue and a foreign currency account receivable. [$2.70 × 16,000 dinars] No entry for the forward contract. Accounts Receivable (dinars) Foreign Exchange Gain or Loss To revalue the foreign currency account receivable and recognize a foreign exchange gain. [($2.80 − $2.70) × 16,000 dinars]

43,200

OCI Forward Contract To record the change in fair value of the forward contract as a liability. [($2.90 − $2.775) × 16,000 dinars]

2,000

12/31/23

Debit

Credit 43,200

1,600 1,600

2,000

Chapter 07 - Consolidated Financial Statements—Ownership Patterns and Income Taxes – Hoyle, Schaefer, Doupnik, Advanced Accounting, 15e

Foreign Exchange Gain or Loss OCI To record a foreign exchange loss on the forward contract to offset the foreign exchange gain on the account receivable.

1,600

OCI Foreign Exchange Gain or Loss To amortize the forward contract premium to net income over the life of the contract. [$1,200 × 1/3 = $400]

400

Impact on 2023 net income: Sales Foreign exchange gain (loss) Total

1,600

400

$43,200 400 $43,600

Date

Journal Entry

3/1/24

Accounts Receivable (dinars) Foreign Exchange Gain or Loss To revalue the foreign currency account receivable and recognize a foreign exchange gain. [($2.95 − $2.80) × 16,000 dinars]

Debit 2,400

OCI Forward Contract To adjust the carrying value of the forward contract to its current fair value. [($2.95 − $2.775) × 16,000 = $2,800 − $2,000 = $800]

800

2,400

800

Foreign Exchange Gain or Loss OCI To record a foreign exchange loss on the forward contract to offset the foreign exchange gain on the account receivable.

2,400

OCI Foreign Exchange Gain or Loss To amortize the forward contract premium to net income over the life of the contract. [$1,200 × 2/3 = $800]

800

2,400

800

Foreign Currency (dinars) Accounts Receivable (dinars) To record the receipt of dinars from the foreign customer. [$2.95 × 16,000 dinars]

47,200

Cash [$2.775 × 16,000 dinars] Forward Contract Foreign Currency (dinars) To record settlement of the forward contract.

44,400 2,800

McGraw-Hill/Irwin 10-56

Credit

47,200

Chapter 10 – Translation of Foreign Currency Financial Statements – Hoyle, Schaefer, Doupnik, Advanced Accounting, 15e

Impact on 2024 net income: Foreign exchange gain (loss) Total

$800 $800

Impact on net income over both periods, which is equal to net cash inflow: $43,600 + $800 = $44,400 31. (continued) b. Fair Value Hedge Date

Journal Entry

Debit

12/1/23

Accounts Receivable (dinars) Sales To record sales revenue and a foreign currency account receivable. [16,000 × $2.70]

43,200

Credit 43,200

No entry for the forward contract. 12/31/23

Accounts Receivable (dinars) Foreign Exchange Gain or Loss To revalue the foreign currency account receivable and recognize a foreign exchange gain. [16,000 × ($2.80 − $2.70)]

1,600

Foreign Exchange Gain or Loss Forward Contract To record the change in fair value of the forward contract as a liability and recognize a foreign exchange loss on the forward contract. [16,000 × ($2.90 − $2.775)]

2,000

OCI Foreign Exchange Gain or Loss To adjust the net amount recognized as foreign exchange loss to reflect the current period‘s amortization of the forward contract premium.

800

1,600

2,000

800

Note that the amount recognized in OCI is closed to AOCI at the end of the period. Impact on 2023 net income: Sales Foreign exchange gain (loss) Total

$43,200 400 $43,600

32. (continued) b. Fair Value Hedge (continued)

Chapter 07 - Consolidated Financial Statements—Ownership Patterns and Income Taxes – Hoyle, Schaefer, Doupnik, Advanced Accounting, 15e

Date

Journal Entry

Debit

3/1/24

Accounts Receivable (dinars) Foreign Exchange Gain or Loss To revalue the foreign currency account receivable and recognize a foreign exchange gain. [16,000 × ($2.95 − $2.80)]

2,400

Foreign Exchange Gain or Loss Forward Contract To adjust the carrying value of the forward contract to its current fair value and recognize a foreign exchange loss. [16,000 × ($2.95 − $2.775) = $2,800 − $2,000 = $800]

800

Foreign Exchange Gain or Loss AOCI To adjust the net amount recognized as foreign exchange gain to reflect the current period's amortization of forward contract premium by transferring the amount of loss deferred in AOCI to net income

800

2,400

800

Foreign Currency (dinars) Accounts Receivable (dinars) To record the receipt of dinars from the foreign customer.

47,200

Cash Forward Contract Foreign Currency (dinars) To record settlement of the forward contract.

44,400 2,800

Impact on 2024 net income: Foreign exchange gain (loss) Total

Credit

47,200

$800 $800

Impact on net income over both periods, which is equal to net cash inflow: $43,600 + $800 = $44,400 32.(40 minutes) (Forward contract hedge of foreign currency payable) The dinar is selling at a premium in the forward market (forward rate > spot rate). The forward contract includes a premium of $1,200 [16,000 dinars × ($2.775 − $2.70)]. The premium will be amortized as a decrease to net income over the life of the forward contract at the rate of $400 per month [$1,200 / 3 months]. a. Cash Flow Hedge Date Journal Entry

Debit

12/1/23

43,200

Cost of Goods Sold Accounts Payable (dinars) To record the purchase of materials immediately as cost of

McGraw-Hill/Irwin 10-58

Credit 43,200

Chapter 10 – Translation of Foreign Currency Financial Statements – Hoyle, Schaefer, Doupnik, Advanced Accounting, 15e

goods sold and record a foreign currency account payable. No entry for the forward contract. 12/31/23

Foreign Exchange Gain or Loss Accounts Payable (dinars) To revalue the foreign currency account payable and recognize a foreign exchange loss.

1,600

Forward Contract OCI To record the change in fair value of the forward contract as an asset.

2,000

OCI Foreign Exchange Gain or Loss To record a foreign exchange gain on the forward contract to offset the foreign exchange loss on the account payable.

1,600

Foreign Exchange Gain or Loss OCI To amortize the forward contract premium to net income over the life of the contract.

400

Impact on 2023 net income: Cost of goods sold Foreign exchange gain (loss) Total

1,600

2,000

1,600

400

$(43,200) (400) $(43,600)

32. (continued) a. Fair Value Hedge (continued) Date

Journal Entry

Debit

3/1/24

Foreign Exchange Gain or Loss Accounts Payable (dinars) To revalue the foreign currency account payable and recognize a foreign exchange loss.

2,400 2,400

Forward Contract OCI To adjust the carrying value of the forward contract to its current fair value.

800

OCI Foreign Exchange Gain or Loss To record a gain on forward contract to offset the foreign exchange loss on account payable.

2,400

Foreign Exchange Gain or Loss OCI

Credit

800

2,400

800

Chapter 07 - Consolidated Financial Statements—Ownership Patterns and Income Taxes – Hoyle, Schaefer, Doupnik, Advanced Accounting, 15e

To allocate the forward contract premium to net income over the life of the contract. Foreign Currency (dinars) Cash Forward Contract To record settlement of the forward contract.

47,200

Accounts Payable (dinars) Foreign Currency (dinars) To record the payment of dinars to the foreign supplier.

47,200

Impact on 2024 net income: Foreign exchange gain (loss) Total

44,400 2,800

47,200

$(800) $(800)

Impact on net income over both periods, which is equal to net cash outflow: $(43,600) + $(800) = $(44,600) 32. (continued) b. Fair Value Hedge Date

Journal Entry

Debit

12/1/23

Cost of Goods Sold Accounts Payable (dinar) To record the purchase of materials immediately as cost of goods sold and record a foreign currency account payable.

43,200

Credit 43,200

No entry for the forward contract. 12/31/23

Foreign Exchange Gain or Loss Accounts Payable (dinar) To revalue the foreign currency account payable and recognize a foreign exchange loss.

1,600

Forward Contract Foreign Exchange Gain or Loss To record the change in fair value of the forward contract as an asset and recognize a foreign exchange gain on forward contract.

2,000

Foreign Exchange Gain or Loss OCI To adjust the net amount recognized as foreign exchange gain to reflect the current period‘s amortization of the forward contract premium.

800

Impact on 2023 net income: Cost of goods sold McGraw-Hill/Irwin 10-60

1,600

2,000

800

$(43,200) © The McGraw-Hill Companies, Inc., 2017 Solutions Manual

Chapter 10 – Translation of Foreign Currency Financial Statements – Hoyle, Schaefer, Doupnik, Advanced Accounting, 15e

Foreign exchange gain (loss) Total

(400) $(43,600)

Chapter 07 - Consolidated Financial Statements—Ownership Patterns and Income Taxes – Hoyle, Schaefer, Doupnik, Advanced Accounting, 15e

32. (continued) b. Cash Flow Hedge (continued) Date

Journal Entry

3/1/24

Foreign Exchange Gain or Loss Accounts Payable (dinars) To revalue the foreign currency account payable and recognize a foreign exchange loss.

Debit 2,400

Forward Contract Foreign Exchange Gain or Loss To adjust the carrying value of the forward contract to its current fair value and recognize a foreign exchange gain on forward contract.

800

AOCI Foreign Exchange Gain or Loss To adjust the net amount recognized as foreign exchange loss to reflect the current period's amortization of forward contract premium by transferring the amount of loss deferred in AOCI to net income

800

2,400

800

Foreign Currency (dinars) Cash Forward Contract To record settlement of the forward contract.

47,200

Accounts Payable (dinars) Foreign Currency (dinars) To record the payment of dinars to the foreign supplier.

47,200

Impact on 2024 net income: Foreign exchange gain (loss) Total

Credit

800

44,400 2,800

47,200

$(800) $(800)

Impact on net income over both periods, which is equal to net cash outflow: $(43,800) + $(800) = $(44,400) 33.(30 minutes) (Option hedge of foreign currency receivable) Date

Fair Value

Intrinsic Value

Time Value

6/1 6/30 9/1

$2,500 $2,200 $2,000

$ -0$1,000 $2,000

$2,500 $1,200 $-0-

Change in Time Value – – $1,300 – $1,200

To allocate the change in time value of the option to net income over the life of the option, Maxwell should recognize a net foreign exchange loss of $1,300 in

McGraw-Hill/Irwin 10-62

Chapter 10 – Translation of Foreign Currency Financial Statements – Hoyle, Schaefer, Doupnik, Advanced Accounting, 15e

the second quarter and a net foreign exchange loss of $1,200 in the third quarter. a. Cash Flow Hedge 6/1

6/30

Accounts Receivable (P) Sales [$0.062 × 1,000,000]

62,000

Foreign Currency Option [$0.0025 × 1,000,000] Cash

2,500

Foreign Exchange Gain or Loss Accounts Receivable (P) [($0.061 – $0.062) × 1,000,000]

1,000

OCI Foreign Currency Option [($0.0022 – $0.0025) × 1,000,000] OCI Foreign Exchange Gain or Loss (Gain on option to offset loss on receivable)

62,000 2,500 1,000 300 300 1,000 1,000

Foreign Exchange Gain or Loss 1,300 OCI (Change in time value of option is recognized in net income) 9/1

Foreign Exchange Gain or Loss Accounts Receivable (P) [($0.060 – $0.061) × 1,000,000]

1,300

1,000 1,000

OCI Foreign Currency Option [$2,200 – $2,000]

200

OCI Foreign Exchange Gain or Loss (Gain on option to offset loss on receivable)

1,000

200 1,000

Foreign Exchange Gain or Loss 1,200 OCI (Change in time value of option is recognized in net income)

1,200

33. (continued) Foreign Currency (P) [$0.060 × 1,000,000] Accounts Receivable (P)

60,000

Cash

62,000

60,000

Chapter 07 - Consolidated Financial Statements—Ownership Patterns and Income Taxes – Hoyle, Schaefer, Doupnik, Advanced Accounting, 15e

Foreign Currency (P) Foreign Currency Option

60,000 2,000

Impact on Net Income over the Two Accounting Periods: Sales $62,000 Foreign exchange gain (loss) (2,500) Impact on net income $59,500 = Net cash inflow b. Fair Value Hedge 6/1

6/30

9/1

Accounts Receivable (P) Sales [$0.062 × 1,000,000]

62,000

Foreign Currency Option [$0.0025 × 1,000,000] Cash

2,500

Foreign Exchange Gain or Loss Accounts Receivable (P) [($0.061 – $0.062) × 1,000,000]

1,000

Foreign Exchange Gain or Loss Foreign Currency Option [($0.022 – $0.025) × 1,000,000]

300

Foreign Exchange Gain or Loss Accounts Receivable (P) [($0.060 – $0.061) × 1,000,000]

1,000

62,000 2,500

1,000

300

1,000

Foreign Exchange Gain or Loss Foreign Currency Option [$2,200 − $2,000]

200 200

Foreign Currency (P) [$0.060 × 1,000,000] Accounts Receivable (P)

60,000

Cash Foreign Currency (P) Foreign Currency Option

62,000

60,000 60,000 2,000

Impact on Net Income over the Two Accounting Periods: Sales $62,000 Foreign exchange gain (loss) (2,500) Impact on net income $59,500 = Net cash inflow 34.(30 minutes) (Option hedge of foreign currency payable) Date

Fair Value

Intrinsic Value

Time Value

9/1 9/30

$2,000 $7,500

$ -0$6,000

$2,000 $1,500

McGraw-Hill/Irwin 10-64

Change in Time Value - $500

Chapter 10 – Translation of Foreign Currency Financial Statements – Hoyle, Schaefer, Doupnik, Advanced Accounting, 15e

12/1

$18,000

$ -0-

- $1,500

To allocate the change in time value of the option to net income over the life of the option, Maxwell should recognize a net foreign exchange loss of $500 in the second quarter and a net foreign exchange loss of $1,500 in the third quarter. a. Cash Flow Hedge 9/1

9/30

Inventory [$0.852 × 1,000,000] Accounts Payable (francs)

852,000

Foreign Currency Option Cash [1,000,000 × $0.002]

2,000

Foreign Exchange Gain or Loss Accounts Payable (francs) [($0.858 – $0.852) × 1,000,000]

6,000

Foreign Currency Option OCI [$7,500 – $2,000]

5,500

OCI Foreign Exchange Gain or Loss (Gain on option to offset loss on receivable)

6,000

852,000 2,000 6,000

5,500

6,000

Foreign Exchange Gain or Loss 500 OCI (Recognize change in time value of option in net income)

500

34. (continued) 12/1

Foreign Exchange Gain or Loss Accounts Payable (francs) [($0.870 – $0.858) × 1,000,000]

12,000

Foreign Currency Option OCI [$18,000 – $7,500]

10,500

OCI Foreign Exchange Gain or Loss

12,000

Foreign Exchange Gain or Loss OCI

1,500

12,000

10,500

12,000 1,500

(Recognize change in time value of option in net income)

Chapter 07 - Consolidated Financial Statements—Ownership Patterns and Income Taxes – Hoyle, Schaefer, Doupnik, Advanced Accounting, 15e

Foreign Currency (francs) Cash Foreign Currency Option

870,000

Accounts Payable (francs) Foreign Currency (francs) Date of Sale:

870,000

Cost of Goods Sold Inventory

852,000

Overall impact on net income: Cost of goods sold Foreign exchange gain (loss) Total

852,000 18,000 870,000

852,000 $(852,000) ($2,000) $(854,000) = net cash outflow

34. (continued) b. Fair Value Hedge 9/1

9/30

12/1

Inventory [$0.852 × 1,000,000] Accounts Payable (francs)

852,000

Foreign Currency Option Cash [1,000,000 × $0.002]

2,000

Foreign Exchange Gain or Loss Accounts Payable (francs) [($0.858 – $0.852) × 1,000,000]

6,000

Foreign Currency Option Foreign Exchange Gain or Loss [$7,500 – $2,000]

5,500

Foreign Exchange Gain or Loss Accounts Payable (francs) [($0.870 – $0.858) × 1,000,000]

12,000

Foreign Currency Option Foreign Exchange Gain or Loss [$18,000 – $7,500]

10,500

Foreign Currency (francs) Cash Foreign Currency Option

870,000

Accounts Payable (francs)

870,000

McGraw-Hill/Irwin 10-66

852,000 2,000 6,000

5,500

12,000

10,500

852,000 18,000

Chapter 10 – Translation of Foreign Currency Financial Statements – Hoyle, Schaefer, Doupnik, Advanced Accounting, 15e

Foreign Currency (francs)

870,000

Date of Sale: Cost of Goods Sold Inventory

852,000 852,000

Overall impact on net income: Cost of goods sold Foreign exchange gain (loss) Total

$(852,000) ($2,000) $(854,000) = net cash outflow

35.(30 minutes) (Forward contract cash flow hedge of forecasted foreign currency transaction (purchase)) The yuan is selling at a discount in the forward market (forward rate < spot rate). The forward contract includes a discount of $1,500 [($0.21 - $0.195) × 100,000 yuan]. The discount will be amortized as a decrease to net income over the life of the forward contract at the rate of $250 per month [$1,500 / 6 months]. 2023 Journal Entries 11/01 There is no entry for the forward contract.

12/31 OCI Forward Contract To record the forward contract at its fair value of $(2,500) as a liability with the counterpart to OCI. Cost of Goods Sold OCI To amortize the forward contract discount to net income (as an adjustment to Cost of Goods Sold) with the counterpart to OCI. [$250 × 2 months]

2,500 2,500

500 500

The impact on net income for the year 2023 is: Cost of goods sold $(500) Impact on net income $(500) OCI has a net debit balance of $2,000 that is closed to AOCI. 2024 Journal Entries 4/30

Forward Contract OCI To adjust the forward contract liability to its fair value of $(1,500) with the counterpart to OCI.

1,000 1,000

Chapter 07 - Consolidated Financial Statements—Ownership Patterns and Income Taxes – Hoyle, Schaefer, Doupnik, Advanced Accounting, 15e

Cost of Goods Sold OCI To amortize the forward contract discount to net income (as an adjustment to Cost of Goods Sold) with the counterpart to OCI. [$250 × 4 months] 35. (continued)

1,000

Foreign Currency (yuan) Forward Contract Cash To record settlement of the forward contract and close the forward contract liability account.

18,000 1,500

Inventory Foreign Currency (yuan) To record the purchase of inventory.

18,000

1,000

19,500

18,000

Date of Sale: Cost of Goods Sold Inventory To transfer the cost of inventory to cost of goods sold. The impact on net income for the year 2024 is: Cost of goods sold Impact on net income

18,000 18,000

$(19,000) $(19,000)

Over the two accounting periods, Cost of Goods Sold is recognized in the amount of $19,500, which is equal to the decrease in Cash related to the import purchase. 36.(30 minutes) (Option cash flow hedge of forecasted foreign currency transaction (sale)) Date

Fair Value

Intrinsic Value

Time Value

11/30/23 12/31/23 1/31/24

$3,000 $12,0002 $15,0004

$ -0$10,0003 $15,000

$3,000 $2,000 $ -0-

Change in Time Value - $1,000 - $2,000

$0.006 × FC 500,000 = $3,000 $0.024 × FC 500,000 = $12,000 3 ($0.52 − $0.50) × FC 500,000 = $10,000 4 ($0.52 − $0.49) × FC 500,000 = $15,000 2

To allocate the change in time value of the option to net income over the life of the option, Raval should recognize a negative (debit) adjustment to Sales of $1,000 in 2023 and a negative (debit) adjustment to Sales of $2,000 in 2024. 2023 Journal Entries McGraw-Hill/Irwin 10-68

Chapter 10 – Translation of Foreign Currency Financial Statements – Hoyle, Schaefer, Doupnik, Advanced Accounting, 15e

11/30 Foreign Currency Option Cash [$0.006 × FC 500,000]

3,000

12/31 Foreign Currency Option OCI [$12,000 − $3,000]

9,000

3,000

9,000

Sales OCI (Change in time value)

1,000 1,000

The impact on net income for the year 2023 is: Sales $(1,000) Impact on net income $(1,000) 2024 Journal Entries 1/31

Foreign Currency Option OCI [$15,000 − $12,000]

3,000

Sales OCI (Change in time value)

2,000

3,000

2,000

36. (continued) Foreign Currency (FC) Sales

245,000

Cash Foreign Currency (FC) Foreign Currency Option

260,000

AOCI4 Sales

15,000

245,000 245,000 15,000 15,000

After closing OCI, AOCI has a credit balance of $15,000.

The impact on net income for the year 2024 is: Sales Impact on net income

$258,000 $258,000

The net impact on net income over the two years is an increase in Sales of $257,000 (negative $1,000 in 2023 plus positive $258,000 in 2024), which is equal to the increase in Cash ($260,000 − $3,000). 10-69 © McGraw Hill LLC. All rights reserved. No reproduction or distribution without the prior written consent of McGraw Hill LLC.

Chapter 07 - Consolidated Financial Statements—Ownership Patterns and Income Taxes – Hoyle, Schaefer, Doupnik, Advanced Accounting, 15e

37.(30 minutes) (Forward contract fair value hedge – foreign currency receivable and firm commitment (sale)) Because the forward exchange rate is used to measure the fair value of the firm commitment, forward points may not be excluded in assessing hedge effectiveness. Therefore, the forward contract premium is not amortized to net income. a. Journal Entries 10/1/23

There is no entry to record either the sales agreement or the forward contract as both are executory contracts.

12/31/23 Foreign Exchange Gain or Loss Forward Contract [($0.31 − $0.29) × PLN 1,000,000]

1/31/24

20,000 20,000

Firm Commitment Foreign Exchange Gain or Loss

20,000

Forward Contract Foreign Exchange Gain or Loss

10,000

Foreign Exchange Gain or Loss Firm Commitment

10,000

Foreign Currency (PLN) Sales

300,000

Cash Forward Contract Foreign Currency (PLN)

290,000 10,000

Sales Firm Commitment

10,000

20,000 10,000 10,000 300,000

300,000 10,000

Overall impact on net income is: Sales Impact on net income

$290,000 $290,000

= Cash Inflow

b. The company would have been better off without the forward contract by $10,000. In that case the increase in Cash would have been $300,000 [$0.30 spot rate on 1/31/24 × PLN 1,000,000]. With the forward contract, the company generates only $290,000 of cash inflow. 38.(30 minutes) (Forward contract fair value hedge of a foreign currency firm commitment (purchase))

McGraw-Hill/Irwin 10-70

Chapter 10 – Translation of Foreign Currency Financial Statements – Hoyle, Schaefer, Doupnik, Advanced Accounting, 15e

Date

Forward Rate to 10/31

Forward Contract Fair Value Change in Fair Value

8/1 $0.60 $ -09/30 $0.66 $24,0001 10/31 $0.68 (spot) $32,0002 1 ($264,000 – $240,000) = $24,000. 2 ($272,000 – $240,000) = $32,000.

+$24,000 +$8,000

Firm Commitment Fair Value Change in Fair Value $ -0$(24,000)1 $(32,000)2

– $24,000 – $8,000

a. Journal entries 8/1 There is no entry to record either the purchase agreement or the forward contract as both are executory contracts. 9/30

Forward Contract Foreign Exchange Gain or Loss

24,000

Foreign Exchange Gain or Loss Firm Commitment

24,000

24,000 24,000

b. The net impact on third quarter net income is $0. (Because the forward component of the forward contract is not excluded in assessing hedge effectiveness, there is no amortization of forward points.) 10/31 Forward Contract Foreign Exchange Gain or Loss Foreign Exchange Gain or Loss Firm Commitment

8,000 8,000 8,000 8,000

Foreign Currency (pounds) [400,000 × $0.68] Cash [400,000 × $0.60] Forward Contract

272,000

Inventory Foreign Currency (pounds)

272,000

240,000 32,000 272,000

Nov. Cost-of-Goods-Sold Inventory

272,000 272,000

Firm Commitment Cost of Goods Sold

32,000 32,000

b. The net impact on fourth quarter net income is negative $240,000: Cost of goods sold Impact on net income

$(240,000) $(240,000) 10-71

Chapter 07 - Consolidated Financial Statements—Ownership Patterns and Income Taxes – Hoyle, Schaefer, Doupnik, Advanced Accounting, 15e

c. The net cash outflow is $240,000. 39.(30 minutes) (Option fair value hedge of a foreign currency firm commitment (sale)) Firm Commitment Spot Rate

Date

Fair Value $(6,000) $(10,000)

Option Change in Fair Value

Option Premium for 9/1

– $6,000 – $4,000

$0.020 $0.072 N/A

Fair Value

Change in Fair Value

$2,000 $7,200 $10,000

+ $5,200 + $2,800

6/1 6/30 9/1

$1.00 $0.94 $0.90

Date

Fair Value

Intrinsic Value

Time Value

Change in Time Value

6/1 6/30 9/1

$2,000 $7,200 $10,000

$ -0$6,000 $10,000

$2,000 $1,200 $ -0-

– $800 – $1,200

To allocate the change in time value of the option to net income over the life of the option, Daniels should recognize a net foreign exchange loss of $800 in the second quarter and a net foreign exchange loss of $1,200 in the third quarter. a. Journal Entries 6/1

6/30

9/1

Foreign Currency Option Cash There is no entry to record the sales agreement because it is an executory contract.

2,000

Foreign Exchange Gain or Loss Firm Commitment

6,000

Foreign Currency Option Foreign Exchange Gain or Loss

5,200

Foreign Exchange Gain or Loss Firm Commitment

4,000

Foreign Currency Option Foreign Exchange Gain or Loss

2,800

Foreign Currency (francs) Sales

90,000

Cash Foreign Currency (francs)

100,000

McGraw-Hill/Irwin 10-72

2,000

6,000 5,200 4,000 2,800 90,000 90,000

Chapter 10 – Translation of Foreign Currency Financial Statements – Hoyle, Schaefer, Doupnik, Advanced Accounting, 15e

Foreign Currency Option

10,000

Firm Commitment Sales

10,000 10,000

b. Impact on Net Income The impact on net income for the second quarter is: Foreign exchange gain (loss) $(800) Impact on net income $(800) The impact on net income for the third quarter is: Sales ($90,000 + $10,000) $100,000 Foreign exchange gain (loss) (1,200) Impact on net income $ 98,800 The impact on net income over the second and third quarters is: $98,000 ($100,000 sales − $2,000 net foreign exchange loss) c. Net Cash Inflow The net cash inflow resulting from the sale is: $98,000 ($100,000 – $2,000) 40.(30 minutes) (Option fair value hedge of a foreign currency firm commitment (purchase)) Firm commitment on 11/20 to pay 100,000 rupees on 12/20. Option with strike price of $0.050 acquired on 11/20.

Firm Commitment Date 11/20 a) 12/20 b) 12/20 1. 2. 3.

Spot Rate

$0.050 $0.053 $0.048

Fair Value $(3,000)1 $ 2,0002

Change in Fair Value

– $3,000 + $2,000

Fair Value

$1,000 $3,0003 $04

Option Intrinsic Value

$0 $3,000 $0

Time Value

$1,000 $0 $0

$50,000 – $53,000 = $(3,000). $50,000 – $48,000 = $2,000. Given the spot rate on 12/20 of $0.053, a call option with a strike price of $0.050 has an intrinsic value of $3,000 [($0.053 − $0.050) × 1,000,000 rupees]. Given the spot rate on 12/20 of $0.048, a call option with a strike price of $0.050 has no intrinsic value.

a. The option strike price ($0.050) is less than the spot rate ($0.053) on December 20, the date the parts are to be paid for. Therefore, Amaretta will exercise its option. The journal entries are as follows:

Chapter 07 - Consolidated Financial Statements—Ownership Patterns and Income Taxes – Hoyle, Schaefer, Doupnik, Advanced Accounting, 15e

11/20

Foreign Currency Option Cash

1,000 1,000

There is no entry to record the purchase agreement because it is an executory contract. 12/20

Foreign Exchange Gain or Loss Firm Commitment

3,000

Foreign Currency Option Foreign Exchange Gain or Loss

2,000

3,000 2,000

The two above entries result in a net foreign exchange loss of $1,000, which effectively recognizes the change in the time value of the option in net income (from $1,000 to $0). Foreign Currency (rupees) Cash Foreign Currency Option

53,000

Merchandise Inventory Foreign Currency (rupees)

53,000

50,000 3,000 53,000

40. (continued) By 12/31 Cost of Goods Sold Merchandise Inventory

53,000 53,000

Firm Commitment 3,000 Cost of Goods Sold 3,000 (This final entry is made in the same period when inventory affects net income through cost-of-goods-sold, i.e., prior to 12/31) The net effect on net income for the year ended 12/31 is: Foreign Exchange Gain (Loss) Cost-of-Goods Sold Net decrease in net income

$ (1,000) (50,000) $(51,000)

The net decrease in net income is equal to net cash outflow: Cash paid for foreign currency option Cash paid for merchandise inventory Net cash outflow

$ 1,000 50,000 $51,000

b. The option strike price ($0.050) is greater than the spot rate ($0.048) on December 20, the date the parts are to be paid for. Therefore, Amaretta will allow the option to expire unexercised. Foreign currency will be acquired at the spot rate on December 20. The journal entries are as follows:

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Chapter 10 – Translation of Foreign Currency Financial Statements – Hoyle, Schaefer, Doupnik, Advanced Accounting, 15e

11/20

Foreign Currency Option 1,000 Cash 1,000 There is no entry to record the purchase agreement because it is an executory contract.

12/20

Firm Commitment Foreign Exchange Gain or Loss

2,000

Foreign Exchange Gain or Loss Foreign Currency Option

1,000

2,000 1,000

The two entries above result in a net foreign exchange gain (credit balance) of $1,000. The following adjustment is required to record a net foreign exchange loss (debit balance) of $1,000 to recognize the change in the time value of the option in net income. Foreign Exchange Gain or Loss OCI (OCI is closed to AOCI)

2,000 2,000

40. (continued) Foreign Currency (rupees) Cash

48,000

Merchandise Inventory Foreign Currency (rupees)

48,000

By 12/31 Cost of Goods Sold Merchandise Inventory

48,000 48,000 48,000

AOCI 2,000 Cost of Goods Sold 2,000 (This entry closes the balance in AOCI as an adjustment to cost of goods sold) Cost of Goods Sold 2,000 Firm Commitment 2,000 (This final entry is made in the same period when inventory affects net income through cost of goods sold, i.e., prior to 12/31) The net effect on net income for the year ended 12/31 is: Foreign exchange gain (loss) Cost of goods sold Net decrease in net income

$ (1,000) (48,000) $(49,000)

Chapter 07 - Consolidated Financial Statements—Ownership Patterns and Income Taxes – Hoyle, Schaefer, Doupnik, Advanced Accounting, 15e

Cash paid for foreign currency option Cash paid for merchandise inventory Net cash outflow

$ 1,000 48,000 $49,000

41.(20 minutes) (Option cash flow hedge of a forecasted transaction) Date

Fair Value

12/15/23 12/31/23 3/15/24

$5,0001 $7,500 $10,000

Intrinsic Value

Time Value

Change in Time Value

$ -0$4,0002 $10,000

$5,000 $3,5003 $ -0-

– $1,500 – $3,500

$0.005 × 1,000,000 = $5,000 ($0.584 − $0.580) × 1,000,000 = $4,000 3 $7,500 − $4,000 = $3,500 2

a. 12/15/23 Foreign Currency Option Cash [1 million francs × $0.005]

5,000 5,000

No journal entry related to the forecasted transaction. 12/31/23 Foreign Currency Option OCI To recognize the increase in the value of the foreign currency option with the counterpart recorded in OCI.

2,500 2,000

Cost of Goods Sold 1,500 OCI To recognize the decrease in the time value of the option as an increase in cost of goods sold with the counterpart recorded in OCI. 3/15/24

Foreign Currency Option OCI To recognize the increase in the value of the foreign currency option with the counterpart recorded in OCI.

2,500

Cost of Goods Sold OCI To recognize the decrease in the time value of the option as an increase in cost of goods sold with the counterpart recorded in OCI.

3,500

McGraw-Hill/Irwin 10-76

1,500

2,500

3,500

Chapter 10 – Translation of Foreign Currency Financial Statements – Hoyle, Schaefer, Doupnik, Advanced Accounting, 15e

Foreign Currency (francs) Cash Foreign Currency Option To record exercise of the foreign currency option at the strike price of $0.58 and close the foreign currency option account.

590,000

Raw Materials Inventory Foreign Currency (francs) To record the purchase of raw materials and the payment of 1 million francs to the supplier.

590,000

AOCI Cost of Goods Sold To transfer the amount accumulated in AOCI as an adjustment to cost of goods sold (on the date the transaction is forecasted to take place).

10,000

580,000 10,000

590,000

10,000

Date of Sale: Cost of Goods Sold Raw Materials Inventory To transfer the cost of the raw materials to cost of goods sold.

590,000 590,000

b. Impact on net income: 2023 – Cost of goods sold 2024 – Cost-of-goods-sold

$ (1,500) $(583,500)

The overall impact on net income over the two accounting periods is $(585,000). c. Net cash outflow for raw materials: $585,000 = $5,000 + $580,000 42.(60 minutes) (Unhedged foreign currency transaction; forward contract hedge of foreign currency liability; forward contract and option hedge of foreign currency firm commitment (purchase); option hedge of forecasted foreign currency transaction) Part a. Foreign Currency Liability (Unhedged) 8/15 9/30 10/15

Inventory Accounts Payable (euro)

55,000

Foreign Exchange Gain or Loss Accounts Payable (euro)

2,500

Foreign Exchange Gain or Loss Accounts Payable (euro)

1,500

55,000 2,500 1,500

Chapter 07 - Consolidated Financial Statements—Ownership Patterns and Income Taxes – Hoyle, Schaefer, Doupnik, Advanced Accounting, 15e

Foreign Currency (euro) Cash

59,000

Accounts Payable (euro) Foreign Currency euro)

59,000

59,000 59,000

Date of Sale: Cost of Goods Sold Inventory

55,000 55,000

42. (continued) Part b. Forward Contract Cash Flow Hedge of a Foreign Currency Liability The € is selling at a premium in the forward market (forward rate > spot rate). The forward contract includes a premium of $3,000 [($1.16 − $1.10) × €50,000]. The premium will be amortized as a decrease in net income over the life of the forward contract on a straight-line basis: $2,250 (¾) on September 30 and $750 (¼) on October 15. Accounts Payable (C)

Date 8/15 9/30 10/15 1 2

Spot Rate $1.10 $1.15 $1.18

U.S. Dollar Value $55,000 $57,500 $59,000

Change in U.S. Dollar Value +$2,500 +$1,500

Forward Rate to 10/15 $1.16 $1.19 $1.18 (spot)

Forward Contract Change Fair in Fair Value Value $0 $1,5001 +$1,500 2 $1,000 - $500

($1.19 – $1.16) × € 50,000 = $1,500. ($1.18 – $1.16) × € 50,000 = $1,000.

8/15

9/30

Inventory Accounts Payable (euro) There is no formal entry for the forward contract.

55,000

Foreign Exchange Gain or Loss Accounts Payable (euro)

2,500

Forward Contract OCI

1,500

OCI Foreign Exchange Gain or Loss

2,500

Foreign Exchange Gain or Loss OCI

2,250

McGraw-Hill/Irwin 10-78

55,000

2,500 1,500 2,500 2,250

Chapter 10 – Translation of Foreign Currency Financial Statements – Hoyle, Schaefer, Doupnik, Advanced Accounting, 15e

The impact on net income in the third quarter is: Foreign exchange gain (loss) Net impact

$(2,250) $(2,250)

42. (continued)

10/15 Foreign Exchange Gain or Loss Accounts Payable (euro)

1,500 1,500

OCI Forward Contract

500 500

OCI Foreign Exchange Gain or Loss

1,500 1,500

Foreign Exchange Gain or Loss OCI

750 750

Foreign Currency (euro) Cash Forward Contract

59,000

Accounts Payable (euro) Foreign Currency (euro)

59,000

58,000 1,000 59,000

Date of sale: Cost of Goods Sold Inventory

55,000 55,000

The impact on net income in the fourth quarter is: Cost of goods sold Foreign exchange gain (loss) Net impact

$(55,000) (750) $(55,750)

The net impact on net income for the year is: Cost of goods sold Foreign exchange gain (loss) Net impact

$(55,000) (3,000) $(58,000)

= Net cash outflow

42. (continued) Part c. Forward Contract Fair Value Hedge of a Foreign Currency Firm Commitment (Purchase) 10-79 © McGraw Hill LLC. All rights reserved. No reproduction or distribution without the prior written consent of McGraw Hill LLC.

Chapter 07 - Consolidated Financial Statements—Ownership Patterns and Income Taxes – Hoyle, Schaefer, Doupnik, Advanced Accounting, 15e

8/15 There is no formal entry for the forward contract or the purchase order. 9/30

Forward Contract Foreign Exchange Gain or Loss

1,500

Foreign Exchange Gain or Loss Firm Commitment

1,500

1,500 1,500

The impact on net income in the third quarter is $0. 10/15 Foreign Exchange Gain or Loss Forward Contract

500 500

Firm Commitment Foreign Exchange Gain or Loss

500 500

Foreign Currency (euro) Cash Forward Contract

59,000

Inventory Foreign Currency (euro)

59,000

58,000 1,000 59,000

Date of Sale: Cost of Goods Sold Inventory

59,000

Firm Commitment Cost of Goods Sold

1,000

59,000 1,000

The impact on net income in the fourth quarter (and for the year) is: Cost of goods sold Net impact

$(58,000) $(58,000)

= Net cash outflow

42. (continued) Part d. Option Fair Value Hedge of a Foreign Currency Firm Commitment (Purchase) The following schedule summarizes the changes in the components of the fair value of the euro call option with a strike price of $1.10 and an exercise date of October 15.

Date

McGraw-Hill/Irwin 10-80

Spot Option Rate Premium

Fair Value

Change in Fair Value

Intrinsic Value

Time Value

Change in Time Value

Chapter 10 – Translation of Foreign Currency Financial Statements – Hoyle, Schaefer, Doupnik, Advanced Accounting, 15e

8/15 9/30 10/15 1. 2.

$1.10 $1.15 $1.18

$0.05 $0.06 N/A

$2,500 $3,000 $4,0003

+ $500 + $1,000

$0 $2,500 $4,000

$2,5001 $5002 $04

- $2,000 - $500

Because the strike price and spot rate are the same, the option has no intrinsic value. Fair value is attributable solely to the time value of the option. With a spot rate of $1.15 and a strike price of $1.00, the option has an intrinsic value of $2,500 [($1.15 − $1.10) × 50,000]. The remaining $500 of fair value is attributable to time value. The fair value of the option is determined by the difference between the original strike price and the current spot rate [($1.18 − $1.10) × 50,000 = $4,000]. The time value of the option at maturity is zero.

The fair value of the firm commitment is determined by referring to changes in the spot rate.

Date

Spot Rate

Firm Commitment Fair Value

8/15 9/30 10/15

$1.10 $1.15 $1.18

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

1 2

Change in Fair Value – $2,500 – $1,500

[($1.15 − $1.10) × 50,000 = $2,500 [($1.18 − $1.10) × 50,000 = $4,000

Journal Entries 8/15

Foreign Currency Option Cash

2,500 2,500

42. (continued) 9/30

Foreign Currency Option

500 500

Foreign Exchange Gain or Loss

2,500 2,500

Firm Commitment

The impact on third-quarter net income is $(2,000), which is equal to the current period‘s change in the time value of the option. 10/15 Foreign Currency Option

1,000 1,000

Foreign Exchange Gain or Loss

1,500 1,500

Firm Commitment

Chapter 07 - Consolidated Financial Statements—Ownership Patterns and Income Taxes – Hoyle, Schaefer, Doupnik, Advanced Accounting, 15e

The impact of these two entries is $(500), which is equal to the current quarter‘s change in the time value of the option. Foreign Currency (euro) Cash Foreign Currency Option

59,000

Inventory Foreign Currency (euro)

59,000

55,000 4,000 59,000

Date of sale: Cost of Goods Sold Inventory

59,000

Firm Commitment Cost of Goods Sold

4,000

59,000 4,000

The impact on fourth quarter net income is: Foreign exchange gain (loss) Cost of goods sold Net impact

$ (500) (55,000) $(55,500)

The total amount recognized as a decrease in net income over the two quarters is $57,500 ($2,500 foreign exchange loss plus $55,000 cost of goods sold), which is equal to the total decrease in Cash ($2,500 for the option plus $55,000 for the foreign currency). 42. (continued) Part e. Option Cash Flow Hedge of a Forecasted Foreign Currency Transaction (Purchase) The following schedule summarizes the changes in the components of the fair value of the euro call option with a strike price of $1.10 and an exercise date of October 15. Date 8/15 9/30 10/15

Spot Option Rate Premium $1.10 $1.15 $1.18

$0.05 $0.06 N/A

Fair Value

Change in Fair Value

Intrinsic Value

Time Value

$2,500 $3,000 $4,0003

+ $500 + $1,000

$0 $2,500 $4,000

$2,5001 $5002 $04

Change in Time Value - $2,000 - $500

Because the strike price and spot rate are the same, the option has no intrinsic value. Fair value is attributable solely to the time value of the option.

With a spot rate of $1.15 and a strike price of $1.00, the option has an intrinsic value of

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Chapter 10 – Translation of Foreign Currency Financial Statements – Hoyle, Schaefer, Doupnik, Advanced Accounting, 15e

$2,500 [($1.15 − $1.10) × 50,000]. The remaining $500 of fair value is attributable to time value. The fair value of the option is determined by the difference between the original strike price and the current spot rate [($1.18 − $1.10) × 50,000 = $4,000]. The time value of the option at maturity is zero.

Journal Entries 8/15 9/30

Foreign Currency Option Cash

2,500

Foreign Currency Option OCI

500

2,500 500

Cost of Goods Sold OCI

2,000 2,000

The impact on third quarter net income is: Cost of goods sold Net impact

$(2,000) $(2,000)

42. (continued) 10/15 Foreign Currency Option OCI

1,000

Cost of Goods Sold OCI

500

1,000 500

Foreign Currency (euro) Cash Foreign Currency Option

59,000

Inventory Foreign Currency (euro)

59,000

55,000 4,000 59,000

Date of sale: Cost of Goods Sold Inventory

59,000

AOCI Cost of Goods Sold

4,000

59,000 4,000

The impact on fourth quarter net income is: Cost of goods sold Net impact

$(55,500) $(55,500) 10-83

Chapter 07 - Consolidated Financial Statements—Ownership Patterns and Income Taxes – Hoyle, Schaefer, Doupnik, Advanced Accounting, 15e

The total amount recognized as Cost of Goods Sold (net decrease in net income) over the two quarters is $57,500, which is equal to the total decrease in Cash ($2,500 for the option plus $55,000 for the foreign currency). Chapter 9 Develop Your Skills Research Case—International Flavors and Fragrances The responses to this assignment might change over time as the company changes its use of foreign currency derivatives or changes the manner in which it discloses its foreign currency hedging activities in the annual report. The following responses are based on IFF‘s 2020 Form 10-K. 1 In 2020, IFF provided information in Form 10-K related to its management of foreign exchange risk in the following locations: a. Item 7A. Quantitative and Qualitative Disclosures about Market Risk, third and fourth paragraphs. c. Notes to Consolidated Financial Statements, Note 17. Financial Instruments, under ―Derivatives.‖ 2 Note 17 (page 99) indicates that IFF uses ―foreign currency forward contracts with the objective of reducing exposure to cash flow volatility associated with its intercompany loans, foreign currency receivables and payables (i.e., hedges of foreign currency denominated assets and liabilities) and anticipated purchases of certain raw materials used in operations (i.e., hedges of forecasted transactions).‖ (Highlighting and comments in parentheses have been added.) It appears that IFF designates foreign currency forward contracts as cash flow hedges; there is no mention of fair value hedges in Note 17. Also, it appears that some foreign currency forward contracts are not designated as hedging instruments at all, as indicated in the first full sentence on page 101  The company also uses cross currency swaps as net investment hedges. This type of hedge is discussed in the next chapter of this book. 3 In the second to last paragraph of Note 17 (page 101), the company indicates that ―the ineffective portion of the above noted cash flow hedges and net investment hedges was not material for the years ended December 31, 2020 and 2019.‖

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Chapter 10 – Translation of Foreign Currency Financial Statements – Hoyle, Schaefer, Doupnik, Advanced Accounting, 15e

Accounting Standards Case—Forecasted Transactions Questions asked in the case are:  Is management‘s intent sufficient to assess that a forecasted transaction is likely to occur?  If not, what additional evidence must be considered? Source of guidance: FASB ASC 815-20-55-24 Derivatives and Hedging; HedgingGeneral; Implementation Guidance and Illustrations; Probability of a Forecasted Transaction ASC 815-20-55-24 states: ―An assessment of the likelihood that a forecasted transaction will take place should not be based solely on management's intent because intent is not verifiable. The transaction's probability should be supported by observable facts and the attendant circumstances. Consideration should be given to all of the following circumstances in assessing the likelihood that a transaction will occur. a. The frequency of similar past transactions b. The financial and operational ability of the entity to carry out the transaction c. Substantial commitments of resources to a particular activity (for example, a manufacturing facility that can be used in the short run only to process a particular type of commodity) d. The extent of loss or disruption of operations that could result if the transaction does not occur e. The likelihood that transactions with substantially different characteristics might be used to achieve the same business purpose (for example, an entity that intends to raise cash may have several ways of doing so, ranging from a short-term bank loan to a common stock offering).‖ The answers to the specific questions asked in the case are:  Management‘s intent is not sufficient to assess whether a forecasted transaction is likely to occur.  Additional evidence listed in items a. through e. in ASC 815-20-55-24 must be considered in assessing that likelihood.

Chapter 07 - Consolidated Financial Statements—Ownership Patterns and Income Taxes – Hoyle, Schaefer, Doupnik, Advanced Accounting, 15e

Analysis Case—Cash Flow Hedge 1. Premium The amount recognized as Cost of Goods Sold on March 31 must be the current quarter‘s amortization of forward points. Because COGS has a debit balance, net income has been reduced. A forward contract premium results in an increase in COGS, thus the Swiss franc must have sold at a premium on February 1 in the three-month forward market. 2. $1.09 Given that $6,000 is recognized as Cost of Goods Sold on March 31, the forward rate on February 1 must have been $1.09 [($1.09 forward – $1.00 spot) × 100,000 Swiss francs = $9,000 premium × 2/3 = $6,000]. The total premium is $9,000, which is amortized over three months at the rate of $3,000 per month, or $6,000 for the months of February and March. 3. $1.11 Given that the forward contract is reported as an asset of $2,000 on March 31, the forward rate at March 31 must have been $1.11 [($1.11 – $1.09) × 100,000 Swiss francs = $2,000]. The fact that the forward contract is an asset signals that the forward rate at March 31 is higher than the forward rate on February 1. 4. $103,000 Given that the forward rate on February 1 was $1.09 (determined in 2.), the total amount recognized as Cost of Goods Sold related to the purchase of component parts is $109,000 [100,000 Swiss francs × $1.09]. Because $6,000 already was recognized as COGS in the first quarter ending March 31, an additional $103,000 must be recognized as COGS in the second quarter ending June 30.

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Chapter 10 – Translation of Foreign Currency Financial Statements – Hoyle, Schaefer, Doupnik, Advanced Accounting, 15e

Internet Case—Historical Exchange Rates Note to Instructors: At the time you assign this case to students, please verify that www.x-rates.com still reports the exchange rates used in the solution below. These exchange rates are direct quotes obtained from www.x-rates.com, Historical Lookup, in October 2021. For unexplained reasons, in the past, www.x-rates.com has made changes over time to the historical exchange rates that it reports. 1. Spreadsheets for the calculation of the foreign exchange gains (losses) related to Diez Mil Company‘s (DMC) foreign currency accounts receivable.

Indian rupee Thai baht

INR THB

Foreign Currency Account Receivable 3,655,000 1,625,000

Japanese yen

JPY

5,494,000

0.009103

50,011.88

Malaysian ringgit

MYR

207,400

0.241122

50,008.70

Currency

Code

Exchange Rate on Sep. 6, 2021

U.S. Dollar Value on Sep. 6, 2021

0.013682 0.030776

$ 50,007.71 50,011.00

$ 200,039.29

Code

Foreign Currency Account Receivable

Indian rupee

INR

3,655,000

0.013479

$ 49,265.75

$ (741.97)

Thai baht

THB

1,625,000

0.029711

48,280.38

(1,730.62)

Japanese yen

JPY

5,494,000

0.008967

49,264.70

(747.18)

Malaysian ringgit

MYR

207,400

0.238953

49,558.85

(449.85)

$ 196,369.67

$ (3,669.62)

Currency

Exchange Rate on Sep. 30, 2021

U.S. Dollar Value on Sep. 30, 2021

Foreign Exchange Gain (Loss) on Sep. 30, 2021

Chapter 07 - Consolidated Financial Statements—Ownership Patterns and Income Taxes – Hoyle, Schaefer, Doupnik, Advanced Accounting, 15e

Internet Case—Historical Exchange Rates (continued)

Code

Foreign Currency Account Receivable

Exchange Rate on Oct. 6, 2021

U.S. Dollar Value on Oct. 6, 2021

Foreign Exchange Gain (Loss) on Oct. 6, 2021

Indian rupee

INR

3,655,000

0.013360

$ 48,830.80

$ (434.95)

Thai baht

THB

1,625,000

0.029558

$ 48,031.75

$ (248.63)

Japanese yen

JPY

5,494,000

0.008981

$ 49,341.61

$ 76.91

Malaysian ringgit

MYR

207,400

0.239008

$ 49,570.26

$ 11.41

$ 195,774.42

$ (595.25)

Currency

Code

Foreign Currency Account Receivable

U.S. Dollar Value on Sep. 6, 2021

U.S. Dollar Value on Oct. 6, 2021

Indian rupee

INR

3,655,000

$ 50,007.71

$ 48,830.80

$ (1,176.91)

Thai baht

THB

1,625,000

50,011.00

48,031.75

$ (1,979.25)

Japanese yen

JPY

5,494,000

50,011.88

49,341.61

$ (670.27)

Malaysian ringgit

MYR

207,400

50,008.70

49,570.26

$ (438.44)

$ 200,039.29

$ 195,774.42

$ (4,264.87)

Currency

Net Foreign Exchange Gain (Loss)

Source of exchange rates: www.x-rates.com, Historical Lookup 2. DMC would have reported a net foreign exchange loss of $3,669.62 in the fiscal year ended September 30, 2021, and a net foreign exchange loss of $595.25 in the fiscal year ended September 30, 2022 related to these foreign currency receivables. Over the entire one-month life of these foreign currency receivables, DMC would have reported a net foreign exchange loss of $4,264.87. 3. Assuming a strike price equal to the September 6, 2021 spot rate, the purchase of a put option for $500 would have been beneficial for three of the four foreign currency transactions: the Indian rupee transaction, the Thai baht transaction, and the Japanese yen transaction. For a total option cost of $1,500 on these three currencies, DMC could have avoided foreign exchange losses totaling $3,826.43, resulting in a net benefit of $2,326.43. Internet Case—Historical Exchange Rates (continued) The company also realized a foreign exchange loss on the Malaysian ringgit transaction, but the amount was only $438.44. Paying $500 for an option to avoid what turned out to be a $438.44 loss would not have benefited the company; the company would have been worse off by $61.56 ($500.00 $438.44). Communication Case—Forward Contracts and Options

McGraw-Hill/Irwin 10-88

Chapter 10 – Translation of Foreign Currency Financial Statements – Hoyle, Schaefer, Doupnik, Advanced Accounting, 15e

To:

CEO, Palmetto Bug Extermination Company (PBEC)

The primary advantage of using forward contracts to hedge foreign exchange risk is that there is no cost to enter into them. The disadvantage is that the company is obligated to exchange foreign currency for dollars at the contracted forward rate. Depending upon the future spot rate, this might or might not be advantageous for the company. In contrast, the primary disadvantage of using foreign currency options to hedge foreign exchange risk is that there is an upfront cost incurred to purchase them. The primary advantage is that the company is not required to exchange foreign currency for dollars at the option strike price if it is disadvantageous to do so. The company can simply allow the option to expire unexercised and the only cost is the initial premium that was paid to acquire the option. Exporters sometimes use forward contracts to hedge export sales (import purchases) when the foreign currency is selling at a forward premium (discount) as this locks in premium revenue (discount revenue). The risk associated with this strategy is that the customer may or may not pay on time. If an exporter enters into a forward contract to sell foreign currency, and the customer does not pay on time, the exporter will need to purchase foreign currency at the spot rate to settle the forward contract. This is essentially the same as speculation; a gain or loss could arise. In this case, the exporter might be better off by purchasing a foreign currency put option. The exporter can simply allow the option to exercise if it has not received foreign currency from the customer by the expiration date. Since PBEC is making import purchases, it has more control over the timing of when it will need foreign currency. In that case, it should be safe to enter into a forward contract to purchase foreign currency on the date when PBEC plans to pay for its purchases. However, there is always the risk that the supplier does not deliver on time, in which case the forward contract provides PBEC with foreign currency for which it has no current use. The bottom line is that there is no right or wrong answer to the question which hedging instrument should be used to hedge the Swiss franc exposure to foreign exchange risk. Both forward contracts and option have advantages and disadvantages.

CHAPTER 10 TRANSLATION OF FOREIGN CURRENCY FINANCIAL STATEMENTS Chapter Outline I.

In today's global economy, many companies have invested in operations in foreign countries.

Chapter 07 - Consolidated Financial Statements—Ownership Patterns and Income Taxes – Hoyle, Schaefer, Doupnik, Advanced Accounting, 15e

A. In preparing consolidated financial statements on a worldwide basis, the foreign currency accounts prepared by foreign operations must be restated into the parent company's reporting currency. B. There are two major issues related to the translation of foreign currency financial statements. 1. Which method should be used? 2. How should the resulting translation adjustment be reported on the consolidated financial statements? C. Translation methods differ on the basis of which accounts are translated at the current exchange rate and which are translated at a historical exchange rate. Translating accounts at the current exchange rate creates a translation adjustment. D. Historically, accountants have experimented with a number of different translation methods. The dominant methods currently in use are the temporal method and the current rate method. E. Translation adjustments can be either (1) reported as a translation gain or loss in net income (closed to Retained Earnings on the balance sheet) or (2) as a cumulative translation adjustment in other comprehensive income (deferred in Accumulated Other Comprehensive Income on the balance sheet). II.

The primary objective of the temporal method is to maintain the underlying valuation method used by the foreign entity to account for its assets and liabilities. A. Assets and liabilities carried at current or future value are translated at the current exchange rate. Assets and liabilities carried at cost and stockholders' equity items are translated at a historical exchange rate. B. By translating some assets at the current exchange rate and others at historical rates the temporal method distorts financial ratios calculated in the foreign currency. C. Most income statement items are translated at average-for-the-period rates. However, cost-of-goods-sold, depreciation, and amortization expense are translated at relevant historical exchange rates. D. Balance sheet exposure under the temporal method is defined as cash, marketable securities, and receivables minus total liabilities. A net liability exposure often exists. 1. When a net liability balance sheet exposure exists, depreciation of the foreign currency results in a positive translation adjustment (gain) and appreciation of the foreign currency results in a negative translation adjustment (loss). 2. Reporting a translation loss when the foreign currency appreciates is thought to be inconsistent with economic reality.

III.

With the current rate method, the net investment in a foreign operation is considered to be exposed to foreign exchange risk. A. Assets and liabilities are translated at the current exchange rate; equity is translated at historical rates. B. Translating assets which are carried at cost using the current exchange rate results in a translated value which is not readily interpretable; it is neither a current value nor a historical cost. C. However, translating all assets at the current rate does maintain underlying ratios and relationships that exist in the foreign currency statements. D. Revenues and expenses which occur evenly throughout the period are translated at the average-for-the-period exchange rate. Income items, such as gains and losses, which are the result of a discrete event, are translated at the actual exchange rate on the date of occurrence.

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Chapter 10 – Translation of Foreign Currency Financial Statements – Hoyle, Schaefer, Doupnik, Advanced Accounting, 15e

E. Balance sheet exposure under the current rate method is equal to the foreign entity's net assets (stockholders' equity). 1. Appreciation in the foreign currency results in a positive translation adjustment (gain); depreciation results in a negative translation adjustment (loss). IV.

FASB ASC 830, Foreign Currency Matters, provides guidelines for the translation of foreign currency financial statements by U.S.-based multinational corporations. The appropriate translation method and disposition of translation adjustment depends upon the functional currency of the foreign entity. A. The functional currency is the primary currency of the foreign entity's operating environment. It can be either the U.S. dollar or a foreign currency. 1. U.S. GAAP lists six indicators that are to be used in determining an entity's functional currency. There are no guidelines as to how these indicators are to be weighted. B. If a foreign currency is the functional currency, the foreign entity's financial statements are "translated" using the current rate method and the resulting translation adjustment is reported as a separate component of equity. The average-for-the-period exchange rate is used to translate the foreign entity's income statement. 1. Upon the sale or liquidation of a specific foreign entity, the cumulative translation adjustment related to that entity is taken to income as an adjustment to the gain or loss on sale or liquidation. C. If the U.S. dollar is the functional currency, foreign currency financial statements are "remeasured" using the temporal method with "remeasurement" gains and losses reported in operating income. D. If a foreign entity operates in a highly inflationary economy (cumulative three-year inflation greater than 100%), its financial statements are remeasured into U.S. dollars using the temporal method and remeasurement gains and losses are reported in income.

Some companies hedge the balance sheet exposures of their foreign entities so as to avoid adverse effects on net income and/or stockholders' equity. A. Balance sheet exposures can be hedged with derivative financial instruments, such as foreign currency options and forward contracts, or with a nonderivative financial instrument, such as a foreign currency borrowing. B. The paradox of hedging balance sheet exposure is that by avoiding a translation adjustment (or remeasurement gain/loss), which is not immediately realized in cash, realized foreign exchange gains and losses on the hedging instrument generally arise. C. When a remeasurement-related balance sheet exposure is hedged, both the gain/loss on the hedging instrument and the remeasurement loss/gain are reported in net income. D. When a translation-related balance sheet exposure is hedged (referred to by the FASB as a hedge of a net investment in a foreign operation), FASB ASC Topic 815, Derivatives and Hedging, stipulates that hedge accounting is appropriate and the gain/loss on the hedging instrument should be treated in the same manner as the translation adjustment being hedged. That is, both should be reported in AOCI. Answer to Discussion Question: How Do We Report This? This case represents the ongoing debate as to the proper reporting of foreign currency balances. Southwestern has invested the equivalent of $30,000 (150,000 vilseks) in each of three assets. The relative value of the vilsek has now changed. Thus, 150,000 vilseks now can be converted into $34,500. However, the subsidiary does not have vilseks--only land, inventory, and investments. Although the current exchange rate is given, the company has no apparent plans to 10-91 © McGraw Hill LLC. All rights reserved. No reproduction or distribution without the prior written consent of McGraw Hill LLC.

Chapter 07 - Consolidated Financial Statements—Ownership Patterns and Income Taxes – Hoyle, Schaefer, Doupnik, Advanced Accounting, 15e

convert its assets into dollars. Instead, these three assets are being held, each with a historical cost of 150,000 vilseks. Under the temporal method, these assets (except for the investments if carried at market value) would be reported in the parent's balance sheet at the original cost of $30,000. Unfortunately, as the finance director points out, an old, outdated rate is being utilized if the $30,000 amount is reported. (Of course, given that prices tend to change over time, the same can be said for any asset reported at historical cost.) Conversely, the current rate method requires that each of the three assets be reported at $34,500 based on the current exchange rate. As the controller indicates, though, $34,500 was not the original cost expended by Southwestern. In addition, using the current rate means that each of the assets will constantly report a "floating" value, one that will change with each exchange rate fluctuation. Finally, the $34,500 amount is based on the current value of the vilsek ($0.23) and the historical cost in vilseks (150,000 vilseks) for the three assets. The current exchange rate is only significant if the assets are sold with the proceeds being converted into U.S. dollars. Since an imminent sale is not indicated, the validity of reporting the $34,500 might again be questioned. In addition, even if the assets were sold, $34,500 does not accurately reflect the proceeds in U.S. dollars because 150,000 vilseks is the historical cost and not the current fair value of each of these assets. As a classroom exercise or written assignment, students could be required to select a reported value for each of the three assets and then defend their position. What amount is actually the fairest representation of each of the three assets? What amount is the best conveyor of information to an outside party? There is no single best answer to these questions. The purpose of this type of exercise is to encourage students to consider the objectives of financial reporting. Students should not just assume that the current official pronouncement is correct. One possible approach to the case is to assign several students to represent banks or stockholders and discuss the types of information that is most needed by these users. Another group of students can take the position of the company responsible for preparing the information and discuss management's preference for providing one type of information over another. Yet another group could take a purely theoretical approach and discuss the goals that accounting has attempted to reach. Although a final resolution may not be achieved, some excellent class discussion is possible. The temporal and current rate methods of translation differ primarily with regard to the exchange rate used to translate those assets that are reported at historical cost--inventories, prepaids, PP&E, and intangibles. The debate regarding the appropriate exchange rate for translating assets exists only because some assets are reported at historical cost. If all assets were reported at their current fair value, there would be no need to use the historical exchange rate for translating assets in order to maintain the asset's historical cost in U.S. dollar terms. All assets would be translated at the current exchange rate. The differences between the temporal method and current rate method would disappear.

McGraw-Hill/Irwin 10-92

Chapter 10 – Translation of Foreign Currency Financial Statements – Hoyle, Schaefer, Doupnik, Advanced Accounting, 15e

Answers to Questions 1. The two major issues related to the translation of foreign currency financial statements are: (a) which method should be used and (b) where should the resulting translation adjustment be reported in the consolidated financial statements. The first issue relates to determining the appropriate exchange rate (historical, current, or average for the current period) for the translation of foreign currency balances. Those items translated at the current exchange rate are exposed to translation adjustment. The second issue relates to whether the translation adjustment should be treated as a gain or loss in income, or should be deferred as a separate component of stockholders‘ equity. 2. Balance sheet exposure arises when a foreign currency balance is translated at the current exchange rate. By translating at the current exchange rate, the foreign currency item in essence is being revalued in U.S. dollar terms on the consolidated financial statements. There will be either a net asset balance sheet exposure or net liability balance sheet exposure depending upon whether assets translated at the current rate are greater or less than liabilities translated at the current rate. Balance sheet exposure generates a translation adjustment which does not result in an inflow or outflow of cash. Transaction exposure, which results from the receipt or payment of foreign currency, generates foreign exchange gains and losses which are realized in cash. 3. The major concept underlying the temporal method is that the translation process should result in a set of translated U.S. dollar financial statements as if the foreign subsidiary‘s transactions had actually been carried out using U.S. dollars. To achieve this objective, assets carried at historical cost and stockholders‘ equity are translated at historical exchange rates; assets carried at current value and liabilities (carried at current value) are translated at the current exchange rate. Under this concept, the foreign subsidiary‘s monetary assets and liabilities are considered to be foreign currency cash, receivables, and payables of the parent which are exposed to transaction risk. For example, if the foreign currency appreciates, then the foreign currency receivables increase in U.S. dollar value and a gain is recognized. Balance sheet exposure under the temporal method is analogous to the net transaction exposure which exists from having both receivables and payables in a particular foreign currency. The major concept underlying the current rate method is that the entire foreign investment is exposed to foreign exchange risk. Therefore all assets and liabilities are translated at the current exchange rate. Balance sheet exposure under this concept is equal to the net investment. 4. The major differences relate to non-monetary assets carried at historical cost and related expenses, i.e., inventory and cost of goods sold; property, plant, and equipment and depreciation expense; and intangible assets and amortization expense. Under the temporal method, these items are all translated at historical exchange rates. Under the current rate method, the assets are translated at the current exchange rate and the related expenses are translated at the average exchange rate for the current period. 5. The Retained Earnings balance is created by a multitude of transactions: all revenues, expenses, gains, losses, and dividends since the company‘s inception. Identifying each component of this account so that a separate translation of each component can be made would be virtually impossible. Therefore, in the initial year that Statement 52 was applied, the 10-93 © McGraw Hill LLC. All rights reserved. No reproduction or distribution without the prior written consent of McGraw Hill LLC.

Chapter 07 - Consolidated Financial Statements—Ownership Patterns and Income Taxes – Hoyle, Schaefer, Doupnik, Advanced Accounting, 15e

ending balance calculated under Statement 8 was merely brought forward. Thereafter, the ending balance translated each year for retained earnings becomes the beginning balance for the following year. 6. The functional currency is the currency of the subsidiary‘s primary economic environment. It is usually identified as the currency in which the company generates and expends cash. FASB ASC 830 recommends that several factors such as the location of primary sales markets, sources of materials and labor, the source of financing, and the amount of intercompany transactions should be evaluated in identifying an entity‘s functional currency. FASB ASC 830 does not provide any guidance as to how these factors are to be weighted (equally or otherwise) when identifying an entity‘s functional currency. 7. Translation is required when a foreign currency is the functional currency. Remeasurement is required in two situations: a. The U.S. dollar is the functional currency. b. The foreign subsidiary operates in a highly inflationary country. Remeasurement is carried out using the temporal method, with remeasurement gains and losses reported in consolidated income. Translation is done using the current rate method and the resulting translation adjustment is carried in accumulated other comprehensive income as a separate component of stockholders‘ equity. 8. The foreign subsidiary's net asset position in foreign currency at the beginning of the period is first determined. Changes in net assets are determined to explain the net asset balance in foreign currency at the end of the period. The beginning net asset position and changes in net assets are translated at appropriate exchange rates and the ending net asset position in dollars is determined. The ending net asset balance in foreign currency is then translated at the current rate and this result is subtracted from the ending net asset position in dollars (already calculated). The difference is the translation adjustment. It is positive if the actual dollar net asset position is less than the net asset position based on the current exchange rate. The translation adjustment is negative if the actual dollar net asset position is greater than if translated at the current rate. The cumulative translation adjustment is reported on the U.S. dollar Balance Sheet in the Stockholders‘ Equity Section as a part of Accumulated Other Comprehensive Income. 9. The temporal method must be used to remeasure the financial statements of operations in highly inflationary countries. One reason for mandating the use of the temporal method is that it avoids the disappearing plant problem that exists when the current rate method is used. Under the current rate method, fixed assets are translated at current exchange rates. With high rates of inflation, the foreign currency will depreciate significantly. When the historical cost of fixed assets is translated at a significantly lower current exchange rate, the dollar value of fixed assets ―disappears.‖ This problem is avoided by translating at the historical exchange rate as is done under the temporal method. 10. Differences exist between IFRS and U.S. GAAP with regard to (a) the hierarchy of factors used to determine the functional currency and (b) the method used to translate the financial statements of a subsidiary located in a hyperinflationary country.

McGraw-Hill/Irwin 10-94

Chapter 10 – Translation of Foreign Currency Financial Statements – Hoyle, Schaefer, Doupnik, Advanced Accounting, 15e

IAS 21 establishes primary factors and other factors to be considered in determining an entity‘s functional currency. When the indicators are mixed and the functional currency is not obvious, the parent must give priority to the primary indicators in determining the foreign entity‘s functional currency. U.S. GAAP does not have a similar hierarchy. In translating the foreign currency financial statements of a subsidiary located in a highly inflationary economy, IAS 21 requires financial statements to first be restated for local inflation and then translated into the parent‘s currency using the current exchange rate for all financial statement items. In contrast, U.S. GAAP requires use of the temporal method with no adjustment for inflation in this situation. 11. Although balance sheet exposure does not result in cash inflows and outflows, it does nevertheless affect amounts reported in consolidated financial statements. If the foreign currency is the functional currency, translation adjustments will be reported in stockholders‘ equity. If translation adjustments are negative and therefore reduce total stockholders‘ equity, there is an adverse (inflationary) impact on the debt to equity ratio. Companies with restrictive debt covenants requiring them to stay below a maximum debt to equity ratio, may find it necessary to hedge their balance sheet exposure so as to avoid negative translation adjustments being reported. If the U.S. dollar is the functional currency or an operation is located in a high inflation country, remeasurement gains and losses are reported in income. Companies might want to hedge their balance sheet exposure in this situation to avoid the adverse impact remeasurement losses can have on consolidated income and earnings per share. The paradox in hedging balance sheet exposure is that, by agreeing to receive or deliver foreign currency in the future under a forward contract, a transaction exposure is created. This transaction exposure is speculative in nature, given that there is no underlying inflow or outflow of foreign currency that can be used to satisfy the forward contract. By hedging balance sheet exposure, a company might incur a realized foreign exchange loss to avoid an unrealized negative translation adjustment or unrealized remeasurement loss. 12. The gains and losses arising from financial instruments used to hedge balance sheet exposure are treated in a similar manner as the item the hedge is intended to cover. If the U.S. dollar is the functional currency (remeasurement under the temporal method), gains and losses on the hedging instruments are offset against the related remeasurement gains and losses in the calculation of net income. If the foreign currency is the functional currency (translation under the current rate method), hedge accounting is applied, and gains and losses on the hedging instruments are taken to AOCI to offset the translation adjustment. 13. Application of the equity method to a foreign subsidiary results in the cumulative translation adjustment (CTA) related to that foreign subsidiary being included in the parent‘s Investment in Subsidiary account and also as a separate component of the parent‘s equity (reported in a separate line in the parent company‘s column on the consolidation worksheet). In addition, translation of a foreign subsidiary‘s foreign currency financial statements results in the CTA related to that foreign subsidiary being included as a separate component of the subsidiary‘s equity (reported as a separate line item in the foreign subsidiary‘s column on the consolidation worksheet). Thus, the CTA is reflected in both the parent and subsidiary columns of the consolidation worksheet and therefore would be double-counted if no adjustment is made. As is true for other subsidiary stockholders‘ equity accounts (i.e., contributed capital and beginning retained earnings), the balance in the subsidiary‘s CTA account must be eliminated against the Investment in Subsidiary account through a consolidation entry on the

Chapter 07 - Consolidated Financial Statements—Ownership Patterns and Income Taxes – Hoyle, Schaefer, Doupnik, Advanced Accounting, 15e

consolidation worksheet. As a result of this consolidation entry, the Investment in Subsidiary balance is fully eliminated and double-counting the CTA is avoided. A second consolidation entry related to the CTA is required to revalue the excess of fair value over book value for the change in exchange rates since the date of acquisition. Because the excess of fair value over book value is not carried in either the parent‘s or the subsidiary‘s books, but only on the consolidation worksheet, the CTA related to the excess also is not included in the CTA amount reflected in the parent and subsidiary columns of the consolidation worksheet.

McGraw-Hill/Irwin 10-96

Chapter 10 – Translation of Foreign Currency Financial Statements – Hoyle, Schaefer, Doupnik, Advanced Accounting, 15e

Answers to Problems 1. C (Definition of functional currency) 2. A (Comparison of current rate and temporal methods) 3. D (Translation process (current rate method)) 4. C (Determine appropriate translation method and resulting translation adjustment) Because the yuan is the functional currency, the financial statements must be translated using the current rate method. Therefore, answers a. and d. can be eliminated. Because the subsidiary has a net asset position and the yuan has depreciated from $0.16 to $0.12, a negative translation adjustment will result. 5. A

(Translation process (current rate method) – asset and related contra-account) All asset accounts are translated at current rates.

6. A

(Translation process (current rate method) – assets) Because the foreign currency is the functional currency, translation (rather than remeasurement) is required. All assets accounts are translated at current rates: ($200,000 + $100,000 + $50,000 + $80,000) = $430,000.

7. C

(Remeasurement process (temporal method) – assets) Because the U.S. dollar is the functional currency, remeasurement is required. All receivables are remeasured at current rates. Assets carried at historical cost, such as land and patents, are remeasured at historical rates: ($200,000 + $100,000 + $55,000 + $85,000) = $440,000.

8. A

(Remeasurement process (temporal method) – inventory) The U.S. dollar is the foreign subsidiary‘s functional currency, so remeasurement (rather than translation) is appropriate. Inventory is translated at the historical exchange rate [100,000 x $0.16 = $16,000].

9. A

(Remeasurement process (temporal method) – cost of goods sold) The U.S. dollar is the foreign subsidiary‘s functional currency, so remeasurement is appropriate. Cost of goods sold is translated at the historical rate in effect when the 10-97

Chapter 07 - Consolidated Financial Statements—Ownership Patterns and Income Taxes – Hoyle, Schaefer, Doupnik, Advanced Accounting, 15e

inventory was acquired [100,000 x $0.16 = $16,000]. 10. D

(Translation process (current rate method) – marketable securities and inventory) The foreign currency is the functional currency, so translation is appropriate. All assets are translated at the current exchange rate of $0.19. Both marketable equity securities and inventory are reported at $19,000 (10,000 won x $0.19 = $19,000).

11. C (Remeasurement process (temporal method) – marketable securities and inventory) The U.S. dollar is the functional currency, so remeasurement is appropriate. Marketable equity securities (carried at fair value) are remeasured at the current exchange rate of $0.19 (100,000 x $0.19 = $19,000). Inventory (carried at cost) is remeasured at the historical exchange rate of $0.16 (100,000 x $0.16 = $16,000). 12. C (Concepts underlying current rate and temporal methods) By translating items carried at historical cost by the historical exchange rate, the temporal method maintains the underlying valuation method used by the foreign subsidiary in preparing its financial statements. 13. A (Remeasurement process (temporal method)) Long-term debt (including bonds payable) is translated at the current exchange rate under the temporal method. 14. D (Determine appropriate translation method and treatment of translation adjustment) When the U.S. dollar is the functional currency, U.S. GAAP requires remeasurement using the temporal method with remeasurement gains and losses reported in net income. 15. C (Translation process (current rate method) – insurance expense and prepaid insurance) Insurance expense is translated at the average exchange rate; prepaid insurance is translated at the current exchange rate. 16. C (Treatment of gains and losses on hedges of net investments) Gains and losses on hedges of net investments (whether through a forward contract, borrowing, or other technique) are offset against the translation adjustment being hedged. 17. C (Indicator that foreign currency is the functional currency)

McGraw-Hill/Irwin 10-98

Chapter 10 – Translation of Foreign Currency Financial Statements – Hoyle, Schaefer, Doupnik, Advanced Accounting, 15e

Of the four choices, only ―obtaining financing in a foreign currency‖ is an indicator that a foreign currency is the functional currency of a foreign subsidiary. 18. (10 minutes) (Highly inflationary economy (temporal method) – cost of goods sold) Beginning inventory Purchases Ending inventory Cost of goods sold

LCU LCU

500,000 x $0.80 = 5,100,000 x $1.00 = (600,000) x $1.10 = 5,000,000

$ 400,000 5,100,000 (660,000) $4,840,000

19. (10 minutes) (Calculation of translation adjustment) Beginning net assets, 1/1 .............. R 20,000 x $0.25 = Increase in net assets: Net income ................................ 40,000 x $0.28 = Ending net assets, 12/31................ R 60,000 Ending net assets at current exchange rate .............. R 60,000 x $0.31 = Translation adjustment (positive) $ (2,400) 20. (15 minutes) (Calculation of remeasurement gain/loss) Beginning net monetary assets, 1/1 E 500,000 Increases in net monetary assets: Sale of inventory ............................ 160,000 Decreases in net monetary assets: (300,000) Purchase of warehouse ................. Purchase of inventory.................... (100,000) Transfer to parent........................... (10,000) Ending net monetary assets, 12/31 E 250,000 Ending net monetary assets at the current exchange rate.............. E 250,000 Remeasurement loss .....................

$ 5,000 11,200 $ 16,200 $ 18,600

x $1.14 =

$570,000

x $1.20 =

192,000

x $1.14 = x $1.18 = x $1.18 =

(342,000) (118,000) (11,800) $290,200

x $1.16 =

(290,000) $ 200

21. (10 minutes) (Nonlocal currency balances in the financial statements of a foreign operation) a. On December 31, 2024, the Brazilian subsidiary remeasures the € 100,000 note payable into BRL using the current BRL per € exchange rate as follows: € 100,000 x BRL 4.6 = BRL 460,000 The BRL 460,000 note payable is then translated into US$ using the December 31, 2024 US$ per BRL exchange rate as follows: BRL 460,000 x $0.20 = $92,000. b. On December 31, 2024, the Brazilian subsidiary would recognize a foreign exchange loss from remeasurement of the € note payable, calculated as follows: € 100,000 x (BRL 4.6 – BRL 4.2) = BRL 40,000. The BRL 40,000 foreign exchange loss is translated into US$ using the average 2024 US$ per BRL exchange rate as follows: 10-99 © McGraw Hill LLC. All rights reserved. No reproduction or distribution without the prior written consent of McGraw Hill LLC.

Chapter 07 - Consolidated Financial Statements—Ownership Patterns and Income Taxes – Hoyle, Schaefer, Doupnik, Advanced Accounting, 15e

BRL 40,000 x $0.25 = $10,000. 22. (5 minutes) (Determine translated values under the current rate method) As a translation, both the asset (inventory) and the liability (accounts payable) utilize the current exchange rate at the balance sheet date (December 31). Thus, the translated values are as follows: Inventory Accounts payable

LCU250,000 x 20% = LCU50,000 x $0.54 = $27,000 LCU250,000 x 30% = LCU75,000 x $0.54 = $40,500

23. (10 minutes) (Determine appropriate exchange rates under the current rate method [translation] and temporal method [remeasurement]) Accounts payable Accounts receivable Accumulated depreciation Advertising expense Amortization expense Buildings Cash Common stock Depreciation expense Dividends (10/1) Notes payable Patents (net) Salary expense Sales

Translation $0.16 C $0.16 C $0.16 C $0.19 A $0.19 A $0.16 C $0.16 C $0.28 H $0.19 A $0.20 H $0.16 C $0.16 C $0.19 A $0.19 A

Remeasurement $0.16 C $0.16 C $0.26 H $0.19 A $0.25 H $0.26 H $0.16 C $0.28 H $0.26 H $0.20 H $0.16 C $0.25 H $0.19 A $0.19 A

* C = current rate, H = historical rate, A = average rate 24. (20 minutes) (Calculate translation adjustment and remeasurement gain/loss and explain their economic relevance) The translation adjustment and remeasurement gain/loss can be determined as the amount that keeps the dollar balance sheet in balance:

CHF

McGraw-Hill/Irwin 10-100

Translation Rate

US$

Remeasurement Rate

US$

Chapter 10 – Translation of Foreign Currency Financial Statements – Hoyle, Schaefer, Doupnik, Advanced Accounting, 15e Cash Inventory Property, plant & equip. Total Notes payable Owners‘ equity Translation adjustment Retained earnings (remeasurement loss) Total

800,000 1,300,000 4,000,000

$1.10 $1.10 $1.10

880,000 1,430,000 4,400,000

$1.10 $1.00 $1.00

880,000 1,300,000 4,000,000

6,100,000 2,100,000 4,000,000

$1.10 $1.00

6,710,000 2,310,000 4,000,000 400,000

$1.10 $1.00

6,180,000 2,310,000 4,000,000 (130,000)

6,100,000

6,710,000

6,180,000

Alternatively, the translation adjustment and remeasurement loss can be calculated by analyzing the subsidiary‘s balance sheet exposure:

Translation

CHF

Beginning net assets, 12/18 Ending net assets, 12/31 at current exchange rate Translation adjustment (positive)

4,000,000

$1.00 H

4,000,000

$1.10 C

4,400,000 (400,000)

(1,300,000)

$1.00 H

(1,300,000)

$1.10 C

(1,430,000) 130,000

Remeasurement

US$

CHF

Beginning net monetary liabilities, 12/18 Ending net monetary liabilities, 12/31 at current exchange rate Remeasurement loss

US$

Economic Relevance of Translation Adjustment The translation adjustment increases stockholders‘ equity by $400,000. The positive translation adjustment arises because the Swiss subsidiary has a net asset position of CHF 4,000,000 and the Swiss franc appreciates by $0.10 [CHF 4,000,000 x $0.10 = $400,000]. The positive translation adjustment is not realized in terms of U.S. dollar cash flow. It would be a realized gain only if Stephkado sold this operation on December 31 for exactly CHF 4,000,000 and converted the sales proceeds into dollars at the current exchange rate of $1.10 per Swiss franc. 24. (continued) Economic Relevance of Remeasurement Loss The remeasurement loss arises because the Swiss subsidiary has a net monetary liability position of CHF1,300,000 (Cash of CHF 800,000 less Notes payable of CHF 2,100,000) and the Swiss franc has appreciated by $0.10 [CHF 1,300,000 x $0.10 = $130,000]. The loss is unrealized. It would be realized only if (a) the Swiss subsidiary converted its Swiss franc cash into dollars at December 31, thereby realizing a transaction gain of $80,000 [CHF800,000 x ($1.10-$1.00)], and (b) the parent paid off the Swiss franc note payable using U.S. dollars, thereby realizing a transaction loss of $210,000 [CHF2,100,000 x ($1.10-$1.00)]. (The note could have been paid at December 1 10-101 © McGraw Hill LLC. All rights reserved. No reproduction or distribution without the prior written consent of McGraw Hill LLC.

Chapter 07 - Consolidated Financial Statements—Ownership Patterns and Income Taxes – Hoyle, Schaefer, Doupnik, Advanced Accounting, 15e

for $2,100,000 [CHF2,100,000 x $1.00]. At December 31, it takes $2,310,000 to pay off the note [CHF2,100,000 x $1.10].) The transaction gain of $80,000 and transaction loss of $210,000 would result in a net loss of $130,000. 25. (15 minutes) (Determine the amounts at which foreign currency balances are reported on a foreign subsidiary‘s trial balance and in the parent‘s consolidated financial statements) a. Remeasurement of Swiss franc (CHF) balances into Israeli shekels (ILS) to report on the Israeli subsidiary‘s trial balance.

December 31, 2024

CHF

Interest expense Interest payable Note payable

Exchange Rate

25,000 x 31,250 x 500,000 x

ILS*

3.95 A 4.02 C 4.02 C

= = =

98,750 125,625 2,010,000

* Amounts at which the CHF balances are carried on the ILS trial balance b. Translation of remeasured Swiss franc (CHF) balances into U.S. dollars (USD) to report in the U.S. parent‘s consolidated financial statements.

December 31, 2024

ILS

Interest expense Interest payable Note payable

98,750 x 125,625 x 2,010,000 x

Exchange Rate 0.27 A 0.25 C 0.25 C

USD** = = =

26,662.50 31,406.25 502,500.00

** Amounts at which the CHF balances are reported in the USD financial statements 26. (30 minutes) (Prepare financial statements for a foreign subsidiary and then translate them into U.S. dollars) Sullivan‘s Island Company Income Statement Rent revenue Interest expense Depreciation expense Repair expense* Net income

Pounds

Exchange Rate

96,000 (14,000) (20,000) (4,000) 58,000

$2.04 $2.04 $2.04 $2.05

U.S. Dollars 195,840 (28,560) (40,800) (8,200) 118,280

* Repair expense is the only expense not incurred evenly throughout the year. Sullivan‘s Island Company Statement of Retained Earnings

Pounds

McGraw-Hill/Irwin 10-102

Exchange Rate

U.S. Dollars

Chapter 10 – Translation of Foreign Currency Financial Statements – Hoyle, Schaefer, Doupnik, Advanced Accounting, 15e Retained earnings, 1/1 Net income Dividends declared, 12/31 Retained earnings, 12/31

-058,000 (12,000) 46,000

given from I/S* $2.08

-0118,280 (24,960) 93,320

*I/S = Income Statement Sullivan‘s Island Company Balance Sheet Cash Accounts receivable Building Accumulated depreciation Total assets Interest payable Note payable Contributed capital Retained earnings, 12/31 Subtotal Translation adjustment Total liabilities and equity

Pounds

Exchange Rate

64,000 16,000 200,000 (20,000) 260,000 14,000 140,000 60,000 46,000 260,000 260,000

$2.08 $2.08 $2.08 $2.08 $2.08 $2.08 $2.00 from State of R/E* from Schedule A

U.S. Dollars 133,120 33,280 416,000 (41,600) 540,800 29,120 291,200 120,000 93,320 533,640 7,160 540,800

*State of R/E = Statement of Retained Earnings 26. (continued) Schedule A – Computation of Translation Adjustment

Pounds Beginning net assets Increase in net assets: Contributed capital Net income Decrease in net assets: Dividends declared Ending net assets Ending net assets at current exchange rate Translation adjustment (credit - positive)

-0-

Exchange Rate

U.S. Dollars

$2.00

-0-

60,000 58,000

$2.00 from I/S*

120,000 118,280

(12,000) 106,000

from State of R/E**

(24,960) 213,320

106,000

$2.08

220,480 (7,160)

* I/S = Income Statement ** State of R/E = Statement of Retained Earnings 27. (30 minutes) (Prepare a statement of cash flows for a foreign subsidiary and then translate it into U.S. dollars) Sullivan‘s Island Company Statement of Cash Flows

Pounds

Exchange Rate

U.S. Dollars

Chapter 07 - Consolidated Financial Statements—Ownership Patterns and Income Taxes – Hoyle, Schaefer, Doupnik, Advanced Accounting, 15e Operating Activities: Net income plus: Depreciation less: Increase in accounts receivable plus: Increase in interest payable Cash flow from operating activities Investing Activities: Purchase of building Cash flow from investing activities Financing Activities: Capital contribution Borrowing on note Dividends Cash flow from financing activities Increase in cash Effect of exchange rate change on cash Beginning balance in cash Ending balance in cash

58,000 20,000 (16,000) 14,000 76,000

from Problem 26 $2.04 $2.04 $2.04

118,280 40,800 (32,640) 28,560 155,000

(200,000) (200,000)

$2.00

(400,000) (400,000)

60,000 140,000 (12,000) 188,000 64,000 0 64,000

$2.00 $2.00 $2.08

120,000 280,000 (24,960) 375,040 130,040 3,080 0 133,120

$2.08

28. (25 minutes) (Compute translation adjustment and remeasurement gain/loss) a. Translation—only changes in net assets have an impact on the computation of the translation adjustment. Net asset balance, 1/1 Increases in net assets (income): Sold inventory at a profit, 5/1 Sold land at a gain, 6/1 Decreases in net assets: Paid a dividend, 12/1 Depreciation recorded Net asset balance, 12/31 Net asset balance, 12/31 at current exchange rate Translation adjustment—positive

NGN 30,000,000

x $.0064 =

$192,000

6,000,000 2,000,000

x $.0068 = x $.0070 =

40,800 14,000

(3,000,000) (2,000,000) NGN 33,000,000

x $.0082 = x $.0074 =

(24,600) (14,800) $207,400

NGN 33,000,000

x $.0084 =

(277,200) $(69,800)

b. Remeasurement—only changes in net monetary assets and liabilities have an impact on the computation of the remeasurement gain. Net monetary liability position, 1/1NGN (4,000,000) x $.0064 = Increases in monetary assets: Sold inventory, 5/1 16,000,000 x $.0068 = Sold land, 6/1 6,000,000 x $.0070 = Decreases in monetary assets: Bought inventory, 10/1 (20,000,000) x $.0078 = Bought land, 11/1 (3,000,000) x $.0080 = Paid a dividend, 12/1 (3,000,000) x $.0082 = Net monetary liability position,12/31NGN (8,000,000) Net monetary liability position,12/31 at current exchange rate NGN (8,000,000) x $.0084 = Remeasurement gain

McGraw-Hill/Irwin 10-104

$(25,600) 108,800 42,000 (156,000) (24,000) (24,600) $(79,400) (67,200) $(12,200)

Chapter 10 – Translation of Foreign Currency Financial Statements – Hoyle, Schaefer, Doupnik, Advanced Accounting, 15e

Note: The purchase of land on account did not result in a decrease in monetary assets, rather an increase in monetary liabilities. Payment on the note payable and collection of accounts receivable do not affect the net monetary liability position. 29. (20 minutes) (Compute translation adjustment and remeasurement gain/loss) a. The translation adjustment is based on changes in the net assets of the subsidiary.

Dinars Net assets, Jan. 1 Increase in net assets: Service revenue, May 1 Decrease in net assets: Operating expense, June 1

Exchange Rate

U.S. Dollars

150,000

0.36

54,000

120,000

0.37

44,400

(100,000)

0.39

(39,000)

Net assets, Dec. 31

170,000

Net asset, Dec. 31 at current exchange rate Translation adjustment (credit - positive)

170,000

59,400 0.41

69,700 (10,300)

b. The remeasurement gain or loss is based on changes in the net monetary assets (liabilities) of the subsidiary.

Net monetary assets (liabilities), Jan. 1 Changes in net monetary assets: Service revenue, May 1 Operating expense, June 1

Dinars

Exchange Rate

(50,000)

0.36

(18,000)

120,000

0.37

44,400

(100,000)

0.39

(39,000)

Net monetary assets (liabilities), Dec. 31

(30,000)

Net monetary assets (liabilities), Dec. 31 at current exchange rate Remeasurement gain (credit)

(30,000)

U.S. Dollars

(12,600) 0.41

(12,300) (300)

c. Translated value of land 200,000 dinars x $0.41 = $82,000 Remeasured value of land 200,000 dinars x $0.33 = $66,000 30. (10 minutes) (Determine the appropriate exchange rate under the current rate method [translation] and temporal method [remeasurement])

Account

(a) Current Rate Method Translation

(b) Temporal Method Remeasurement

Chapter 07 - Consolidated Financial Statements—Ownership Patterns and Income Taxes – Hoyle, Schaefer, Doupnik, Advanced Accounting, 15e Sales Inventory Equipment Rent expense Dividends Notes receivable Accumulated depreciation--equipment Salary payable Depreciation expense

$0.20 A $0.22 C $0.22 C $0.20 A $0.21 H $0.22 C $0.22 C $0.22 C $0.20 A

$0.20 A $0.19 H $0.13 H $0.20 A $0.21 H $0.22 C $0.13 H $0.22 C $0.13 H

C = current exchange rate, A = average exchange rate, H = Historical exchange rate 31. (30 minutes) (Determine translation adjustment; prepare journal entries for forward contract hedge of a net investment; determine amount to be reported in accumulated other comprehensive income) a. Net assets, 1/1 (132,000 – 54,000)

CAD 78,000

x $0.80 =

$62,400

Net income

26,000

x $0.77 =

20,020

Dividends, 3/1

(5,000)

x $0.78 =

(3,900)

Dividends, 10/1

(5,000)

x $0.76 =

(3,800)

Change in net assets:

Net assets, 12/31

CAD 94,000

$74,720

Net assets at current exchange rate, 12/31 Translation adjustment (negative)

CAD 94,000

x $0.75 =

70,500

$ 4,220

b. Forward contract journal entries 10/1 No entry [The forward contract has no value on this date] Note: there are no forward points on this forward contract; the forward rate of $0.76 is equal to the spot rate of $0.76. On 12/31, the forward contract has a positive fair value of $4,000 [CAD 400,000 x ($0.76 - $0.75)] 12/31

Forward Contract ........................................... 4,000 Translation Adjustment (positive) ........... 4,000 (To record the change in the value of the forward contract as an adjustment to the translation adjustment) Foreign Currency (CAD) ................................

McGraw-Hill/Irwin 10-106

300,000

Chapter 10 – Translation of Foreign Currency Financial Statements – Hoyle, Schaefer, Doupnik, Advanced Accounting, 15e

Cash .......................................................... 300,000 (To record the purchase of CAD 400,000 at the spot rate of $0.75) Cash ................................................................ 304,000 Foreign Currency (CAD)........................... 300,000 Forward Contract...................................... 4,000 (To record delivery of CAD 400,000, receipt of $304,000, and close the forward contract account.) c. The net negative translation adjustment (debit balance) to be reported in Accumulated Other Comprehensive Income at 12/31 is $220 ($4,220 – $4,000). 32. (45 minutes) (Translation and remeasurement of foreign subsidiary trial balance) a. Translation of Subsidiary Trial Balance

Debits Cash Accounts Receivable Equipment Accumulated Depreciation Land Accounts Payable Notes Payable Common Stock Dividends Sales Salary Expense Depreciation Expense Miscellaneous Expense

8,000 R x 1.62 9,000 R x 1.62 3,000 R x 1.62 600 R x 1.62 5,000 R x 1.62 3,000 R x 1.62 5,000 R x 1.62 10,000 R x 1.71 4,000 R x 1.66 25,000 R x 1.64 5,000 R x 1.64 600 R x 1.64 9,000 R x 1.64

Translation Adjustment (negative)

Credits

$12,960 14,580 4,860 $ 972 8,100 4,860 8,100 17,100 6,640 41,000 8,200 984 14,760 $71,084 948 $72,032

$72,032

Calculation of Translation Adjustment Net assets, 1/1…................................................... -0Increase in net assets: Common stock issued ....................................... 10,000 Rx 1.71 Sales… ................................................................... 25,000 Rx 1.64 Decrease in net assets: Dividends… .......................................................... ( 4,000) Rx 1.66 Salary expense… ................................................. ( 5,000) Rx 1.64 Depreciation expense ......................................... ( 600) Rx 1.64 Miscellaneous expense ..................................... ( 9,000) Rx 1.64 Net assets, 12/31 .................................................. 16,400* R Net assets, 12/31 at current exchange rate ......................................... 16,400 Rx 1.62 Translation adjustment (negative) ................

-0$17,100 41,000 (6,640) (8,200) ( 984) (14,760) $27,516 26,568 $ 948

* This amount can be verified as ending assets (24,400 R) minus ending liabilities (8,000 R) – net assets, 12/31 = 16,400 R.

Chapter 07 - Consolidated Financial Statements—Ownership Patterns and Income Taxes – Hoyle, Schaefer, Doupnik, Advanced Accounting, 15e

b. Remeasurement of Subsidiary Trial Balance

Debits Cash Accounts Receivable Equipment Accumulated Depreciation Land Accounts Payable Notes Payable Common Stock Dividends Sales Salary Expense Depreciation Expense Miscellaneous Expense

8,000 9,000 3,000 600 5,000 3,000 5,000 10,000 4,000 25,000 5,000 600 9,000

R x 1.62 R x 1.62 R x 1.71 R x 1.71 R x 1.59 R x 1.62 R x 1.62 R x 1.71 R x 1.66 R x 1.64 R x 1.64 R x 1.71 R x 1.64

$ 1,026 7,950 4,860 8,100 17,100 6,640 41,000 8,200 1,026 14,760 $71,246 840 $72,086

Remeasurement loss (debit)

Calculation of Remeasurement Loss Net monetary assets, 1/1 Increase in net monetary assets: Common stock issued Sales Decrease in net monetary assets: Acquired equipment Acquired land Dividends Salary expense Miscellaneous expense Net monetary assets, 12/31 Net monetary assets, 12/31 at current exchange rate Remeasurement loss (debit)

Credits

$12,960 14,580 5,130

-0-

$72,086

-0-

10,000 R x 1.71 25,000 R x 1.64

$17,100 41,000

(3,000) R x 1.71 (5,000) R x 1.59 (4,000) R x 1.66 (5,000) R x 1.64 (9,000) R x 1.64 9,000* R

(5,130) (7,950) (6,640) (8,200) (14,760) $15,420

9,000 R x 1.62

14,580 $ 840

* This amount can be verified as ending assets (17,000 R) minus ending liabilities (8,000 R) – net assets, 12/31 = 9,000 R. 33. (30 minutes) (Translate financial statements of a foreign subsidiary) LIVINGSTON COMPANY Income Statement For the Year Ending December 31, 2024

Pounds

McGraw-Hill/Irwin 10-108

Exchange Rate

Code

U.S. Dollars

Chapter 10 – Translation of Foreign Currency Financial Statements – Hoyle, Schaefer, Doupnik, Advanced Accounting, 15e

Sales

270,000

1.59

429,300

Cost of goods sold Gross profit Less: Operating expenses

(155,000) 115,000 (54,000)

1.59

(246,450) 182,850 (85,860)

Gain on sale of equipment

10,000

1.72

17,200

Net income

71,000

114,190

Statement of Retained Earnings For the Year Ending December 31, 2024

Pounds

Exchange Rate

Retained earnings, 1/1 Net income

216,000 71,000

given above

Less: Dividends

(26,000)

1.61

Retained earnings, 12/31

261,000

Code

U.S. Dollars 396,520 114,190

(41,860) 468,850

Balance Sheet December 31, 2024

Pounds

Exchange Rate

Code

U.S. Dollars

Assets Cash Receivables Inventory

44,000 116,000 58,000

1.54 1.54 1.54

C C C

67,760 178,640 89,320

Fixed assets (net)

339,000

1.54

522,060

Total assets Liabilities and Equities Liabilities Common stock Retained earnings, 12/31 Translation adjustment

557,000

Total liabilities and equities

557,000

176,000 120,000 261,000

857,780 1.54 2.08

C H above

271,040 249,600 468,850 (131,710) 857,780

33. (continued) Calculation of Translation Adjustment:

Pounds

Ex Rate

Code

U.S. Dollars

Chapter 07 - Consolidated Financial Statements—Ownership Patterns and Income Taxes – Hoyle, Schaefer, Doupnik, Advanced Accounting, 15e

Net assets, 1/1 Net income

336,000 71,000

1.67 above

Dividends

(26,000)

above

Net assets, 12/31

381,000

Net assets at current exchange rate Translation adjustment, 2024 (negative)

381,000

Cumulative translation adjustment, 1/1 (negative) Cumulative translation adjustment, 12/31 (negative)

BOY

561,120 114,190 (41,860) 633,450

1.54

586,740 46,710

given

85,000 131,710

Code: A = average; C = current; H = historical; BOY = beginning of year 34. (35 minutes) (Compute remeasurement gain/loss and translation adjustment) a. Remeasurement Gain or Loss

Exchange Rate

KR Net monetary assets, 1/1/24* Increases in net monetary assets: Issued Common Stock (4/1/24) Sold Building** (7/1/24) Sales (2024) Decreases in net monetary assets: Purchased Equipment (4/1/24) Paid Dividends (10/1/24) Rent Expense (2024) Salary Expense (2024) Utilities Expense (2024) Net monetary assets, 12/31/24 Net monetary assets, 12/31/24 at current exchange rate Remeasurement gain (credit)

US$

35,000

$3.00

$105,000

13,000 10,000 162,000

x x x

$3.10 $3.30 $3.20

= = =

40,300 33,000 518,400

(64,000) (57,000) (21,500) (45,000) (7,000) 25,500

x x x x x

$3.10 $3.40 $3.20 $3.20 $3.20

= = = = =

(198,400) (193,800) (68,800) (144,000) (22,400) $69,300

25,500

$3.50

89,250 $(19,950)

* Net monetary assets: (Cash + Accounts Receivable) - (Account Payable + Bonds Payable) ** Cash proceeds from the sale of the building of KR10,000 is determined by adding the Book value of the building sold of KR1,500 and the Gain on sale of building of KR 8,500. b. Translation Adjustment

McGraw-Hill/Irwin 10-110

Exchange Rate

US$

Chapter 10 – Translation of Foreign Currency Financial Statements – Hoyle, Schaefer, Doupnik, Advanced Accounting, 15e Net assets, 1/1/24* Increases in net assets: Issued Common Stock (4/1/24) Gain on Sale of Building** (7/1/24) Sales (2024) Decreases in net assets: Paid Dividends (10/1/24) Depreciation expense (2024) Rent Expense (2024) Salary Expense (2024) Utilities Expense (2024) Net assets, 12/31/24 Net assets, 12/31/24 at current exchange rate Translation adjustment (credit)

124,000

$3.00

$372,000

13,000 8,500 162,000

x x x

$3.10 $3.30 $3.20

= = =

40,300 28,050 518,400

x x x x

$3.40 $3.20 $3.20 $3.20 $3.20

= = = = =

(193,800) (128,000) (68,800) (144,000) (22,400) $401,750

$3.50

479,500 $ (77,750)

(57,000) (40,000) (21,500) (45,000) (7,000) 137,000

137,000

* Net assets: Common stock + Retained earnings ** Selling a building at a gain of KR 8,500 increases net assets by that amount. 35. (90 minutes) (Remeasure non-functional currency accounts into foreign functional currency and then translate foreign functional currency financial statements into U.S. dollars) a. Remeasurement of Mexican Operations

Canadi an Dollars Debit

Pesos Accounts payable Accumulated depreciation Building and equipment Cash Depreciation expense Inventory (beginning —income statement) Inventory (ending —income statement) Inventory (ending—balance sheet) Purchases Receivables Salary expense Sales Main office Remeasurement loss Total

Schedule One—Remeasure. Loss

49,000 19,000 40,000 59,000 2,000

x .35 C x .25 H x .25 H x .35 C x .25 H

10,000 20,650 500

23,000

x .30 A (‘23)

6,900

28,000 28,000 68,000 21,000 9,000 124,000 30,000

x .34 A (‘24) x .34 A (‘24) x .34 A (‘24) x .35 C x .34 A x .34 A given Schedule One

Pesos

Credit 17,150 4,750

9,520 9,520 23,120 7,350 3,060 42,160 7,530 10 81,110

81,110

Canadian Dollars

Chapter 07 - Consolidated Financial Statements—Ownership Patterns and Income Taxes – Hoyle, Schaefer, Doupnik, Advanced Accounting, 15e Net monetary liabilities, 1/1/24* Increases in net monetary assets Sales Decreases in net monetary assets Purchases Salary Expense Net monetary assets, 12/31/24** Net monetary assets, 12/31/24 at current exchange rate Remeasurement loss

(16,000)

x .32

(5,120)

124,000

x .34

42,160

(68,000) ( 9,000) 31,000

x .34 x .34

(23,120) ( 3,060) 10,860

31,000

x .35

10,850 10

Net monetary liabilities, 1/1/24, can be determined by first determining the net monetary assets at 12/31/24 and then backing out the changes in monetary assets and liabilities during 2024—sales, purchases, and salary expense. Net monetary assets, 12/31/24: Cash + Receivables – Accounts Payable

35.

(continued) b. and c. The following C$ financial statements are produced by combining the amounts from the main operation with the remeasured amounts from the branch operation. The Branch Operation and Main Office accounts offset each other. Cost of goods sold for the Mexican branch is determined by combining beginning inventory, purchases, and ending inventory as remeasured in C$.

Income Statement For the Year Ended December 31, 2024

Sales Cost of goods sold Gross profit Depreciation expense Salary expense Utility expense Gain on sale of equipment Remeasurement loss Net income

C$ 354,160 (223,500) 130,660 (8,500) (29,060) (9,000) 5,000 (10) C$ 89,090

c. Translation into U.S. dollars— Current Rate Method x 0.67 A = x 0.67 A =

x 0.67 A = x 0.67 A = x 0.67 A = x 0.68 H = x 0.67 A =

$ 237,287.20 (149,745.00) 87,542.20 (5,695.00) (19,470.20) (6,030.00) 3,400.00 (6.70) $ 59,740.30

Statement of Retained Earnings For the Year Ended December 31, 2024 Retained earnings, 1/1/24 Net income (above) Dividends Retained earnings, 12/31/24 35.

C$ C$

135,530 89,090 ( 28,000) 196,620

Given Above x 0.69 H =

$ 70,421.00 59,740.30 (19,320.00) $110,841.30

(continued) b. and c.

McGraw-Hill/Irwin 10-112

Chapter 10 – Translation of Foreign Currency Financial Statements – Hoyle, Schaefer, Doupnik, Advanced Accounting, 15e

Balance Sheet December 31, 2024

U.S. Dollars Cash Receivables Inventory Building and equipment Accumulated depreciation Total

46,650 75,350 107,520 177,000 (31,750) 374,770

x 0.65 C = x 0.65 C = x 0.65 C = x 0.65 C = x 0.65 C =

$ 30,322.50 48,977.50 69,888.00 115,050.00 (20,637.50) $243,600.50

Accounts payable Notes payable Common stock Retained earnings Cumulative translation adjustment Total

52,150 76,000 50,000 196,620

x 0.65 C = x 0.65 C = x 0.45 H = Above Schedule Two

374,770

$ 33,897.50 49,400.00 22,500.00 110,841.30 26,961.70 $ 243,600.50

185,530

x 0.70 =

$129,871.00

Above x 0.69 =

89,090 (28,000) 246,620

59,740.30 (19,320.00) $170,291.30

246,620

x 0.65 =

160,303.00 $ 9,988.30

Schedule Two—Translation Adjustment Net assets, 1/1/24 Changes in net assets Net income Dividends Net assets, 12/31/24 Net assets, 12/31/24 at current exchange rate Translation adjustment, 2024 (negative) Cumulative translation adjustment, 1/1/24 (positive) Cumulative translation adjustment, 12/31/24 (positive)

(36,950.00) $(26,961.70)

36. (90 minutes) (Translate foreign currency financial statements and prepare consolidation worksheet) Step One Simbel's financial statements are first translated into U.S. dollars after reclassification of the 10,000 pound expenditure for rent from rent expense to prepaid rent. Credit balances are in parentheses. Translation Worksheet

Account

Egyptian Pounds

Exchange Rate

U.S. Dollars

Chapter 07 - Consolidated Financial Statements—Ownership Patterns and Income Taxes – Hoyle, Schaefer, Doupnik, Advanced Accounting, 15e Sales Cost of goods sold Salary expense Rent expense (adjusted) Other expenses Gain on sale of building, 10/1/24 Net income

(800,000) 420,000 74,000 36,000 59,000 (30,000) (241,000)

0.274 0.274 0.274 0.274 0.274 0.273

(219,200) 115,080 20,276 9,864 16,166 (8,190) (66,004)

R/E, 1/1/24 Net income Dividends R/E,12/31/24

(133,000) (241,000) 50,000 (324,000)

Schedule 1 Above 0.275

(38,244) (66,004) 13,750 (90,498)

Cash and receivables Inventory Prepaid rent (adjusted) Property, plant & equipment Total

146,000 297,000 10,000 455,000 908,000

0.270 0.270 0.270 0.270

39,420 80,190 2,700 122,850 245,160

Accounts payable Notes payable Common stock Add‘l paid-in capital Retained earnings, 12/31/24 Subtotal Cumulative translation adjustment (negative) Total

(54,000) (140,000) (240,000) (150,000) (324,000)

0.270 0.270 0.300 0.300 Above

(14,580) (37,800) (72,000) (45,000) (90,498) (259,878)

Schedule 2

14,718 (245,160)

(908,000)

36. (continued) Schedule 1—Translation of 1/1/24 Retained Earnings

Egyptian Pounds Retained earnings, 1/1/23 Net income, 2023 Dividends, 6/1/23 Retained earnings, 1/1/24

-0(163,000) 30,000 (133,000)

U.S.Dollars -0(46,944) 8,700 (38,244)

0.288 0.290

Schedule 2—Calculation of Cumulative Translation Adjustment at 12/31/24

Egyptian Pounds

McGraw-Hill/Irwin 10-114

U.S.Dollars

Chapter 10 – Translation of Foreign Currency Financial Statements – Hoyle, Schaefer, Doupnik, Advanced Accounting, 15e Net assets, 1/1/23 Net income, 2023 Dividends, 6/1/23 Net assets, 12/31/23 Net assets, 12/31/23 at current exchange rate Translation adjustment, 2023 (negative) Net assets, 1/1/24 Net income, 2024 Dividends, 6/1/24 Net assets, 12/31/24 Net assets, 12/31/24 at current exchange rate Translation adjustment, 2024 (negative) Cumulative translation adjustment, 12/31/24 (negative)

(390,000) (163,000) 30,000 (523,000)

0.300 0.288 0.290

(117,000) (46,944) 8,700 (155,244)

(523,000)

0.280

(523,000) (241,000) 50,000 (714,000)

0.280 Above 0.275

(146,440) (8,804) (146,440) (66,004) 13,750 (198,694)

(714,000)

0.270

(192,780) (5,914) (14,718)

36. (continued) Step Two Cayce and Simbel's U.S. dollar accounts are then consolidated. Necessary consolidation entries are made in the consolidation worksheet. Consolidation Worksheet

Consolida tion Entries Account

Cayce Dollars

Simbel Dollars

Debit

Consolidated Balances Credit

Dollars

Chapter 07 - Consolidated Financial Statements—Ownership Patterns and Income Taxes – Hoyle, Schaefer, Doupnik, Advanced Accounting, 15e Sales Cost of goods sold Salary expense Rent expense Other expenses Dividend income Gain, 10/1/24 Net income

(200,000) 93,800 19,000 7,000 21,000 (13,750) -0(72,950)

(219,200) 115,080 20,276 9,864 16,166 -0(8,190) (66,004)

Ret earn, 1/1/24 Net income Dividends Ret earn, 12/31/24

(318,000) (72,950) 24,000 (366,950)

(38,244) (66,004) 13,750 (90,498)

Cash and receivables Inventory Prepaid rent Investment Property, plant & equipment Total

110,750 98,000 30,000 126,000

39,420 80,190 2,700 -0-

398,000 762,750

122,850 245,160

Accounts payable Notes payable Common stock Additional PIC Ret earn, 12/31/24 Subtotal Cum trans adjust Total

(60,800) (132,000) (120,000) (83,000) (366,950)

(14,580) (37,800) (72,000) (45,000) (90,498) (259,878) 14,718 (245,160)

(762,750)

(419,200) 208,880 39,276 16,864 37,166 -0(8,190) (125,204)

(I) 13,750

(S) 38,244

(*C) 38,244 (I) 13,750

(*C) 38,244

(S)164,244

(S) 9,000

(E) 900

(S) 72,000 (S) 45,000 (E) 900 217,138

217,138

(356,244) (125,204) 24,000 (457,448) 150,170 178,190 32,700 -0528,950 890,010 (75,380) (169,800) (120,000) (83,000) (457,448) (905,628) 15,618 (890,010)

36. (continued) Explanation of Consolidation Entries Entry *C Investment in Simbel ........................................................ 38,244 Retained earnings, 1/1/24........................................... 38,244 To accrue 2024 increase in subsidiary book value (see Schedule 1). Entry is needed because parent is using the initial value method. Entry S Common stock (Simbel) .................................................. 72,000 Add'l paid-in-capital (Simbel) .......................................... 45,000 Retained earnings, 1/1/24 (Simbel).................................. 38,244 Property, plant & equipment (revaluation)...................... 9,000 Investment in Simbel.................................................. 164,244 To eliminate subsidiary's stockholders' equity accounts and allocate the excess of acquisition consideration over book value to land (Property, plant & equipment). The excess of acquisition consideration over book value is calculated as follows: Acquisition consideration................................................ $126,000 Book value, 1/1/24 ............................................................

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Common stock ................................................................. (72,000) Add‘l paid-in capital ......................................................... (45,000) Excess of acquisition consideration over book value... $ 9,000 The excess of acquisition consideration over book value is 30,000 pounds. The U.S. dollar equivalent at 1/1/24, the date of acquisition, is $9,000 (£E30,000 x $0.30). Entry I Dividend income............................................................... 13,750 Dividends .................................................................... 13,750 To eliminate intra-entity dividend payments recorded by parent as income. Entry E Cumulative translation adjustment ................................. 900 Property, plant & equipment (revaluation)................ 900 To revalue (write-down) the excess of acquisition consideration over book value for the change in exchange rate since the date of acquisition with the counterpart recognized in the consolidated cumulative translation adjustment. The revaluation of "excess" is calculated as follows: Excess of acquisition consideration over book value U.S. dollar equivalent at 12/31/24 U.S. dollar equivalent at 1/1/24 Cumulative translation adjustment related to excess, 12/31/24 (negative)

£E30,000 x $0.27 = $8,100 £E30,000 x $0.30 = 9,000 $( 900)

37. (90 minutes) Translate [remeasure] foreign currency financial statements using U.S. GAAP and explain sign of translation adjustment [remeasurement gain/loss]) Part I (a). Czech koruna is the functional currency—current rate method

KčS

Exchange Rate

US$

Chapter 07 - Consolidated Financial Statements—Ownership Patterns and Income Taxes – Hoyle, Schaefer, Doupnik, Advanced Accounting, 15e Sales Cost of goods sold Depreciation expense—equipment Depreciation expense—buildings Research and development expense Other expenses Net income Retained earnings, 1/1/24 Dividends, 12/15/24 Retained earnings, 12/31/24

25,000,000 (12,000,000) (2,500,000) (1,800,000) (1,200,000) (1,000,000) 6,500,000 500,000 (1,500,000) 5,500,000

0.035 0.035 0.035 0.035 0.035 0.035

Cash Accounts receivable Inventory Equipment Accum. deprec.—equipment Buildings Accum. deprec.—buildings Land Total assets Accounts payable Long-term debt Common stock Additional paid-in capital Retained earnings, 12/31/24 Translation adjustment Total liabilities and equities

2,000,000 3,300,000 8,500,000 25,000,000 (8,500,000) 72,000,000 (30,300,000) 6,000,000 78,000,000 2,500,000 50,000,000 5,000,000 15,000,000 5,500,000 78,000,000

0.030 0.030 0.030 0.030 0.030 0.030 0.030 0.030

given 0.031

0.030 0.030 0.050 0.050 above

to balance

875,000 (420,000) (87,500) (63,000) (42,000) (35,000) 227,500 22,500 (46,500) 203,500 60,000 99,000 255,000 750,000 (255,000) 2,160,000 (909,000) 180,000 2,340,000 75,000 1,500,000 250,000 750,000 203,500 (438,500) 2,340,000

37. (continued) Calculation of Translation Adjustment Cumulative translation adjustment, 12/31/23 (negative) Net assets, 1/1/24 KčS 20,500,000 0.040 Net income, 2024 6,500,000 0.035 Dividends, 12/15/24 (1,500,000) 0.031 Net assets, 12/31/24 KčS 25,500,000 Net assets, 12/31/24 at current exchange rate KčS 25,500,000 0.030 Translation adjustment, 2024 (negative) Cumulative translation adjustment, 12/31/24 (negative)

$202,500 $820,000 227,500 (46,500) $1,001,000 $ 765,000 $236,000 $438,500

37. (continued) Part I (b). U.S. dollar is the functional currency—temporal method

KčS

McGraw-Hill/Irwin 10-118

Exchange Rate

US$

Chapter 10 – Translation of Foreign Currency Financial Statements – Hoyle, Schaefer, Doupnik, Advanced Accounting, 15e Sales Cost of goods sold Depreciation expense—equipment Depreciation expense—buildings Research and development expense Other expenses Income before remeasurement gain Remeasurement gain, 2024 Net income Retained earnings, 1/1/24 Dividends, 12/15/24 Retained earnings, 12/31/24

25,000,000 (12,000,000) (2,500,000) (1,800,000) (1,200,000) (1,000,000) 6,500,000 6,500,000 500,000 (1,500,000) 5,500,000

0.035 Sched. A Sched. B Sched. C 0.035 0.035

Cash Accounts receivable Inventory Equipment Accum. deprec.—equipment Buildings Accum. deprec.—buildings Land Total assets

2,000,000 3,300,000 8,500,000 25,000,000 (8,500,000) 72,000,000 (30,300,000) 6,000,000 78,000,000

0.030 0.030 0.032 Sched.B Sched.B Sched.C Sched.C 0.050

60,000 99,000 272,000 1,180,000 (418,000) 3,408,000 (1,510,200) 300,000 3,390,800

Accounts payable Long-term debt Common stock Additional paid-in capital Retained earnings, 12/31/24 Total liabilities and equities

2,500,000 50,000,000 5,000,000 15,000,000 5,500,000 78,000,000

0.030 0.030 0.050 0.050 above

75,000 1,500,000 250,000 750,000 815,800 3,390,800

KčS

US$

6,000,000 14,500,000 (8,500,000) 12,000,000

0.043 0.035 0.032

258,000 507,500 (272,000) 493,500

given 0.031

875,000 (493,500) (118,000) (85,200) (42,000) (35,000) 101,300 408,000 509,300 353,000 (46,500) 815,800

Schedule A—Cost of goods sold Beginning inventory Purchases Ending inventory Cost of goods sold

37. (continued) Schedule B—Equipment

KčS

US$

Old Equipment—at 1/1/23 New Equipment—acquired 1/3/24 Total

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

0.050 0.036

1,000,000 180,000 1,180,000

Accum. Depr.—Old Equipment Accum. Depr.—New Equipment Total Deprec expense—Old Equipment Deprec expense—New Equipment Total

8,000,000 500,000 8,500,000 2,000,000 500,000 2,500,000

0.050 0.036

400,000 18,000 418,000 100,000 18,000 118,000

0.050 0.036

Schedule C—Buildings

Chapter 07 - Consolidated Financial Statements—Ownership Patterns and Income Taxes – Hoyle, Schaefer, Doupnik, Advanced Accounting, 15e

Old Buildings—at 1/1/23 New Buildings—acquired 3/5/24 Total Accum. Depr.—Old Buildings Accum. Depr.—New Buildings Total Deprec. expense—Old Buildings Deprec. expense—New Buildings Total

Calculation of Remeasurement Gain Net mon. liabilities, 1/1/24 Increase in mon. assets: Sales Decrease in mon. assets: Purchase of inventory Research and development Other expenses Dividends, 12/15/24 Purchase of equipment, 1/3/24 Purchase of buildings, 3/5/24 Net mon. liabilities, 12/31/24 Net mon. liabilities, 12/31/24 at current exchange rate Remeasurement gain—2024

KčS

US$

60,000,000 12,000,000 72,000,000 30,000,000 300,000 30,300,000 1,500,000 300,000 1,800,000

0.050 0.034

3,000,000 408,000 3,408,000 1,500,000 10,200 1,510,200 75,000 10,200 85,200

0.050 0.034 0.050 0.034

KčS

US$

(37,000,000)

0.040

(1,480,000)

25,000,000

0.035

875,000

(14,500,000) (1,200,000) (1,000,000) (1,500,000) (5,000,000) (12,000,000) (47,200,000)

0.035 0.035 0.035 0.031 0.036 0.034

(507,500) (42,000) (35,000) (46,500) (180,000) (408,000) (1,824,000)

(47,200,000)

0.030

(1,416,000) ( 408,000)

37. (continued) Part I (c). U.S. dollar is the functional currency—temporal method (no long-term debt)

McGraw-Hill/Irwin 10-120

Chapter 10 – Translation of Foreign Currency Financial Statements – Hoyle, Schaefer, Doupnik, Advanced Accounting, 15e

KčS

Exchange Rate

Sales Cost of goods sold Depreciation expense—equipment Depreciation expense—buildings Research and development expense Other expenses Income before remeasurement loss Remeasurement loss, 2024 Net income Retained earnings, 1/1/24 Dividends, 12/15/24 Retained earnings, 12/31/24

25,000,000 (12,000,000) (2,500,000) (1,800,000) (1,200,000) (1,000,000) 6,500,000 6,500,000 500,000 (1,500,000) 5,500,000

0.035 Sched. A Sched. B Sched. C 0.035 0.035

Cash Accounts receivable Inventory Equipment Accum. deprec.—equipment Buildings Accum. deprec.—buildings Land Total assets

2,000,000 3,300,000 8,500,000 25,000,000 (8,500,000) 72,000,000 (30,300,000) 6,000,000 78,000,000

0.030 0.030 0.032 Sched. B Sched. B Sched. C Sched .C 0.050

60,000 99,000 272,000 1,180,000 (418,000) 3,408,000 (1,510,200) 300,000 3,390,800

Accounts payable Long-term debt Common stock Additional paid in capital Retained earnings, 12/31/24 Total liabilities and equities

2,500,000 0 20,000,000 50,000,000 5,500,000 78,000,000

0.030 0.030 0.050 0.050 above

75,000 0 1,000,000 2,500,000 (184,200) 3,390,800

given 0.031

US$ 875,000 (493,500) (118,000) (85,200) (42,000) (35,000) 101,300 (92,000) 9,300 (147,000) (46,500) (184,200)

Schedule A—Cost of goods sold - same as in Part I (b) Schedule B—Equipment - same as in Part I (b) Schedule C—Buildings - same as in Part I (b) 37. (continued) Calculation of Remeasurement Loss

Chapter 07 - Consolidated Financial Statements—Ownership Patterns and Income Taxes – Hoyle, Schaefer, Doupnik, Advanced Accounting, 15e

Net monetary assets, 1/1/24 Increase in monetary assets: Sales Decrease in monetary assets: Purchase of inventory Research and development Other expenses Dividends, 12/15/24 Purchase of equipment, 1/3/24 Purchase of buildings, 3/5/24 Net monetary assets, 12/31/24 Net monetary assets, 12/31/24 at current exchange rate Remeasurement loss—2024

KčS

US$

13,000,000

0.040

520,000

25,000,000

0.035

875,000

(14,500,000) (1,200,000) (1,000,000) (1,500,000) (5,000,000) (12,000,000) 2,800,000

0.035 0.035 0.035 0.031 0.036 0.034

(507,500) (42,000) (35,000) (46,500) (180,000) (408,000) 176,000

2,800,000

0.030

84,000 92,000

37. (continued) Part II. Explanation of the negative translation adjustment in Part I (a), remeasurement gain in Part I (b), and remeasurement loss in Part I (c). The negative translation adjustment in Part I (a) arises because of two factors: (1) there is a net asset balance sheet exposure and (2) the Czech koruna has depreciated against the U.S. dollar during 2024 (from $0.040 at 1/1/24 to $0.030 at 12/31/24). A net asset balance sheet exposure exists because all assets are translated at the current exchange rate and exceed total liabilities which are also translated at the current exchange rate. The remeasurement gain in Part I (b) arises because of two factors: (1) there is a net monetary liability balance sheet exposure and (2) the Czech koruna has depreciated against the U.S. dollar. Under the temporal method, Cash and Accounts Receivable are the only assets translated at the current exchange rate (total KčS 5,300,000). Accounts Payable and Long-term Debt are also translated at the current exchange rate (total KčS 52,500,000). Because the Czech koruna amount of liabilities translated at the current rate exceeds the Czech koruna amount of assets translated at the current rate, a net monetary liability balance sheet exposure exists. The remeasurement loss in Part I (c) arises because of two factors: (1) there is a net monetary asset balance sheet exposure and (2) the Czech koruna has depreciated against the U.S. dollar during 2024. Cash and Accounts Receivable are the only assets translated at the current exchange rate (total KčS 5,300,000). Because there is no Longterm Debt in part 1(c), Accounts Payable is the only liability translated at the current exchange rate (total KčS 2,500,000). Because the Czech koruna amount of assets translated at the current rate exceeds the Czech koruna amount of liabilities translated at the current rate, a net monetary asset balance sheet exposure exists. 38. (90 minutes) Remeasure the foreign currency transactions of a foreign subsidiary into the subsidiary‘s functional currency and then translate the subsidiary‘s trial balance into the parent‘s reporting currency a.

McGraw-Hill/Irwin 10-122

Chapter 10 – Translation of Foreign Currency Financial Statements – Hoyle, Schaefer, Doupnik, Advanced Accounting, 15e

Remeasurement of Brazilian Real (BRL) Trial Balance into Mexican Pesos (MXN) BRL

Debit Cash Accounts Receivable Notes Payable Sales Rent Expense Interest Expense

Credit

5,500 28,000 5,000 35,000 6,000 500 40,000

MXN

Exchange Rate

Debit 6.30 C 6.30 C 6.30 C 6.20 A 6.20 A 6.20 A

40,000

31,500 217,000 37,200 251,350

Remeasurement Gain Total

Credit

34,650 176,400

251,350

3,100 248,500 2,850 251,350

Calculation of Remeasurement Gain

BRL Net monetary asset balance, 1/1/24 Increase in net monetary items: Income (sales less rent and interest) Decrease in net monetary items: Not applicable Net monetary assets, 12/31/24 Net monetary assets, 12/31/24, at current exchange rate Remeasurement loss (gain)

Exchange Rate

MXN

28,500

6.20 A

176,700

28,500

176,700

28,500

6.30 C (2,850)

-0-

179,550

Chapter 07 - Consolidated Financial Statements—Ownership Patterns and Income Taxes – Hoyle, Schaefer, Doupnik, Advanced Accounting, 15e

38. (continued) b. Translation of Mexican Peso (MXN) Balances into U.S. Dollars (USD)

Unadjusted MXN Debit

McGraw-Hill/Irwin

MXN Credit

Adjustments MXN Debit

MXN Credit

Adjusted MXN Debit

MXN Credit

Rate

USD Debit

Solutions Manual

USD Credit

Chapter 10 – Translation of Foreign Currency Financial Statements – Hoyle, Schaefer, Doupnik, Advanced Accounting, 15e Cash Accounts Receivable Inventory Land Machinery and Equipment Accumulated Depreciation Accounts Payable Notes Payable Common Stock Retained Earnings, 1/1/24 Sales Cost of Goods Sold Depreciation Expense Rent Expense Interest Expense Remeasurement Gain/Loss Dividends, 7/1/24 Total Cumulative Translation Adjustment (negative)

1,000,000 3,000,000

34,650 176,400

5,000,000 2,000,000 15,000,000

1,034,650 3,176,400

0.072 0.072

74,494.80 228,700.80

5,000,000 2,000,000 15,000,000

0.072 0.072 0.072

360,000.00 144,000.00 1,080,000.00

6,000,000 1,500,000 4,000,000 12,000,000 2,500,000

31,500

34,000,000

217,000

28,000,000 600,000

0.072

432,000.00

1,500,000 4,031,500 12,000,000 2,500,000

0.072 0.072 Given Given

108,000.00 290,268.00 1,000,000.00 200,000.00

34,217,000

0.075 0.075 0.075

28,000,000 600,000

3,000,000 400,000

37,200 3,100

3,037,200 403,100 2,850

2,000,000 60,000,000

6,000,000

60,000,000

251,350

2,850 2,000,000 60,251,350

60,251,350

2,566,275.00 2,100,000.00 45,000.00

0.075 0.075 0.075

227,790.00 30,232.50

0.073

146,000.00 4,436,218.10 160,538.65

4,596,756.75

213.75

Chapter 13 – Accounting for Legal Reorganizations and Liquidations – Hoyle, Schaefer, Doupnik, Advanced Accounting, 15e

38. (continued) Calculation of Cumulative Translation Adjustment MXN Net asset balance, 1/1/24 Increase in net assets: Income, 2024 Decrease in net assets: Dividends, 12/1/24 Net assets, 12/31/24 Net assets, 12/31/24, at current exchange rate Translation adjustment, 2024 (debit) Cumulative translation adjustment, 1/1/24 (debit) Cumulative translation adjustment, 12/31/24 (debit)

14,500,000

Exchange Rate 0.080 H

1,160,000.00

2,179,550

0.075 A

163,466.25

(2,000,000) 14,679,550

0.073 H

(146,000.00) 1,177,466.25

14,679,550

0.072 C

1,056,927.60 120,538.65 40,000.00 160,538.65

Given

USD

Chapter 10 Develop Your Skills Research Case 1—Foreign Currency Translation and Hedging Disclosures The responses to this assignment will depend upon the company selected by the student for analysis. The amount of translation adjustment reported in other comprehensive income usually can be found in a statement of comprehensive income. A positive translation adjustment indicates that the foreign currencies in which the company operates, on average, increased in dollar value during the year. A negative translation adjustment indicates the opposite. Research Case 2—Foreign Currency Translation and Hedging Disclosures a. In its 2020 Annual Report, IBM provided information related to foreign currency translation and hedging activities in the following locations: i. Management Discussion, under Currency Rate Fluctuations, p. 62-63. ii. Note A. Significant Accounting Policies, under Translation of Non-U.S Currency Amounts and Derivative Financial Instruments, p. 82-83. iii. Note T. Derivative Financial Instruments, under Foreign Exchange Risk, pp. 123. In its Form 10-K for the Fiscal Year Ended May 31, 2021, Oracle provided information related to foreign currency hedging activities in the following locations: i. Item 1A. Risk Factors, p. 18. ii. Item 7A. Quantitative and Qualitative Disclosures about Market Risk, under Currency Risk, p. 58. iii. Note 1. Organization and Significant Accounting Policies, under Derivative Financial Instruments, p. 79. iv. Note 10. Derivative Financial Instruments, p. 90-92.

Chapter 13 – Accounting for Legal Reorganizations and Liquidations – Hoyle, Schaefer, Doupnik, Advanced Accounting, 15e

Research Case 2 (continued) b. IBM‘s foreign operations do not have a predominant functional currency. The company indicates that it operates in multiple functional currencies (AR, p. 123). Most of IBM‘s foreign operations probably have the foreign currency as functional currency and therefore are translated into dollars using the current rate method with translation adjustments reflected in stockholders‘ equity. There is no mention of foreign currency amounts being remeasured or remeasurement gains and losses being reflected in net income. Oracle‘s foreign operations do not appear to have a predominant functional currency. On page 80 of Form 10-K, the company states: ―We transact business in various foreign currencies. In general, the functional currency of a foreign operation is the local country‘s currency.‖ There is no specific mention of foreign currency amounts being remeasured or remeasurement gains and losses being reflected in net income. c. From the Consolidated Statement of Comprehensive Income (AR, p. 69), it can be seen that IBM reported translation adjustments as follows: Year ended December 31, 2020: negative $(1,500) million Year ended December 31, 2019: negative $(39) million Year ended December 31, 2018: negative $(730) million The negative signs of the translation adjustments in each year indicate that, on average, the foreign currency functional currencies of IBM‘s foreign operations decreased in value against the U.S. dollar in those years. Given the size of the translation adjustments, the decrease in U.S. dollar value was much larger in 2020 than in 2019, which was much larger than in 2018. Oracle reported foreign currency translation adjustments in Consolidated Statements of Comprehensive Income (10-K, page 68) as follows: Fiscal Year ended May 31, 2021: positive $479 million Fiscal Year ended May 31, 2020: negative $(78) million Fiscal Year ended May 31, 2019: negative $(149) million The positive sign of the translation adjustment in FY 2021 indicates that, on average, the foreign currency functional currencies of Oracle‘s foreign operations increased in value against the U.S. dollar in that year. Conversely, in FY 2020 and FY 2019, the negative signs of the translation adjustments indicate that foreign currencies on average depreciated against the U.S. dollar. Research Case 2 (continued) d. IBM uses foreign currency borrowings, foreign currency forward contracts, and currency swaps to hedge certain of its net investments in foreign operations. In Note T. Derivative Financial Instruments, under Foreign Exchange Risk, IBM indicates that ―a large portion of the company‘s foreign currency denominated debt portfolio is designated as a hedge of net investment in foreign subsidiaries…The company also uses cross-currency swaps and foreign exchange forward contracts for this risk management purpose‖ (AR, p. 123).

Chapter 13 – Accounting for Legal Reorganizations and Liquidations – Hoyle, Schaefer, Doupnik, Advanced Accounting, 15e

Oracle provides no information regarding hedges of net investments in foreign operations. In Item 7A, under Currency Risk, the company discusses ―Foreign Currency Translation Risk‖ (10-K, p. 58), but there is no indication that Oracle hedges against this risk. Accounting Standards Case 1—More than One Functional Currency This case requires students to search the authoritative literature to determine how the functional currency should be determined for a foreign entity that has more than one distinct and separable operation. Source of guidance: FASB ASC 830-10-55-6 Foreign Currency Matters; Overall; Implementation Guidance and Illustrations: The Functional Currency ASC 830-10-55-6 states: ―In some instances, a foreign entity might have more than one distinct and separable operation. For example, a foreign entity might have one operation that sells parent-entity-produced products and another operation that manufactures and sells foreign-entity-produced products. If they are conducted in different economic environments, those two operations might have different functional currencies. Similarly, a single subsidiary of a financial institution might have relatively self-contained and integrated operations in each of several different countries. In those circumstances, each operation may be considered to be an entity as that term is used in this Subtopic, and, based on the facts and circumstances, each operation might have a different functional currency.‖ This guidance indicates that the functional currency should be determined separately for each distinct and separable operation of a single foreign entity. Within its Mexican subsidiary, Lynch should designate the Mexican peso as the functional currency for the Small Appliance division and the U.S. dollar as the functional currency for the Electronics division. Accounting Standards Case 2—Change in Functional Currency This case requires students to search the authoritative literature to determine how an entity should handle a change in foreign currency from the foreign currency to the U.S. dollar. Specific questions are:  Should the change in functional currency be treated as a change in accounting principle with retrospective restatement of the carrying values of nonmonetary assets?  Should the cumulative translation adjustment be removed from equity and, if so, where should it go? Source of guidance: FASB ASC 830-10-45-10 Foreign Currency Matters; General; Other Presentation Matters; Functional Currency Changes from Foreign Currency to Reporting Currency ASC 830-10-45-10 states: ―If the functional currency changes from a foreign currency to the reporting currency, translation adjustments for prior periods shall not be removed from equity and the translated amounts for nonmonetary assets at the end of the prior period become the accounting basis for those assets in the period of the change and 13-3 © McGraw Hill LLC. All rights reserved. No reproduction or distribution without the prior written consent of McGraw Hill LLC.

Chapter 13 – Accounting for Legal Reorganizations and Liquidations – Hoyle, Schaefer, Doupnik, Advanced Accounting, 15e

subsequent periods.‖ In essence, the authoritative guidance indicates that the change in functional currency from the Canadian dollar to the U.S. dollar should not be treated as a change in accounting principle with retrospective adjustments. Instead, the change should be handled prospectively with no adjustments made to the carrying amounts of nonmonetary assets or to the accumulated translation adjustment related to the Canadian subsidiary carried in AOCI. Excel Case—Translating Foreign Currency Financial Statements a. b.

Spreadsheet for the translation (current rate method) and remeasurement (temporal method) of the FC financial statements of the foreign subsidiary. Current Rate Method Rate $0.45 $0.45 subtotal $0.45 $0.45 n/a subtotal $0.45 subtotal

Temporal Method

December 31, 2024 Sales Cost of goods sold Gross profit Selling expense Depreciation expense Remeasurement gain/loss Income before tax Income taxes Net income Retained earnings, 1/1/24 Ret. earnings, 12/31/24

FC 5,000 (3,000) 2,000 (400) (600) 0 1,000 (300) 700 0 700

Cash Inventory Property, plant & equipment Less: Accum. deprec. Total assets

1,000 2,000 6,000 (600) 8,400

Current liabilities Long-term debt Contributed capital Cum. trans. adjustment* Retained earnings Total liabilities and stockholders‘ equity

1,500 $0.38 C 3,000 $0.38 C 3,200 $0.50 H 0 to balance 700 from I/S 8,400 A=L+SE

A A A A

total $0.38 $0.38 $0.38 $0.38 total

C C C C

USD Rate $2,250 $0.45 A (1,350) Schedule A 900 subtotal (180) $0.45 A (270) $0.50 H 0 to balance 450 subtotal (135) $0.45 A 315 subtotal 0 315 from B/S 380 760 2,280 (228) 3,192

$0.38 $0.43 $0.50 $0.50 total

USD $2,250 (1,360) 890 (180) (300) 355 765 (135) 630 0 630

C H H H

380 860 3,000 (300) 3,940

570 $0.38 C 1,140 $0.38 C 1,600 $0.50 H (433) n/a 315 to balance 3,192 A=L+SE

570 1,140 1,600 0 630 3,940

Key:

Chapter 13 – Accounting for Legal Reorganizations and Liquidations – Hoyle, Schaefer, Doupnik, Advanced Accounting, 15e

Average exchange rate Current exchange rate Historical exchange rate

A C H

Excel Case (continued) Schedule A - Calculation of COGS Under the Temporal Method Exchange Rates

Given

January 1-31, 2024 Average 2024 December 31, 2024 Inventory purchases

$0.50 $0.45 $0.38 $0.43

Key: Average exchange rate Current exchange rate Historical exchange rate

Temporal method— COGS (on a FIFO basis) Beg invent Purchases End invent COGS

1,000 4,000 (2,000) 3,000

$0.50 H $0.43 H $0.43 H

$500 1,720 (860) $1,360

A C H

* Computation of Cumulative Translation Adjustment

Net assets, 1/1/24 Net income, 2024 Net assets, 12/31/24 Net assets, 12/31/24 at current exchange rate Translation adjustment (negative)

FC 3,200 700 3,900

Rate $0.50 $0.45

USD 1,600 315 1,915

3,900

$0.38

1,482 433

c. With the FC as functional currency, the U.S. dollar net income reflected in the consolidated income statement using the current rate method is $315. If the U.S. dollar were the functional currency, the amount using the temporal method would be twice as much—$630. With the FC as functional currency (current rate method), the amount of total assets reported on the consolidated balance sheet is 19% [($3,192 – $3,940)/$3,940] smaller than if the U.S. dollar were functional currency (temporal method). The relations between the current ratio, the debt to equity ratio, profit margin, return on equity, and inventory turnover calculated from the FC financial statements and from the translated U.S. dollar financial statements are shown below. Excel Case (continued)

Current Rate

Temporal

Chapter 13 – Accounting for Legal Reorganizations and Liquidations – Hoyle, Schaefer, Doupnik, Advanced Accounting, 15e

Current ratio CA CL

3,000 1,500 2.0

1,140 570 2.0

1,240 570 2.1754

4,500 3,900 1.15385

1,710 1,482 1.15385

1,710 2,230 0.76682

700 5,000 0.14

315 2,250 0.14

630 2,250 0.28

700 3,550 0.19718

315 1,541 0.20441

630 1,915 0.32898

COGS

3,000

1,350

1,360

Average Inventory

1,000 3

380 3.55263

430 3.16279

Debt to equity ratio Total liabilities Total stockholders‘ equity Profit margin NI Sales Return on equity NI Average TSE Inventory turnover

These results show that the temporal method distorts all ratios as calculated from the original foreign currency (FC) financial statements. The current rate method maintains ratios that use numbers in the numerator and denominator from the balance sheet only (current ratio, debt-to-equity ratio) or the income statement only (profit margin). For ratios that combine numbers from the income statement and balance sheet (return on equity, inventory turnover), the current rate method also creates distortions. The U.S. dollar amounts reported under the temporal method for inventory and fixed assets reflect the equivalent U.S. dollar cost of those assets as if the parent had sent dollars to the subsidiary to purchase the assets. For example, to purchase FC 6,000 worth of fixed assets when the exchange rate was $0.50/FC, the parent would have had to provide the subsidiary with $3,000. Excel Case (continued) The U.S. dollar amounts reported under the current rate method for inventory and fixed assets reflect neither the equivalent U.S. dollar cost of those assets nor their U.S. dollar current value. By multiplying the FC historical cost by the current exchange rate, these assets are reported at what they would have cost in U.S. dollars if the current exchange rate had been in effect when they were purchased. This is a hypothetical number with little, if any, meaning. Communication Case—Functional Currency of Foreign Subsidiary Possible answers to the specific questions asked in this case follow:

Chapter 13 – Accounting for Legal Reorganizations and Liquidations – Hoyle, Schaefer, Doupnik, Advanced Accounting, 15e

1. What is the functional currency of a foreign subsidiary? The concept of ―functional currency‖ was created by the FASB in developing the current U.S. GAAP rules for translating foreign currency financial statements into U.S. dollars for the purpose of consolidation. The functional currency of a foreign subsidiary is defined as the primary currency of the foreign subsidiary‘s operating environment. The functional currency can be either a foreign currency (typically, the local currency) or the U.S. dollar. 2. Why must the functional currency of a foreign subsidiary be determined? In translating foreign currency financial statements into U.S. dollars for consolidation purposes, one of two methods must be used: the current rate method or the temporal method. In accordance with U.S. GAAP, the method to be used depends upon the functional currency of the foreign subsidiary: When a foreign currency is the functional currency, the current rate method of translation is used; When the U.S. dollar is the functional currency, the temporal method is used. Thus, the functional currency of a foreign subsidiary must be determined to select the appropriate method for translating its financial statements. 3. How is the functional currency of a foreign subsidiary determined? The FASB prescribes that six different indicators must be considered in determining the functional currency of a foreign subsidiary. These indicators include, for example, whether there is an active local sales market for the subsidiary‘s products, and whether the subsidiary obtains its financing in foreign currency or in U.S. dollars. The FASB requires that these six indicators should be considered, but it does not provide any guidance with regard to the relative weights to be placed on the various indicators. As a result, there is some flexibility in determining the functional currency of a foreign subsidiary. Ultimately, management‘s judgment is essential in evaluating the facts to determine the foreign subsidiary‘s functional currency. Excel and Analysis Case—Parker Inc. and Suffolk PLC This assignment requires translation of foreign currency financial statements under three different sets of assumptions regarding changes in the U.S. dollar value of the British pound. Under the first set of assumptions, the British pound appreciates steadily from $1.60 at 1/1/23 to $1.68 at 12/31/24. Under the second set of assumptions, the exchange rate remains $1.60 from 1/1/23 to 12/31/24. Under the third set of assumptions, the British pound depreciates steadily from $1.60 at 1/1/23 to $1.52 at 12/31/24. Part I—Appreciating Foreign Currency Relevant exchange rates:

January 1, 2023 2023 Average December 31, 2023 January 30, 2024 2024 Average December 31, 2024

$1.60 $1.62 $1.64 $1.65 $1.66 $1.68

Chapter 13 – Accounting for Legal Reorganizations and Liquidations – Hoyle, Schaefer, Doupnik, Advanced Accounting, 15e

Excel and Analysis Case (continued) a. Translation of Suffolk‘s December 31, 2024 trial balance from British pounds to U.S. dollars. Suffolk PLC Trial Balance December 31, 2024

Cash Accounts receivable Inventory Property, plant, & equipment (net) Accounts payable Long-term debt Common stock Retained earnings, 1/1/24 Sales Cost of goods sold Depreciation Other expenses Dividends, 1/30/24 Cumulative translation adjustment—positive (credit balance)

Pounds

Exchange Rate

Dollars

£ 1,500,000 5,200,000 18,000,000 36,000,000 (1,450,000) (5,000,000) (44,000,000) (8,000,000) (28,000,000) 16,000,000 2,000,000 6,000,000 1,750,000

$1.68 $1.68 $1.68 $1.68 $1.68 $1.68 $1.60 Schedule A $1.66 $1.66 $1.66 $1.66 $1.65

$ 2,520,000 8,736,000 30,240,000 60,480,000 (2,436,000) (8,400,000) (70,400,000) (12,840,000) (46,480,000) 26,560,000 3,320,000 9,960,000 2,887,500 (4,147,500) $0

£0

Note: Amounts in parentheses are credit balances.

Schedule A

Pounds

Retained earnings, 1/1/23 Net income, 2023 Retained earnings, 12/31/23

£(6,000,000) (2,000,000) £(8,000,000)

Exchange Rate $1.60 $1.62

Dollars $ (9,600,000) (3,240,000) $(12,840,000)

Excel and Analysis Case (continued) b. Schedule detailing the change in Suffolk‘s cumulative translation adjustment for 2023 and 2024. Determination of Cumulative Translation Adjustment

Pounds

Exchange Rate

Dollars

Chapter 13 – Accounting for Legal Reorganizations and Liquidations – Hoyle, Schaefer, Doupnik, Advanced Accounting, 15e

Net assets, 1/1/23 Net income, 2023 Translation adjustment, 2023 (positive) Net assets, 1/1/24 Net income, 2024 Dividends, 2024 Translation adjustment, 2024 (positive) Net assets, 12/31/24 Cumulative Translation Adjustment, 12/31/24 (positive)

£50,000,000 2,000,000

$1.64 $1.64

$1.60 $1.62

$2,000,000 40,000 $2,040,000

£52,000,000 4,000,000 (1,750,000)

$1.68 $1.68 $1.68

$1.64 $1.66 $1.65

2,080,000 80,000 (52,500) 2,107,500

£ 54,250,000 $4,147,500

Cost Allocation Schedule Cost Book value Excess of cost over book value

Translation Adjustment Related to Excess of Cost Over Book Value Excess of cost over book value U.S. dollar value at 12/31/24 U.S. dollar value at 1/1/23 Translation adjustment related to excess, 12/31/24—positive

Pounds £52,000,000 50,000,000 £ 2,000,000

Pounds £2,000,000

Exchange Rate $1.60 $1.60

Exchange Rate

Dollars $83,200,000 80,000,000 $ 3,200,000

Dollars

$1.68 $1.60

$3,360,000 3,200,000 $ 160,000

Consolidation Entries

Consolidated

Excel and Analysis Case (continued) c. Consolidation Worksheet—December 31, 2024 Parker

Suffolk

Chapter 13 – Accounting for Legal Reorganizations and Liquidations – Hoyle, Schaefer, Doupnik, Advanced Accounting, 15e Sales Cost of goods sold Depreciation Other expenses Dividend income Net income

($70,000,000) 34,000,000 20,000,000 6,000,000 (2,887,500) ($12,887,500)

($46,480,000) 26,560,000 3,320,000 9,960,000

Ret. earnings, 1/1/24 Net income Dividends Ret. earnings, 12/31/24

($48,000,000) (12,887,500) 4,500,000 ($56,387,500)

($12,840,000) (6,640,000) 2,887,500 ($16,592,500)

Cash Accounts receivable Inventory Investment in Suffolk

$3,687,500 10,000,000 30,000,000 83,200,000

$2,520,000 8,736,000 30,240,000

Prop, plant & eq. (net)

105,000,000

60,480,000

Accounts payable Long-term debt Common stock Ret. earnings, 12/31/24 Cum. trans. adj.

(25,500,000) (50,000,000) (100,000,000) (56,387,500)

(2,436,000) (8,400,000) (70,400,000) (16,592,500) (4,147,500) $0

($116,480,000) 60,560,000 23,320,000 15,960,000 0 ($16,640,000)

2,887,500 ($6,640,000) 12,840,000

3,240,000 2,887,500

3,240,000

83,240,000 3,200,000

3,200,000 160,000

$6,207,500 18,736,000 60,240,000 0 168,840,000

70,400,000

$92,727,500

($51,240,000) (16,640,000) 4,500,000 ($63,380,000)

160,000 $92,727,500

(27,936,000) (58,400,000) (100,000,000) (63,380,000) (4,307,500) $0

Excel and Analysis Case (continued) d. Consolidated income statement and balance sheet—2024. Parker, Inc. Consolidated Income Statement For the year ended December 31, 2024 Sales Cost of goods sold Depreciation Other expenses Net income

$ 116,480,000 (60,560,000) (23,320,000) (15,960,000) $ 16,640,000 Parker, Inc. Consolidated Balance Sheet December 31, 2024

Assets Cash Accounts receivable Inventory Property, plant & equipment (net) Total

$ 6,207,500 18,736,000 60,240,000 168,840,000 $254,023,500

Liabilities and Shareholders' Equity Accounts payable Long-term debt

$ 27,936,000 58,400,000

Chapter 13 – Accounting for Legal Reorganizations and Liquidations – Hoyle, Schaefer, Doupnik, Advanced Accounting, 15e

Common stock Retained earnings Accum. other comp. income Total

100,000,000 63,380,000 4,307,500 $254,023,500

Excel and Analysis Case (continued) Part II—Stable Foreign Currency Relevant exchange rates:

January 1, 2023 2023 Average December 31, 2023 January 30, 2024 2024 Average December 31, 2024

$1.60 $1.60 $1.60 $1.60 $1.60 $1.60

a. Translation of Suffolk‘s December 31, 2024 trial balance from British pounds to U.S. dollars. Suffolk PLC Trial Balance December 31, 2024

Pounds

Exchange Rate

Dollars

£ 1,500,000 5,200,000 18,000,000 36,000,000 (1,450,000) (5,000,000) (44,000,000) (8,000,000) (28,000,000) 16,000,000 2,000,000 6,000,000 1,750,000

$1.60 $1.60 $1.60 $1.60 $1.60 $1.60 $1.60 Schedule A $1.60 $1.60 $1.60 $1.60 $1.60

$ 2,400,000 8,320,000 28,800,000 57,600,000 (2,320,000) (8,000,000) (70,400,000) (12,800,000) (44,800,000) 25,600,000 3,200,000 9,600,000 2,800,000 0 $0

£0

Note: Amounts in parentheses are credit balances.

Schedule A Retained earnings, 1/1/23 Net income, 2023 Retained earnings, 12/31/23

Pounds £(6,000,000) (2,000,000) £(8,000,000)

Exchange Rate $1.60 $1.60

Dollars $ (9,600,000) (3,200,000) $(12,800,000)

Excel and Analysis Case (continued)

Chapter 13 – Accounting for Legal Reorganizations and Liquidations – Hoyle, Schaefer, Doupnik, Advanced Accounting, 15e

b. Schedule detailing the change in Suffolk‘s cumulative translation adjustment for 2023 and 2024. Determination of Cumulative Translation Adjustment Net assets, 1/1/23 Net income, 2023 Translation adjustment, 2023 Net assets, 1/1/24 Net income, 2024 Dividends, 2024 Translation adjustment, 2024 Net assets, 12/31/24 Cumulative Translation Adjustment, 12/31/24

Pounds £50,000,000 2,000,000

Exchange Exchange Rate Rate $1.60 $1.60 $1.60 $1.60

£52,000,000 4,000,000 (1,750,000)

$1.60 $1.60 $1.60

$1.60 $1.60 $1.60 0

Dollars $0 0 $0 0 0 0

£54,250,000 $0

Cost Allocation Schedule Cost Book value Excess of cost over book value

Pounds £52,000,000 50,000,000 £ 2,000,000

Translation Adjustment Related to Excess of Cost Over Book Value

Pounds

Excess of cost over book value U.S. dollar value at 12/31/24 U.S. dollar value at 1/1/23 Translation adjustment related to excess, 12/31/24

Exchange Rate $1.60 $1.60

Dollars $83,200,000 80,000,000 $ 3,200,000

Exchange Rate

Dollars

$1.60 $1.60

$3,200,000 3,200,000

£ 2,000,000

Excel and Analysis Case (continued) c. Consolidation Worksheet—December 31, 2024 Parker

Suffolk

Consolidation Entries

Consolidated

($70,000,000) 34,000,000 20,000,000 6,000,000 (2,800,000) ($12,800,000)

($44,800,000) 25,600,000 3,200,000 9,600,000

Ret. earnings, 1/1/24 Net income Dividends Ret. earnings, 12/31/24

($48,000,000) (12,800,000) 4,500,000 ($56,300,000)

($12,800,000) (6,400,000) 2,800,000 ($16,400,000)

Cash Accounts receivable Inventory Investment in Suffolk

$3,600,000 10,000,000 30,000,000 83,200,000

$2,400,000 8,320,000 28,800,000

Prop, plant & eq. (net)

105,000,000

57,600,000

Accounts payable Long-term debt Common stock Ret. earnings, 12/31/24 Cum. Trans. adj.

(25,500,000) (50,000,000) (100,000,000) (56,300,000)

(2,320,000) (8,000,000) (70,400,000) (16,400,000) 0 $0

($114,800,000) 59,600,000 23,200,000 15,600,000 0 ($16,400,000)

2,800,000 ($6,400,000) 12,800,000

3,200,000 2,800,000

3,200,000

83,200,000 3,200,000

3,200,000 0

$6,000,000 18,320,000 58,800,000 0 165,800,000

70,400,000

$92,400,000

($51,200,000) (16,400,000) 4,500,000 ($63,100,000)

0 $92,400,000

(27,820,000) (58,000,000) (100,000,000) (63,100,000) 0 $0

$114,800,000 (59,600,000) (23,200,000) (15,600,000) $ 16,400,000 Parker, Inc. Consolidated Balance Sheet December 31, 2024

Assets Cash Accounts receivable Inventory Property, plant & equipment (net) Total

$ 6,000,000 18,320,000 58,800,000 165,800,000 $248,920,000

Liabilities and Shareholders' Equity Accounts payable Long-term debt

$ 27,820,000 58,000,000

Chapter 13 – Accounting for Legal Reorganizations and Liquidations – Hoyle, Schaefer, Doupnik, Advanced Accounting, 15e

Common stock Retained earnings Accum. other comp. income Total

100,000,000 63,100,000 0 $248,920,000

Excel and Analysis Case (continued) Part III—Depreciating Foreign Currency Relevant exchange rates:

January 1, 2023 2023 Average December 31, 2023 January 30, 2024 2024 Average December 31, 2024

$1.60 $1.58 $1.56 $1.55 $1.54 $1.52

a. Translation of Suffolk‘s December 31, 2024 trial balance from British pounds to U.S. dollars. Suffolk PLC Trial Balance December 31, 2024

Pounds

Exchange Rate

Dollars

£ 1,500,000 5,200,000 18,000,000 36,000,000 (1,450,000) (5,000,000) (44,000,000) (8,000,000) (28,000,000) 16,000,000 2,000,000 6,000,000 1,750,000

$1.52 $1.52 $1.52 $1.52 $1.52 $1.52 $1.60 Schedule A $1.54 $1.54 $1.54 $1.54 $1.55

$ 2,280,000 7,904,000 27,360,000 54,720,000 (2,204,000) (7,600,000) (70,400,000) (12,760,000) (43,120,000) 24,640,000 3,080,000 9,240,000 2,712,500 4,147,500 $0

£0

Note: Amounts in parentheses are credit balances.

Schedule A Retained earnings, 1/1/23 Net income, 2023 Retained earnings, 12/31/23

Pounds

Exchange Rate

£(6,000,000) (2,000,000) £(8,000,000)

$1.60 $1.58

Dollars $ (9,600,000) (3,160,000) $(12,760,000)

Excel and Analysis Case (continued)

Chapter 13 – Accounting for Legal Reorganizations and Liquidations – Hoyle, Schaefer, Doupnik, Advanced Accounting, 15e

b. Schedule detailing the change in Suffolk‘s cumulative translation adjustment for 2023 and 2024. Determination of Cumulative Translation Adjustment Net assets, 1/1/23 Net income, 2023 Translation adjustment, 2023 (negative) Net assets, 1/1/24 Net income, 2024 Dividends, 2024 Translation adjustment, 2024 (negative) Net assets, 12/31/24 Cumulative Translation Adjustment, 12/31/24 (negative)

Pounds Exchange Exchange Rate Rate

Dollars

£50,000,000 2,000,000

$1.56 $1.56

$1.60 $1.58

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

£52,000,000 4,000,000 (1,750,000)

$1.52 $1.52 $1.52

$1.56 $1.54 $1.55

(2,080,000) (80,000) 52,500

$(2,040,000)

(2,107,500) £54,250,000 $(4,147,500)

Cost Allocation Schedule Cost Book value Excess of cost over book value

Pounds £52,000,000 50,000,000 £ 2,000,000

Pounds £2,000,000

Exchange Rate $1.60 $1.60

Exchange Rate $1.52 $1.60

Dollars $83,200,000 80,000,000 $ 3,200,000

Dollars $3,040,000 3,200,000 $ (160,000)

Excel and Analysis Case (continued) c. Consolidation Worksheet—December 31, 2024

Parker

Suffolk

Consolidation Entries

Consolidated

Chapter 13 – Accounting for Legal Reorganizations and Liquidations – Hoyle, Schaefer, Doupnik, Advanced Accounting, 15e Sales Cost of goods sold

($70,000,000) 34,000,000

($43,120,000) 24,640,000

Depreciation

20,000,000

3,080,000

Other expenses

6,000,000

9,240,000

Dividend income

(2,712,500)

58,640,000 23,080,000 15,240,000 2,712,500

Net income

($12,712,500)

($6,160,000)

Ret. earnings, 1/1/24

($48,000,000)

($12,760,000)

Net income

(12,712,500)

(6,160,000)

Dividends

4,500,000

2,712,500

($56,212,500)

($16,207,500)

Cash

$3,512,500

$2,280,000

Accounts receivable

10,000,000

7,904,000

Inventory

30,000,000

27,360,000

Investment in Suffolk

83,200,000

Ret. earnings, 12/31/24

($113,120,000)

0 ($16,160,000)

12,760,000

3,160,000

($51,160,000) (16,160,000)

2,712,500

4,500,000 ($62,820,000) $5,792,500 17,904,000 57,360,000

3,160,000

83,160,000

3,200,000 Prop, plant & eq. (net)

105,000,000

54,720,000

3,200,000

162,760,000 160,000

Accounts payable

(25,500,000)

(2,204,000)

Long-term debt

(50,000,000)

(7,600,000)

Common stock

(100,000,000)

(70,400,000)

Ret. earnings, 12/31/24

(56,212,500)

(16,207,500)

Cum. Trans. adj. $0

(27,704,000) (57,600,000) 70,400,000

(100,000,000) (62,820,000)

4,147,500

160,000

$92,392,500

4,307,500 $92,392,500

Chapter 13 – Accounting for Legal Reorganizations and Liquidations – Hoyle, Schaefer, Doupnik, Advanced Accounting, 15e

$ 113,120,000 (58,640,000) (23,080,000) (15,240,000) $ 16,160,000 Parker, Inc. Consolidated Balance Sheet December 31, 2024

Assets Cash Accounts receivable Inventory Property, plant & equipment (net) Total

$ 5,792,500 17,904,000 57,360,000 162,760,000 $243,816,500

Liabilities and Shareholders' Equity Accounts payable Long-term debt Common stock Retained earnings Accum. other comp. income Total

$ 27,704,000 57,600,000 100,000,000 62,820,000 (4,307,500) $243,816,500

Excel and Analysis Case (continued) Part IV—Risk Assessment Report and Financial Management Recommendations

Chapter 13 – Accounting for Legal Reorganizations and Liquidations – Hoyle, Schaefer, Doupnik, Advanced Accounting, 15e

December 31, 2024 Exchange Rate $1.68

$1.60

$1.52

Consolidated net income Percentage difference

$16,640,000 101.5% + 1.5%

$16,400,000 100% --

$16,160,000 98.5% - 1.5%

Cash flow from dividends Percentage difference

$2,887,500 103% + 3%

$2,800,000 100% --

$2,712,500 97% - 3%

Total Liabilities Total Stockholders‘ equity Debt-to-equity ratio Percentage difference

$86,336,000 $167,687,500 51.5% 98% - 2%

$85,820,000 $163,100,000 52.6% 100% --

$85,304,000 $158,512,500 53.8% 102% + 2%

Appreciation of the British pound from $1.60 to $1.68 results in consolidated net income being 1.5% higher, cash flow from dividends being 3% higher, and the debt-toequity ratio being 2% lower than if there had been no change in exchange rates. Depreciation of the British pound from $1.60 to $1.52 would have resulted in income being 1.5% lower, cash flow from dividends being 3% lower, and the debt-to-equity ratio being 2% higher than if there had been no change in exchange rates. An increase in the dollar value of the British pound results in higher profitability, greater cash inflow, and an improved debt-to-equity ratio. The opposite is true for a decrease in the dollar value of the British pound. If the British pound is expected to appreciate, Parker should not hedge its British pound exposure associated with its investment in Suffolk. However, if the British pound is expected to depreciate, Parker may wish to hedge its British pound net asset and cash flow exposure in some way. The decline in dollar value of future British pound dividend payments could be hedged by selling British pounds forward or by purchasing a British pound put option. The negative translation adjustment reported in accumulated other comprehensive income could be avoided using an option or forward contract, or by taking out a loan in British pounds.

CHAPTER 11 WORLDWIDE ACCOUNTING DIVERSITY AND INTERNATIONAL STANDARDS Chapter Outline I.

Accounting and financial reporting rules differ across countries. There are a variety of factors influencing a country‘s accounting system. A. Legal system—primarily relates to how accounting principles are established; code law countries generally having legislated accounting principles and common law countries

Chapter 13 – Accounting for Legal Reorganizations and Liquidations – Hoyle, Schaefer, Doupnik, Advanced Accounting, 15e

having principles established by non-legislative means. B. Taxation—financial statements serve as the basis for taxation in many countries. In those countries with a close linkage between accounting and taxation, accounting practice tends to be more conservative so as to reduce the amount of income subject to taxation. C. Financing system—where shareholders are a major provider of financing, the demand for information made available outside the company becomes greater. In those countries in which family members, banks, and the government are the major providers of business finance, there is less demand for public accountability and information disclosure. D. Inflation—historically, caused some countries, especially in Latin America, to develop accounting principles in which traditional historical cost accounting is abandoned in favor of inflation adjusted figures. As inflation has been brought under control in most countries, this factor is no longer of significant influence. E. Political and economic ties—can explain the usage of a British style of accounting throughout most of the former British Empire. They also explain why member nations of the European Union use a common set of accounting standards (i.e., IFRS). II.

Differences in accounting across countries cause several problems. A. Consolidating foreign subsidiaries requires that the financial statements prepared in accordance with foreign GAAP must be converted into the parent company‘s GAAP. B. Companies interested in obtaining capital in foreign countries often are required to provide financial statements prepared in accordance with accounting rules in that country, which are likely to differ from rules in the home country. C. Investors interested in investing in foreign companies may have a difficult time in making comparisons across potential investments because of differences in accounting rules across countries.

III.

The International Accounting Standards Committee (IASC) was formed in 1973 in hopes of improving and promoting the worldwide harmonization of accounting principles. It was superseded by the International Accounting Standards Board (IASB) in 2001. A. The IASC issued 41 International Accounting Standards (IAS) covering a broad range of accounting issues. Several IASs have been superseded or withdrawn, leaving 25 in effect. B. The membership of the IASC was composed of over 140 accountancy bodies from more than 100 nations. C. The IASC was not in a position to enforce its standards. Instead, member accountancy bodies pledged to work toward acceptance of IASs in the respective countries. D. Because of criticism that too many options were allowed in its standards and therefore true comparability was not being achieved, the IASC undertook a Comparability Project in the 1990s, revising 10 of its standards to eliminate alternatives. E. The IASC derived much of its legitimacy as an international standard setter through endorsement of its activities by the International Organization of Securities Commissions. IOSCO and the IASC agreed that, if the IASC could develop a set of core standards, IOSCO would recommend that stock exchanges allow foreign companies to use IASs in preparing financial statements. The IASC completed the set of core standards in 1998, IOSCO endorsed their usage by foreign companies in 2000, and many members of IOSCO adopted this recommendation.

IV.

The International Accounting Standards Board (IASB) replaced the IASC in 2001. A. The IASB comprises 16 members, at least 13 of whom must be full-time. Full-time 13-19 © McGraw Hill LLC. All rights reserved. No reproduction or distribution without the prior written consent of McGraw Hill LLC.

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IASB members are required to sever their relationships with former employers to ensure independence. To ensure a broad international diversity, there normally are four members from Europe; four from North America; four from the Asia/Oceania region; one from Africa; one from South America; and two from any area to achieve geographic balance. Ten affirmative votes are required for passage of a new standard and if there are fewer than 16 members, then nine affirmative votes are required B. IASB standards are referred to as International Financial Reporting Standards (IFRS) and consist of (a) IASs issued by the IASC (and adopted by the IASB), (b) individual International Financial Reporting Standards developed by the IASB, (c) Interpretations issued by the Standing Interpretations Committee (SIC) (until 2001), and (d) Interpretations issued by the International Financial Reporting Interpretations Committee (IFRIC). C. In addition to 25 IASs, 17 IFRSs (as of January 2022), and 20 SICs and IFRICs, the IASB also has a Conceptual Framework for Financial Reporting, which serves as a guide to determine the proper accounting in those areas not covered by IFRS. D. As of the beginning of 2022, more than 140 countries required the use of IFRS by all (or most) domestic publicly traded companies. Many countries also allow foreign companies that are listed on their securities markets to use IFRS. E. There are two primary methods used by countries to incorporate IFRS into their financial reporting requirements for listed companies: (1) full adoption of IFRS as issued by the IASB, without any intervening review or approval by a local body, and (2) adoption of IFRS after some form of national or multinational review and approval process. F. The IASB created IFRS for SMEs in 2009 (revised in 2015), which is a simplified version of full IFRS intended to be used by non-public companies. V.

IFRS 1, First-time Adoption of IFRS, established guidelines that a company must use in transitioning from previously-used GAAP to IFRS. A. Companies transitioning to IFRS must prepare an opening balance sheet at the ―date of transition.‖ The transition date is the beginning of the earliest period for which an entity presents full comparative information under IFRS. For example, for a company preparing its first set of financial statements for the calendar year 2024, the date of transition is January 1, 2023. B. An entity must complete the following steps to prepare the opening IFRS balance sheet: 1. Determine applicable IFRS accounting policies based on standards in force on the reporting date. 2. Recognize assets and liabilities required to be recognized under IFRS that were not recognized under previous GAAP and derecognize assets and liabilities previously recognized that are not allowed to be recognized under IFRS. 3. Measure assets and liabilities recognized on the opening balance sheet in accordance with IFRS. 4. Reclassify items previously classified in a different manner from what is acceptable under IFRS.

VI.

IAS 8, “Accounting Policies, Changes in Accounting Estimates and Errors,‖ establishes guidelines for determining appropriate IFRS accounting policies. A. Companies must use the following hierarchy to determine accounting policies that will be used in preparing IFRS financial statements. 1. Apply specifically relevant standards (IASs, IFRSs, or Interpretations) dealing with an accounting issue. 13-20 © McGraw Hill LLC. All rights reserved. No reproduction or distribution without the prior written consent of McGraw Hill LLC.

Chapter 13 – Accounting for Legal Reorganizations and Liquidations – Hoyle, Schaefer, Doupnik, Advanced Accounting, 15e

2. Refer to other IASB standards dealing with similar or related issues. 3. Refer to the definitions, recognition criteria, and measurement concepts in the IASB Conceptual Framework. 4. Consider the most recent pronouncements of other standard-setting bodies that use a similar conceptual framework, other accounting literature, and accepted industry practice to the extent that these do not conflict with sources in 2. and 3. above. B. Because the FASB and IASB conceptual frameworks are similar, step 4 provides an opportunity for entities to adopt FASB standards in dealing with accounting issues where steps 1 through 3 are not helpful. VII.

The U.S. FASB adopted a strategy of convergence with IASB standards. A. In 2002, the IASB and FASB signed the so-called ―Norwalk Agreement‖ to ―use their best efforts to (a) make their existing financial reporting standards fully compatible as soon as is practicable and (b) coordinate their work program to ensure that once achieved, compatibility is maintained.‖ B. The FASB-IASB convergence process resulted in changes made to U.S. GAAP, IFRS, or both in a number of areas including: Share-based payment, Discontinued operations, Segment reporting, Business combinations, Borrowing costs, Joint ventures, Fair value measurement, and Revenue recognition. C. Topics on which the Boards were unable to identify a common solution include: Impairment, Derecognition, Income taxes, Research and development, Postemployment benefits, Insurance contracts, and Leases. D. The FASB and IASB completed their formal convergence process in 2016, and the Boards have no plans to work together on future projects.

VIII.

The U.S. SEC‘s early interest in IFRS stemmed from IOSCO‘s endorsement of IFRS for cross-listing purposes. A. After considering this issue for several years, in 2007 the SEC amended its rules to allow foreign registrants to prepare financial statements in accordance with IFRS without reconciliation to U.S. GAAP. Since 2007, foreign companies using IFRS have been able to list securities on U.S. securities markets without providing any U.S. GAAP information in their annual reports. B. To level the playing field for U.S. companies, in July 2007, the SEC issued a concept release to determine public interest in allowing U.S. companies to choose between IFRS and U.S. GAAP in preparing financial statements. Many comment letter writers were not in favor of allowing U.S. companies to choose between IFRS and U.S. GAAP instead recommending that U.S. companies be required to use IFRS. C. In November 2008, the SEC issued the so-called ―IFRS Roadmap.‖ The SEC indicated it would monitor several milestones until 2011 at which time it would decide whether to require U.S. companies to follow IFRS over a three-year phase-in period. The Roadmap indicated 2014 as the first year of IFRS adoption, but a subsequent SEC Release in February 2010 pushed that date back to ―approximately 2015 or 2016.‖ D. In 2011, the SEC Staff published a discussion paper that suggested an alternative framework for incorporating IFRS into the U.S. financial reporting system. This framework combines the existing FASB-IASB convergence project with the endorsement process followed in many countries and the EU. Some refer to this method as ―condorsement.‖ E. The 2011 deadline established by the SEC in its IFRS Roadmap came and went without the Commission making a decision whether to require the use of IFRS in the U.S. In July 2012, the SEC staff issued a Final Staff Report that summarized analysis 13-21 © McGraw Hill LLC. All rights reserved. No reproduction or distribution without the prior written consent of McGraw Hill LLC.

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conducted by the SEC Staff on the possible use of IFRS by U.S. companies, but it did not include conclusions or recommendation for action by the Commission and did not provide insight into the nature or timetable for next steps. F. Since 2015, the SEC chief accountants have indicated on several occasions that the SEC is unlikely in the foreseeable future to recommend requiring or allowing the use of IFRS by U.S. publicly traded companies. IX.

Numerous differences exist between IFRS and U.S. GAAP. A. Differences exist with respect to recognition, measurement, presentation, and disclosure. Exhibit 11.8 lists several key differences. B. IAS 1, ―Presentation of Financial Statements,‖ provides guidance with respect to the purpose of financial statements, components of financial statements, basic principles and assumptions, and the overriding principle of fair presentation. There is no equivalent to IAS 1 in U.S. GAAP.

Many foreign subsidiaries of U.S.-based companies use IFRS to prepare financial statements, and these must be converted to U.S. GAAP before they can be consolidated. A. As a result, many U.S. accountants involved in the preparation of consolidated financial statements need to be able to convert IFRS financial statement balances to U.S. GAAP. B. Conversion from IFRS to U.S. GAAP is not as simple as converting, say, from kilometers to miles. C. Converting financial statements from IFRS to U.S. GAAP requires an expertise in both sets of accounting standards, as well as the analytical ability to determine how to get from point A (IFRS) to point B (U.S. GAAP).

XI.

Even if all countries adopt a similar set of accounting standards, two obstacles remain in achieving the goal of worldwide comparability of financial statements. A. IFRS must be translated into languages other than English to be usable by nonEnglish speaking preparers of financial statements. It is difficult to translate some words and phrases into other languages without a distortion of meaning. B. Culture can affect the manner in which an accountant interprets and applies an accounting standard. Differences in culture can lead to differences in application of the same standard across countries.

Answer to Discussion Question: Which Accounting Method Really is Appropriate? Students in the United States often assume that U.S. GAAP is superior and that all reporting issues can (or should) be resolved by following U.S. rules. However, the reporting of research and development costs is a good example of a rule where different approaches can be justified and the U.S. rule might be nothing more than an easy method to apply. In the United States, except for computer software development, all development costs are expensed as incurred because of the difficulty of assessing the future value of these projects. International Financial Reporting Standards (IFRS) requires capitalization of development costs when certain criteria are met. The issue is not whether costs that will have future benefits should be capitalized. Most accountants around the world would recommend capitalizing a cost that leads to future revenues that are in excess of that cost. The real issue is whether criteria can be developed for identifying projects that will lead to the recovery of those costs. In the U.S., the FASB felt that such decisions were too subjective and open to manipulation.

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Conversely, under IFRS, development costs must be recognized as an intangible asset when an enterprise can demonstrate all of the following: (a) the technical feasibility of completing the intangible asset so that it will be available for use or sale; (b) its intention to complete the intangible asset and use or sell it; (c) its ability to use or sell the intangible asset; (d) how the intangible asset will generate probable future economic benefits. Among other things, the enterprise should demonstrate the existence of a market for the output of the intangible asset or the existence of the intangible asset itself or, if it is to be used internally, the usefulness of the intangible asset; (e) the availability of adequate technical, financial and other resources to complete the development and to use or sell the intangible asset; and (f) its ability to measure the expenditure attributable to the intangible asset during its development reliably. The IFRS treatment of development costs begs the question: How easy is it for an accountant to determine whether the development project will result in an intangible asset, such as a patent, that will generate future economic benefits? In U.S. GAAP, a conservative approach has been taken because of the difficulty of determining whether an asset has been or will be created. To ensure comparability, all companies are required to expense all R&D costs. As a result, costs related to development costs that prove to be very valuable to a company for years to come are expensed immediately. Do the benefits of consistency and comparability (each company expenses all costs each year) outweigh the cost of producing financial statements that might omit valuable assets from the balance sheet? No definitive answer exists for this question. In any case, users of financial statements need to be aware of the fundamental differences in approach that exist in accounting for development costs before making comparisons between companies using different accounting standards. Answers to Questions 1. The five factors most often cited as affecting a country's accounting system are: (1) legal system, (2) taxation, (3) providers of financing, (4) inflation, and (5) political and economic ties. The legal system is primarily related to how accounting principles are established; code law countries generally having legislated accounting principles and common law countries having principles established by non-legislative means. In some countries, financial statements serve as the basis for taxation and in other countries they do not. In those countries with a close linkage between accounting and taxation, accounting practice tends to be more conservative so as to reduce the amount of income subject to taxation. Shareholders are a major provider of financing in some countries. As shareholder financing increases in importance, the demand for information made available outside the company becomes greater. In those countries in which family members, banks, and the government are the major providers of business finance, there tends to be less demand for public accountability and information disclosure. Historically, chronic high inflation caused some countries, especially in Latin America, to develop accounting principles in which traditional historical cost accounting is abandoned in favor of inflation adjusted figures. Because inflation has been brought under control in most countries of the world, this factor is no longer of much significance. Political and economic ties can explain the usage of a British style of accounting throughout most of the former British empire. More recently, the European Union (a political and economic union of European nations) has forced all member nations to adopt IFRS for public companies.

Chapter 13 – Accounting for Legal Reorganizations and Liquidations – Hoyle, Schaefer, Doupnik, Advanced Accounting, 15e

2. Problems caused by accounting diversity for a company like Nestlé include: (a) the additional cost associated with restating foreign GAAP financial statements of foreign subsidiaries to parent company GAAP to prepare consolidated financial statements, (b) the additional cost associated with preparing Nestlé financial statements in foreign GAAP (or reconciling to foreign GAAP) to gain access to foreign capital markets, and (c) difficulty in understanding and comparing financial statements of potential foreign acquisition targets. 3. Several of the IASC‘s original standards were criticized for allowing too many alternative methods of accounting for a particular item. As a result, through the selection of different acceptable options, the financial statements of two companies following International Accounting Standards still might not have been comparable. To enhance the comparability of financial statements prepared in accordance with International Accounting Standards, and at the urging of the International Organization of Securities Commissions, the IASC systematically reviewed its existing standards (in the so-called Comparability Project) and revised ten of them by eliminating previously acceptable alternatives. 4. A major difference between the IASB and the IASC is the composition of the Board and the manner in which Board members are selected. IASB has at least 13 and as many as 16 fulltime members, the IASC had zero. Full-time IASB members must sever their employment relationships with former employers and must maintain their independence. This was not the case for IASC members, who typically were practicing accountants. The most important criterion for appointment to the IASB is technical competence, which was not the case with the IASC. (Although not stated in the body of the chapter, there was a perception that some appointments to the IASC were based on political connections and not competence.) [Some of the common features of the IASC and IASB are that both (a) issue/d ―international standards,‖ (b) have/had their headquarters in London, and (c) use/d English as the working language.] 5. IFRS are made up of:  International Financial Reporting Standards (IFRSs) issued by the IASB.  International Accounting Standards (IASs) issued by the IASC (and adopted by the IASB).  Interpretations issued by the International Financial Reporting Interpretations Committee (IFRICs).  Interpretations issued by the Standing Interpretations Committee (SICs) (and adopted by the IASB) 6. There are a number of ways in which a country could use IFRS, including: a. adopt IFRS as its national GAAP, b. require domestic listed companies to use IFRS in preparing their consolidated financial statements, c. permit domestic listed companies to use IFRS, d. require or allow foreign companies listed on a domestic stock exchange to use IFRS. 7. IFRS for SMEs was created as a simplified version of full IFRS to be used by small and medium sized enterprises that typically are not publicly traded. IFRS for SMEs does not require several complicated accounting treatments found in full IFRS, such as goodwill impairment testing and capitalization of borrowing costs, and does not allow use of the revaluation model available in full IFRS. Topics in full IFRS might be omitted from IFRS for SMEs or might be modified for SMEs (for example, goodwill is amortized over its useful life under IFRS for SMEs and is instead tested for impairment in full IFRS. IFRS for SMEs requires approximately 300 disclosures as compared to 3,000 disclosures required by full 13-24 © McGraw Hill LLC. All rights reserved. No reproduction or distribution without the prior written consent of McGraw Hill LLC.

Chapter 13 – Accounting for Legal Reorganizations and Liquidations – Hoyle, Schaefer, Doupnik, Advanced Accounting, 15e

IFRS. 8. This statement is true in that EU publicly traded companies are required to use IFRS in preparing consolidated financial statements. It is false in that non-public companies in most EU nations are not required to use IFRS and publicly traded companies in some EU countries do not use IFRS in preparing their separate parent company only financial statements. Instead, these companies use local GAAP. 9. The bottom section of Exhibit 11.5 shows the countries as of January 2022 that do not allow publicly-traded domestic companies to use IFRS in preparing consolidated financial statements. The most economically important countries in this group are the United States and China. However, China has substantially converged its national standards with IFRS. 10. When adopting IFRS, a company must prepare an ―IFRS opening balance sheet‖ at the date of transition. The date of transition is the beginning of the earliest period for which comparative information must be presented, i.e., two years prior to the ―reporting date.‖ A company must follow five steps in preparing its IFRS opening balance sheet: 1. Determine applicable IFRS accounting policies based on standards that will be in force on the reporting date. 2. Recognize assets and liabilities required to be recognized under IFRS that were not recognized under prior GAAP, and derecognize assets and liabilities recognized under prior GAAP that are not allowed to be recognized under IFRS. 3. Measure assets and liabilities recognized on the IFRS opening balance sheet in accordance with IFRS (that will be in force on the reporting date). 4. Reclassify items previously classified in a different manner from what is acceptable under IFRS. 5. Comply with all disclosure and presentation requirements. 11. According to the accounting policy hierarchy in IAS 8, if a company is faced with an accounting issue for which (a) there is no specific IASB standard that applies, (b) there are no IASB standards on related issues, and (c) reference to the IASB‘s Framework does not help in determining an appropriate accounting treatment, then the company should consider the most recent pronouncements of other standard-setting bodies that use a similar conceptual framework. The FASB‘s conceptual framework is similar to the IASB‘s, so reference to FASB pronouncements would be acceptable under IAS 8 when conditions (a), (b), and (c) exist. 12. IFRS 1 requires an entity transitioning to IFRS to prepare an IFRS opening balance sheet two years prior to the first IFRS reporting date. To be able to prepare the IFRS opening balance sheet, an entity would have to begin gathering information on GAAP differences earlier than two years prior to the first IFRS reporting date. For example, an entity planning to publish IFRS financial statements for the year ended December 31, 2025, would need to begin the process sometime during 2023 at the very latest. 13. The extreme approaches that a company might follow in determining appropriate accounting policies for preparing its initial set of IFRS financial statements are: 1. Adopt accounting policies acceptable under IFRS that minimize change from existing accounting policies used under current GAAP. 2. Take a fresh start, clean slate approach and develop accounting policies acceptable under IFRS that will result in financial statements that reflect the economic substance of transactions and present the most economically meaningful information possible.

Chapter 13 – Accounting for Legal Reorganizations and Liquidations – Hoyle, Schaefer, Doupnik, Advanced Accounting, 15e

14. In the Norwalk Agreement, the IASB and FASB agreed to ―use their best efforts to (a) make their existing financial reporting standards fully compatible as soon as is practicable and (b) coordinate their work program to ensure that once achieved, compatibility is maintained.‖ 15. The IASB-FASB convergence process was successful in that it resulted in the Boards adopting a common approach in several areas. In some cases, the IASB adopted the U.S. GAAP approach, in other cases, the FASB adopted the IFRS approach, and there are a number of issues on which the Boards have jointly developed a new approach. Areas in which the convergence process reduced existing differences between IFRS and U.S. GAAP include: Share-based payment, Discontinued operations, Segment reporting, Business combinations, Borrowing costs, Joint ventures, Fair value measurement, and Revenue recognition. The convergence process was unsuccessful in several areas in which the Boards tried but were unable to identify a common solution, including: Impairment, Derecognition, Income taxes, Research and development, Post-employment benefits, Insurance contracts, and Leases. In these areas, differences between IFRS and U.S. GAAP continue to exist. 16. Since 2007, foreign companies listed on U.S. stock exchanges may file IFRS financial statements with the U.S. SEC without providing any reconciliation to U.S. GAAP. Domestic companies listed on U.S. stock exchanges must file financial statements with the SEC prepared in accordance with U.S. GAAP. 17. In U.S. companies with foreign subsidiaries that use IFRS, U.S. accountants work on converting IFRS financial statements provided by the foreign subsidiaries to U.S. GAAP. Conversely, in U.S. companies that are subsidiaries of a foreign parent that uses IFRS, U.S. accountants provide financial statement information to the parent based on IFRS. In addition, U.S. auditors use IFRS when auditing parent or subsidiary companies that report in IFRS. 18. Recognition differences between IFRS and U.S. GAAP include:  Recognition of development costs as an intangible asset under IFRS when certain criteria are met, which is not acceptable under U.S. GAAP (except for computer software development costs).  Recognition of contingent losses when more likely than not under IFRS and when probable under U.S. GAAP.  Difference in the determination of whether an asset is impaired. 19. Measurement differences between IFRS and U.S. GAAP include:  Acceptable use of LIFO under U.S. GAAP, but not IFRS.  Reversal of inventory writedowns allowed under IFRS, but not under U.S. GAAP.  Revaluation of property, plant, and equipment allowed under IFRS, but not under U.S. GAAP.  Use of component depreciation required under IFRS, but not under U.S. GAAP  Subsequent reversal of impairment losses allowed by IFRS, but not U.S. GAAP. 20. Classification differences between IFRS and U.S. GAAP include:  Compound financial instruments are split into liability and equity components under IFRS but are classified as liabilities only under U.S. GAAP.  Bank overdrafts are a reduction in cash and cash equivalents under IFRS but are classified as liabilities under U.S. GAAP.  Interest paid may be classified as operating or financing in the statement of cash flows

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under IFRS, but must be classified as operating under U.S. GAAP 21. Even if all countries adopt a similar set of accounting standards, two obstacles remain in achieving the goal of worldwide comparability of financial statements.  First, IFRS must be translated into languages other than English to be usable by nonEnglish speaking preparers of financial statements. It is difficult to translate some words and phrases found in IFRS into non-English languages without a distortion of meaning.  Second, culture can affect the manner in which accountants interpret and apply accounting standards. Differences in culture can lead to differences in how the same standard is applied across countries.

Chapter 13 – Accounting for Legal Reorganizations and Liquidations – Hoyle, Schaefer, Doupnik, Advanced Accounting, 15e

Answers to Problems

1. B 2. C 3. D 4. C 5. D 6. C 7. A 8. D 9. B 10. A 11. B 12. D 13. D 14. D 15. D 16. A 17. C Problems 18-24 require IFRS balances to be converted to U.S. GAAP. Note that the solutions provided here for Problems 18-24 also include a partial conversion worksheet to show how the conversion entry correctly converts IFRS balances to U.S. GAAP. The problems do NOT require students to prepare a partial conversion worksheet.

18.(20 minutes) (Compound Financial Instruments – Convertible Bonds) Note: Other than dates, percentages, number of years, and present value factors, all amounts are in lira.

Chapter 13 – Accounting for Legal Reorganizations and Liquidations – Hoyle, Schaefer, Doupnik, Advanced Accounting, 15e

Under IFRS, convertible bonds are a compound financial instrument that must be split into separate debt and equity components based upon their fair values. The fair value of the debt component is equal to the present value of a similar bond without a conversion feature; such bonds pay interest of 12%. Thus, Izmir‘s bond must be discounted at 12% to determine the fair value of the debt component. Present value of 100,000, 10-year bonds, 12% discount rate PV of face value of bonds 100,000 × 0.3219732

PV of annuity of annual interest payments (100,000 × 10% = 10,000) 10,000 × 5.6502230 Fair value of the debt component of the convertible bonds Fair value of bonds (in total) (selling price) Fair value of debt component (above) Fair value of equity component (residual)

= 32,197 = 56,502 88,699

100,000 88,699 11,301

IFRS 12/31/24

Cash Bonds Payable Additional Paid-in Capital-Convertible Bonds

100,000 88,699 11,301

Under U.S. GAAP, bonds are not split into separate debt and equity components but are treated solely as debt. 18. (continued) U.S. GAAP 12/31/24

Cash Bonds Payable

100,000 100,000

To convert from IFRS to U.S. GAAP on 12/31/24, the equity component of the convertible bonds must be reclassified as debt. Conversion Entry 12/31/24

Additional Paid-in Capital-Convertible Bonds Bonds Payable

11,301 11,301

Conversion Entry Debit Credit

U.S. GAAP 100,000

Chapter 13 – Accounting for Legal Reorganizations and Liquidations – Hoyle, Schaefer, Doupnik, Advanced Accounting, 15e

Total assets Bonds Payable Total liabilities Additional Paid-in Capital Total liabilities and equity

100,000 (88,699) (88,699) (11,301) (100,000)

11,301 11,301 11,301

11,301

100,000 (100,000) (100,000) -0(100,000)

Note: Parentheses reflect credit balances. 2025

The same conversion entry made on 12/31/24 also would be made on 12/31/25, and every year after that until the bonds are repaid. 19.(30 minutes) (Property, Plant, and Equipment – Component Depreciation) Note: Other than dates and number of years, all amounts are in rupees. Under IFRS, a depreciable asset comprised of components with different useful lives and/or salvage values must be depreciated on a component basis. Thus, Surat has determined depreciation expense should be 1,000,000 rupees as shown here (amounts are in rupees): Component Fuselage Engines Interior Total

Cost 10,000,000 15,000,000 5,000,000 30,000,000

Useful Life 40 years 30 years 20 years

Depreciation 250,000 500,000 250,000 1,000,000

The U.S. parent of Surat does not depreciate assets on a component basis, but instead depreciates assets over their useful life as a whole. Thus, depreciation expense under U.S. GAAP would be 750,000 (30,000,000 ÷ 40 years). The journal entries in 2023 under the two sets of standards are as follows: IFRS 1/1/23

Aircraft Cash

30,000,000 30,000,000

12/31/23

Depreciation Expense Accumulated Depreciation–Aircraft

1,000,000 1,000,000

U.S. GAAP 1/1/23

Aircraft Cash

30,000,000 30,000,000

12/31/23

Chapter 13 – Accounting for Legal Reorganizations and Liquidations – Hoyle, Schaefer, Doupnik, Advanced Accounting, 15e

Depreciation Expense Accumulated Depreciation–Aircraft

750,000 750,000

The entry needed to properly convert the IFRS balances to U.S. GAAP is: Conversion Entry 12/31/23

Accumulated Depreciation–Aircraft Depreciation Expense

250,000 250,000

19. (continued) [Note: The 12/31/23 partial conversion worksheet below summarizes the above entries, and shows that the conversion entry results in the correct amounts being reported in the U.S. GAAP column.] Partial Conversion Worksheet, 12/31/23 (amounts in rupees) Account IFRS Depreciation expense 1,000,000 Net income, 2023 1,000,000 Retained earnings, 1/1/23 -0Retained earnings, 12/31/23 1,000,000 Cash (30,000,000) Aircraft 30,000,000 Accumulated depreciation–Aircraft (1,000,000) Total assets (1,000,000) Total liabilities -0Retained earnings, 12/31/23 (above) 1,000,000 Total liabilities and equity 1,000,000

Conversion Entry Debit Credit 250,000

250,000

U.S. GAAP 750,000 750,000 -0750,000 (30,000,000) 30,000,000 (750,000) (750,000) -0750,000 750,000

Note: Parentheses reflect credit balances.

The following journal entries are made in 2024 to record depreciation. IFRS 12/31/24

Depreciation Expense Accumulated Depreciation–Aircraft

1,000,000 1,000,000

U.S. GAAP 12/31/24

Depreciation Expense Accumulated Depreciation–Aircraft

750,000 750,000

From a U.S. GAAP perspective, 2024 depreciation expense is overstated by 250,000, 12/31/24 accumulated depreciation is overstated by 500,000, and the beginning balance in retained earnings (at 1/1/24) is understated by 250,000. The following entry converts the IFRS balances to U.S. GAAP. 13-31 © McGraw Hill LLC. All rights reserved. No reproduction or distribution without the prior written consent of McGraw Hill LLC.

Chapter 13 – Accounting for Legal Reorganizations and Liquidations – Hoyle, Schaefer, Doupnik, Advanced Accounting, 15e

Conversion Entry 12/31/24

Accumulated Depreciation–Aircraft Depreciation Expense Retained Earnings, 1/1/24

500,000 250,000 250,000

19. (continued) [Note: The 12/31/24 partial conversion worksheet below summarizes the above entries, and shows that the conversion entry results in the correct amounts being reported in the U.S. GAAP column.] Partial Conversion Worksheet, 12/31/24 (amounts in rupees) Account IFRS Depreciation expense 1,000,000 Net income, 2024 1,000,000 Retained earnings, 1/1/24 1,000,000 Retained earnings, 12/31/24 2,000,000 Cash (30,000,000) Aircraft 30,000,000 Accumulated depreciation–Aircraft (2,000,000) Total assets (2,000,000) Total liabilities -0Retained earnings, 12/31/24 (above) 2,000,000 Total liabilities and equity 2,000,000

Conversion Entry Debit Credit 250,000 250,000

500,000

U.S. GAAP 750,000 750,000 750,000 1,500,000 (30,000,000) 30,000,000 (1,500,000) (1,500,000) -01,500,000 1,500,000

Note: Parentheses reflect credit balances.

20. (30 minutes) (Defined Benefit Plan – Past Service Cost) Note: Other than dates and number of years, all amounts are in yuan. Under IFRS, past service cost is recognized as expense in net income in the period in which the defined benefit plan is amended. IFRS 1/1/23

Past Service Cost Expense Defined Benefit Obligation

60,000 60,000

Under U.S. GAAP, past (prior) service cost is deferred in AOCI and then amortized to net income over the remaining service life of employees affected by the plan amendment, which is 15 years in this case. U.S. GAAP 1/1/23

Deferred Past Service Costs (AOCI) Defined Benefit Obligation

60,000 60,000

Chapter 13 – Accounting for Legal Reorganizations and Liquidations – Hoyle, Schaefer, Doupnik, Advanced Accounting, 15e

12/31/23

Past Service Cost Expense Deferred Past Service Cost (AOCI)

4,000 4,000

From a U.S. GAAP perspective, IFRS overstates past service cost expense by 56,000 and understates AOCI by 56,000. The following entry converts from IFRS to U.S. GAAP. Conversion Entry 12/31/23

Deferred Past Service Cost (AOCI) Past Service Cost Expense

56,000 56,000

20. (continued) [Note: The 12/31/23 partial conversion worksheet below summarizes the above entries, and shows that the conversion entry results in the correct amounts being reported in the U.S. GAAP column.] Partial Conversion Worksheet, 12/31/23 (amounts in yuan) Account Past service cost expense Net income, 2023 Retained earnings, 1/1/23 Retained earnings, 12/31/23 Deferred past service cost AOCI, 1/1/23 AOCI, 12/31/23 Total assets Defined benefit obligations Total liabilities AOCI, 12/31/23 (above) Retained earnings, 12/31/23 (above) Total liabilities and equity

IFRS 60,000 60,000 -060,000 -0-0-0-0(60,000) (60,000)

Conversion Entry Debit Credit 56,000

56,000

60,000 -056,000

U.S. GAAP 4,000 4,000 -04,000 56,000 -056,000 -0(60,000) (60,000) 56,000 4,000 -0-

56,000

Note: Parentheses reflect credit balances.

The 2024 journal entries under IFRS and U.S. GAAP to account for the past service cost are as follows: IFRS 2024

No entries are needed. Past service cost was fully expensed in 2023. U.S. GAAP 12/31/24

Past Service Cost Expense Deferred Past Service Cost (AOCI)

4,000 4,000

Chapter 13 – Accounting for Legal Reorganizations and Liquidations – Hoyle, Schaefer, Doupnik, Advanced Accounting, 15e

From a U.S. GAAP perspective, IFRS understates expenses in 2024 by 4,000, understates beginning retained earnings by 56,000, understates the negative balance in beginning AOCI by 56,000, and understates the negative ending balance in AOCI by 52,000. 20. (continued) Conversion Entries 12/31/24

(1) AOCI, 1/1/24 Retained Earnings, 1/1/24

56,000 56,000

(2) Past Service Cost Expense Deferred Past Service Cost (AOCI)

4,000 4,000

[Note: The 12/31/24 partial conversion worksheet below summarizes the above entries, and shows that the conversion entries result in the correct amounts being reported in the U.S. GAAP column.] Partial Conversion Worksheet, 12/31/24 (amounts in yuan) Account Past service cost expense Net income, 2024 Retained earnings, 1/1/24 Retained earnings, 12/31/24 Deferred past service cost (AOCI) AOCI, 1/1/24 AOCI, 12/31/24 Total assets Defined benefit obligations Total liabilities AOCI, 12/31/24 (above) Retained earnings, 12/31/24 (above) Total liabilities and equity

IFRS -0-060,000 60,000 -0-0-0-0(60,000) (60,000) -060,000 -0-

Conversion Entries Debit Credit (2) 4,000 (1) 56,000 (2) 4,000 (1) 56,000

60,000

U.S. GAAP 4,000 4,000 4,000 8,000 (4,000) 56,000 52,000 -0(60,000) (60,000) 52,000 8,000 -0-

60,000

Note: Parentheses reflect credit balances.

The entries needed to convert the IFRS balances to a U.S. GAAP basis are as follows: 21.(20 minutes) (Intangible Asset – Impairment) Note: Other than dates, all amounts are in markkas. Under IFRS, an asset is impaired when its carrying amount exceeds its recoverable amount, which is the larger of net selling price and value in use. Mikkeli correctly determines an impairment loss on the brand as follows: Carrying amount

40,000 13-34

Chapter 13 – Accounting for Legal Reorganizations and Liquidations – Hoyle, Schaefer, Doupnik, Advanced Accounting, 15e

Recoverable amount (1) Net selling price (Selling price less costs to sell) (2) Value in use (PV of future cash flows) Recoverable amount (larger of (1) and (2)) Impairment loss

35,000 34,000

35,000 5,000

The following journal entry is made. IFRS 12/31/24

Impairment Loss Brand

5,000

Under U.S. GAAP, the carrying amount of an asset is first compared with the future cash flows (undiscounted) to be generated from the asset to determine if an impairment exists. Carrying amount 40,000 Future cash flows (undiscounted) 42,000 Because future cash flows exceed carrying amount, the brand is not impaired under U.S. GAAP. U.S. GAAP 12/31/24

No entries are needed. The entry to convert from IFRS to U.S. GAAP simply reverses the impairment loss entry made under IFRS. Conversion Entry 12/31/24

Brand Impairment Loss

5,000 5,000

21. (continued) [Note: The 12/31/24 partial conversion worksheet below summarizes the above entries, and shows that the conversion entry results in the correct amounts being reported in the U.S. GAAP column.] Partial Conversion Worksheet, 12/31/24 (amounts in markkas) Account Impairment loss Net income Retained earnings, 1/1/24 Retained earnings, 12/31/24 Cash Brand (net) Total assets

IFRS 5,000 5,000 -05,000 (40,000) 35,000 (5,000)

Conversion Entries Debit Credit 5,000

5,000

U.S. GAAP -0-0-0-0(40,000) 40,000 -0-

Chapter 13 – Accounting for Legal Reorganizations and Liquidations – Hoyle, Schaefer, Doupnik, Advanced Accounting, 15e

Total liabilities Retained earnings, 12/31/24 (above) Total liabilities and equity

-05,000 5,000

-0-0-05,000

5,000

Note: Parentheses reflect credit balances.

Possible extension of this problem to 2025 Although the problem only requires entry(ies) at 12/31/24, instructors might want to ask students to think about what entry(ies), if any, would be made at 12/31/25, assuming that the Brand has suffered no further impairment in 2025. In that case, the following conversion entry would be made on 12/31/25. Conversion Entry 12/31/25

Brand Retained Earnings, 1/1/25

5,000 5,000

22.(20 minutes) (Intangible Asset – Research and Development Cost) Note: Other than dates, number of years, and percentages, all amounts are in krone. Under IFRS, 250,000 (1,000,000 × 25%) of development costs incurred in 2023 are capitalized as a finite-lived intangible asset. However, amortization does not begin until the product generated by the intangible asset is brought to market in January 2024. IFRS 2023

Development Expense Intangible Asset Cash

750,000 250,000

1,000,000

Under U.S. GAAP, the entire 1,000,000 of development costs incurred in 2023 are expensed. U.S. GAAP 2023

Development Expense Cash

1,000,000 1,000,000

To convert from IFRS to U.S. GAAP the following conversion entry must be made. Conversion Entry 12/31/23

Development Expense Intangible Asset

250,000

Chapter 13 – Accounting for Legal Reorganizations and Liquidations – Hoyle, Schaefer, Doupnik, Advanced Accounting, 15e

[Note: The 12/31/23 partial conversion worksheet below summarizes the above entries, and shows that the conversion entry results in the correct amounts being reported in the U.S. GAAP column.] Partial Conversion Worksheet, 12/31/23 (amounts in krone) Account Development expense Amortization expense Net income, 2023 Retained earnings, 1/1/23 Retained earnings, 12/31/23 Cash Intangible asset (net) Total assets Total liabilities Retained earnings, 12/31/23 (above) Total liabilities and equity

IFRS 750,000 -0750,000 -0750,000 (1,000,000) 250,000 (750,000) -0750,000 750,000

Conversion Entry Debit Credit 250,000

250,000

U.S. GAAP 1,000,000 -01,000,000 -01,000,000 (1,000,000) -0(1,000,000) -01,000,000 1,000,000

250,000

Note: Parentheses reflect credit balances.

In 2024, related to the development costs incurred in 2023, 50,000 (250,000 ÷ 5 years) of amortization expense is recognized under IFRS. IFRS 12/31/24

Amortization Expense Intangible Asset

50,000

Because all development costs incurred in 2023 were expensed in that year, no entries are needed under U.S. GAAP U.S. GAAP 12/31/24

No entries 22. (continued) The following entry converts the IFRS balances to the amounts needed under U.S. GAAP. Conversion Entry 12/31/24

Retained Earnings, 1/1/24 Intangible Asset Amortization Expense

250,000

200,000 50,000

[Note: The 12/31/24 partial conversion worksheet below summarizes the above entries, and shows that the conversion entry results in the correct amounts being reported in the 13-37 © McGraw Hill LLC. All rights reserved. No reproduction or distribution without the prior written consent of McGraw Hill LLC.

Chapter 13 – Accounting for Legal Reorganizations and Liquidations – Hoyle, Schaefer, Doupnik, Advanced Accounting, 15e

U.S. GAAP column.] Partial Conversion Worksheet, 12/31/24 (credits in parentheses) Account Development expense Amortization expense Net income, 2024 Retained earnings, 1/1/24 Retained earnings, 12/31/24 Cash Intangible asset (net) Total assets Total liabilities Retained earnings, 12/31/24 (above) Total liabilities and equity

IFRS -050,000 50,000 750,000 800,000 (1,000,000) 200,000 (800,000) -0800,000 800,000

Conversion Entry Debit Credit 50,000 250,000 200,000

250,000

U.S. GAAP -0-0-01,000,000 1,000,000 (1,000,000) -0(1,000,000) -01,000,000 1,000,000

250,000

Note: Parentheses reflect credit balances.

23.(20 minutes) (Loss Contingency – Lawsuit) Note: Other than dates and percentages, all amounts are in yen. Under IFRS, because the probability of loss on December 31, 2023, is 55% (i.e., ―more likely than not‖), a loss and related provision (liability) must be recognized. The loss must be recognized at its ―best estimate.‖ IFRS 12/31/23

Litigation Loss Provision for Litigation Loss

4,000,000 4,000,000

Assuming that Sapporo‘s parent company follows the common practice under U.S. GAAP of accruing contingencies only when the probability of loss is 70% or larger, a loss would not be recognized in 2023 under U.S. GAAP. U.S. GAAP 2023

No entries To convert from IFRS to U.S. GAAP, the entry made under IFRS to recognize a litigation loss must be reversed. Conversion Entry 12/31/23

Provision for Litigation Loss Litigation Loss

4,000,000 4,000,000

Chapter 13 – Accounting for Legal Reorganizations and Liquidations – Hoyle, Schaefer, Doupnik, Advanced Accounting, 15e

[Note: The 12/31/39 partial conversion worksheet below summarizes the above entries, and shows that the conversion entry results in the correct amounts being reported in the U.S. GAAP column.] Partial Conversion Worksheet, 12/31/23 (amounts in yen) Account IFRS Litigation loss 4,000,000 Net income, 2023 4,000,000 Retained earnings, 1/1/23 -0Retained earnings, 12/31/23 4,000,000 Cash -0Total assets -0Provision for litigation loss (4,000,000) Total liabilities (4,000,000) Retained earnings, 12/31/23 (above) 4,000,000 Total liabilities and equity -0-

Conversion Entries Debit Credit 4,000,000

4,000,000

U.S. GAAP -0-0-0-0-0-0-0-0-0-0-

4,000,000

Note: Parentheses reflect credit balances.

Under IFRS, when the lawsuit is concluded and payment made on May 5, 2024, an additional 1,000,000 loss must be recognized, as follows: IFRS 5/15/24

Litigation Loss Provision for Litigation Loss Cash

1,000,000 4,000,000

5,000,000

Under U.S. GAAP, the entire payment of 5,000,000 is recognized as a loss at the date of payment: U.S. GAAP 5/15/24

Litigation Loss Cash

5,000,000 5,000,000

From a U.S. GAAP perspective, the IFRS balances understate the amount of litigation loss for 2024 by 4,000,000, and understate the beginning balance in retained earnings by the same amount. The appropriate conversion entry is: 23. (continued) Conversion Entry 12/31/24

Litigation Loss Retained Earnings, 1/1/24

4,000,000 4,000,000

Chapter 13 – Accounting for Legal Reorganizations and Liquidations – Hoyle, Schaefer, Doupnik, Advanced Accounting, 15e

[Note: The 12/31/24 partial conversion worksheet below summarizes the above entries, and shows that the conversion entry results in the correct amounts being reported in the U.S. GAAP column.] Partial Conversion Worksheet, 12/31/24 (amounts in yen) Account IFRS Litigation loss 1,000,000 Net income 1,000,000 Retained earnings, 1/1/24 4,000,000 Retained earnings, 12/31/24 5,000,000 Cash (5,000,000) Total assets (5,000,000) Provision for litigation loss -0Total liabilities -0Retained earnings, 12/31/24 (above) 5,000,000 Total liabilities and equity 5,000,000

Conversion Entry Debit Credit 4,000,000 4,000,000

4,000,000

U.S. GAAP 5,000,000 5,000,000 -05,000,000 (5,000,000) (5,000,000) -0-05,000,000 5,000,000

4,000,000

Note: Parentheses reflect credit balances.

24.(40 minutes) (Property, Plant, and Equipment – Revaluation of Equipment) Note: Other than dates and number of years, all amounts are in pesos. Under IFRS, the equipment will be revalued on January 1, 2023. The accumulated depreciation of 50,000 will be eliminated (debit) on that date and the equipment account will be increased (debit) by 40,000 for the difference between its original cost of 500,000 and the revaluation amount of 540,000. The offsetting credit goes to a revaluation surplus account, which is a component of AOCI. On December 31, 2023, depreciation based on the revaluation amount is recognized: 60,000 (540,000 ÷ 9 years). The IFRS journal entries for 2022 and 2023 are shown below. IFRS 1/1/22

Equipment Cash

500,000 500,000

12/31/22

Depreciation Expense Accumulated Depreciation–Equipment

50,000 50,000

1/1/23

50,000 40,000

Accumulated Depreciation–Equipment Equipment Revaluation Surplus (AOCI)

90,000

12/31/23

60,000

Depreciation Expense Accumulated Depreciation–Equipment

60,000 13-40

Chapter 13 – Accounting for Legal Reorganizations and Liquidations – Hoyle, Schaefer, Doupnik, Advanced Accounting, 15e

Carrying amount of Equipment, 12/31/23 (IFRS)

Equipment Accumulated Depreciation–Equipment Net

540,000 (60,000) 480,000

24. (continued) Revaluation is not permitted under U.S. GAAP. The equipment is depreciated at the rate of 50,000 per year. U.S. GAAP 1/1/22

Equipment Cash

500,000 500,000

12/31/22

50,000

Depreciation Expense Accumulated Depreciation–Equipment

50,000

12/31/23

50,000

Depreciation Expense Accumulated Depreciation–Equipment

50,000

Carrying amount of Equipment, 12/31/23 (U.S. GAAP)

Equipment Accumulated Depreciation–Equipment Net

500,000 (100,000) 400,000

From a U.S. GAAP perspective, IFRS overstates Depreciation Expense in 2023 by 10,000, overstates Equipment by 40,000, understates Accumulated Depreciation by 40,000, and overstates AOCI by 90,000. To convert from IFRS to U.S. GAAP the following entry is made on 12/31/23: Conversion Entry 12/31/23

Revaluation Surplus (AOCI) Depreciation Expense Equipment Accumulated Depreciation–Equipment

90,000 10,000 40,000 40,000

24. (continued) [Note: The 12/31/23 partial conversion worksheet below summarizes the above entries, and shows that the conversion entry results in the correct amounts being reported in the U.S. GAAP column.] Partial Conversion Worksheet, 12/31/23 (amounts in pesos) Account

IFRS

Conversion Entry Debit Credit

U.S. GAAP

Chapter 13 – Accounting for Legal Reorganizations and Liquidations – Hoyle, Schaefer, Doupnik, Advanced Accounting, 15e

Depreciation expense Net income, 2023 Retained earnings, 1/1/23 Retained earnings, 12/31/23 Revaluation surplus AOCI, 1/1/23 AOCI, 12/31/23 Cash Equipment Accumulated depreciation–equipment Total assets Total liabilities AOCI, 12/31/23 (above) Retained earnings, 12/31/23 (above) Total liabilities and equity

60,000 60,000 50,000 110,000 (90,000) -0(90,000) (500,000) 540,000 (60,000) (20,000) -0(90,000) 110,000 20,000

10,000

90,000

40,000 40,000

90,000

50,000 50,000 50,000 100,000 -0-0-0(500,000) 500,000 (100,000) (100,000) -0-0100,000 100,000

Note: Parentheses reflect credit balances.

In 2024, an additional 60,000 of depreciation is recognized under IFRS, which results in a carrying amount for Equipment at 12/31/24 of 420,000. IFRS 12/31/24

Depreciation Expense Accumulated Depreciation–Equipment

60,000 60,000

Carrying amount of Equipment, 12/31/24 (IFRS)

540,000 (120,000) 420,000

Equipment Accumulated Depreciation–Equipment Net 24. (continued)

In 2024, an additional 50,000 of depreciation is recognized under U.S. GAAP which results in a carrying amount for Equipment at 12/31/24 of 350,000. U.S. GAAP 12/31/24

Depreciation Expense Accumulated Depreciation–Equipment

50,000 50,000

Carrying amount of Equipment, 12/31/24 (U.S. GAAP)

Equipment Accumulated Depreciation–Equipment Net

500,000 (150,000) 350,000

From a U.S. GAAP perspective, 2024 Depreciation Expense is overstated by 10,000, the beginning balance in Retained Earnings is understated by 10,000, Equipment is

Chapter 13 – Accounting for Legal Reorganizations and Liquidations – Hoyle, Schaefer, Doupnik, Advanced Accounting, 15e

overstated by 40,000, Accumulated Depreciation is understated by 30,000, and AOCI is still overstated by 90,000. The entry to convert from IFRS to U.S. GAAP is as follows: Conversion Entry 12/31/24

Revaluation Surplus (AOCI) Depreciation Expense Retained earnings, 1/1/24 Equipment Accumulated Depreciation–Equipment

90,000 10,000 10,000 40,000 30,000

24. (continued) [Note: The 12/31/24 partial conversion worksheet below summarizes the above entries, and shows that the conversion entry results in the correct amounts being reported in the U.S. GAAP column.] Partial Conversion Worksheet, 12/31/24 (amounts in pesos) Account Depreciation expense Net income, 2024 Retained earnings, 1/1/24 Retained earnings, 12/31/24 AOCI, 1/1/24 AOCI, 12/31/24 Cash Equipment Accumulated depreciation–equipment Total assets Total liabilities AOCI, 12/31/24 (above) Retained earnings, 12/31/24 (above) Total liabilities and equity

IFRS 60,000 60,000 110,000 170,000 (90,000) (90,000) (500,000) 540,000 (120,000) (80,000) -0(90,000) 170,000 80,000

Conversion Entries Debit Credit 10,000 10,000 90,000 40,000 30,000

90,000

U.S. GAAP 50,000 50,000 100,000 150,000 -0-0(500,000) 500,000 (150,000) (150,000) -0-0150,000 150,000

Note: Parentheses reflect credit balances. Problems 25-28 require U.S. GAAP amounts to be converted to IFRS Note that the solutions provided here for Problems 25-28 also include a partial conversion worksheet to show how the conversion entry correctly converts U.S. GAAP balances to IFRS. The problems do NOT require students to prepare a partial conversion worksheet.

25.(20 minutes) (Loss Contingency – Litigation) Summary of Facts: Lawsuit initiated, 2023 Range of possible loss

80% probability of loss $20,000 − $70,000 13-43

Chapter 13 – Accounting for Legal Reorganizations and Liquidations – Hoyle, Schaefer, Doupnik, Advanced Accounting, 15e

Lawsuit settled, 2024

$60,000 payment 2023

U.S. GAAP

In 2023, the company would recognize a litigation loss and litigation liability in the amount of $20,000, the lowest amount in the range of possible loss. 12/31/23

Litigation Loss Litigation Liability

20,000 20,000

IFRS

In 2023, the company would recognize a loss contingency and litigation liability in the amount of $45,000 [($20,000 + $70,000) ÷ 2], the midpoint in the range of possible loss. 12/31/23

Litigation Loss Litigation Liability

45,000 45,000

Conversion from U.S. GAAP to IFRS – 2023

To convert from U.S. GAAP to IFRS an additional loss and liability of $25,000 must be recognized. The following conversion entry is required. 12/31/23

Litigation Loss Litigation Liability

25,000 25,000

25. (continued) [Note: The 12/31/23 partial conversion worksheet below summarizes the above entries, and shows that the conversion entry results in the correct amounts being reported in the IFRS column.] Partial Conversion Worksheet, 12/31/23 (amounts in $) Account Litigation loss Net income, 2023 Retained earnings, 1/1/23 Retained earnings, 12/31/23 Cash Total assets Litigation liability Total liabilities Retained earnings, 12/31/23 (above) Total liabilities and equity

U.S. GAAP 20,000 20,000 -020,000 -0-0(20,000) (20,000) 20,000 -0-

Conversion Entry Debit Credit 25,000

25,000

IFRS 45,000 45,000 -045,000 -0-0(45,000) (45,000) 45,000 -0-

25,000

Note: Parentheses reflect credit balances.

Chapter 13 – Accounting for Legal Reorganizations and Liquidations – Hoyle, Schaefer, Doupnik, Advanced Accounting, 15e

2024 U.S. GAAP

In 2024, the company would recognize an additional litigation loss of $40,000, remove the existing liability of $20,000, and record an outflow of cash of $60,000. 12/31/24

Litigation Loss Litigation Liability Cash

40,000 20,000 60,000

IFRS

In 2024, the company would recognize an additional litigation loss of $15,000, remove the existing liability of $45,000, and record an outflow of cash of $60,000. 12/31/24

Litigation Loss Litigation Liability Cash

15,000 45,000 60,000

25. (continued) Conversion from U.S. GAAP to IFRS – 2024

From an IFRS perspective, U.S. GAAP understates the beginning balance in retained earnings by $25,000, and overstates the 2024 litigation loss by the same amount. 12/31/24

Retained Earnings, 1/1/24 Litigation Loss

25,000 25,000

[Note: The 12/31/24 partial conversion worksheet below summarizes the above entries, and shows that the conversion entry results in the correct amounts being reported in the IFRS column.] Partial Conversion Worksheet, 12/31/24 (amounts in $) Account Litigation loss Net income, 2024 Retained earnings, 1/1/24 Retained earnings, 12/31/24 Cash Total assets Litigation liability Total liabilities Retained earnings, 12/31/24 (above) Total liabilities and equity

U.S. GAAP 40,000 40,000 20,000 60,000 (60,000) (60,000) -0-060,000 60,000

Conversion Entry Debit Credit 25,000 25,000

25,000

IFRS 15,000 15,000 45,000 60,000 (60,000) (60,000) -0-060,000 60,000

25,000

Chapter 13 – Accounting for Legal Reorganizations and Liquidations – Hoyle, Schaefer, Doupnik, Advanced Accounting, 15e

26.(45 minutes) (Property, Plant, and Equipment – Revaluation) Summary of Facts: Equipment Cost, 1/1/23 Residual value, 1/1/23 Useful life, 1/1/23

$78,400 $10,000 6 years

Fair value, 1/1/24 Residual value, 1/1/24 Useful life, 1/1/24

$74,500 $10,000 5 years 2023

U.S. GAAP and IFRS

In 2023, the company would record the acquisition of the equipment at its cost of $78,400 and recognize depreciation of $11,400 [($78,400 – $10,000) ÷ 6 years]. The following entries would be made under both U.S. GAAP and IFRS. No conversion entry is needed. 1/1/23

Equipment Cash

78,400 78,400

12/31/23

Depreciation Expense Accumulated Depreciation–Equipment

11,400 11,400 2024

U.S. GAAP

In 2024, depreciation expense of $11,400 again would be recognized under U.S. GAAP. 12/31/24

Depreciation Expense Accumulated Depreciation–Equipment

11,400 11,400

IFRS

On January 1, 2024, the Equipment would be revalued to its fair value of $74,500. This is accomplished as follows: The 1/1/24 balance in Accumulated Depreciation–Equipment of $11,400 is eliminated, and the Equipment account is written down from its historical cost of $78,400 to its fair value on 1/1/24 of $74,500 (writedown of $3,900). This results in a net increase in the carrying amount of Equipment of $7,500, which is offset by a credit to Revaluation Surplus, a separate component of Accumulated Other Comprehensive Income (AOCI). The journal entry to revalue Equipment under IFRS is: 26. (continued) 1/1/24

Chapter 13 – Accounting for Legal Reorganizations and Liquidations – Hoyle, Schaefer, Doupnik, Advanced Accounting, 15e

Accumulated Depreciation–Equipment Equipment Revaluation Surplus (AOCI)

11,400 3,900 7,500

The new carrying amount of Equipment of $74,500 with a salvage value of $10,000 is depreciated over its remaining useful life of 5 years at the rate of $12,900 per year [($74,500 – $10,000) ÷ 5 years]. Depreciation Expense is recognized on December 31, 2024, as follows: 12/31/24

Depreciation Expense Accumulated Depreciation–Equipment

12,900 12,900

Conversion from U.S. GAAP to IFRS – 2024

From an IFRS perspective, U.S. GAAP: 1. understates 2024 Depreciation Expense by $1,500, 2. understates Revaluation Surplus (AOCI) by $7,500, 3. overstates Equipment by $3,900, and 4. overstates Accumulated Depreciation–Equipment by $9,900. The entries to convert U.S. GAAP balances to IFRS on December 31, 2024, are: 12/31/24

(1) Accumulated Depreciation–Equipment Equipment Revaluation Surplus (AOCI)

11,400 3,900 7,500

(2)

Depreciation Expense Accumulated Depreciation–Equipment

1,500 1,500

26. (continued) [Note: The 12/31/24 partial conversion worksheet below summarizes the above entries, and shows that the conversion entries result in the correct amounts being reported in the IFRS column.] Partial Conversion Worksheet, 12/31/24 (amounts in $) Account Depreciation expense Net income, 2024 Retained earnings, 1/1/24* Retained earnings, 12/31/24 Revaluation surplus (AOCI) AOCI, 1/1/24

U.S. GAAP 11,400 11,400 11,400 22,800 -0-0-

Conversion Entry Debit Credit (2) 1,500

(1) 7,500

IFRS 12,900 12,900 11,400 24,300 (7,500) -0-

Chapter 13 – Accounting for Legal Reorganizations and Liquidations – Hoyle, Schaefer, Doupnik, Advanced Accounting, 15e

AOCI, 12/31/24 Cash Equipment Accumulated depreciation–equipment Total assets Total liabilities AOCI, 12/31/24 (above) Retained earnings, 12/31/24 (above) Total liabilities and equity

-0(78,400) 78,400 (22,800) (22,800) -0-022,800 22,800

(1) 11,400

(1) 3,900 (2) 1,500

12,900

(7,500) (78,400) 74,500 (12,900) (16,800) -0(7,500) 24,300 16,800

Note: Parentheses reflect credit balances.

* Reflects depreciation expense recognized in 2023. 27.(15 minutes) (Intangible Assets – Research and Development Costs) Summary of Facts: Research and Development Costs, 2023 % of 2023 R&D costs capitalizable under IFRS New product developed from 2023 R&D brought to market # of years new product will generate sales revenue

$650,000 30% January 2024 10 years

2023 U.S. GAAP

Under U.S. GAAP, $650,000 of research and development costs would be expensed in 2023. 2023

Research and Development Expense Cash

650,000 650,000

IFRS

In accordance with IAS 38, $455,000 ($650,000 × 70%) of research and development costs would be expensed in 2023, and $195,000 ($650,000 × 30%) of development costs would be capitalized as an intangible asset. The intangible asset will be amortized over its useful life of ten years, but only beginning in 2024 when the newly developed product is brought to market. 2023

Research and Development Expense Deferred Development Cost (Intangible Asset) Cash

455,000 195,000 650,000

Conversion from U.S. GAAP to IFRS – 2023

To convert from U.S. GAAP to IFRS on December 31, 2023, an intangible asset with a carrying amount of $195,000 must be recognized, and net income must be increased by the same amount. The following conversion entry is required.

Chapter 13 – Accounting for Legal Reorganizations and Liquidations – Hoyle, Schaefer, Doupnik, Advanced Accounting, 15e

12/31/23

Deferred Development Cost (Intangible Asset) Research and Development Expense

195,000 195,000

[Note: The 12/31/23 partial conversion worksheet on the next page summarizes the above entries, and shows that the conversion entry results in the correct amounts being reported in the IFRS column.] 27. (continued) Partial Conversion Worksheet, 12/31/23 (amounts in $) Account Development expense Amortization expense Net income, 2023 Retained earnings, 1/1/23 Retained earnings, 12/31/23 Cash Intangible asset (net) Total assets Total liabilities Retained earnings, 12/31/23 (above) Total liabilities and equity

U.S. GAAP 650,000 -0650,000 -0650,000 (650,000) -0(650,000) -0650,000 650,000

Conversion Entry Debit Credit 195,000

195,000

IFRS 455,000 -0455,000 -0455,000 (650,000) 195,000 (455,000) -0455,000 455,000

195,000

Note: Parentheses reflect credit balances.

2024 U.S. GAAP

Because the research and development costs incurred in 2023 were fully expensed in that year, no further entries are required in 2024 under U.S. GAAP. IFRS

In 2024, the company would recognize $19,500 ($195,000 ÷ 10 years) of amortization expense on the intangible asset (deferred development costs) under IFRS. The journal entry is: 12/31/24

Amortization Expense 19,500 Deferred Development Cost (Intangible Asset)

19,500

Conversion from U.S. GAAP to IFRS – 2024

To convert from U.S. GAAP to IFRS at December 31, 2024, an intangible asset with a carrying amount of $175,500 ($195,000 − $19,500) must be recognized, and $19,500 of amortization expense must be recorded. From an IFRS perspective, retained earnings on 1/1/24 is understated by $195,000. The following entries effect this conversion. 12/31/24

Chapter 13 – Accounting for Legal Reorganizations and Liquidations – Hoyle, Schaefer, Doupnik, Advanced Accounting, 15e

Deferred Development Cost (Intangible Asset) Retained Earnings, 1/1/24

195,000 195,000

Amortization Expense 19,500 Deferred Development Cost (Intangible Asset)

19,500

27. (continued) [Note: The 12/31/24 partial conversion worksheet below summarizes the above entries, and shows that the conversion entries result in the correct amounts being reported in the IFRS column.] Partial Conversion Worksheet, 12/31/24 (amounts in $) Account Amortization expense Net income, 2024 Retained earnings, 1/1/24 Retained earnings, 12/31/24 Cash Intangible asset (net) Total assets Total liabilities Retained earnings, 12/31/24 (above) Total liabilities and equity

Conversion Entries U.S. GAAP -0-0650,000 650,000 (650,000) -0(650,000) -0650,000 650,000

Debit (2) 19,500

Credit (1) 195,000

(1) 195,000

(2) 19,500

214,500

IFRS 19,500 19,500 455,000 474,500 (650,000) 175,500 (474,500) -0474,500 474,500

Note: Parentheses reflect credit balances.

28.(20 minutes) (Property, Plant, and Equipment – Impairment) Summary of facts: Cost of equipment, 1/1/23 Salvage value Useful life 5 years Depreciation expense, 2023 Carrying amount, 12/31/23 Expected future cash flows, 12/31/23 PV of expected future cash flows, 12/31/23 Fair value (selling price less costs to dispose), 12/31/23

$135,000 zero $27,000 $108,000 116,000 100,000 96,600

2023 U.S. GAAP

Under U.S. GAAP, an asset is impaired when its carrying amount exceeds the expected future cash flows (undiscounted) to be derived from use of the asset. Expected future cash flows are $116,000, which exceeds the carrying value of $108,000, so the asset is not impaired. Depreciation expense for the year is $27,000 ($135,000 ÷ 5 years), and the

Chapter 13 – Accounting for Legal Reorganizations and Liquidations – Hoyle, Schaefer, Doupnik, Advanced Accounting, 15e

equipment will be carried on the December 31, 2023 balance sheet at $108,000. Beginning of 2023

Equipment Cash

135,000 135,000

12/31/23

Depreciation Expense Accumulated Depreciation–Equipment

27,000 27,000

IFRS

In accordance with IAS 36, ―Impairment of Assets,‖ an asset is impaired when its carrying amount exceeds its recoverable amount, which is the greater of (a) value in use (present value of expected future cash flows), and (b) net selling price, less costs to dispose. The carrying amount of the equipment at December 31, 2023 is $108,000; original cost of $135,000 less accumulated depreciation of $27,000 ($135,000 ’ 5 years). The asset‘s recoverable amount is $100,000 (the higher of value in use of $100,000 and fair value of $96,600), so the asset is impaired. An impairment loss of $8,000 ($108,000 – $100,000) would be recognized at the end of 2023, in addition to depreciation expense for the year of $27,000. The equipment will be carried on the December 31, 2023 balance sheet at $100,000.

Beginning of 2023

Equipment Cash

135,000 135,000

12/31/23

Depreciation Expense Accumulated Depreciation–Equipment

27,000

Impairment Loss Equipment

8,000

27,000 8,000

28. (continued) Conversion from U.S. GAAP to IFRS – 2023

To convert from U.S. GAAP to IFRS on December 31, 2023, an impairment loss of $8,000 must be recognized and the Equipment account must be reduced by the same amount. The following conversion entry is required. 12/31/23

Impairment Loss Equipment

8,000 8,000

[Note: The 12/31/23 partial conversion worksheet below summarizes the above entries, and shows that the conversion entry results in the correct amounts being reported in the IFRS column.] 13-51 © McGraw Hill LLC. All rights reserved. No reproduction or distribution without the prior written consent of McGraw Hill LLC.

Chapter 13 – Accounting for Legal Reorganizations and Liquidations – Hoyle, Schaefer, Doupnik, Advanced Accounting, 15e

Partial Conversion Worksheet, 12/31/23 (amounts in $)

Conversion Entry U.S. GAAP 27,000 -027,000 -027,000 (135,000) 135,000 (27,000) (27,000) -027,000 27,000

Account Depreciation expense Impairment loss Net income, 2023 Retained earnings, 1/1/23 Retained earnings, 12/31/23 Cash Equipment Accumulated depreciation–equipment Total assets Total liabilities Retained earnings, 12/31/23 (above) Total liabilities and equity

Debit

Credit

8,000

IFRS 27,000 8,000 35,000 -035,000 (135,000) 127,000 (27,000) (35,000) -035,000 35,000

8,000

Note: Parentheses reflect credit balances.

2024 U.S. GAAP

Under U.S. GAAP, depreciation of $27,000 is recognized in 2024. 12/31/24

Depreciation Expense Accumulated Depreciation–Equipment

27,000 27,000

28. (continued) IFRS

Under IFRS, equipment has a carrying amount on January 1, 2024 of $100,000 and a remaining useful life of 4 years. Depreciation to be recognized in 2024 is $25,000 ($100,000 ÷ 4 years). 12/31/24

Depreciation Expense Accumulated Depreciation–Equipment

25,000 25,000

Conversion from U.S. GAAP to IFRS – 2024

The 12/31/24 partial conversion worksheet below shows the balances under U.S. GAAP and IFRS. From an IFRS perspective, depreciation expense is overstated by $2,000, retained earnings (1/1/24) is overstated by $8,000, equipment is overstated by $8,000, and accumulated depreciation–equipment is understated by $2,000. The following conversion entries convert the U.S. GAAP balances to the appropriate amounts under IFRS. 12/31/24

Chapter 13 – Accounting for Legal Reorganizations and Liquidations – Hoyle, Schaefer, Doupnik, Advanced Accounting, 15e

Retained Earnings, 1/1/24 Equipment

8,000

Accumulated Depreciation–Equipment Depreciation Expense

2,000

8,000 2,000

[Note: The 12/31/24 partial conversion worksheet below summarizes the above entries, and shows that the conversion entries result in the correct amounts being reported in the IFRS column.] Partial Conversion Worksheet, 12/31/24 (amounts in $) Account Depreciation expense Net income, 2024 Retained earnings, 1/1/24 Retained earnings, 12/31/24 Cash Equipment Accumulated depreciation–equipment Total assets Total liabilities Retained earnings, 12/31/24 (above) Total liabilities and equity

Conversion Entry U.S. GAAP 27,000 27,000 27,000 54,000 (135,000) 135,000 (54,000) (54,000) -054,000 54,000

Debit

Credit (2) 2,000

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

10,000

IFRS 25,000 25,000 35,000 60,000 (135,000) 127,000 (52,000) (60,000) -060,000 60,000

10,000

Note: Parentheses reflect credit balances. Chapter 11 Develop Your Skills Analysis Case 1—Application of IAS 16

This assignment demonstrates the effect one difference between IFRS and U.S. GAAP would have on a company's net income and stockholders' equity over a 20-year period. Depreciation expense in Years 1 and 2 under both sets of rules is $500,000 ($10,000,000 ÷ 20 years) per year. Accumulated depreciation on January 1, Year 3 is $1,000,000. On that date, under IFRS, Abacab would revalue the building through the following journal entry: Accumulated Depreciation Building Revaluation Surplus (AOCI)

1,000,000 2,000,000 3,000,000

As a result of this entry, the building has a book value of $12,000,000. Under IFRS, the revalued amount of the building will be depreciated over the remaining useful life of 18 years at the rate of $666,667 per year ($12,000,000 ÷ 18 years).

Chapter 13 – Accounting for Legal Reorganizations and Liquidations – Hoyle, Schaefer, Doupnik, Advanced Accounting, 15e

a. Depreciation Expense IFRS U.S. GAAP

Year 2 $500,000 $500,000

Year 3 $666,667 $500,000

Year 4 $666,667 $500,000

Book Value of Building IFRS U.S. GAAP Difference

1/2/Y3 $12,000,000 $9,000,000 $3,000,000

12/31/Y3 $11,333,333 $8,500,000 $2,833,333

12/31/Y4 $10,666,666 $8,000,000 $2,666,666

c. Pre-tax income will be $166,667 smaller in each year (Year 3 -Year 20) under IFRS. Cumulatively, IFRS-pretax income will be $3,000,000 smaller than U.S. GAAP pretax income over this 18-year period. Stockholders' equity (AOCI) will be $3,000,000 greater under IFRS at January 1, Year 3. This difference will decrease by $166,667 each year (due to greater IFRS depreciation expense resulting in a smaller amount of retained earnings), such that stockholders' equity will be the same under both sets of rules at December 31, Year 20. The difference in stockholders' equity each year between IFRS and U.S. GAAP will be equal to the difference in the book value of the building under the two sets of standards. Analysis Case 2— Reconciliation of IFRS to U.S. GAAP

Note: Income taxes are ignored in this case. Vitous Ltd. Schedule to Reconcile IFRS Net Income and Stockholders‘ Equity to U.S. GAAP 2024 Net income under IFRS

$ 100,000

Adjustments: Add depreciation on revaluation amount in current year under IFRS

3,500

Add current year‘s amortization of deferred development costs

16,000

Net income under U.S. GAAP

$ 119,500

12/31/24 Stockholders‘ equity under IFRS

$ 1,000,000

Adjustments:

Chapter 13 – Accounting for Legal Reorganizations and Liquidations – Hoyle, Schaefer, Doupnik, Advanced Accounting, 15e

Subtract revaluation surplus Add accumulated depreciation on revaluation amount under IFRS (2024 only)

(35,000)

Subtract equity component of convertible bonds Subtract total amount of development costs capitalized under IFRS in 2023 Add cumulative amount of amortization expense on development costs recognized under IFRS (2024 only)

(5,000)

Stockholders‘ equity under U.S. GAAP

3,500

(80,000) 16,000 $ 899,500

Explanation for adjustments: 1. Under IFRS – Vitous recorded a Revaluation Surplus (stock equity account) of $35,000 on 1/1/24. In 2024, $3,500 of additional depreciation expense was taken on the revaluation amount ($35,000 ÷ 10 years). Under U.S. GAAP – neither of these would have been recognized. To reconcile from IFRS to U.S. GAAP – add $3,500 to IFRS 2024 net income; subtract a total of $31,500 from IFRS 12/31/24 stockholders‘ equity (subtract $35,000 Revaluation Surplus and add $3,500 of accumulated depreciation on the revaluation amount). Analysis Case 2 (continued) 2. Under IFRS – Vitous split recognition of the convertible bonds into a liability component of $45,000 and an equity component of $5,000. Under U.S. GAAP – Vitous would recognize the convertible bonds as a liability of $50,000. There is no equity component. To reconcile from IFRS to U.S. GAAP – subtract $5,000 from IFRS 12/31/24 stockholders‘ equity. 3. Under IFRS – Vitous recognized a deferred development cost intangible asset of $80,000 in 2023. In 2024, the year in which the intangible asset was put into service, amortization expense related to this asset was $16,000 ($80,000 ÷ 5 years). Under U.S. GAAP – Vitous would have expensed development costs of $80,000 in 2023. In 2024, there is $16,000 more expense under IFRS than under U.S. GAAP. To reconcile from IFRS to U.S. GAAP – add $16,000 to IFRS 2024 net income. At 12/31/24, the decrease in retained earnings is $64,000 smaller under IFRS than under U.S. GAAP. To reconcile from IFRS to U.S. GAAP, subtract a total of $64,000 from IFRS 12/31/24 stockholders‘ equity. This can be done by first subtracting the total amount of deferred development cost intangible asset from IFRS stockholders‘ equity ($80,000), and then adding the cumulative amount of amortization expense taken on

Chapter 13 – Accounting for Legal Reorganizations and Liquidations – Hoyle, Schaefer, Doupnik, Advanced Accounting, 15e

that intangible asset ($16,000). The net result from these two adjustments is a decrease in stockholders‘ equity of $64,000. Research Case—Differences Between IFRS and U.S. GAAP

Although several public accounting firms have published comparisons of IFRS and U.S. GAAP on their websites, the ―US GAAP/IFRS Accounting Differences Identifier Tool‖ created by Ernst & Young (available at www.ey.com) is probably the best source of information for answering the specific questions in this case. (The most recent version of this document at the time this book went to press was January 2021.) The accounting issues and questions students are asked to research, and the answers to those questions based on EY‘s ―US GAAP/IFRS Accounting Differences Identifier Tool: January 2021 (EY 2021),‖ are presented below: 1. The equity method of accounting is used to account for investments in investee companies over which the investor has significant influence. Should “potential voting rights” be considered in determining whether the investor has significant influence? Note: Potential voting rights are stock option, warrants, or other debt or equity instruments held by an investor that are convertible into ordinary shares, or, if exercised or converted, give the investor voting power or reduce another party‘s voting power over an investee. U.S. GAAP – Potential voting rights held in an investee are generally not taken into consideration in determining whether the investor has significant influence over the investee. IFRS – Potential voting rights that are currently exercisable or convertible are considered when assessing whether the investor has significant influence. Potential voting rights that cannot be exercised or converted until a future date or until the occurrence of a future event are not considered when assessing significant influence. Implication: Due to the difference between U.S. GAAP and IFRS on how potential voting rights are considered in determining whether an investor has significant influence over the investee, an investor may conclude that it has significant influence and apply the equity method to an investment in investee under IFRS but conclude that it does not have significant influence under U.S. GAAP. Source: EY 2021, pages 36 and 37. Research Case (continued) 2. Contingent liabilities (provisions) must be recognized on the balance sheet when certain conditions are met. Should contingent liabilities (provisions) be measured at a discounted amount (that is, present value)?

Chapter 13 – Accounting for Legal Reorganizations and Liquidations – Hoyle, Schaefer, Doupnik, Advanced Accounting, 15e

U.S. GAAP – Discounting of contingent liabilities is not generally addressed in U.S. GAAP. ASC 410-30 specifically provides that the measurement of an environmental liability may be discounted to reflect the time value of money only if the aggregate amount of the liability and the amount and timing of cash flows related to that liability are fixed or reliably determinable. IFRS – Provisions should be discounted to present value if the effect of the time value of money is material. The increase in the provision due to the passage of time is recognized as an interest expense. Implication: The criterion for measuring contingent liabilities at present values differs between U.S. GAAP (liability and timing of cash flows are fixed and reliably determinable) and IFRS (difference between discounted and undiscounted liability is material). Thus, a contingent liability could be measured and recognized at present value under one set of standards but not the other. Source: EY 2021, pages 315 and 316. 3. Some gains and losses are included in other comprehensive income (rather than net income). Should these items be accumulated and reported separately on the statement of financial position (balance sheet)? U.S. GAAP – The total of accumulated other comprehensive income (AOCI) must be reported separately from retained earnings and additional paid-in capital (APIC) in a statement of financial position (balance sheet). IFRS – The presentation or disclosure of AOCI in the statement of financial position (balance sheet) is not required under IFRS. Implication: Although IAS 1 does not require separate presentation of AOCI, such presentation is not precluded by IAS 1 and therefore would be acceptable under IFRS. The presentation of AOCI could, but does not have to, differ under IFRS and U.S. GAAP Source: EY 2021, pages 7 and 8. Research Case (continued) 4. An event that occurs after the balance sheet date that provides additional evidence about conditions existing at the balance sheet date usually requires an adjustment to the financial statements. What is the post-balance sheet cutoff date for determining events that require an adjustment? U.S. GAAP – An event that occurs after the balance sheet date but before the financial statements have been issued (or are available to be issued) usually requires an adjustment to the financial statements.

Chapter 13 – Accounting for Legal Reorganizations and Liquidations – Hoyle, Schaefer, Doupnik, Advanced Accounting, 15e

IFRS – An event that occurs after the balance sheet date but before the financial statements have been authorized for issue requires an adjustment to the financial statements. Implication: Financial statements could be considered authorized for issue under IFRS before such financial statements would be considered issued (or available to be issued) under US GAAP. Accordingly, an adjusting subsequent event may be recognized in financial statements prepared under US GAAP when the same subsequent event would not be recognized in financial statements prepared under IFRS. Source: EY 2021, pages 415 and 416. Internet Case 1—Foreign Company Annual Report

The responses to this assignment will depend on the company selected by the student. A comparison of the findings across companies selected by students can lead to a lively classroom discussion. The instructor might wish to complete this assignment for a non-U S. company of his/her choice to lead the discussion. Internet Case 2—IFRS Website

The responses to this assignment will depend on the country selected by the student. Instructors might wish to complete this assignment for a country of their choice and provide the solution to students to demonstrate the format and level of detail expected in the report. An example of the information that could be included in a report is presented here for Argentina. Excerpts from the Jurisdictional Profile for Argentina include:

―Argentina has already adopted IFRS Standards for all companies whose securities are publicly traded and that are regulated by the CNV.‖ ―The CNVs IFRS requirement does not apply to banks or insurance companies (see below).‖ ―Companies with regulators other than the CNV (financial institutions and insurance companies) are not currently permitted to apply IFRS Standards:  banks must apply the accounting regulations enforced by the Central Bank of Argentina – BCRA); and  insurance companies must apply the accounting regulations enforced by the Superintendency of Insurance.‖ 13-58 © McGraw Hill LLC. All rights reserved. No reproduction or distribution without the prior written consent of McGraw Hill LLC.

Chapter 13 – Accounting for Legal Reorganizations and Liquidations – Hoyle, Schaefer, Doupnik, Advanced Accounting, 15e

―On 12 February 2014, the BCRA issued Communication A5541 (in Spanish) announcing a plan to converge the BCRA accounting standards for banks with IFRS Standards.‖ ―Argentina has 23 Provinces and one autonomous city equivalent to a Province (Buenos Aires). The use of IFRS Standards for local statutory purposes is determined by each Province‘s Registry of Commerce. Currently, more than half of the Provinces permit the use of IFRS Standards in their jurisdictions for companies whose securities do not trade in a public market. However, currently the Provinces in which most of the unlisted companies are registered (particularly the city of Buenos Aires) have not endorsed the use of IFRS Standards for non-public companies. Companies that do not use IFRS Standards may choose the IFRS for SMEs Standard or Argentinean standards developed by CENCyA.‖ In response to the question ―Which IFRS are required or permitted for domestic companies?‖ the response is ―IFRS as issued by the IASB Board.‖ In response to the question ―Are all or some foreign companies whose securities trade in a public market either REQUIRED or PERMITTED to use IFRS Standards in their consolidated financial statements?‖ the answer is ―Required.‖ In response to the question ―Are IFRS Standards incorporated into law or regulations?‖ the response is ―Yes.‖ In response to the question ―Has the jurisdiction adopted the IFRS for SMEs Standard for at least some SMEs?‖ the answer is ―Yes (but subject to the approval of individual Provincial governments).‖

CHAPTER 12 FINANCIAL REPORTING AND THE SECURITIES AND EXCHANGE COMMISSION Chapter Outline I.

In the United States, the Securities and Exchange Commission (SEC), created by Act of Congress, is responsible for ensuring that complete and reliable information concerning publicly traded securities is available to investors. A. Although the SEC regulates requirements created by many legislative acts, the most significant are the Securities Act of 1933, the Securities Exchange Act of 1934, and the Sarbanes-Oxley Act of 2002. B. The SEC has sought to accomplish its objectives by working to achieve several goals that include: 1. Assuring adequate disclosure of data before securities can be bought and sold, 2. Preventing the misuse of information by inside parties, 13-59 © McGraw Hill LLC. All rights reserved. No reproduction or distribution without the prior written consent of McGraw Hill LLC.

Chapter 13 – Accounting for Legal Reorganizations and Liquidations – Hoyle, Schaefer, Doupnik, Advanced Accounting, 15e

3. Regulating the operation of stock exchanges and other securities markets, and 4. Prohibiting the dissemination of materially misstated information. C. Disclosure requirements of the SEC are contained primarily in two sets of regulations: 1. Regulation S-K establishes rules for all nonfinancial information, such as management‘s discussion of the issuer‘s business activities. 2. Regulation S-X prescribes the form and content of the financial statements that are included in the various SEC filings. D. The ability to establish disclosure requirements gives the SEC the ultimate authority for accounting principles in this country, although it has generally allowed the FASB to set official guidance. E. The SEC's integrated disclosure system requires that most information that is reported to the SEC must also go to the company's stockholders at various times throughout the year. F. In August 2000, the SEC promulgated Regulation FD (Fair Disclosure), ordinarily referred to as Regulation FD or Reg FD.1 Regulation FD prohibits public companies from disclosing material information that was previously nonpublic to certain parties, unless the public receives intentional disclosures simultaneously and non-intentional disclosures promptly. II.

As a direct result of the corporate accounting scandals exposed in 2001 and 2002, Congress passed the Sarbanes-Oxley Act of 2002. This legislation has had a wide-ranging impact on corporate financial reporting and the accounting profession as a whole. A. One of the most important results of this act is the creation of the Public Company Accounting Oversight Board. 1. This five-member board is appointed by the SEC and funded by fees assessed against publicly traded companies. 2. The board has been given the authority to enforce auditing, quality control, and independence standards. Such power reduces the accounting profession‘s ability to regulate itself as it has done in the past seven decades. B. All accounting firms that audit companies with securities that are publicly traded must register with the Public Company Accounting Oversight Board. 1. This registration process allows the new board to gather considerable information from the public accounting firms. 2. All registered firms are subject to inspection by the Public Company Accounting Oversight Board as often as each year.

Regulation FD is codified as 17 C.F.R. 243.

Chapter 13 – Accounting for Legal Reorganizations and Liquidations – Hoyle, Schaefer, Doupnik, Advanced Accounting, 15e

C. The Sarbanes-Oxley Act eliminates a number of consulting services that an accounting firm can perform for an audit client. The goal of this approach is to strengthen the independence of the auditing profession. D. The Sarbanes-Oxley Act also requires the audit committee of a company‘s Board of Directors to be made up of individuals who are independent of the management. The audit committee is now responsible for the appointment and compensation of the independent auditors. E. Due to additional financial scandals, Congress supplemented Sarbanes-Oxley with The Wall Street Reform and Consumer Protection Act of 2010 to expand the federal government‘s role in regulating corporate governance. F. As part of the Sarbanes-Oxley Act, Congress enacted new rules for publicly traded firms requiring greater use of real-time disclosures for material changes in their financial condition or operations between periodic 10-K and 10-Q filings. These rules required timelier disclosures of performance information, as well as disclosures of a broad range of economic events useful in forecasting firms‘ future performance. For example, the rules required real-time disclosures of terminated material definitive agreements (for example, licensing contracts). III.

Several methods can be used by the SEC to affect generally accepted accounting principles in the United States. A. Additional disclosure requirements. B. Moratorium on specific accounting practices. C. Challenging individual statements and other reporting by companies filing with the SEC. D. Overruling the FASB (as illustrated by the rejection of SFAS 19).

IV.

SEC Content in the FASB‘s Accounting Standards Codification (ASC). A. In addition to authoritative financial accounting and reporting guidance that has been issued by the FASB ("FASB guidance"), the FASB‘s Accounting Standards Codification (ASC) includes relevant portions of financial accounting and reporting guidance that has been issued by the SEC and its staff ("SEC guidance"). B. In the Codification, SEC guidance is organized in the same manner as—but separate from—FASB guidance. 1. The distinction between FASB and SEC guidance is made at the Section level of the Codification content‘s hierarchy (Topic-Subtopic-Section-paragraph). 2. SEC Sections are identified with the same standardized two-digit Section numbers and titles as FASB Sections, except that the Section number is preceded by the letter "S." 3. Additionally, Section S99, SEC Materials, is also an SEC Section; there is no FASB Section that corresponds to it.

Companies that offer securities for sale to the public must meet a number of filing requirements monitored by the SEC.

Chapter 13 – Accounting for Legal Reorganizations and Liquidations – Hoyle, Schaefer, Doupnik, Advanced Accounting, 15e

A. Registration statements are required prior to the issuance of any new security. 1. Depending on specific circumstances, specified forms are required for this purpose (including Forms S-1 and S-3). 2. After completing the appropriate registration form, a company will normally receive a letter of comments from the SEC requesting changes and/or additional disclosures that the SEC deems necessary. 3. Unless exempt from registration, securities cannot be sold until the registration statement is made effective by the SEC. B. Companies that have their securities publicly traded on an exchange must also make regular periodic filings with the SEC. Some of the most common of these disclosure documents are: 1. Form 10-K is an annual report presenting the company's activities and financial position. 2. Form 10-Q contains condensed interim financial statements. 3. Form 8-K discloses the occurrence of a unique or significant happening. Form 8-K filings include required disclosures such as (a) material information that must be disclosed under Regulation FD (Fair Disclosure) and (b) real-time disclosures for material changes in financial condition or operations between periodic 10-K and/or 10-Q filings, due to new disclosure rules enacted as part of the Sarbanes-Oxley Act, which prior to August 2004 firms would have reserved for later 10-Ks or 10-Qs. 4. A proxy statement (Form 14A) solicits voting power to be used at stockholders' meetings. VI.

The SEC has developed a system that allows investors to gain access to filed information electronically over the Internet. This system is known as EDGAR and contains extensive information and documentation relating to practically every publicly traded security.

Answer to Discussion Question Is the Disclosure Worth the Cost? No ultimate answer exists to the question of how the SEC should weigh the costs of disclosure versus the need for adequate information. Students often feel that the importance of the work of the SEC is unquestioned. That is far from reality, as many business owners and investors will advise. Businesses often resist all demands for additional disclosure as being unimportant and not worth the cost of gathering the data. This is also far from reality. This discussion question is intended to show the high cost to the American economy of ensuring that adequate and fair information is available. The $400 million estimate that was made in 1975 (nearly fifty (50) years ago) is a staggering figure. It shows this concern has existed for decades. Could investors have been appropriately protected for a smaller amount? This question becomes especially relevant when coupled with the quotation from George Bentson that "I found that there

Chapter 13 – Accounting for Legal Reorganizations and Liquidations – Hoyle, Schaefer, Doupnik, Advanced Accounting, 15e

was little evidence of fraud related to financial statements in the period prior to the enactment of the Securities Acts." The question is even more interesting considering the accounting scandals that were discovered in 2001 and 2002. These problems took place despite the presence of the SEC. On the other hand, perhaps the disclosure and compliance are still inadequate and the cost of additional compliance will result in future unknown benefits. One method of approaching this question is to ask students to envision what would result if the SEC was simply to be dissolved. How would companies entice investors into contributing funds? What methods would companies invent to provide assurance to investors? Would more or less money be invested? Would the allocation of resources to the various companies throughout the country be changed? Would investors be adequately protected? How would a new ‗start up‘ company attract investors? In other words, does the work of the SEC have an actual impact on the amount of investments that are made and the distribution of these funds to the companies in the country? Once the benefits of having an authority like the SEC are established, how should these benefits be weighed against the cost of disclosure? Although $400 million (which was the estimated cost fifty (50) years ago, is an extremely large amount, it is a very small number in comparison to the dollars that are invested each year in the United States. Is this just the price that must be paid to provide comfort to the investing public? Although no resolution can be made of this question, it should provide for a good deal of class discussion. Answers to Questions 1. Many of the federal securities laws were passed initially in hopes of putting an end to abuses that were present in securities trading. These problems were first brought to the public's attention by the stock market crash in 1929. Two special concerns were the manipulation of stock market prices in part through the dissemination of inaccurate financial data and the misuse of information by insiders, such as corporate officers and directors. However, the passage of legislative actions also was intended to help restore public confidence in the capital market system that was and is so essential to the American economy. 2. The corporate accounting scandals of this period took several forms. Some were based on manipulating loopholes in generally accepted accounting principles to allow companies to avoid adequately disclosing risky ventures. Others were simply fraudulent reporting of transactions; expenses, for example, were recorded as assets to make the company‘s balance sheet(s) look better. Even others were based on the use of corporate funds for personal benefit. The reasons for such behavior can be many and varied. Personal greed is always a motivator. However, the need of a company to report ever-increasing profits in a stock market that was rising at an amazing speed during the mid and late 1990s put significant pressure on many executives. In hindsight, the lack of adequate safeguards in place at corporations, at accounting firms, and even at the SEC must also be considered as playing a role in creating an environment where such practices were allowed to take place. 3. The Sarbanes-Oxley Act has numerous provisions, almost all of which are designed in one way or another to restore public confidence. Several of those provisions include:  

A Public Company Accounting Oversight Board has been created to enforce and regulate auditing, quality control, and independence standards. All accounting firms that audit publicly-held issuers of securities must register with the Oversight Board and provide detailed information about their operations.

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   

All registered firms must be inspected by the Oversight Board to ensure adequate quality control in their audit work. Registered firms are prohibited from providing certain consulting services to audit clients. Corporate audit committees must be composed of members of the Board of Directors who are independent of management. Audit committees must have authority to employ and compensate the independent auditors.

4. The Sarbanes-Oxley Act gives the SEC the power and responsibility to oversee the work of the Public Company Accounting Oversight Board. For example, the five board members are appointed by the SEC. 5. According to the Sarbanes-Oxley Act, accounting firms are only required to register with the Public Company Accounting Oversight Board if they prepare, issue, or participate in the preparation of an audit report for an ―issuer.‖ An issuer is defined by the Act but normally refers to any organization issuing securities to the public. 6. Registration with the PCAOB forces accounting firms to (a) provide a significant amount of information about its operations, (b) have their activities open to inspection by the Public Company Accounting Oversight Board, and (c) be subject to the rulings and authority of this Board. 7. The Sarbanes-Oxley Act gives the Public Company Accounting Oversight Board authority over auditing independence rules. Therefore, all future changes made by this body will be an indirect result of the legislation. Moreover, the Sarbanes-Oxley Act specifically eliminated the accounting firms‘ ability to provide certain non-attestation services to their audit clients. It further required that audit committees be made up of members of an organization‘s Board of Directors who are independent of management. The audit committee must then be responsible for the appointment and compensation of the independent auditors. 8. Prior to the Sarbanes-Oxley Act, most accounting firms were required to undergo periodic peer reviews of their audit documentation and their quality control procedures. However, those reviews were largely done by one accounting firm on another and, given the accounting scandals discovered during 2001 and 2002, apparently did not do enough to ensure the quality of audit work. The new inspection process will be carried out under the authority of the Public Company Accounting Oversight Board. That inspection process will attempt to create a process that goes further in making certain that every firm does quality work on every engagement. 9. "Regulation S-K" establishes disclosure and other reporting requirements for the nonfinancial information that is contained in filings with the SEC. 10. "Regulation S-X" prescribes the form and content of the financial statements, notes, related schedules, and any other financial information included in the various reports filed with the SEC. 11. The Securities and Exchange Commission is composed of more than two dozen divisions and major offices. Some of these include the following: — Division of Corporation Finance—ensures that standards for reporting and disclosure are followed. — Division of Market Regulation—regulates national securities exchanges and investment

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brokers and dealers. — Division of Enforcement—supervises investigations and directs enforcement activities. — Office of Compliance Inspections and Examinations—verifies compliance by brokers, dealers, and investment companies. — Office of the Chief Accountant—responsible for accounting and auditing matters that arise in connection with the securities laws. 12. The Securities Act of 1933 regulates the initial offering of securities by a company or its underwriters. This Act is often referred to as the ―truth in securities act‖ and it is the statute that now governs the issuers‘ registration statements. 13. The Securities Exchange Act of 1934 regulates the subsequent buying and selling of securities through brokers and exchanges. This regulation extends to virtually all aspects of the resale of non-exempt securities. 14. The goals of the SEC are many. However, several prominent goals are as follows: — Ensuring that full and fair information is disclosed to all investors before securities can be exchanged. — Prohibiting the use of materially misstated information. — Preventing the misuse of information, especially by parties inside of the company. — Regulating the operation of securities markets. 15. Information to be included in proxy solicitation material includes the following data: — Five-year summary of operations including sales, total assets, income from continuing operations, and cash dividends per share. — Description of business activities. — Three-year summary of industry segments, export sales, and foreign and domestic operations. — A list of the directors of the company and its executive officers. — Market price of the company's common stock for each quarterly period within the two most recent years. — Restrictions on the company's ability to continue dividend payments. — Management's discussion and analysis of financial conditions, changes in financial condition, and results of operations. — All nonaudit services provided by the company's independent auditors. — Statement as to whether the board of directors approved all nonaudit work of the independent auditors. — Percentage of nonaudit fees paid to the independent auditors in relation to total annual audit fees. — Individual nonaudit fees that are larger than 3 percent of the annual audit fee. 16. A proxy statement is a request made to stockholders for the right to cast their votes at stockholders' meetings. The control of the entire company will rest with any group that is able to get a majority of votes through proxy agreements. Thus, the proxy statements are important because they are used in determining the control and direction of the company. 17. Any change made by the SEC in its Regulation S-X, the financial reporting regulation, will have a direct impact on the form and content of the financial reporting of the publicly-held companies in this country. Thus, the Commission has the ability to dictate generally accepted accounting principles. In addition, Financial Reporting Releases are issued by the SEC to explain changes to be made in accounting. Staff Accounting Bulletins are also prepared to 13-65 © McGraw Hill LLC. All rights reserved. No reproduction or distribution without the prior written consent of McGraw Hill LLC.

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explain views on current reporting matters. The SEC has historically limited the use of its authority over generally accepted accounting principles to (1) disclosure issues and (2) areas of accounting where authoritative guidance was thought to be lacking. For example, additional disclosure of specified matters may be required in areas deemed important by the SEC. The Commission can also prohibit practices that are not thought to be appropriate, especially where official guidance is not available. 18. Financial Reporting Releases are issued by the SEC to explain desired changes in reporting requirements. FRRs are used to supplement Regulations S-X and S-K. Staff Accounting Bulletins inform the financial community of views on current matters relating to accounting and disclosure issues. 19. Prior to 1977, the SEC had restricted the use of its accounting authority primarily to disclosure requirements and areas of financial reporting where authoritative guidance was not available. The FASB (and its predecessors in the private sector) had been allowed to establish generally accepted accounting principles in the U.S. The setting of accounting standards was viewed as a process that should be based on theory and research rather than being subjected to government edict. However, when the SEC overruled the FASB's method of reporting unsuccessful exploration costs incurred by gas and oil producing companies, several important precedents were set. The government (through the SEC) showed that it was willing to become a more active participant in setting rules for the accounting profession. The FASB (and other authoritative bodies) then had to be more concerned about pleasing the government prior to establishing standards. Many concerns were raised at the time (as well as since then) as to whether the development of generally accepted accounting principles should be at the mercy of the federal government. 20. Registration statements are designed to disclose and make available adequate relevant data about both a company and its new securities (stocks or bonds) before the securities can be issued to the public. 21. Disclosure of sufficient information – Registration Statement disclosure - is required by the Securities Act of 1933. 22. Part I of a registration statement is called a prospectus and must be furnished to every potential buyer of the securities to be issued. It contains information such as financial statements and supplementary data, an explanation of the intended use of the money being raised, a description of the capital structure of the company, and a description of the business and the properties that it holds. Part II of the registration statement provides information that is needed by the SEC staff. Part II includes data such as marketing arrangements for the new securities, the expenses of the issuance, sales to special parties, and the like. 23. Revenues are raised by the SEC, in part, through a registration fee for shares being initially issued. In 2022, this fee was $92.70 for each $1 million of security offering. 24. In the filing of registration statements, a number of different forms are available depending upon the circumstances. Of these forms, these two are especially common: — Form S-1 which is used by new registrants or by companies that have filed with the SEC

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for less than 36 months; — Form S-3 which is completed by larger companies, including foreign issuers that have filed with the SEC for a considerable length of time and have a significant following in the stock market. Form S-3 permits incorporation of other documents by reference. This permits inclusion of significant data concerning the Issuer, where the data has appeared in other filings. 25. Incorporation by reference is a process allowed when preparing filings with the SEC, and often other governmental agencies. It is intended to reduce the quantity of redundant information that must be processed. When data is required that has already appeared in a previous filing, the company need only refer to the earlier disclosure rather than repeat the information. 26. A pre-filing conference is a meeting between a prospective registrant and the staff of the SEC in hopes of resolving potential problems that may be expected to arise in an upcoming filing. The reporting and disclosure of complicated financial transactions may be discussed by the parties. The conference may also be used to determine the appropriate handling of unusual problems. 27. A letter of comments (which is also known as a "deficiency letter") is issued by the SEC to a filing company after a registration statement has been reviewed. The letter lists changes and additional disclosures that the SEC feels are necessary before the registration statement can be made effective. 28. A prospectus is the first part of a registration statement, the portion that has to be furnished to every potential buyer of a new security. The prospectus discloses a significant amount of specified information about the issuing company as well as about the new security. For example, the financial statements of the company must be included along with a description of current business operations. The prospectus also informs potential buyers of the intended use of the new funds and the capital structure of the company. 29. Certain new security issues are exempt from the registration requirements monitored by the SEC. For example, securities sold within a single state are normally not subject to these federal laws. In addition, the securities of banks, savings and loan associations, and governments do not come under the Securities Act of 1933. Several other offerings are also exempt from completing formal registration statements although other legal filings may be required:

Private placements to a limited number of sophisticated investors; Securities issued to current stockholders without a commission being paid (usually a stock dividend or stock split); Securities issued by nonprofit organizations; Small offerings under Regulation A for up to $20 million and up to $75 million to nonaccredited investors and using general solicitation; Offerings under Regulation D—Rule 504 for up to $10 million made to any number of investors; Offerings under Regulation D—Rule 506 for any dollar amount to unlimited accredited investors and no more than 35 sophisticated investors; Offerings under Regulation Crowdfunding of no more than $5 million made to any

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number of investors. 30. Private placements of securities under Regulation D: Rule 506 have become extremely popular in recent years because they are exempt from the registration requirements of the SEC. The securities are issued to no more than 35 sophisticated investors (identified as having knowledge and experience in financial matters) who already have sufficient information available to them about the issuing company. General solicitation is not permitted. 31. Blue sky laws are securities laws enforced by individual states. In contrast to federal securities laws, blue sky laws usually apply only to sales that are restricted to a particular state. 32. A wraparound filing is one in which a company uses its annual report to shareholders to fulfill reporting requirements of the SEC in a Form 10-K. Rather than repeat the information within the Form 10-K, incorporation by reference is used to direct the SEC to the location of the required data in the annual report. 33. Form 8-K is not issued on a regular basis but only when disclosure of a unique or significant occurrence is to be made. Thus, a company has some choice as to the necessity of issuing a Form 8-K. The SEC does, however, list several events that require disclosure in this manner: —resignation of a director; —change in control of the company; —acquisition or disposition of assets; —changes in independent accountants; —bankruptcy or receivership. 34. The Management's Discussion and Analysis (MD&A) is a narrative description of the company's past, its present, and its future. The management describes its priorities, accomplishments, and concerns. In many cases, the MD&A allows the management to share information with owners and other interested parties that would not otherwise be conveyed. 35. The Form 10-K is an annual report (financial statements and related information) whereas the Form 10-Q contains condensed interim financial statements and is filed quarterly. 36. The EDGAR system is intended to allow companies to file information with the SEC in an electronic format and then make that information available on-line to all interested parties. Answers to Problems 1. D – A is false because intrastate offerings are typically exempt from registration; B is false because the 1934 Securities Exchange Act regulates post-issuance trading of securities; and C is false because blue sky legislation is state law.

2. B – Remember that regulation S-X is the regulation that focuses upon financial information disclosure. 3. C – Regulation S-K addresses nonfinancial information filed with the SEC while Regulation S-X addresses the form and content of financial documentation filed with the SEC. 4. A – Remember that the 1933 Act deals with Registration and the 1934 Act deals with Regulation. 13-68 © McGraw Hill LLC. All rights reserved. No reproduction or distribution without the prior written consent of McGraw Hill LLC.

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5. C – Not all auditing firms are required to register with (or be inspected by) the PCAOB; only those firms that prepare, issue, or participate in the preparation of an audit report for an issuer. Issuers do incur additional fees as a result of SOX. 6. C – The SEC appoints the five (5) PCAOB members. 7. B – Selection of the auditor and approval of the related contract, including the fees, is done by the firm‘s audit committee. This committee must be composed of members of the client‘s board who are independent of management. 8. A – The 1933 Act deals with the requirements for registration of a security prior to its initial offering. 9. D – S-3 is the form for registering securities if / when the issuer already has a significant stock market following. The issuer will likely also file forms 8-K and 10-K, but those are not registration statements. 10. D – The SEC‘s 1977 stand vis-à-vis oil and gas accounting principles was a unique situation wherein the SEC overruled the FASB as far as proper accounting treatment. 11. C – Recall that the letter of comments / deficiency letter relate to the SEC‘s response subsequent to an issuer‘s filing of a Registration Statement. 12. B – This is a useful approach to referencing data which has already been provided to the SEC, or other agency, so that the data is not redundantly produced. 13. A - Recall that the letter of comments / deficiency letter relates to the SEC‘s response subsequent to an issuer‘s filing of a Registration Statement. 14. D – The prospectus must be furnished to all potential new security buyers and is provided to the SEC as part of the registration statement filing. 15. D – A, B, and C are exempt: NFP organizations‘ securities (debt) are exempt from the registration requirement as are governmental securities (for instance municipal bonds). Regulation A has registration exemptions for up to $75 million of securities. The Securities Act of 1933 does not provide for exemption for offerings to 40 sophisticated investors. 16. B – A prospectus is filed only in connection with the initial offering of a security. Therefore, it is not ‗regularly‘ filed with the SEC, unless the issuer is ‗regularly‘ issuing new securities. 17. C – Shelf registrations consist of registering securities in advance so that a large issuer may subsequently offer the securities without the need of additional SEC approval.

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18.C C – EDGAR = Electronic Data Gathering Analysis and Retrieval system. 19.(25 Minutes) (Series of questions about securities regulations). a. Blue sky laws—Individual state laws that regulate the issuance of securities when the transactions are limited to the residents of the state in which the issuing company is organized and principally doing business. Such securities are exempted from regulation by federal securities laws.

b. S-8 Statement—A registration statement that must be filed with the SEC and made effective by that body before a company can issue securities in connection with employee stock plans. c. Letter of Comments - (also known as a Deficiency Letter)—A request by the SEC for changes, explanations, or more information before a registration statement is made effective. The Division of Corporation Finance of the SEC reviews the registration statement and provides the company with a letter of comments so that the company will be able to furnish the additional data needed or make the appropriate changes. d. Public Company Accounting Oversight Board—This five (5) member Board was created by the Sarbanes-Oxley Act of 2002 as a result of the corporate accounting scandals that rocked the stock market and the investing community during 2001 and 2002. This Board falls under the jurisdiction of the SEC and has wide-ranging responsibilities from the registration of accounting firms and the inspection of these same firms to the establishment of auditing, quality control, and independence standards. e. Prospectus— The prospectus is the first part of a registration statement that contains financial statements for the company and indicates the use to be made of the money received from the sale of the securities, the capital structure of the company, and a description of the business and its properties. Every potential buyer of the new security must be furnished with a prospectus. 20. (25 Minutes) (Discussion of the Securities Act of 1933 and the Securities Exchange Act of 1934)

The Securities Act of 1933 and the Securities Exchange Act of 1934 were passed to help rebuild confidence in the capital market system of the United States. Economic development in this country is based on generating large amounts of monetary capital through the issuance of stocks and bonds. To entice sufficient investment, public trust in the integrity of the system must be maintained. Following the stock market crash of 1929, public confidence reached a low level. Federal securities laws were subsequently passed in hopes of achieving several objectives designed to restore trust in the capital markets. Several aspects of these laws should be noted: — Companies were required to supply adequate information to potential buyers before a new security could be issued.

— Companies having publicly traded securities were required to maintain an adequate and continual flow of information to the public. — Stock markets were to be regulated. 13-70 © McGraw Hill LLC. All rights reserved. No reproduction or distribution without the prior written consent of McGraw Hill LLC.

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— Manipulation of stock market prices was to be eliminated. — The use of inside information by corporate officials and directors was made Illegal. To help achieve these goals, the Securities and Exchange Commission (SEC) was created to monitor the capital market system. For example, registration statements had to be filed with the SEC before new stocks or bonds could be issued to the public. These statements were reviewed and could not become effective until all necessary disclosures and financial information were properly presented. Periodic filings (such as Form 10-K and Form 10-Q) were also required of companies having securities that were publicly traded. Because of its ability to require specific types of financial information, the SEC has the ultimate authority to develop generally accepted accounting principles in this country. The SEC also has the power to investigate possible misconduct in connection with corporate reporting and to seek prosecution where necessary.

21.(20 Minutes) (Description of the registration process) In filing a registration statement for a new security, a company must first select the appropriate SEC Registration form. For example, Form S-1 is used by new registrants while Form S-3 is filed by large companies that already have a significant following in the securities markets. Appropriate disclosures and other required data are then prepared in accordance with Regulation S-K and Regulation S-X. When the SEC receives the completed form, it is put through a review. All nonfinancial and financial information are evaluated against various standards. Legal aspects of the document are also checked along with the report of the independent auditor. A letter of comments (commonly referred to as a "deficiency letter") is prepared by the SEC to indicate changes and added disclosures that are considered necessary. The registrant has the right to discuss these issues with the SEC staff if company officials disagree with any part of the letter of comments. After the SEC is satisfied that the registration statement fulfills all rules, it is made effective. The first part of this document, the prospectus, must be made available to any potential buyer of the new security. 22.(15 Minutes) (Discussion of the SEC's influence on generally accepted accounting principles) The SEC has far-ranging authority over the accounting principles in this country. Through its ability to modify Regulation S-X, the SEC holds the power to alter the financial reporting of publicly-traded companies. The SEC has historically chosen to limit such changes to disclosure requirements with the creation of accounting principles being left to the FASB (and its predecessors). Thus, the private sector of the accounting profession had been given de facto responsibility for developing generally accepted accounting principles. Although occasionally the object of criticism, this system (theoretically) allows accounting standards to be the result of research and study rather than government edict. However, the SEC has often acted in accounting areas where clear authoritative guidance was not available. In such cases, additional 13-71 © McGraw Hill LLC. All rights reserved. No reproduction or distribution without the prior written consent of McGraw Hill LLC.

Chapter 13 – Accounting for Legal Reorganizations and Liquidations – Hoyle, Schaefer, Doupnik, Advanced Accounting, 15e

disclosure may be required or the Commission can decide to restrict or even prohibit a particular accounting procedure. The SEC did overrule in 1977 the FASB's method of accounting for unsuccessful exploration and drilling costs incurred by gas and oil producing companies. This action set several important precedents. First, it reaffirmed the SEC's ability to be involved in the standardssetting process. Second, notice was served to the FASB that the private sector needed to make certain that the SEC was satisfied prior to issuing new pronouncements. 23.(20 Minutes) (Listing of forms that are filed with the SEC on a regular periodic basis) Numerous forms may have to be filed regularly with the SEC by a publicly-held company. Four of these forms (Form 10-K, Form 10-Q, Form 8-K, and proxy statements) are frequently encountered. — Form 10-K is an annual report filed shortly after a company's year-end. — Form 10-Q contains condensed interim financial statements and must be filed after the end of each quarter, other than the year-end quarter – because the 10-K is filed after the year-end quarter. — Form 8-K is filed when needed to disclose the occurrence of a unique or significant event such as the resignation of a director, changes in control, acquisition or disposition of assets, changes in independent accountants, bankruptcy, timely disclosure of performance information, economic events such as terminated contracts, and material nonpublic information that may not be selectively disclosed under Regulation FD (Fair Disclosure). Depending upon the frequency of these ‗unique‘ events, Form 8-K may not actually be filed regularly. — Proxy statements, called ―Schedule 14A‖ are requests for the right to cast a stockholder's votes at annual (or other) meetings. Included in the information that must be provided are financial statements, disclosure of matters that are to be voted on, and an identification of the party making the solicitation. 24.(10 Minutes) (Describe the forms used to file with SEC for registration purposes) Some of the most commonly used forms for registering securities to be offered to the public are as follows: — Form S-1—for new registrants or companies that have been filing with the SEC for less than 36 months. This form is used when no other form is prescribed. — Form S-3—for larger companies that already have a significant following in the stock market. — Form S-4—for securities issued in connection with business combinations. — Form S-8—for securities issued in connection with employee stock plans. — Form S-11—for securities issued by various real estate companies.

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— Form F-3—for a foreign issuer.

25.(20 Minutes) (Discussions of the Form 8-K and proxy statements) The Form 8-K is designed to ensure the immediate disclosure by a company of any unique or significant event. Thus, any interested parties are able to obtain needed information without having to wait for a quarterly or annual statement. The filing of the Form 8-K must generally be made within 15 days of the event occurrence (or within 5 business days in certain specified instances). Events that necessitate the filing of a Form 8-K are left to the discretion of the company and its management. However, the SEC does list several circumstances that require such disclosure including the resignation of a director, change in control of the company, acquisition or disposition of assets, change in independent auditors, and bankruptcy. A proxy statement is the package of information that must accompany the request made to a stockholder for the right to cast that owner's votes at a stockholders' meeting. Since obtaining a significant number of proxies would allow an individual or company to influence or control an organization, the request for proxy rights is closely monitored by the SEC. The proxy statement has to be filed with the SEC before being distributed and must include specified information such as: — an annual report, — a disclosure of all matters that will be voted upon at the meeting, and — an identification of the party or parties making the solicitation. 26.(20 Minutes) (Describe provisions of the Sarbanes-Oxley Act as they relate to the creation and responsibilities of the Public Company Accounting Oversight Board) The Sarbanes-Oxley Act of 2002 is a wide-ranging piece of legislation that covers a large number of different areas of corporate financial reporting. Much of this Act deals with the establishment of the Public Company Accounting Oversight Board (PCAOB). The PCAOB is created / addressed in Title I of the Act. The PCAOB is in charge of all auditing, quality control, and independence standards for the accounting profession. The PCAOB has the legal authority to write such rules and / or to amend, modify, repeal, or reject any auditing standard written by the profession (through the Auditing Standards Board and the AICPA). The ultimate authority for such rules now lies clearly with the PCAOB as illustrated at Sec. 103(a)(1) of the Act. All accounting firms that prepare, issue, or participate in the preparation of an audit report for an issuing organization will now have to register with the PCAOB in order to continue providing such services. This registration provides the PCAOB with the ability to gather an almost unlimited amount of information

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about the firms such as disagreements with audit clients, annual fees from both audit and nonaudit services, and the like. The PCAOB must periodically inspect the work of each of the registered accounting firms. The depth and breadth of this inspection encompasses both audit documentation and compliance with quality control standards. Large firms undergo annual inspection whereas smaller firms are inspected only every three years. 27.(30 Minutes) (Discussion of financial reporting and the SEC) a. Staff Accounting Bulletins—According to the website (www.sec.gov) of the Securities and Exchange Commission, ―Staff Accounting Bulletins reflect the Commission staff‘s views regarding accounting-related disclosure practices. They represent interpretations and policies followed by the Division of Corporation Finance and the Office of the Chief Accountant in administering the disclosure requirements of the federal securities laws.‖

b. Wraparound filing—the process of using the annual report furnished to shareholders to fulfill many of the requirements of the Form 10-K to be filed with SEC. The company simply indicates the location of the required information (a process known as incorporation by reference) within the annual report. c. Incorporation by reference—using information in one document filed with the SEC to fulfill other reporting requirements. In this manner, the amount of redundant information being reported is reduced. This process is usually part and parcel of a wraparound filing. d. Division of Corporation Finance—a division of the SEC that establishes standards of reporting and disclosure. This division also reviews the registration statements that are filed with the SEC and issues any needed letters of comments. e. Integrated disclosure system—the use of information that is being given to stockholders to meet the filing requirements of the SEC. f. Management's discussion and analysis—a section in Form 10-K that serves as the management's description of its priorities, accomplishments, and concerns. The narrative describes the company's past performance, present condition, and future direction. g. Chief Accountant of the SEC—the office of the SEC that is ultimately responsible for all accounting and auditing matters that involve the securities laws. 28.(10 Minutes) (Listing of organizations that are normally exempted from the registration requirements of the SEC) — Governments — Banks — Savings and loan associations — Companies that restrict the exchange of their securities to within one state — Companies that restrict an issuance to its own stockholders where no 13-74 © McGraw Hill LLC. All rights reserved. No reproduction or distribution without the prior written consent of McGraw Hill LLC.

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commission is paid to solicit the exchange — Nonprofit organizations — Companies that make small offerings of $20/$75 million to non-accredited investors under Tier 1 or Tier 2 of Regulation A. — Companies that make offerings of no more than $10 million to any number of investors within a 12-month period. (Regulation D—Rule 504) — Companies making private placements, without dollar limitation, to no more than 35 sophisticated investors and/or an unlimited number of accredited investors, not using general solicitation. (Regulation D—Rule 506) — Companies making offerings of no more than $5 million to any number of investors and open to the public including accredited and non-accredited investors. Develop Your Skills

RESEARCH CASE 1 (45 Minutes) The purpose of this question is to allow the student the opportunity of working with the actual regulations posted on the SEC web site. The URL given in the problem will take the student to the entire set of rules set out under Regulation A – for Conditional Small Issue(s) Exemptions. This information covers topics such as offering statements, offering circulars, and the filing of sales material. The student can literally read through the entirety of Regulation A in about fifteen (15) minutes. For this assignment, the student should probably focus on the heading ―Scope of Exemption.‖ This reference provides several pages of information on the exemption from filing a registration statement that is provided to companies by Regulation A. There are a number of issues that the student might want to address in connection with this question: — Where does the company have to be legally incorporated? (The U.S., Canada, or

one of the territories or possessions of the U.S.) — What is the total amount that can be received for the securities being issued? (Tier 1 and Tier 2 companies can issue up to $20 Million and $75 Million of securities respectively.) — When both cash and non-cash consideration are received, how is the total amount of consideration determined? (It is based on the cash price). — What filing must be made with the SEC? (In most cases, a Form 1-A. — Can advertisements of the securities be made? (Yes, published ads as well as radio and television ads are allowed as long as only specified information is included). RESEARCH CASE 2 (30 Minutes)

The SEC v. Calvo case involves a situation similar to the fact pattern in this research case. The student is directed to this case because of the many 13-75 © McGraw Hill LLC. All rights reserved. No reproduction or distribution without the prior written consent of McGraw Hill LLC.

Chapter 13 – Accounting for Legal Reorganizations and Liquidations – Hoyle, Schaefer, Doupnik, Advanced Accounting, 15e

similarities. Use of legal / case research is a very valuable skill for accounting students and practitioners as courts ultimately interpret vague rules, regulations, statutes, and definitions. As was suggested in the text, the definition of ‗security‘ is very broad. The 1933 Securities Act defines ‗security‘ very broadly to include investment contracts. Investment contracts involve: (i) an investment of money or other consideration; (ii) for a common enterprise or undertaking; and (iii) with the expectation of profits to be derived from the efforts of others. In the example, the Tasch Corporation will ‗manage‘ the customer‘s enterprise, the customers are investing money, and the customers are expecting a profit – i.e.: the guaranteed return. A court would very likely conclude that the ―service agreements‖ constitute an investment contract and thus a security. The next issue / question to address is whether the Tasch Corporation can / will be able to structure the issuance of these securities in a manner to avoid the registration requirements. ANALYSIS CASE 1 (45 Minutes)

This assignment requires the student to utilize the EDGAR database to find recent company filings by any publicly-held company. The results that a student gets will depend on the company name that is entered and the time frame for when the student accesses the database. The student may actually be overwhelmed by the amount of filings that a company must make with the SEC. For example, a search for Amazon would display more than eleven (11) filings in just the first two (2) months of 2022. 1. A number of 8-K forms can be found for most companies. Companies now tend to err on the side of over-disclosure with regard to 8-K filings, many of which merely incorporate by reference various press releases or other publicity-related filings. The specific content of the 8-K each student locates will depend on when the student completes the case analysis. 2. A further investigation of the Amazon filings leads to a Form 10-K issued on February 4, 2022 (or later depending on when the student utilizes the database), that contains many attachments including the annual report for 2021. This Form 10K provides extensive information to supplement the data normally reported to shareholders. 3. Finally, a definitive proxy statement can be located for Amazon (DEFA 14A), as ofApril 15, 2021. This is the kind of information that students often have not had the opportunity to access unless they have explored the SEC web site.

Chapter 13 – Accounting for Legal Reorganizations and Liquidations – Hoyle, Schaefer, Doupnik, Advanced Accounting, 15e

Communication Case 1

Here, the student is asked to investigate and review that actual statutory components of the Sarbanes-Oxley Act of 2002. This Act encompasses approximately seventy (70) pages and contains an extensive list of requirements for auditors covered by the Statute. The first issue to consider for the Wojtysiak firm is whether it is presently required to register with the Public Company Accounting Oversight Board (PCAOB). It is not, however, if the Wojtysiak firm becomes the audit firm for the new publicly traded client (and ‗issuer‘) then the firm will likely be required to register and then be subjected to additional disclosures and inspections, most likely on a triennial basis. Additionally, the Wojtysiak firm will need to carefully consider what services it can offer to the new client in light of the Sarbanes-Oxley independence requirements. The student will most likely wish to consider and incorporate the following provisions of the Act.      

Section 102 – Registration with the Board. Section 103 – Auditing, quality control, and independence standards and rules. Section 104 – Inspections of registered public accounting firms. Section 108 – Accounting standards. Section 201 – Services outside the scope of practice of auditors. Section 203 – Audit partner rotation.

The student should be able to write an extensive report on the impact of SarbanesOxley on the Wojtysiak firm, based on these and other provisions of the Act.

CHAPTER 13 ACCOUNTING FOR LEGAL REORGANIZATIONS AND LIQUIDATIONS Chapter Outline I.

Because of myriad possible financial or business difficulties, an entity can become insolvent, unable to pay its debts as they come due. A. To ensure the equitable treatment of all parties involved (stockholders as well as creditors), laws are in place to provide structure for the bankruptcy process in the United States. B. The Bankruptcy Reform Act of 1978 (as amended) provides the primary source of legal guidance. 1. The laws attempt to arrive at a fair distribution of a debtor's assets. 2. They also seek to discharge the obligations of an honest debtor.

Chapter 13 – Accounting for Legal Reorganizations and Liquidations – Hoyle, Schaefer, Doupnik, Advanced Accounting, 15e

II.

Entities often begin to experience financial difficulties well in advance of a formal declaration of bankruptcy. Because the financial reporting process normally assumes an entity is a going concern, this precarious situation poses significant accounting challenges. A. Goodwill and other assets might need to be tested for possible impairment. B. The recognition of a valuation allowance might be required to offset any deferred income tax assets that the company is reporting. C. Specific disclosure warnings become necessary if substantial doubt exists that the company can continue as a going concern for one year from the issuance date of its financial statements. 1. Substantial doubt can arise for many reasons such as ongoing operating losses and working capital shortages. 2. Management must evaluate contingency plans created to prevent the entity from becoming unable to pay its debts during difficult times. 3. If these plans can be implemented to keep the entity from defaulting on its debts, only the reason for the substantial doubt and the plans created by the entity need to be disclosed. 4. If management is uncertain as to whether these plans can be implemented or whether they will actually enable the entity to meet its debts as they come due, the reasons for substantial doubt must be disclosed along with management‘s plans. In addition, a statement must explain that substantial doubt does still exist as to the entity‘s ability to continue as a going concern for one year from the issuance date of the financial statements.

III.

Either the debtor or a group of credits can formally instigate the bankruptcy process. A. A voluntary petition is one filed with the court by the insolvent company itself. In contrast, a minimum number of creditors with, at least, a minimum amount of debt can file an involuntary petition. B. After receiving a bankruptcy petition, the court will normally grant an order for relief to halt all actions against the debtor.

IV.

Within the bankruptcy process, determining the appropriate classification of every creditor is an important step in achieving a fair settlement. A. Fully secured creditors hold a collateral interest in assets of the insolvent company having a value in excess of the related liability. B. Partially secured creditors also have a collateral interest in assets but the expected net realizable value will not completely satisfy the obligation. C. Specific unsecured obligations (including administrative expenses, certain debts to employees, and government claims for unpaid taxes) have priority over other unsecured debts. D. All remaining unsecured creditors will only receive assets from the debtor after the above claims have been satisfied.

An insolvent company often prepares a Statement of Financial Affairs to disclose its current financial position although this statement does not conform to U.S. GAAP. A. The company reports each asset at its net realizable value along with disclosure of any part of that amount that is pledged toward paying specific debts. The debtor classifies liabilities according to the security or priority of the claim. B. A Statement of Financial Affairs is especially useful if prepared at the beginning of the bankruptcy process. It assists all parties in evaluating the outcome of various actions such as liquidation or reorganization. C. Most asset balances reported in this statement are estimates, projections of future events. 13-78 © McGraw Hill LLC. All rights reserved. No reproduction or distribution without the prior written consent of McGraw Hill LLC.

Chapter 13 – Accounting for Legal Reorganizations and Liquidations – Hoyle, Schaefer, Doupnik, Advanced Accounting, 15e

VI.

Bankruptcy proceedings often conclude with the liquidation of the debtor‘s assets to help satisfy creditor claims (a Chapter 7 bankruptcy). A. An appointed trustee oversees the termination of business affairs, liquidation of noncash properties, and distribution of cash resources. B. The trustee prepares a periodic reporting of activities. Historically, this reporting has been in the form of a Statement of Realization and Liquidation. 1. The statement indicates the book value and classification of remaining assets and liabilities. 2. It discloses the effects of all transactions that have occurred to date. 3. This statement is not appropriate for external reporting according to U.S. GAAP. However, smaller companies do not necessarily need bankruptcy statements that follow U.S. GAAP. C. At the point that liquidation becomes imminent, financial reporting must follow the liquidation basis of accounting if the resulting statements are to be in conformity with U.S. GAAP. 1. Liquidation is imminent when the court (or individuals who hold that authority) approve a plan of liquidation. 2. When applying the liquidation basis, the debtor must provide both a statement of net assets in liquidation and a statement of changes in net assets in liquidation. 3. When applying the liquidation basis, a company reports its assets at the cash amount expected to be received. This figure is often lower than the asset‘s fair value. Liability balances remain unchanged until a legal alteration occurs as a result of the legal process.

VII.

As an alternative to liquidation, a company may seek to stay in business and attempt to return to solvency through reorganization (a Chapter 11 bankruptcy). A. A reorganization plan has to be devised that can win approval of each class of creditors and each class of stockholders as well as the bankruptcy court. B. Reorganization plans normally establish a specific course of action designed to save the company. A plan can include proposed changes in operations, methods of generating additional working capital, and a settlement of debts that were in existence on the day the court issued an order for relief.

VIII.

Financial reporting during reorganization is important to allow all of the involved parties to follow along as progress is made. A. FASB‘s Accounting Standards Codification, Topic 852, Reorganizations provides authoritative guidance for preparing financial statements as a company goes through and exits bankruptcy reorganization. B. Specific reporting measures during reorganization include: 1. The company must report gains, losses, revenues, and expenses that result from reorganization separately on the income statement. 2. Professional fees incurred in connection with the bankruptcy must be expensed immediately. 3. Liabilities subject to compromise are reported on the balance sheet based on the expected amount of allowed claims rather than the estimated cash payment.

IX.

Fresh start accounting is often required when a company emerges from reorganization. A. The company restates its assets to their current value but only if (a) the reorganization value of the total assets is less than the allowed claims and (b) the original owners are left holding less than 50 percent of company when it exits bankruptcy..

Chapter 13 – Accounting for Legal Reorganizations and Liquidations – Hoyle, Schaefer, Doupnik, Advanced Accounting, 15e

B. Recognition of goodwill is required if the reorganization value of the emerging company is greater than the value of the identifiable assets (both tangible and intangible). C. Retained earnings must be set at zero to indicate the creation of a new entity.

Answers to Discussion Questions What Do We Do Now? In this case, students have a chance to consider a non-accounting business decision, the forcing of a valued client into bankruptcy. Thurber has already committed several unfortunate mistakes in this case. He has seen a dramatic slowdown in cash payments by Abraham and Sons without seeking any further information about the prospects of the client. He has allowed the treasurer to pressure him into providing additional credit without any valid justification. Now, another company is pushing him into filing a bankruptcy petition without adequate assurance that Abraham and Sons has a real problem. Because Thurber did not actearlier, he should immediately request audited financial statements from Abraham and Sons so that he can make a reasonable decision as to the course to take. Previously successful companies can falter and go bankrupt creating huge losses for their creditors. Thurber needs to assess the risk before choosing an appropriate action. Thurber can glean important figures from the company‘s financial statements. These figures and ratios include the amount of working capital, the current ratio, the debt-to-equity ratio, the trend in sales, the trend in long-term debt, operating activities cash flows, the gross profit percentage, any expenses that rise at a rate faster than sales, the amount of mortgaged property, and the like. Thurber can also ask for a face-to-face meeting with the treasurer (or another officer) of Abraham and Sons. In this meeting, Thurber should discuss the possibility of having the current debt secured in some manner as protection. The development of a formal repayment schedule would also be wise. If the financial statements and a discussion with the client do not alleviate Thurber‘s concerns, he should meet with the other clothing manufacturer who has called as well as with a lawyer and/or accountant. They should discuss possible actions and the outcomes that could result from each. Inevitably, if loss of the receivable seems probable without further action, filing an involuntary petition for bankruptcy may be the wisest decision. However, companies should only take that action after adequate study. Companies rarely prosper by pushing their clients into bankruptcy. Students often address this type of case as a black or white issue with two options: (a) give more credit or (b) force the debtor into bankruptcy. The case simply does not provide sufficient data to arrive at either choice. Students should consider the types of available information that could prove to be beneficial in making a wise decision. Often, in decision-making, the gathering of information is the key step in arriving at the proper action. How Much Is That Building Really Worth? College textbooks frequently present fair value as if it were a known number that is readily available. Students may view an asset‘s fair value as a guarantee that the parties can obtain that much money. Thus, they often believe that producing a statement of financial affairs requires little more than establishing and reporting what a buyer will pay for an asset.

Chapter 13 – Accounting for Legal Reorganizations and Liquidations – Hoyle, Schaefer, Doupnik, Advanced Accounting, 15e

This case emphasizes that an asset‘s net realizable value might actually be no more than a wild guess. Obviously, because of functioning markets, a company determine the value of most stocks and many bonds with accuracy. Other assets such as the building in this case might prove to have a liquidation value that varies from a significant amount down to zero (many deserted buildings are simply never sold because no one wants that type building in that location even if it is in great condition—many cities are filled with such abandoned structures). The accountant faces the problem of preparing a statement of financial affairs that requires the reporting of a single number as the value of each asset. The parties to the bankruptcy can then make important financial decisions based on the presented information. Subsequently, the actual amount received may be significantly different from the figure shown. The users of the information may feel misled when, in fact, the accountant made the best estimate possible. Given the problems faced in determining fair value, the accountant will probably select a conservative number for reporting purposes. In most cases, the possibility of damage to the parties is less with a relatively low figure. However, use of a low value may tempt the creditors to allow the company to reorganize because the information indicates that they stand to gain little by forcing liquidation. For this reason, a conservative approach might actually favor the company attempting to avoid liquidation. Probably the most important lesson from this case is that decision-makers should look with skepticism on many of the numbers reported as representing fair value. In most cases, fair value is an estimated figure that depends on a number of uncertain factors. Is this the Real Purpose of the Bankruptcy Laws? During the 1980s, as described in this case, a rash of voluntary bankruptcies took place in the U.S. to resolve major financial problems. Previously, companies used the bankruptcy laws almost exclusively to settle insolvency problems. However, if a voluntary petition is filed and accepted by the bankruptcy court, companies have a possible method for settling issues before actual insolvency occurs. Sometimes the results are good for the companies but not always. For example, as a condition of its reorganization, A. H. Robins had to agree to the company‘s sale to American Home Products. In effect, the company lost its independence in order to satisfy the lawsuits resulting from Dalkon Shield litigation. As with many of the discussion questions in this book, this case is intended to alert students to a real-life issue and encourage them to consider the reporting and operating ramifications. To function in society, accounting students must know more than the mechanical aspects of a bankruptcy. What are the objectives of the bankruptcy laws and do these particular cases fall outside of those objectives? Would either Manville or its claimants, for example, have been better served by having the company slowly pulled into insolvency over years or perhaps decades? Should a different set of bankruptcy laws be established for companies having these types of financial crises? Although these questions are not directly related to accounting, they are the types of questions that accountants (both as business people and as citizens) need to address. Answers to Questions 1. "Insolvent" refers to a state of financial position whereby a company (or individual) is unable to pay debts as they come due.

Chapter 13 – Accounting for Legal Reorganizations and Liquidations – Hoyle, Schaefer, Doupnik, Advanced Accounting, 15e

2. Goodwill is recognized when one company buys another and pays more than the combined fair value of all acquired assets and liabilities. The justification for the extra payment is that the acquired company has the ability to generate more revenue as a whole than the individual assets and liabilities would have individually. Those excess revenues are felt to come from characteristics of the new subsidiary that do not meet the definition of an asset such as customer loyalty, employee expertise, and name recognition. When a company starts to falter, the accountant should ask whether the assets being held are still capable of generating excess revenue. If not, the goodwill has been impaired and the loss should be reported. For example, customer loyalty and name recognition can be lost by poor management decisions or by unfortunate events. 3. No definitive list of situations exists that would raise substantial doubts about a company‘s ability to continue as a going concern for at least one year from the issuance of the financial statements. However, the book identifies a number of problems that could, either individually or in combination, create that level of doubt: recurring operating losses, working capital deficiencies; negative cash flows from operating activities, loan default, work stoppages or other labor difficulties, legal proceedings, and the loss of a key asset such as a patent or franchise. 4. If management is concerned about a company‘s ability to continue as a going concern for at least one year from the issuance of the financial statements, a number of possible plans could serve to mitigate or reduce that doubt. These include the development of contingency plans to dispose of assets in order to raise cash and reduce costs. The plans could also include the anticipation of borrowing money from financial institutions or other parties. The company could plan to (a) restructure its current debt, (b) reduce operating or capital expenditures, or (c) obtain additional capital from new or existing owners. 5. Management must first decide if the company is able to implement the plans that are in place. Some plans could be so outrageous (increase sales by 300 percent, for example) that implementation is simply not possible. If implementation is likely, then management must decide if the plans would successfully address the issues that led to the substantial doubt of the company remaining a going concern for at least one year from the date the financial statements were issued. Can the plans be implemented? Will the plans succeed in addressing the concern? 6. If substantial doubt is raised but alleviated by management's plans, the conditions that caused the concern should be disclosed along with (a) management's evaluation of their significance and (b) the plans that are expected to solve the concern. If substantial doubt is raised that is not deemed to be alleviated by management's plans, the same information as above is still related. In addition, a clear statement must be included to disclose that substantial doubt exists about the entity's ability to continue as a going concern for one year from the date on which the financial statements were issued. 7. In the United States today, the primary piece of federal legislation that governs most bankruptcy proceedings is the Bankruptcy Reform Act of 1978 and its subsequent amendments. 8. Bankruptcy proceedings have two overriding objectives: — A fair distribution of assets to the various parties that are involved with an insolvent company (or individual) and

Chapter 13 – Accounting for Legal Reorganizations and Liquidations – Hoyle, Schaefer, Doupnik, Advanced Accounting, 15e

— Discharge of the obligations of an honest debtor. 9. A voluntary bankruptcy petition is one filed by an insolvent company to gain protection from its creditors. Creditors may also seek to prevent or limit losses by filing their own (involuntary) petition. Where a company has at least 12 unsecured creditors, a minimum of three (having total unsecured debts of over a set amount that is adjusted every three years for inflation) must sign an involuntary petition. If fewer than 12 unsecured creditors exist, only one is needed to file the petition but the minimum debt level is the same. 10. The granting of an order for relief creates an automatic stay that halts all actions against an insolvent company. The order for relief provides the company as well as its creditors with time to decide on a future course of action. The order for relief also brings the court into the process and provides a structure for what might otherwise be a chaotic event, the distribution of assets to the parties involved. 11. A fully secured creditor has an obligation from an insolvent company but holds a collateral interest in assets that have a value in excess of the debt. These parties can assume that they will suffer no loss regardless of the outcome of the bankruptcy proceedings. A partially secured creditor also has a collateral interest but the liability is larger than the anticipated proceeds from the realization of the attached assets. A portion of the liability is covered but a risk of loss still exists in connection with the remaining debt. Unsecured creditors have no collateral interest and can only hope to collect after the various secured interests have been satisfied. Obviously, this last group of creditors has the highest chance of incurring a loss. 12. A liability classified "with priority" is still unsecured. However, because of provisions of the Bankruptcy Reform Act of 1978, these debts must be paid before any other unsecured obligations. Thus, the chance of loss is reduced, sometimes significantly. Unsecured liabilities having priority include the following: — Claims for administrative expenses, — Obligations arising between the date that a bankruptcy petition is filed and the appointment of a trustee or the issuance of an order for relief. — Employee claims for wages earned during the 180 days preceding the filing of a bankruptcy petition (up to an upper limit per person), — Employee claims for contributions to a benefit plan earned during the 180 days preceding the filing of a bankruptcy petition (within certain restrictions), — Deposits made with the company to acquire goods or services (up to an upper limit), — Government claims for unpaid taxes. 13. Administrative expenses are classified as liabilities with priority to offer some protection to those individuals who serve the company during the period of insolvency. Without a legitimate chance for monetary reward, few people would be willing to provide the various administrative services needed during the bankruptcy process. Also, these debts were incurred after the order for relief. 14. In a Chapter 7 bankruptcy, the assets of the insolvent company are liquidated to satisfy the claims of the creditors. Business activities cease and noncash assets are sold. Conversely, in a Chapter 11 bankruptcy, the company attempts to survive its financial problems and return to solvency. A reorganization plan is developed that will allow the company to continue operations and reach a settlement of its debts. This reorganization plan must be accepted by each class of creditors, each class of stockholders, and the court.

Chapter 13 – Accounting for Legal Reorganizations and Liquidations – Hoyle, Schaefer, Doupnik, Advanced Accounting, 15e

15. The statement of financial affairs helps the parties involved with a bankruptcy to anticipate their potential losses. It reports all assets of the insolvent company at net realizable value whereas liabilities are classified as fully secured, partially secured, with priority, and unsecured. Based on the potential cash inflows and outflows, an estimate can be made of the losses that will be incurred by each group of claimants. A statement of financial affairs is considered especially useful at the beginning of the bankruptcy process since it can assist the parties in evaluating the outcome of various possible actions. 16. In general, a trustee is assigned to prevent loss of the insolvent company's assets and oversee the liquidation and distribution process. A number of rather procedural tasks are normally accomplished by the trustee shortly after appointment such as notifying the post office, changing locks, obtaining possession of corporate records, and opening a new bank account. Thereafter, the trustee might have to operate the company for a period of time to complete any business still in process. The trustee also has the power to void any transfer made by the debtor within 90 days prior to the filing of the bankruptcy petition if the company was insolvent at the time. Subsequently, the trustee works to liquidate noncash assets and make appropriate disbursements to the various claimants. During this entire process, the trustee needs to make a periodic reporting to the court and other interested parties.

17. A trustee can demand the return of any payment (or other asset transfer) made within 90 days prior to the filing of a bankruptcy petition if the company was already insolvent. This legal procedure is known as the voiding of a preference transfer and is intended to prevent one party from gaining an unfair advantage over the remaining claimants. In effect, the payment is viewed as a distribution of the insolvent company's assets, a process that is to be controlled solely by the trustee and the court. 18. A statement of realization and liquidation is designed to report (1) the account balances of the insolvent company at the date the order for relief is entered, (2) the liquidation of noncash assets, (3) the cash distributions made to the various claimants, (4) any other transactions incurred during this period, and (5) any remaining asset and liability balances. Because of changes in U.S. GAAP, this statement is normally limited for internal reporting purposes. 19. To be in conformity with U.S. GAAP, a company must follow the liquidation basis of accounting once liquidation becomes imminent. That point is reached when a plan of liquidation has been approved by the appropriate court or by individuals who have the authority to make that decision. 20. Liquidation is viewed as imminent (so that the liquidation basis of accounting is necessary according to U.S. GAAP) if a formal plan of liquidation has been approved by the court in charge or by individuals who have the authority to make that decision.

Chapter 13 – Accounting for Legal Reorganizations and Liquidations – Hoyle, Schaefer, Doupnik, Advanced Accounting, 15e

21. When a company is viewed as being in liquidation, then, at a minimum, a statement of net assets in liquidation and a statement of changes in net assets in liquidation are required. 22. If the liquidation basis of accounting is applied, assets are reported at the amount of cash that is expected from that liquidation. Because assets often have to be liquidated rather quickly, the amount of cash expected is often a lower amount than the fair value of those assets. If the liquidation basis of accounting is applied, liabilities continue to be reported based on the amount of each claim. The accountant does not attempt to estimate the amount that will have to be paid until formal agreements have been reached. 23. During the liquidation of an insolvent company, control is turned over to an outside trustee. However, in a Chapter 11 bankruptcy (a reorganization), operations will usually be continued so that an attempt can be made to arrive at a plan to save the company. While the bankruptcy proceeds, control is normally retained by the ownership, a group that is legally referred to as the debtor in possession. 24. In a Chapter 11 bankruptcy, the debtor in possession (the present ownership of the company) is given the initial opportunity of filing a reorganization plan with the court. If a formal proposal is not put forth by the debtor in possession within 120 days of the order for relief or is not accepted within 180 days, any interested party has the right to submit a plan. Bankruptcy proceedings often drag on for lengthy periods because the time limitations can be extended by the court. However, the debtor‘s exclusivity to propose a plan cannot be extended beyond 18 months. In recent years, debtors have begun to push for quicker resolutions so that matters can be finalized even if liquidation becomes necessary. 25. Numerous types of proposals are found in reorganization plans. For example, many will set forth specific ideas for changes to be made in the company's operations (to increase profitability) such as selling assets, closing stores, or terminating complete lines of business. In addition, most reorganization plans identify sources that will be tapped in the future to generate additional funding. Proposed changes in management (and the board of directors) may also be spelled out in an attempt to persuade claimants that the company will have the ability to overcome past economic problems. Last, and probably most important, a reorganization plan must include some anticipated settlement of the claims against the company that were in existence at the time the order for relief was entered. Before any reorganization plan is approved, the creditors (as well as the court) must be convinced that the financial rewards will outweigh the amounts that could be received from liquidation. 26. To become effective, a reorganization plan must be accepted by all interested parties. For approval, each class of creditors (more than two-thirds in dollar amount and one-half in number) must vote for the proposal. Each group of stockholders (two-thirds of the shares being voted) must also accept the plan. The court will then confirm the reorganization plan but only if the court feels that all parties are being treated fairly. The court also has the authority to confirm a proposal even if not accepted by the creditors or stockholders. This procedure (known as a "cram down") is only used if the plan is judged to be fair and equitable. 27. A "cram down" is a legal provision whereby the court can confirm a reorganization proposal for an insolvent company even though the plan has not been accepted by a particular class of creditors or stockholders. This step is not taken unless the court believes the plan being put forth is fair and equitable.

Chapter 13 – Accounting for Legal Reorganizations and Liquidations – Hoyle, Schaefer, Doupnik, Advanced Accounting, 15e

28. During reorganization, many debts are in jeopardy of being settled at a significantly reduced amount whereas others will probably be paid at face value because they are secured or have a high priority. Unsecured and partially secured liabilities are likely to be settled at a lowered figure. Conversely, fully secured liabilities and any debts incurred during the reorganization period are normally not at risk of being reduced. Thus, if a balance sheet is produced while a company is in reorganization, all liabilities are reported as either being subject to compromise (reduction) or not being subject to compromise. The debts subject to compromise are reported at the expected amount of allowed claims rather than at an estimate of the settlement figure. Such estimations are often difficult, if not impossible, to make. 29. A company going through a Chapter 11 bankruptcy will report specified reorganization items on its income statement separately from operating figures. However, these reorganization items are reported prior to income tax expense rather than in a manner similar to an extraordinary item. These separately disclosed figures include gains and losses on the sale of assets necessitated by the reorganization. Professional fees incurred in connection with the reorganization are also reported in a similar manner as well as any interest revenue that would not have been earned except for the bankruptcy proceeding. 30. Professional fees incurred during reorganization must be expensed as incurred. Capitalization is not allowed. 31. Fresh start accounting refers to the adjustment of a company's assets to current value at the time the organization emerges from bankruptcy. A company must use fresh start accounting if two criteria are met at the time the reorganization is finalized: (1) the fair value of the assets is less than the total allowed claims as of the date of the order for relief plus the liabilities incurred during reorganization and (2) the original owners are left with less than 50 percent of the voting stock. In fresh start accounting, all assets are reported at current value while liabilities are reported based on the present value of the settlement amounts. If the reorganization value of the company as a whole is greater than the total fair value of the individual assets, goodwill is reported for the excess. Initially, in fresh start accounting, retained earnings must be reported at a zero balance. 32. Fresh start accounting is used by companies that are emerging from a bankruptcy reorganization if the value of the assets held at that time are less than the allowed claims associated with company‘s liabilities (those present at the date of the order for relief and those incurred since that date) and the original owners are left with less than 50 percent of the voting stock of the reorganized company. 33. In fresh start accounting, the tangible and intangible assets of the company are reported at their fair values. Liabilities are reported at the present value of the future cash flows. 34. When a company emerges from bankruptcy, the reorganization value of its assets as a whole must be determined. The figure is normally computed by discounting anticipated future cash flows from the business. This figure is then assigned to the various assets of the company based on individual fair values. The total reorganization value may well be greater than the current value of the individual assets. If so, the residual amount is recorded as the intangible account Goodwill. Each year (or more often in some cases) it is reviewed for impairment.

Chapter 13 – Accounting for Legal Reorganizations and Liquidations – Hoyle, Schaefer, Doupnik, Advanced Accounting, 15e

Answers to Problems 1. B

2. B 3. C 4. D 5. B 6. C 7. A 8. D 9. C 10. B 11. C 12. B 13. A 14. A 15. A 16. B 17. C 18. B 19. D 20. B 21. D 22. A 23. C

Chapter 13 – Accounting for Legal Reorganizations and Liquidations – Hoyle, Schaefer, Doupnik, Advanced Accounting, 15e

24. A 25. D 26. C 27. C 28.(10 Minutes) (Distribution of cash in a business liquidation) Free Assets: Current Assets ........................................................................ Buildings and Equipment ...................................................... Total ...................................................................................

$ 35,000 110,000 $145,000

Liabilities with Priority: Administrative Expenses ....................................................... Salaries Payable (only $3,000 per employee)........................ Income Taxes .......................................................................... Total ...................................................................................

$ 20,000 6,000 8,000 $ 34,000

Free Assets after Payment of Liabilities with Priority ($145,000 – $34,000) ...............................................................

$111,000

Unsecured Liabilities Notes Payable (in excess of value of security) .................... Accounts Payable ................................................................... Bonds Payable ........................................................................ Total ...................................................................................

$ 30,000 85,000 70,000 $185,000

Percentage of Unsecured Liabilities to Be Paid: $111,000/$185,000 = 60 % Payment on Notes Payable: Value of Security (land) .......................................................... 60% of Remaining $30,000 ..................................................... Total Collected.........................................................................

$ 90,000 18,000 $108,000

29.(5 Minutes) (Distribution of assets as a result of liquidation) Liabilities with Priority Paid first—administrative expense ............................................. Paid second—wages: total of $5,850 for Rankin but only up to a maximum of $15,150 for Key ..................................... Total of first priority claims.......................................................... All remaining money available goes to: Government claims to unpaid taxes ..................................... Total of free assets..................................................................

$3,450 21,000 24,450 3,250 $27,700

Chapter 13 – Accounting for Legal Reorganizations and Liquidations – Hoyle, Schaefer, Doupnik, Advanced Accounting, 15e

No payments will be made by Shi in connection with the remainder of (a) the salary to Key and (b) the government claims for unpaid taxes. No payments will be made on any of the unsecured accounts payable since no money is left. 30.(8 Minutes) (Distribution of assets to partially secured creditors) Free Assets: Other Assets ........................................................................... Excess from Assets Pledged with Fully Secured Creditors ($116,000 – $70,000) ......................................... Total ...................................................................................

46,000 $126,000

Liabilities with Priority ...........................................................

$ 42,000

Free Assets after Payment of Liabilities with Priority ($126,000 – $42,000) ...............................................................

$ 84,000

Unsecured Liabilities: Excess of Partially Secured Liabilities Over Pledged Assets ($130,000 – $50,000) ............................................. Unsecured Creditors .............................................................. Total ...................................................................................

$ 80,000 200,000 $280,000

$ 80,000

Percentage of Unsecured Liabilities to Be Paid: $84,000/$280,000 = 30% Payment on Partially Secured Debt: Value of Pledged Asset .......................................................... 30% of Remaining $80,000 ..................................................... Total to be Collected by Holders of This Debt.................

$ 50,000 24,000 $ 74,000

31.(8 Minutes) (Distribution of assets to partially secured creditors) Free Assets: Cash.......................................................................................... Excess from Assets Pledged with Fully Secured Creditors ($110,000 – $90,000) .......................................... Total ....................................................................................

$60,000 20,000 $80,000

Liabilities with Priority..................................................................

22,800

Free Assets after Payment of Liabilities with Priority ...............

$57,200

Unsecured Liabilities: Excess of Partially Secured Liabilities Over Pledged Assets ($170,000 – $140,000) ............................. Accounts Payable.................................................................... Total ....................................................................................

$ 30,000 190,000 $220,000

Chapter 13 – Accounting for Legal Reorganizations and Liquidations – Hoyle, Schaefer, Doupnik, Advanced Accounting, 15e

Percentage of Unsecured Liabilities to be paid: $57,200/$220,000 = 26% Payment on Bond: Value of Pledged Asset ........................................................... 26% of Remaining $30,000...................................................... Total to be Received by Holders .......................................

$140,000 7,800 $147,800

32.(12 Minutes) (Liquidation of assets to satisfy debt) The holder of Debt 2 will receive $100,000 from the sale of the pledged asset. This creditor wants to receive $142,000 out of the total debt of $170,000. Thus, $42,000 must be collected from the remaining debt of $70,000. That is a payoff of 60 percent of the unsecured debt ($42,000/$70,000). To get the additional $42,000, the company must be able to generate enough cash to (a) pay off 100 percent of the liabilities with priority ($110,000) and (b) also pay 60 percent of the unsecured liabilities. Unsecured Liabilities: Unsecured Creditors ................................................................... Excess Liability of Debt 1 in Excess of Pledged Asset ($210,000 – $180,000) ............................................................. Excess Liability of Debt 2 in Excess of Pledged Asset ($170,000 – $100,000) ............................................................. Total Unsecured Liabilities................................................ Necessary Payoff Percentage ..................................................... Cash Needed for These Liabilities ..............................................

$230,000 30,000 70,000 $330,000 60% $198,000

For the holder of Debt 2 to receive exactly $142,000, the other free assets must be sold for $308,000. With that much money, the liabilities with priority ($110,000) can be paid with the remaining $198,000 going to help cover the unsecured debts of $330,000. That is 60 percent coverage of those debts ($198,000/$330,000). This 60 percent figure would insure that the holder of Debt 2 would get $100,000 from the pledged asset and $42,000 ($70,000 × 60%) from the free assets. 33.(8 Minutes) (Payments to be made on unsecured and partially secured liabilities) a. The unpledged assets of $310,000 must be added to any excess to be received from assets pledged on fully secured debts ($220,000 – $160,000 = $60,000) to get amount of free assets available of $370,000. Amount Available ......................................................................... Liabilities with Priority ................................................................. Available for Unsecured Creditors ........................................

$370,000 (182,800) $187,200

Accounts Payable ........................................................................ Partially Secured Debt in Excess of Pledged Assets ($510,000 – $390,000) 120,000

$400,000

Chapter 13 – Accounting for Legal Reorganizations and Liquidations – Hoyle, Schaefer, Doupnik, Advanced Accounting, 15e

Unsecured Liabilities....................................................................

$520,000

Distribution to Unsecured Creditors: $187,200/$520,000 = 36% An unsecured creditor to whom $13,000 is owed can expect to receive $4,680 ($13,000 × 36%). b. The bank will receive a total of $100,800. The secured interest will generate $90,000 (for the $120,000 note). The remaining $30,000 liability is unsecured so that only an additional payment of $10,800 (36%) can be expected. 34.(20 Minutes) (Distribution of cash assets resulting from liquidation) Free Assets: (fair value) Cash ......................................................................................... Inventory .................................................................................. Equipment ................................................................................ Total ...................................................................................

$ 10,000 60,000 50,000 $120,000

Liabilities with Priority: Administrative Expenses ....................................................... Income Taxes .......................................................................... Total ...................................................................................

$ 20,000 30,000 $ 50,000

Free Assets after Payment of Liabilities with Priority ($120,000 – $50,000) ...............................................................

$ 70,000

Unsecured Liabilities Note Payable A (in excess of value of security) .................. Note Payable B (in excess of value of security) .................. Note Payable C ....................................................................... Accounts Payable ................................................................... Total ...................................................................................

$ 20,000 80,000 60,000 120,000 $280,000

Percentage of Unsecured Liabilities to Be Paid: $70,000/$280,000 = 25% Payment on Note Payable A: Value of Security (land) ............................................................... 25% of Remaining $20,000 .......................................................... Total Collected ........................................................................

$ 70,000 5,000 $ 75,000

Payment on Note Payable B: Value of Security (building) ......................................................... 25% of Remaining $80,000 .......................................................... Total Collected ........................................................................

$ 40,000 20,000 $ 60,000

Payment on Note Payable C (unsecured): 25% of $60,000 .............................................................................

$ 15,000

Chapter 13 – Accounting for Legal Reorganizations and Liquidations – Hoyle, Schaefer, Doupnik, Advanced Accounting, 15e

Payment on Administrative Expenses: As a liability with priority, the entire amount due is paid. .........

$ 20,000

Payment on Accounts Payable (unsecured): 25% of $120,000 ...........................................................................

$ 30,000

Payment on Income Taxes Payable: As a liability with priority, the entire amount due is paid. .........

$ 30,000

35.(15 Minutes) (Liquidation of assets to satisfy debt) Note payable B is unsecured. The holders want at least $129,000 of the total balance of $258,000. Thus, at least enough money must become available to pay 50 percent of the unsecured debts ($129,000/$258,000). All values for assets are known except for the company‘s equipment. Unsecured Liabilities: Accounts payable .................................................................... Note payable A—unsecured portion (186,000-168,000) ....... Note payable B ........................................................................ Total ....................................................................................

$188,000 18,000 258,000 $464,000

Free Assets (except for equipment): Cash.......................................................................................... Accounts receivable................................................................ Inventory .................................................................................. Land (value does not cover related debt).............................. Buildings ($336,000 less $308,000 in bonds) ............................................................................. Total ....................................................................................

28,000 $160,000

Less: Liabilities with Priority: Estimated administrative expenses....................................... Taxes payable to government ................................................ Total free assets except for equipment............................

(20,000) (28,000) $112,000

$32,000 36,000 64,000 -0-

In order for unsecured creditors to receive 50 percent of their claims, $232,000 in free assets must be available (50 percent of the $464,000 in total unsecured debts). At present only $112,000 in free assets is available. Thus, another $120,000 must be received from the liquidation of the equipment to have the needed resources ($232,000 – $112,000). 36.(15 Minutes) (Payment of various liabilities as a result of liquidation) Free Assets: Cash.......................................................................................... Receivables (30 percent collectible) ...................................... Inventory ..................................................................................

$30,000 15,000 39,000

Chapter 13 – Accounting for Legal Reorganizations and Liquidations – Hoyle, Schaefer, Doupnik, Advanced Accounting, 15e

Land (value in excess of secured note: $120,000 – $110,000) .......................................................... Total ....................................................................................

10,000 $94,000

Less: Liabilities with priority Salary payable (below maximum)..................................... Free assets available .........................................................

(10,000) $84,000

Unsecured Liabilities: Accounts payable .................................................................... Bonds payable (less secured interest in building: $300,000 – $180,000) .......................................... Unsecured liabilities ..........................................................

$90,000 120,000 $210,000

Percentage of unsecured liabilities to be paid: $84,000/$210,000 = 40% Amounts to be paid for: Salary payable (liability with priority to be paid in full) ........................................................................ Accounts payable (unsecured—will collect 40% of debts of $90,000).................................................. Note payable (fully secured by land—will collect entire balance)......................................................... Bonds payable (partially secured—will collect $180,000 from building and 40 percent of the remaining $120,000).................................................

$10,000 $36,000 $110,000

$228,000

37.(2 Minutes) (Reporting of debts during liquidation) Because of the uncertainty about the amount that will be paid on an unsecured debt, no attempt is made in financial reporting to anticipate the payment. Liabilities are reported at the expected amount of the allowed claim. In this case, the creditors apparently have a legitimate claim of $200,000. 38. (9 Minutes) (Adjusting a company‘s records to fresh start accounting as it comes out of bankruptcy) The individual assets of Larisa Company have a total fair value of $700,000 but a reorganization value of $760,000. Thus, an intangible asset (Goodwill) equal to the $60,000 must be recognized. In addition, the retained earnings deficit must be eliminated and all other asset and liability accounts adjusted to the appropriate value on the day that the company exits from bankruptcy. Common stock was transferred directly from the previous owners to the 13-93 © McGraw Hill LLC. All rights reserved. No reproduction or distribution without the prior written consent of McGraw Hill LLC.

Chapter 13 – Accounting for Legal Reorganizations and Liquidations – Hoyle, Schaefer, Doupnik, Advanced Accounting, 15e

creditors so no change occurs and no entry is needed for the stock account. Because the reorganization value is $760,000 but liabilities are now $300,000, stockholders‘ equity must be $460,000. Retained earnings will be zero and common stock will remain $130,000. Thus, additional paid-in capital should be adjusted to $330,000 ($460,000 less $130,000). Liabilities must be reduced by $500,000 because of the reduction in liabilities in the reorganization plan. Receivables ($90,000 – $80,000) .................................... 10,000 Inventory ($210,000 – $200,000)...................................... 10,000 Buildings ($400,000 – $300,000) ..................................... 100,000 Goodwill............................................................................ 60,000 Liabilities .......................................................................... 500,000 Retained Earnings.............................................................. 370,000 Additional Paid-In Capital ($330,000 – $20,000)......................................................` 310,000 39.(15 Minutes) (Prepare income statement for company going through a bankruptcy reorganization) ADDISON CORPORATION Income Statement Revenues ......................................................................... Costs and expenses: Cost of goods sold .................................................... Rent expense ............................................................. Salaries........................................................................ Depreciation expense ............................................... Advertising expense ................................................. Interest expense ........................................................ Earnings before reorganization items and tax effects Reorganization items: Loss on closing of branch ........................................ Professional fees ....................................................... Interest revenue ......................................................... Loss before income tax benefit................................. Income tax benefit (20 percent) ..................................... Net loss ......................................................................

$ 467,000 $ 211,000 16,000 70,000 22,000 24,000 4,000

(109,000) (71,000) 32,000

(347,000) 120,000

(148,000) (28,000) 5,600 $(22,400)

40. 15 Minutes) (Description of balance sheet for a company emerging from bankruptcy reorganization) a. FASB ASC Topic 852 (Reorganizations) states that a company that is exiting bankruptcy is considered a new entity (so that fair values would be applicable for reporting purposes) if two criteria are met. Otherwise, the company is simply

Chapter 13 – Accounting for Legal Reorganizations and Liquidations – Hoyle, Schaefer, Doupnik, Advanced Accounting, 15e

considered to be a continuation of the old concern, a company that should keep reporting its historical cost figures. The first criterion is that the fair value of the assets of the emerging company must be less than the allowed claims as of the date of the order for relief (plus liabilities incurred during reorganization). The second criterion is that the original owners must be left with less than 50 percent of the voting stock of the emerging company. Whenever both of these criteria are met, the company's assets should be reported at their current fair values. b. Under fresh start accounting, the assets are adjusted to current value on the date that the company successfully emerges from bankruptcy reorganization. A reorganization value for the entity‘s assets as a whole is first determined by discounting the cash flows that are anticipated. This balance is assigned to identifiable assets (both tangible and intangible) in the same manner as in a purchase combination. Any amount of the reorganization value that exceeds the assigned total is recorded as goodwill. c. The reorganization value in excess of the value of the identified assets and liabilities is reported as the intangible asset goodwill. 41.(15 Minutes) (Prepare a balance sheet for a company in bankruptcy reorganization) JAEZ CORPORATION Balance Sheet December 31, 2024 Current assets: Cash ............................................................................ Inventory .................................................................... Land, buildings, and equipment: Land ............................................................................ Buildings .................................................................... Equipment ................................................................... Total assets Liabilities not subject to compromise Current liabilities: Accounts payable ................................................ Long-term liabilities: Note payable (due 2026) ................ $110,000 Note payable (due 2027) ................. 100,000

$ 23,000 45,000 140,000 220,000 154,000

$ 68,000

514,000 $582,000

$ 60,000

210,000

$ 270,000

Chapter 13 – Accounting for Legal Reorganizations and Liquidations – Hoyle, Schaefer, Doupnik, Advanced Accounting, 15e

Accounts payable ...................................................... Accrued expenses ..................................................... Income taxes payable ............................................... Note payable (due 2029) ............................................ Total liabilities ....................................................... Stockholders' equity Common stock ........................................................... Retained earnings (deficit) ........................................ Total liabilities and shareholders' (deficit) ..............

123,000 30,000 22,000 170,000

345,000 615,000

200,000 (233,000) $ 582,000

42.(40 Minutes) (Prepare journal entries for company emerging from bankruptcy using fresh start accounting) Preliminary computations: BOOK VALUES PRIOR TO EMERGING FROM REORGANIZATION — Total assets at book value = $710,000 ($100,000 + $112,000 + $420,000 + $78,000) — Total liabilities at book value = $800,000 ($80,000 + $35,000 + $100,000 + $200,000 + $185,000 + $200,000) — Total common stock = $240,000 (given) — Deficit = $330,000 (given) — Since the above accounts balance, no additional paid-in capital must exist at this time. BOOK VALUES AFTER EMERGING FROM REORGANIZATION

— Total assets = $780,000 (reorganization value – given) — Total liabilities = $340,000 ($5,000 + $4,000 + $100,000 + $50,000 + $71,000 + $110,000) — Total common stock = $240,000 (all 18,000 returned shares are reissued) — Deficit = -0- (eliminated by the reorganization) — Additional paid-in capital = $200,000 (figure needed to balance above accounts after reorganization) — Because the company will have 30,000 shares outstanding after the reorganization, the additional paid-in capital equals $6.67 per share ($200,000/30,000) — Because the company has a reorganization value of $780,000 but the assets have a fair value of only $735,000, goodwill of $45,000 must be recognized JOURNAL ENTRIES — Land and Buildings .................................................... Goodwill ..................................................................... Accounts Receivable ........................................... Inventory ............................................................... Equipment ............................................................. Additional Paid-In Capital (to balance) ............... To adjust accounts to fair value as part of fresh start accounting.

80,000 45,000 20,000 22,000 13,000 70,000

Chapter 13 – Accounting for Legal Reorganizations and Liquidations – Hoyle, Schaefer, Doupnik, Advanced Accounting, 15e

— Common Stock ........................................................... Additional Paid-In Capital .................................... To record shares turned in to the company by the owners as part of the reorganization plan, 18,000 shares at an $8 per share par value.

144,000 144,000

42. (continued) — Accounts Payable ...................................................... Note Payable ......................................................... Common Stock ($8 per share par value) ............ Additional Paid-In Capital ($6.67 per share—see above, or 1/30 of company total) ................... Gain on Debt Discharge ....................................... To record settlement of accounts payable.

80,000

— Accrued Expenses ..................................................... Note Payable ......................................................... Gain on Debt Discharge ....................................... To record settlement of accrued expenses.

35,000

— Note Payable ............................................................... Note Payable ......................................................... Common Stock ($8 per share par value) ............ Additional Paid-In Capital ($6.67 per share—see above, or 1/3 of company total) ..................... Gain on Debt Discharge ....................................... To record settlement of note payable due in 2028.

200,000

185,000

5,000 8,000 6,667 60,333

4,000 31,000

50,000 80,000 66,667 3,333

71,000 56,000 46,667

Gain on Debt Discharge .............................................

11,333

To record settlement of note payable due in 2025. — Note Payable ............................................................... Note Payable ......................................................... Gain on Debt Discharge ....................................... To record settlement of note payable due in 2026.

200,000 110,000 90,000

— Additional Paid-In Capital ($334,000 – $200,000) ..... 134,000 Gain on Debt Discharge ....................................... 196,000 Retained Earnings (deficit) .................................. 330,000 To adjust additional paid-in capital to appropriate balance, close out gain, and eliminate deficit balance as part of fresh start accounting.

Chapter 13 – Accounting for Legal Reorganizations and Liquidations – Hoyle, Schaefer, Doupnik, Advanced Accounting, 15e

43.(25 Minutes) (Prepare a balance sheet for a company emerging from bankruptcy reorganization) a. Smith Corporation must apply fresh start accounting because it meets both requirements established by FASB: The reorganization value of $800,000 of the company is less than the allowed claims of $730,000 ($180,000 + $200,000 + $350,000) plus the liabilities incurred following the order for relief of $97,000. The original owners are left with less than 50 percent (40 percent actually) of the voting stock. b. Because the company has a reorganization value of $800,000 but only $653,000 can be assigned to specific assets based on fair value, the remaining $147,000 is reported as Goodwill. SMITH CORPORATION Balance Sheet December 31, 2024 ASSETS Current Assets: Accounts receivable .................................................. Inventory .................................................................... Land, Buildings, and Equipment: Land and buildings .................................................... Machinery ................................................................... Intangible Assets: Patents ........................................................................ Goodwill ..................................................................... Total Assets ..........................................................

$ 18,000 111,000

$129,000

278,000 121,000

399,000

125,000 147,000 $800,000

272,000

LIABILITIES AND STOCKHOLDERS' EQUITY Current Liabilities: Accounts payable ...................................................... $ 97,000 Long-term Liabilities: Note payable (due in 2 years) ................................... $ 35,000 Note payable (due in 5 years) ................................... 50,000 Note payable (due in 8 years) ................................... 100,000 185,000 Total Liabilities ..................................................... $282,000 Stockholders' Equity: Common stock (par value) ........................................ $500,000 Additional paid-in capital ........................................... 18,000 Retained earnings ..................................................... -0- 518,000 Total Liabilities and Stockholders' Equity ......... $800,000 44.(15 Minutes) (Distribution of assets as a result of liquidation)

Chapter 13 – Accounting for Legal Reorganizations and Liquidations – Hoyle, Schaefer, Doupnik, Advanced Accounting, 15e

Free assets: (liquidation value) Other assets ............................................................... Assets pledged with fully secured creditors in excess of debt ...................................................... Total free assets ...................................................

45,000 $126,000

Free assets after paying liabilities with priority ($126,000 – $36,000) ........................................................

$ 90,000

$ 81,000

Unsecured debts: Accounts payable ....................................................... $283,000 Partially secured liabilities in excess of pledged assets ($180,000 – $103,000) ........................................... 77,000 Total unsecured debts ......................................... $360,000 Percentage of unsecured debts to be paid: $90,000/$360,000 = 25% —Liabilities with priority collect the entire amount of $36,000 —Fully secured liabilities collect the entire amount of $200,000 — Partially secured liabilities collect $103,000 from the pledged assets and 25% of the remaining $77,000 ($19,250) for a total of $122,250. —Unsecured liabilities collect 25% of the $283,000 balance or $70,750. 45.(35 Minutes) (Prepare statement of financial affairs) LIMESTONE COMPANY Statement of Financial Affairs June 3, 2024

Book Values

Available for Unsecured Creditors

Assets

Pledged with Fully Secured Creditors: $400,000 Land and buildings Less: Notes payable-long-term

$310,000 (190,000)

$120,000

Pledged with Partially Secured Creditors: 180,000 Equipment Notes payable—current

$130,000 (250,000)

-0-

Free Assets: 3,000 Cash 65,000 Accounts receivable 88,000 Inventory Total amount available to pay liabilities with priority and unsecured creditors Less: Liabilities with priority (listed below) Available for unsecured creditors Estimated deficiency

3,000 26,000 80,000 $229,000 (42,000) $187,000 21,000

Chapter 13 – Accounting for Legal Reorganizations and Liquidations – Hoyle, Schaefer, Doupnik, Advanced Accounting, 15e

$736,000

$208,000

45. (continued)

Book Values

Unsecured— Nonpriority Liabilities

Liabilities and Stockholders' Equity

Liabilities with Priority: Administrative expenses ................. $ 10,000 Salaries payable ............................... Taxes payable .................................. Total ..................................................

$ 18,000 10,000 14,000 $ 42,000

Fully Secured Creditors: 190,000 Notes payable – long-term .............. Less: Land and buildings.................

$190,000 (310,000)

-0-

Partially Secured Creditors: 250,000 Notes payable current ..................... Less: Equipment..............................

$250,000 (130,000)

$120,000

Unsecured Creditors: 88,000 Accounts payable (other than salaries) 198,000 Stockholders' equity......................... $736,000

88,000 -0$208,000

46.(25 Minutes) (Distribution of assets as a result of liquidation) Free Assets: Cash ................................................................................................. Accounts Receivable ..................................................................... Inventory ......................................................................................... Investments ..................................................................................... Land Value In Excess of Related Debt ($72,000 – $65,000) ......... Total ...........................................................................................

$ 6,000 18,000 31,000 8,000 7,000 $ 70,000

Liabilities with Priority: Administrative Expenses (estimated) ........................................... Salaries Payable ............................................................................. Taxes Payable ................................................................................. Total ...........................................................................................

$ 22,000 6,000 10,000 $ 38,000

Free Assets after Payment of Liabilities with Priority ($70,000 – $38,000) .........................................................................

$ 32,000

Unsecured Liabilities: Notes Payable (in excess of value of buildings) .......................... Bonds Payable (in excess of value of equipment) ......................

$ 10,000 80,000

Chapter 13 – Accounting for Legal Reorganizations and Liquidations – Hoyle, Schaefer, Doupnik, Advanced Accounting, 15e

Accounts Payable ........................................................................... 70,000 Total .................................................................................................$160,000 Percentage of Unsecured Liabilities to Be Paid: $32,000/$160,000 = 20% Payment on the $65,000 of notes payable secured by land will be made in total since the value of the land is greater than the debt. Payment on Notes Payable (secured by buildings): Value of Security (building) ................................................................. 20% of Remaining $10,000 .................................................................. Total Collected by holders .............................................................

$ 68,000 2,000 $ 70,000

Payment on Bonds Payable: Value of Security (equipment) ............................................................ 20% of Remaining $80,000 .................................................................. Total Collected by holders .............................................................

$ 35,000 16,000 $ 51,000

Payment on Accounts Payable (unsecured): 20% of $70,000 ......................................................................................

$ 14,000

Payment of Salaries Payable: As a liability with priority, the entire amount due is paid. .................

$ 6,000

Payment of Taxes Payable: As a liability with priority, the entire amount due is paid. .................

$ 10,000

Payment of Administrative Expenses: As a liability with priority, the entire amount due is paid. .................

$ 22,000

47.(20 Minutes) (Reporting of a reorganization and a liquidation) a. Because the land's net realizable value is less than the amount of the secured note payable, the debt will be reported on a statement of financial affairs as a liability owed to "partially secured creditors." The $80,000 obligation is disclosed in this manner and then reduced by the $48,000 anticipated cash proceeds. The remaining $32,000 balance will be shown by Anteium as an unsecured nonpriority liability. The land is still reported as an asset, one pledged with partially secured creditors. The $31,000 cost is revealed within the statement of financial affairs although this information is not considered relevant in liquidation. The $48,000 net realizable value is reported but is offset by the $80,000 liability. Thus, no cash will be available to unsecured creditors unless a greater amount is generated by the sale.

Chapter 13 – Accounting for Legal Reorganizations and Liquidations – Hoyle, Schaefer, Doupnik, Advanced Accounting, 15e

b. Fresh start accounting must be used because the reorganization value is less than the debts and the original owners are left with less than 50 percent of the voting stock. After reorganization, the assets will be reported at $82,000 with one $5,000 debt. Since the common stock has a total par value of $40,000, additional paid-in capital must be $37,000. Retained earnings will be zero. — Land ...................................................................... 17,000 Investments ......................................................... 5,000 Goodwill ............................................................... 9,000 Additional Paid-In capital ............................. 31,000 To adjust asset values to fair market value (a total of $73,000) with a Goodwill asset established to bring the total up to $82,000 reorganization value. — Note payable ........................................................ 80,000 Additional Paid-In Capital (60% of company total) Gain on Discharge of Debt ........................... To record issuance of stock to bank in settlement of debt.

22,200 57,800

— Accounts Payable ............................................... 20,000 Note Payable .................................................. Gain on Discharge of Debt ........................... To record settlement of accounts payable for 3-year note.

5,000 15,000

47. (continued) — Gain on Discharge of Debt ................................. 72,800 Additional Paid-In Capital .................................. 16,200 Retained Earnings (deficit) ........................... 89,000 To reduce additional paid-in capital balance to correct figure, to close out gain account, and to eliminate deficit as a step in establishing fresh start accounting. c. The bank will collect a total of $59,000. Obviously, the $50,000 proceeds generated by the land sale must go to the bank with the remaining $30,000 obligation then being ranked as an unsecured-nonpriority liability. Anteium (the insolvent company) will have $15,000 of the $26,000 cash left after paying the $11,000 administrative expenses. Unsecured debts total $50,000 ($30,000 from the note and $20,000 of accounts payable). Thus, 30% of these debts will be paid ($15,000/$50,000). The bank collects an additional $9,000 ($30,000 × 30%); the accounts payable collect $6,000 ($20,000 × 30%).

Chapter 13 – Accounting for Legal Reorganizations and Liquidations – Hoyle, Schaefer, Doupnik, Advanced Accounting, 15e

48.(25 Minutes) (Prepare statement of realization and liquidation) a. LITZ CORPORATION Statement of Realization and Liquidation

Cash

Noncash Assets

Liabilities with Priority

Fully Secured Creditors

Balances, 8/8/24 Investments sold Inventory sold Payment is made on note from proceeds of auction Remaining debt is reclassified Administrative expenses incurred

$ 16,000 39,000 48,000

$763,000 (32,000) (69,000)

$ -0-

$259,000

Land and buildings all sold Payment is made on note from proceeds of sale Reclassify liabilities with priority

315,000

(48,000)

Partially Secured Creditors

Unsecured Nonpriority Liabilities

$132,000

$150,000

(48,000) (84,000)

84,000

15,000

(55,000) (259,000) 34,000

84,000 34,000 (15,000) $214,000

b. Total amount available to pay liabilities with priority and unsecured creditors (see part a)

$214,000

$238,000 7,000 (21,000)

(15,000)

(370,000)

(259,000)

Equipment sold Receivables collected Administrative expenses paid Final balances remaining for unsecured creditors

Stockholders' Equity (Deficits)

(34,000)

(210,000) (82,000) -0-

(126,000) (48,000) $34,000

(15,000) -0-

-0-

$200,000

$(20,000)

Chapter 13 – Accounting for Legal Reorganizations and Liquidations – Hoyle, Schaefer, Doupnik, Advanced Accounting, 15e

Less: liabilities with priority

Available for unsecured creditors Percentage of claim to be received by each unsecured creditor ($180,000/$200,000)

(34,000

$180,000

90%

Chapter 13 – Accounting for Legal Reorganizations and Liquidations – Hoyle, Schaefer, Doupnik, Advanced Accounting, 15e

49. (40 Minutes) (Prepare journal entries for company emerging from bankruptcy using fresh start accounting)

Becket Corporation must use fresh start accounting because the reorganization value of $650,000 is less than the company's allowed debts and the original owners hold less than 50 percent of the voting stock after the reorganization. BOOK VALUES AFTER EMERGING FROM REORGANIZATION — Total assets = $637,000 (reorganization value of $650,000 plus proceeds from sale of stock of $77,000 less $90,000 value of land and investments used to settle two debts) — Total liabilities = $350,000 ($130,000 + $40,000 + $180,000) — Total common stock = $160,000 (10,000 additional shares are issued with a $10 per share par value so the total outstanding shares is now = 16,000) — Deficit = -0- (eliminated by the reorganization) — Additional paid-in capital = $127,000 (figure needed to balance above accounts after reorganization) — Because the company has a reorganization value of $650,000 but the individual assets have a total fair value of only $623,000, Goodwill must be recognized as $27,000. JOURNAL ENTRIES — Investments ......................................................... Land ..................................................................... Buildings ............................................................. Goodwill .............................................................. Accounts Receivable .................................... Inventory ........................................................ Equipment ...................................................... Additional Paid-In Capital (to balance)......... To adjust accounts to fair value as part of fresh start accounting.

14,000 23,000 52,000 27,000 20,000 16,000 31,000 49,000

— Cash ...................................................................... Common Stock ($10 par value) .................... Additional Paid-In Capital ............................. To record shares sold to new investor.

77,000

— Cash ..................................................................... Investments ................................................... Investments sold.

40,000

70,000 7,000

40,000

49. (continued) — Notes Payable—Current ..................................... Cash ............................................................... Notes Payable (due in 2028) .........................

220,000 40,000 130,000

Chapter 13 – Accounting for Legal Reorganizations and Liquidations – Hoyle, Schaefer, Doupnik, Advanced Accounting, 15e

Gain on Discharge of Debt ........................... To record settlement of current notes. —Accounts Payable ................................................ Notes Payable (due in 2025) ......................... Gain on Discharge of Debt ........................... To record settlement of accounts payable.

50,000 129,000 40,000 89,000

— Notes Payable (due in 2027) ............................... 325,000 Land ............................................................... Notes Payable (due in 2031) ......................... Common Stock ($10 par value) .................... Additional Paid-In Capital (3/16 of total APIC requirement computed above) Gain on Discharge of Debt ........................... To record settlement of long-term debt.

50,000 180,000 30,000 23,813 41,187

— Gain on Debt Discharge ...................................... 180,187 Additional Paid-In Capital ($127,000 – $79,813) 47,187 Retained Earnings (deficit) ........................... 133,000 To adjust additional paid-in capital to appropriate balance, close out gain, and eliminate deficit balance as part of fresh start accounting. 50.(40 Minutes) (Prepare statement of financial affairs and determine amounts to be paid in liquidation) a. OREGON CORPORATION Statement of Financial Affairs Available for Book Unsecured Values Assets Creditors Pledged with Fully Secured Creditors: $33,000 Land (Plots A and D) Less: Notes payable

$43,000 (30,000)

$13,000

Pledged with Partially Secured Creditors: 28,000 Land (Plots B and C) Less: Notes payable

$25,000 (30,000)

-0-

Free Assets: 6,000 Cash 25,000 Accounts receivable Total available to pay liabilities with priority and unsecured creditors Less: Liabilities with priority (listed below) Available for unsecured creditors Estimated deficiency $92,000

6,000 12,000 $31,000 28,000 $ 3,000 47,000 $50,000

Chapter 13 – Accounting for Legal Reorganizations and Liquidations – Hoyle, Schaefer, Doupnik, Advanced Accounting, 15e

Book Values 0$12,000 30,000

30,000

25,000 20,000 (25,000)* $92,000

Liabilities and Stockholders' Equity Liabilities with Priority: Administrative expenses (estimated) Salaries payable Total (as shown above) Fully Secured Creditors: Notes payable Land (Plots A and D) Partially Secured Creditors: Notes payable Land (Plots B and C) Unsecured Creditors: Notes payable Accounts payable (less salaries shown above) Stockholders' equity

Unsecured— Nonpriority Liabilities $16,000 12,000 $28,000 $30,000 (43,000)

-0-

$30,000 (25,000)

$ 5,000 25,000 20,000 $50,000

*Derived as a balancing figure.

50. (continued) b. According to the statement of financial affairs prepared above, $3,000 cash should be available for unsecured nonpriority creditors. Unfortunately, $50,000 in unsecured nonpriority liabilities exist. Thus, only 6% of these claims will be covered ($3,000/$50,000). Cash of $11,240 will be paid on the note payable that is secured by plot B. The land is to be sold for $11,000 leaving a $4,000 unsecured debt. Since 6% of this amount is expected to be paid, the holder will only receive an additional $240. c. As indicated in part b, only 6% of the unsecured nonpriority claims can be satisfied. Thus, just $1,500 will be paid on the unsecured $25,000 note payable. d. Selling plot D for $30,000 rather than $27,000 generates an additional $3,000 in available cash. The statement of financial affairs produced above would then report $6,000 as the amount available for unsecured nonpriority claims or 12% of the total ($6,000/$50,000). After plot B is sold for $11,000, the remaining $4,000 of this note is classified as an unsecured nonpriority liability. Since 12% of this amount is to be paid, an additional $480 is transferred to the holder of the note for a total of $11,480.

51.(40 Minutes) (Prepare a statement of financial affairs) LYNCH, INC. Statement of Financial Affairs March 14, 2024 Book Values

Assets

Available for Unsecured Creditors

Chapter 13 – Accounting for Legal Reorganizations and Liquidations – Hoyle, Schaefer, Doupnik, Advanced Accounting, 15e

Pledged with Fully Secured Creditors: $40,000 Land and building Less: Notes payable

$75,000 (70,000)

$5,000

Pledged with Partially Secured Creditors: 14,000 Equipment Less: Notes payable

$19,000 (150,000)

-0-

1,000 25,000 100,000 15,000

Free Assets: Cash Accounts receivable Inventory Investments Total available to pay liabilities with priority and unsecured creditors Less: Liabilities with priority (listed below) Available for unsecured creditors Estimated deficiency

1,000 15,000 33,000 21,000 $75,000 (22,000) $53,000 115,000 $168,000

$195,000

51. (continued) Book Values

Unsecured— Nonpriority Liabilities

Liabilities and Stockholders' Equity

Liabilities with Priority: -0- Administrative expenses (estimated) $5,000 Salaries payable 1,000 Payroll taxes payable Total (above)

$16,000 5,000 1,000 $22,000

Fully Secured Creditors: 70,000 Notes payable Land and building

$70,000 (75,000)

-0-

Partially Secured Creditors: 150,000 Notes payable Equipment

$150,000 (19,000)

$ 131,000

Unsecured Creditors: 33,000 Accounts payable 4,000 Advertising payable (68,000) Stockholders' equity $195,000

33,000 4,000 $168,000

Chapter 13 – Accounting for Legal Reorganizations and Liquidations – Hoyle, Schaefer, Doupnik, Advanced Accounting, 15e

52.(30 Minutes) (Prepare a statement of realization and liquidation) LYNCH, INC. Statement of Realization and Liquidation March 14, 2024, to July 23, 2024

Book balances, 3/14/24 Answer from Problem 51 Accounts receivable collected —remaining balance assumed to be uncollectible Inventory sold Accounts payable discovered Land and buildings all sold Fully secured note paid Equipment sold Payment made on partially secured debt Investments sold Administrative expenses accrued Remaining partially secured claims reclassified as unsecured liabilities Final balances remaining for unsecured creditors

Cash

Noncash Assets

Liabilities with Priority

$ 1,000

$194,000

$6,000

18,000

(25,000)

40,000

(100,000)

Fully Secured Creditors

Partially Secured Creditors

Unsecured Nonpriority Liabilities

Stockholders' Equity (Deficits)

$70,000

$150,000

$ 37,000

$(68,000)

(7,000)

10,000 71,000 (70,000) 11,000 (11,000)

(40,000)

21,000

(15,000)

31,000 (70,000)

(14,000)

(3,000) (11,000) 6,000 (20,000)

20,000

$81,000

(60,000) (10,000)

-0-

$26,000

-0-

(139,000) -0-

139,000 $186,000

$(131,000)

Chapter 15 - Partnerships: Termination and Liquidation – Hoyle, Schaefer, Doupnik, Advanced Accounting, 15e

a. The statement of realization and liquidation prepared in (a) indicates that $81,000 in cash remains. $26,000 of this amount must be distributed to liabilities with priority leaving $55,000 for unsecured nonpriority creditors. Since (as shown) these unsecured liabilities amount to $186,000, only 30% (rounded) ($55,000/$186,000) of each debt will be paid. Thus, a creditor holding a $1,000 claim will receive cash of approximately $300. 53.(30 Minutes) (Prepare Journal entries for company emerging from bankruptcy using fresh start accounting) Holmes Corporation must use fresh start accounting because the reorganization value of $225,000 is less than the company's allowed debts and the original owners hold less than 50 percent of the voting stock after the reorganization. BOOK VALUES AFTER EMERGING FROM REORGANIZATION — Total assets = $248,200 ($225,000 reorganization value plus proceeds from sale of stock of $36,000 less $12,800 payment made to settle unsecured liabilities [20 percent of $64,000]) — Total liabilities = $118,000 ($18,000 + $70,000 + $30,000) — Total common stock = $105,000 (11,000 additional shares are issued with a $5 per share par value plus 10,000 existing shares so total outstanding shares = 21,000) — Deficit = -0- (eliminated by the reorganization) — Additional paid-in capital = $25,200 (figure needed to balance above accounts after reorganization) JOURNAL ENTRIES — Goodwill ............................................................... 15,000 Additional Paid-In Capital ............................. To adjust to total reorganization value as part of fresh start accounting ($225,000 – $210,000).

15,000

— Salary Payable ..................................................... Note Payable—1 year .................................... To record note issued for accrued salaries.

18,000 18,000

— Notes Payable ...................................................... Note Payable—6 years .................................. Common Stock ($5 par value) ...................... Additional Paid-In Capital (5/21 of total required APIC computed above) Gain on Discharge of Debt ........................... To record settlement of partially secured debt.

140,000

— Cash ..................................................................... Common Stock ($5 par value) ......................

36,000

30,000 25,000 6,000 79,000

30,000

Chapter 15 - Partnerships: Termination and Liquidation – Hoyle, Schaefer, Doupnik, Advanced Accounting, 15e

Additional Paid-In Capital ............................. To record shares sold to new investor. — Notes Payable ...................................................... 50,000 Accounts Payable ............................................... 10,000 Accrued Expenses .............................................. 4,000 Cash ............................................................... Gain on Discharge of Debt ........................... To record payment of unsecured debts—20% payment made.

6,000

12,800 51,200

— Gain on Debt Discharge ...................................... 130,200 Additional Paid-In Capital ($27,000 – $25,200).. 1,800 Retained Earnings (deficit) ........................... 132,000 To adjust additional paid-in capital to appropriate balance, close out gain, and eliminate deficit balance as part of fresh start accounting. Develop Your Skills

Research Case 1 This case allows students to review the official information provided by the Securities and Exchange Commission in connection with bankrupt organizations. Students can also gain information about reporting requirements for organizations in bankruptcies. This assignment allows students to see how the SEC attempts to educate the public on matters pertaining to financial investing. This site includes a significant amount of general information including the following:            

The differences between a Chapter 7 and a Chapter 11 bankruptcy. The risks incurred by the various parties. A description of a prepackaged bankruptcy plan. The advantages of filing under Chapter 11. The appointment of creditor committees. The development of a reorganization plan. Steps in a Chapter 11 reorganization, especially those that involve the SEC. Conveyance of information about a bankruptcy. Voting on a reorganization plan. The effect on stockholders and bondholders. The steps of a Chapter 7 liquidation. Sources of additional information for a specific bankruptcy case.

Research Case 2 This assignment provides the student with the chance to work with actual data from a real company. Thus, students get a feel for the process of retrieving 15-2 © McGraw Hill LLC. All rights reserved. No reproduction or distribution without the prior written consent of McGraw Hill LLC.

Chapter 15 - Partnerships: Termination and Liquidation – Hoyle, Schaefer, Doupnik, Advanced Accounting, 15e

information of interest about a company that is going through bankruptcy. In addition, this assignment can help them appreciate the frustration that sometimes comes about when analyzing financial statements. Textbooks often have information laid out for students so that analysis may resemble a ―connect the dots‖ assignment. In reality, pages and pages of data are often available that require slow and meticulous study. Here is the actual note as supplied by the company in its 2013 financial statements. This information can serve as the basis for considerable class discussion. 2. Chapter 11 Reorganization On June 13, 2009, Six Flags, Inc. (―SFI‖) and certain of its domestic subsidiaries (collectively, the ―Debtors‖) filed voluntary petitions for relief under Chapter 11 of the United Stated Bankruptcy Code in the United States Bankruptcy Court for the District of Delaware (the ―Bankruptcy Court‖) (Case No. 9-12019) (the ―Chapter 11 Filing‖). SFI‘s subsidiaries that own interests in Six Flags Over Texas (―SFOT‖) and Six Flags Over Georgia (including Six Flags White Water Atlanta) (―SFOG‖ and together with SFOT, the ―Partnership Parks‖) and the parks in Canada and Mexico were not debtors in the Chapter 11 Filing. On April 30, 2010, the Bankruptcy Court entered an order confirming the Debtors' Modified Fourth Amended Joint Plan of Reorganization and the Debtors emerged from Chapter 11. Pursuant to the reorganization plan, all of SFI‘s common stock and other equity and debt securities were canceled as of April 30, 2010. Pursuant to the reorganization plan, all of SFI‘s common stock and other equity and debt securities were canceled as of April 30, 2010. Also on April 30, 2010, but after the reorganization plan became effective and prior to the issuance of securities under the reorganization plan, SFI changed its corporate name to Six Flags Entertainment Corporation ("Holdings"). On April 30, 2010, Holdings issued an aggregate of 109,555,556 shares of common stock at $0.025 par value, as adjusted to reflect the two-for-one stock splits in June 2011 and June 2013. In conjunction with the emergence from Chapter 11 and in accordance with the Financial Accounting Standards Board (―FASB‖) Accounting Standards Codification (―ASC‖) Topic 852, Reorganizations ("FASB ASC 855"), we adopted fresh start accounting, pursuant to which the Company‘s estimated fair value was allocated to its underlying assets and liabilities, which results in financial statements that are not comparable to financial statements for periods prior to emergence. FASB ASC 852 requires separate disclosure of reorganization items such as realized gains and losses from the settlement of liabilities subject to compromise, provisions for losses resulting from the reorganization of the business, as well as professional fees directly related to the process of reorganizing the Debtors under the Bankruptcy Code. The Debtors' reorganization items consisted of the following during the years ended December 31, 2013, 2012 and 2011: Year Ended December 31, 15-3 © McGraw Hill LLC. All rights reserved. No reproduction or distribution without the prior written consent of McGraw Hill LLC.

Chapter 15 - Partnerships: Termination and Liquidation – Hoyle, Schaefer, Doupnik, Advanced Accounting, 15e

(Amounts in thousands) ................................................................ 2013

2012 2011

(Recoveries) costs and expenses directly related to the reorganization ...................................... $ (180) $ 2,168 $ 2,455 Costs and expenses directly related to the reorganization primarily include professional fees associated with advisors to the Debtors, certain creditors and the creditors' committee. Net cash paid for reorganization items, constituting professional fees and finance fees, totaled $0.3 million, $1.8 million and $17.5 million for the years ended December 31, 2013, 2012 and 2011, respectively. Analysis Case 1 As can be determined from the article linked in the assignment, Gold‘s Gym exited reorganization by having the company‘s assets acquired with the resulting funds distributed to the creditors and other interested parties. Here are a few of the most interesting facts given. Notice that the company filed for bankruptcy on May 4, 2020, and the auction of the assets was held on July 13, 2020. Most companies cannot afford to stay in bankruptcy for long because of the uncertainty hanging over operations. ―RSG Group GmbH, Europe‘s innovation leader in the fitness and lifestyle sectors, was selected as the winning bidder in a court-approved auction process held on July 13, 2020.‖ ―Established in 1965 in Venice, California, Gold‘s Gym, hit hard by the economic shutdown due to the COVID-19 pandemic, filed voluntary petitions for relief under Chapter 11 on May 4, 2020, in an effort to facilitate the financial restructuring of the company.‖ ―In mid-May, as part of the initial bankruptcy filing, Gold‘s Gym announced its plan to emerge from bankruptcy quickly through a pre-negotiated plan from its majority owner, TRT Holdings, Inc.‖ ―Gold‘s Gym will emerge from bankruptcy with 61 company-owned gyms and more than 600 franchise-owned gyms, along with a healthy balance sheet.‖ Additional articles about this reorganization can be found at the following sites. ---https://www.dallasnews.com/business/local-companies/2020/07/14/iconic-goldsgym-to-be-acquired-by-german-fitness-group-for-100-million/ ---https://www.clubindustry.com/commercial-clubs/gold-s-gym-international-to-be-

Chapter 15 - Partnerships: Termination and Liquidation – Hoyle, Schaefer, Doupnik, Advanced Accounting, 15e

acquired-by-german-company-rsg-group-for-100 Analysis Case 2

While an entity is going through bankruptcy reorganization, creditors, investors, employees, and other interested parties want to know the status of the process. This assignment helps students determine what information they can uncover about a reorganization that is in process. Different entities will undoubtedly provide widely differing amounts of information based on the length of time that has passed. For example, on these two websites, students can get extensive information about scores of bankruptcy cases including:           

Alamo Drafthouse Cinemas Holdings, LCC Briggs & Stratton Corporation Helios and Matheson Analytics Inc. Hi-Crush Inc., Orexigen Therapeutics, Inc. Philippine Airlines, Inc. Sherwin Alumna Company, LLC Tarragon Corporation Teligent, Inc. Tropicana Entertainment, LLC Westinghouse Electric Company, LLC

Communications Case 1

A study of any corporation that is leaving bankruptcy after a reorganization offers a wealth of information about the company and the actions that were taken to save it from bankruptcy. Here are a few facts and plans that a student should notice in reading about the reorganization of J. Crew. 

$1.6 billion of secured debt was converted into equity so that the debtors are now in charge of the company.



J. Crew exited bankruptcy with a $400 million loan that is due in 2027. This agreement gives the company cash without the immediate need of worrying about a quick payment.



Company officials plan to rely on a more focused selection of products.



The company wants to improve the retailer‘s relationship with its customers.

Chapter 15 - Partnerships: Termination and Liquidation – Hoyle, Schaefer, Doupnik, Advanced Accounting, 15e



J. Crew will start to prioritize frictionless shopping to make buying easier for customers.



The company will expand its Madewell Brand products so that they will be able to appeal to a broader range of customers.



The company entered into bankruptcy with a reorganization plan already in place so that it was able to exit bankruptcy fairly quickly.

COMMUNICATIONS CASE 2 This assignment encourages students to work with several practical accounting journals such as The CPA Journal and the Journal of Accountancy. These sources provide a considerable amount of information about the nature of the work that can be performed for a company before, during, and after bankruptcy.

CHAPTER 14 PARTNERSHIPS: FORMATION AND OPERATION Chapter Outline I.

Business organizations that are formed legally as partnerships, although they are not always as visible as corporations, still proliferate throughout this country especially in the legal, medical, and accounting professions. A. Advantages of the partnership format include ease of creation and the absence of the double taxation effect inherent to the income earned by a corporation and distributed to its owners. B. Partnerships, however, rarely grow to a significant size (when compared with large corporate organizations) primarily because of the unlimited liability assumed by each general partner. C. Alternative legal formats have been created over the years to combine the benefits of corporations and partnerships such as S corporations, limited liability partnerships, and limited liability companies.

II.

Partnership accounting and the capital accounts A. The distinctive aspects of partnership accounting center on the capital accounts maintained for each individual partner. B. The basis of accounting for these capital balances is the Articles of Partnership agreement which establishes provisions for initial investments, withdrawals, admission of a new partner, retirement of a partner, etc. C. The actual contribution made by the partners to the business should be recorded at fair value. A problem arises, however, when a contribution is truly intangible such as a particular expertise or an established client base. 1. In the bonus method, only identifiable assets are valued and recorded. The capital account balances are then aligned to indicate the percentage of the actual contributions made by each partner. 2. In the goodwill method, the amount contributed and the corresponding percentage of the initial capital balance are used to calculate the value of the business and the presence of goodwill. Goodwill is then recorded as an intangible asset. 15-6 © McGraw Hill LLC. All rights reserved. No reproduction or distribution without the prior written consent of McGraw Hill LLC.

Chapter 15 - Partnerships: Termination and Liquidation – Hoyle, Schaefer, Doupnik, Advanced Accounting, 15e

III.

Partnership income allocation A. At the end of each fiscal period, the revenue and expense accounts must be closed out with the resulting income figure assigned to the individual capital accounts. B. The method of allocating income to the capital accounts should be established within the Articles of Partnership. 1. The partners can simply assume an equal division of profits and losses. 2. Alternatively, the partners can select any method to arrive at an equitable allocation. Relevant factors may include the amount of capital invested, the time worked in the business, and the degree of business expertise.

IV.

Accounting for partnership dissolution A. Over time, the identity of the individuals within a partnership can change through admission of a new partner or the death, retirement, or withdrawal of a current partner. B. Each change in composition serves to dissolve the original partnership usually so that a new partnership can be formed to continue the business. Thus, dissolution does not necessarily affect the operations of the business. C. Admission of a new partner. 1. A new partner will often buy all (or a portion) of the interest owned by one or more of the present partners. a. The capital account balances can simply be reclassified to reflect the identity of the new ownership. b. As an alternative, all accounts may be adjusted to fair value with the price paid used as the basis for calculating any goodwill. 2. A new partner can also be admitted by a direct contribution to the partnership business. a. The bonus (or no revaluation) method records the identifiable assets contributed at fair value. The new partner‘s capital is set equal to a prearranged percentage or amount. The remaining capital balances are then aligned based on profit and loss percentages. b. The goodwill (or revaluation) approach initially adjusts all assets and liabilities of the partnership to fair value and records goodwill based on the amount paid (which is used to calculate the implied value of the business). D. Withdrawal of a partner 1. The final asset distribution to an individual should be based on the agreement established in the Articles of Partnership and will often vary in amount from that partner's ending capital balance. 2. The difference between the amount paid and the final capital balance can simply be recorded as an adjustment to the remaining partners' capital accounts in the same manner as the bonus method. 3. As an alternative, all accounts can be adjusted to fair value with the amount of payment used as the basis for computing goodwill.

Chapter 15 - Partnerships: Termination and Liquidation – Hoyle, Schaefer, Doupnik, Advanced Accounting, 15e

Answers to Discussion Questions What kind of business is this? The owners of this business face a common problem: they began operations without seriously considering the company‘s legal form. The accountant now needs to specify the advantages and disadvantages of the partnership versus corporate or some other legal form. Eventually, the owners must make this decision but should consider all relevant factors in their choice. The accountant should discuss the following issues with the two owners: — Ease of formation. A formal partnership can be created by the writing of an Articles of Partnership. If income allocation and partners‘ contributions are already determined, the document preparation should be relatively simple. Forming a corporation is a usually a more difficult task depending on individual state laws. The accountant should explain the specific procedures that apply to partnerships in the state where the business is organized and conducts its operations. — Business liabilities. In a partnership, any partner may be held liable for all business debts. Thus, if liabilities escalate and the business fails, each partner risks a large possible loss. The same problem does not exist in a corporation where owners and the business are separate entities. For the owners, potential losses are, in corporations, normally limited to the amount invested. However, in many small, newly created, corporations, the owners are required to personally guarantee any loans. Therefore, to an extent, the concept of unlimited liability may actually be present in either case. The partners should forecast the amount of debts that will be incurred and the possible outcome if the business would happen to fail. — Lawsuits. Some businesses are more susceptible to lawsuits than others. A florist, for example, would likely have less risk than a pharmaceutical company. The concept of personal liability for business debts becomes especially important when litigation risk is high. To reduce such risk, creating a corporation to protect the personal property of the stockholders may be a wise move. The owners of a partnership may become personally responsible for losses created by a business mistake or accident. The need for this responsibility is recognized in states that prohibit doctors, lawyers, accountants, and the like from incorporating. Such states, however, allow licensed professionals to operate LLPs. — Taxation. In a partnership, all income is allocated to the owners immediately and they are taxed on this amount. Double-taxation is avoided. A corporation pays an income tax and any dividends are then taxed again when collected by the owners. Therefore, traditionally, partnerships are viewed as having a tax advantage. The accountant should also mention to the partners other possible tax factors that may affect their decision. For example, in small corporations, double taxation may not be a problem. If salaries paid to the owners are reasonable and approximate the company's profits so that no dividends are distributed, only one tax is paid in either case. As another issue, if a partnership suffers a loss (which often happens when companies begin operations), that loss is passed to the partners and can be used to reduce other taxable income. However, in a corporation, losses are carried back and forward to reduce other taxable income that is earned by the business, possibly delaying the benefits of the loss. As mentioned in the textbook, the owners should consider forming an S Corporation—a business that is incorporated but still taxed as a partnership. — Bankruptcy. If the business should ever fail and have to be liquidated, losses of a partnership 15-8 © McGraw Hill LLC. All rights reserved. No reproduction or distribution without the prior written consent of McGraw Hill LLC.

Chapter 15 - Partnerships: Termination and Liquidation – Hoyle, Schaefer, Doupnik, Advanced Accounting, 15e

are passed directly to the owners to reduce taxable income immediately. For a corporation, the loss is a capital loss to the stockholders which can only offset their own capital gains or be deducted at the rate of $3,000 per year. Thus, if a large loss is incurred, the tax benefits may not be realized for years into the future. — Growth potential. Traditionally, corporations have more growth potential than do partnerships. Ownership interests can be easily transferred. The limitation on liability encourages ownership by individuals who cannot participate in the management of the company. Partnerships are more restricted in adding new owners. Partnerships usually have to entice individuals who are willing to work in the business in order to obtain additional capital. Therefore, the accountant may want to address the following questions in advising these clients:  What amount of time and energy is involved in becoming incorporated?  How much profit or loss is anticipated from the operations of this business in the foreseeable future?  How much debt will the new business incur?  Will this debt be guaranteed by the owners?  How much salary do the owners anticipate withdrawing from the business?  What are the chances of incurring lawsuits?  What is the possibility that the business will fail?  How large do the owners expect this business to grow? Do they anticipate the need for new owners and new capital?  Does the creation of an S Corporation apply to this particular business? How Will the Profits Be Split? This case is designed to point up the difficulty of designing a profit-sharing arrangement that is fair to all parties. Currently, these three individuals have incomes totaling an amount in excess of the first year income that is expected. Thus, the adopted plan will have an immediate impact on them. The reduction of income must be absorbed by the partners in some equitable manner. In addition, the income is projected to increase relatively fast so that the agreed-upon method needs to reward all participants properly over time. Dewars has built up the firm and still handles the bigger clients although he plans to reduce his workload over the next few years. Thus, one method of compensation would be to credit him with interest on the capital built up in the business. However, if that number alone is used, it will tend to escalate even if his work hours are reduced. For this reason, Dewars' share of the profits could also be based in some way on the number of hours that he works. According to the information presented, this number will probably shrink over the years, reducing the profits allocated to Dewars. Thus, this partner might be given interest equal to 10 percent of his capital balance and $50 for each hour worked. Huffman is contributing a significant number of hours to the firm but tends to work on the smaller jobs. A possible allocation technique would be to give this partner a per hour allocation but one that is somewhat smaller than Dewars. For example, Huffman could receive an income allocation of $30 per hour to begin. That number could then be programmed to escalate over the years as Huffman starts to take over the bigger jobs. Scriba's role is to develop a tax practice within the firm. Consequently, one suggestion would be to credit her capital account with a percentage of the tax revenues (20 percent, for example) each 15-9 © McGraw Hill LLC. All rights reserved. No reproduction or distribution without the prior written consent of McGraw Hill LLC.

Chapter 15 - Partnerships: Termination and Liquidation – Hoyle, Schaefer, Doupnik, Advanced Accounting, 15e

year. In that way, she benefits by the amount of business that she brings to the organization. During the first years, though, she may have trouble getting the new part of this business to generate significant revenues. Thus, the partners may want to set a minimum figure for her income allocation. She could be credited, as an example, with 20 percent of tax revenues but not less than $50,000. Many answers to this question are possible. The above is just a simple suggestion based on the facts presented in the case. Income allocation techniques are usually designed to reward the partners for the attributes that they bring to the organization. Even with the above system, percentages would still be necessary to assign any remaining profit or loss. If the partners are not totally satisfied with the system as designed, the percentages could be weighted or adjusted to reward any partner not properly compensated.

Chapter 15 - Partnerships: Termination and Liquidation – Hoyle, Schaefer, Doupnik, Advanced Accounting, 15e

Answers to Questions 1. The advantages of operating a business as a partnership include the ease of formation and the avoidance of the double taxation effect that inherently reduces the profits distributed to the owners of a corporation. In addition, because the losses of a partnership pass, for tax purposes, directly through to the owners, partnerships have historically been used (especially in certain industries) to reduce or defer income taxes. Several disadvantages also are evident from the partnership format. Each general partner, for example, has unlimited liability for all debts of the business. This potential liability can be especially significant in light of the concept of mutual agency, the right that each partner has to create liabilities in the name of the partnership. Because of the risks created by unlimited liability and mutual agency, the growth potential of most partnerships is severely limited. Few people are willing to become general partners in an organization unless they can maintain some day-to-day contact and control over the business. Further discussion of these issues can be found in the Answer to the first Discussion Question that appears above. 2. Specific partnership accounting problems center in the equity (or capital) section of the balance sheet. In a corporation, stockholders' equity is divided between earned capital and contributed capital. Conversely, for a partnership, each partner has an individual capital account that is not differentiated according to its sources. Virtually all accounting issues encountered purely in connection with the partnership format are related to recording and maintaining these capital balances. 3. The balance in each partner's capital account measures that partner's interest in the book value of the business‘ net assets. This figure arises from contributions, earnings, drawings, and other capital transactions. 4. A Subchapter S corporation is formed legally as a corporation so that its owners enjoy limited legal liability and easy transferability of ownership. However, if a company qualifies and becomes a Subchapter S Corporation, it will be taxed in virtually the same manner as a partnership. Hence, income will be taxed only once and that is to the owners at the time that it is earned by the corporation. Use of this designation is quite restricted. To qualify as a Subchapter S Corporation, a company can only have one class of stock and must have no more than 100 owners. These owners can only be individuals, estates, certain tax-exempt entities, and certain types of trusts. Most corporations that do not qualify as Subchapter S Corporations are automatically Subchapter C Corporations. These entities are also corporations but they pay income taxes when the income is earned. Additionally, the owners are liable for a second income tax when dividends are distributed to them. Thus, the income earned by a Subchapter C Corporation faces the double taxation effect commonly associated with corporations. 5. In a general partnership, each partner can have unlimited liability for the debts of the business. Therefore, a partner may face a significant risk, especially in connection with the actions and activities of other partners. However, general partnerships are easy to form and often serve well in smaller businesses where all partners know each other. The major advantage of a general partnership is that all income earned by the business is only taxed once when earned by the business so that no second tax is incurred when distributions are 15-11 © McGraw Hill LLC. All rights reserved. No reproduction or distribution without the prior written consent of McGraw Hill LLC.

Chapter 15 - Partnerships: Termination and Liquidation – Hoyle, Schaefer, Doupnik, Advanced Accounting, 15e

made to owners. A limited liability partnership (LLP) is very similar to a general partnership except in the method by which a partner‘s liability is measured. In an LLP, the partners can still lose their entire investment and be held responsible for all contractual debts of the business such as loans. However, partners cannot be held responsible for damages caused by other partners. For example, if one partner carelessly causes damage and is sued, the other partners are not held responsible. A limited liability company can now be created in certain situations. This type of organization is classified as a partnership for tax purposes so that the double-taxation effect is avoided. However, the liability of the owners is limited to their individual investments like a Subchapter C Corporation. Depending on state law, the number of owners is not restricted in the same manner as a Subchapter S Corporation so that there is a greater potential for growth. 6. The Articles of Partnership is a legal agreement that should be created as a prerequisite for the formation of a partnership. This document defines the rights and responsibilities of the partners in relation to the business and in relation to each other. Thus, it serves as a governing document for the partnership. The Articles of Partnership may contain any number of provisions but should normally specify each of the following: a. b. c. d. e.

Name and address of each partner Business location Description of the nature of the business Rights and responsibilities of each partner Initial investment to be made by each partner along with the method to be used for valuation f. Specific method by which profits and losses are to be allocated g. Periodic withdrawals to be allowed each partner h. Procedure for admitting new partners i. Method for arbitrating partnership disputes j. Method for settling a partner's share in the business upon withdrawal, retirement, or death 7. To give fair recognition to noncash contributions, all assets donated by the partners (such as land or inventory) should be recorded by the partnership at their fair values at the date of investment. However, for taxation purposes, the partner‘s book value is retained. 8. In forming a partnership, one or more of the partners may be contributing some factor (such as an established clientele or an expertise) which is not viewed normally as an asset in the traditional accounting sense. In effect, the partner will be receiving a larger capital balance than the identifiable contributions would warrant. The bonus method of recording this transaction is to value and record only the identifiable assets such as land and buildings. The capital accounts are then aligned to recognize the proportionate interest assigned to each partner's investment. If, for example, the capital balances are to be equal, they are set at identical amounts that correspond in total to the value of the identifiable assets. As an alternative, the amounts contributed along with the established capital percentages can be used to determine mathematically the implied total value of the business and the presence of any goodwill brought into the business. This goodwill is recognized at the time that the 15-12 © McGraw Hill LLC. All rights reserved. No reproduction or distribution without the prior written consent of McGraw Hill LLC.

Chapter 15 - Partnerships: Termination and Liquidation – Hoyle, Schaefer, Doupnik, Advanced Accounting, 15e

partnership is created so that the amount can be credited to the appropriate partner. 9. The Drawing account measures the amount of assets that a particular partner takes from the business during the current period. Often, only regularly allowed distributions are recorded in the Drawing account with larger, more sporadic withdrawals recorded as direct reductions to the partner's capital balance. 10. At the end of each fiscal year, when revenues and expenses are closed out, some assignment must be made of the resulting income figure because a partnership will have two or more capital accounts rather than a single retained earnings balance. This allocation to the capital accounts is based on the agreement established by the partners preferably as a part of the Articles of Partnership. 11. The allocation process can be based on any number of factors. The actual assignment of income should be designed to give fair and equitable treatment to each of the partners. Often, an interest factor is used to reward the capital investment of the partners. A salary allowance is utilized as a means of recognizing the amount of time worked by an individual or a certain degree of business expertise. The allocation process can be further refined by a ratio that is either divided evenly among the partners or weighted in favor of one or more members. 12. If agreement as to the allocation of income has not been specified, an equal division among all partners is presumed. If an agreement has been reached for assigning profits but no mention is made concerning losses, the assumption is made that the same method is intended in either case. 13. The dissolution of a partnership is the breakup or cessation of the partnership. Many reasons can exist for a partnership to dissolve. One partner may withdraw, retire, or die. A new partner may be admitted to the partnership. The original partnership terminates whenever the identity of the individuals serving as partners has changed. Dissolution, however, does not necessarily lead to the liquidation of the business. In most cases, but not all, a new partnership is formed which takes over the business. Such dissolutions are no more than changes in the composition of the ownership and should not affect operations. 14. A new partner can join a partnership by acquiring part or all of the interest of one or more of the present partners. This transaction is carried out with the individual partners directly and not with the partnership. A new partner may also enter through a contribution to the business. In such cases, the investment is made to the partnership rather than to the individuals. 15. In selling an interest in a partnership, three rights are conveyed to the new owner: a. The right of co-ownership of the business property; b. The right to a specified allocation of profits and losses generated by the partnership's business; and c. The right to participate in the management of the business. No problem exists in selling or assigning the first two of these rights. However, the right to participate in management decisions can only be transferred with the consent of all partners. 16. Goodwill recognized in a capital transaction is allocated to the original partners based on the

Chapter 15 - Partnerships: Termination and Liquidation – Hoyle, Schaefer, Doupnik, Advanced Accounting, 15e

profit and loss ratio. The amount is assumed to represent unrealized gains in the value of the business. To determine the amount of goodwill, the implied value of the business as a whole must be calculated based on the price paid for a portion by the new partner. The difference between this implied value and the total capital is assumed to be goodwill or some other adjustment to asset value. 17. Allocating goodwill to an entering partner may be necessary for several reasons. One of the most common is that the partner is bringing to the partnership an attribute that is not an asset in the traditional accounting sense. For example, a new partner with an excellent business reputation might be credited with goodwill at the time of entrance. Other factors such as an established clientele or a professional expertise can justify attributing goodwill to the new partner. The partnership might make this same concession to an entering partner if cash is urgently needed by the business and a larger share of the capital has to be offered as an enticement to generate the new investment. 18. Book values in most cases measure historical cost expenditures which often have undergone years of allocation and changes in value. For this reason, book value will frequently fail to mirror or even resemble the actual worth of a business. In addition, the goodwill that is assumed to be present in a business as a going concern is not a factor that is always reflected within book values. Therefore, distributing partnership property to a withdrawing partner based on book value would not necessarily be fair. Hence, the Articles of Partnership should spell out a method by which an equitable settlement can be achieved.

Chapter 15 - Partnerships: Termination and Liquidation – Hoyle, Schaefer, Doupnik, Advanced Accounting, 15e

Answers to Problems 1. B

2. C 3. D 4. C MaryAnn's investment equals 1/3 of total capital ($50,000 ÷ $150,000). However, she receives only a 1/4 interest capital balance. One explanation for the difference is that the business assets are worth more than book value. To achieve agreement, the net assets could be valued upward to fair value with the adjustment credited to the original partners‘ capital accounts. Alternatively, a bonus could be credited to the original partners. 5. C Based on the new contribution, the company‘s implied value is $312,500 ($125,000 ÷ 40%) which is less than the capital balances ($300,000 in original capital plus $125,000 to be invested). Thus, either the assets are overvalued or the new partner is contributing goodwill in addition to a cash investment. Because the problem indicates that goodwill is recognized, goodwill must be computed. Note that the $125,000 cash contribution is going into the business and, thus, increases capital. Anne's investment = 40% (Original capital plus Anne's investment) $125,000 + Goodwill = 4 ($300,000 + $125,000 + Goodwill) $125,000 + Goodwill = $170,000 + .4 Goodwill .60 Goodwill = $45,000 Goodwill = $75,000 Anne's investment (Capital) = $125,000 + $75,000 = $200,000

6. B The partnership‘s implied value is $980,000 ($245,000 ÷ 25%). Because the current capital total is only $750,000, goodwill of $230,000 must be recognized. Ranzilla's investment is paid directly to the partners and does not affect the capital total. Of the $230,000 in goodwill, 40 percent or $92,000 is attributed to Donovan bringing that capital balance to $392,000. Because a 25% interest is conveyed to the new partner, Donovan's balance decreases by 25% or $98,000—resulting in a new balance of $294,000. 7. B Total capital is $200,000 ($110,000 + $40,000 + $50,000) after the new investment. As Evan's portion is 30 percent, the capital balance becomes $60,000 ($200,000 × 30%). Because only $50,000 was paid, a bonus of $10,000 is taken from the two original partners based on their profit and loss ratios: Maxwell – $7,000 (70%) and Russell – $3,000 (30%). The reduction drops Russell's capital balance from $40,000 to $37,000. 8. B Total capital is $270,000 ($120,000 + $90,000 + $60,000) after the new investment. However, the implied value of the business based on the new investment is $300,000 ($60,000 ÷ 20%). Thus, goodwill of $30,000 must be 15-15 © McGraw Hill LLC. All rights reserved. No reproduction or distribution without the prior written consent of McGraw Hill LLC.

Chapter 15 - Partnerships: Termination and Liquidation – Hoyle, Schaefer, Doupnik, Advanced Accounting, 15e

recognized with the offsetting allocation to the original partners based on their profit and loss ratio: Patrick $18,000 (60%) and Caitlin $12,000 (40%). The increase raises Caitlin's capital from $90,000 to $102,000. 9. A Total capital is $450,000 ($210,000 + $140,000 + $100,000) after the new investment. As Claudius' portion is to be 20 percent, the new capital balance would be $90,000 ($450,000 × 20%). Because $100,000 was paid, a bonus of $10,000 is given to the two original partners based on their profit and loss ratio: Messalina – $6,000 (60%) and Romulus – $4,000 (40%). The increase raises Messalina's capital balance from $210,000 to $216,000 and Romulus's capital balance from $140,000 to $144,000. 10. D ALLOCATION OF NET INCOME ALEXANDER

Net income Interest—5% of beginning capital Salary........................................ Remainder to allocate.............. ($52,500 divided on a 3:3:4 basis) Total allocation .............

STATEMENT OF CAPITAL Beginning capital ..................... Net income (above).................. Drawings (given) ...................... Ending capital ..........................

BERTRAND

COLOMA

$ 4,500

$ 5,000 45,000

$ 8,000

15,750 $20,250

15,750 $65,750

21,000 $29,000

ALEXANDER

$90,000 20,250 (25,000) $85,250

BERTRAND

$100,000 65,750 (25,000) $140,750

TOTAL

$115,000 (17,500) (45,000) $ 52,500 (52,500) -0-

COLOMA

TOTAL

$160,000 29,000 (25,000) $164,000

$350,000 115,000 (75,000) $390,000

11.(30 minutes) (Compute capital balances after 2 years of partnership operations) ALLOCATION OF NET INCOME—YEAR ONE ALLEGAN

Net loss..................................... Interest—10% of beginning capital Salary........................................ Remainder to allocate.............. ($80,000 divided on a 5:2:3 basis) Total allocation...................

BERRIEN

KENT

$11,000 20,000

$ 8,000 -0-

$11,000 10,000

(40,000) $(9,000)

(16,000) $ (8,000)

(24,000) $ (3,000)

TOTAL

$(20,000) (30,000) (30,000) $(80,000) 80,000 -0-

STATEMENT OF CAPITAL—YEAR ONE ALLEGAN

Beginning capital ..................... Net loss (above) ....................... Drawings (given) ...................... Ending capital.....................

$110,000 (9,000) (10,000) $ 91,000

BERRIEN

$80,000 (8,000) (10,000) $62,000

KENT

$110,000 (3,000) (10,000) $ 97,000

TOTAL

$300,000 (20,000) (30,000) $250,000

Chapter 15 - Partnerships: Termination and Liquidation – Hoyle, Schaefer, Doupnik, Advanced Accounting, 15e

11. (continued) ALLOCATION OF NET INCOME—YEAR TWO ALLEGAN

Net income Interest—10% of beginning capital...................... Salary.............................................. Remainder to allocate.................... ($15,000 divided on a 5:2:3 basis) Total allocation ...................

BERRIEN

KENT

TOTAL

(25,000) (30,000) $(15,000) 15,000 -0-

$40,000 $ 9,100 20,000

$ 6,200 -0-

$ 9,700 10,000

(7,500) $21,600

(3,000) $3,200

(4,500) $15,200

STATEMENT OF CAPITAL—YEAR TWO Beginning capital (above).............. Net income (above) ........................ Drawings (given) ............................ Ending capital...........................

ALLEGAN

BERRIEN

$ 91,000 21,600 (10,000) $102,600

$62,000 3,200 (10,000) $55,200

KENT

TOTAL

$ 97,000 15,200 (10,000) $102,200

$250,000 40,000 (30,000) $260,000

12.(8 minutes) (Compute capital balance after withdrawal of a partner using bonus method) Under the bonus method, Callo‘s $10,000 excess payment over his capital balance is deducted from the remaining partners‘ capital accounts according to their remaining relative profit and loss ratios, 2:3. Bella‘s capital balance before withdrawal bonus to Callo $30,000 Allocation of Callo‘s bonus (3/5 × $10,000) (6,000) Bella‘s capital balance after Callo‘s withdrawal $24,000 Callo receives a $10,000 bonus ($100,000 less $90,000 capital balance). This bonus is deducted from the two remaining partners according to their profit and loss ratio (2:3). A 60 percent (3/5) reduction is assigned to Bella which decreases that partner‘s capital balance from $30,000 to $24,000. 13.(8 minutes) (Compute capital balance after withdrawal of a partner using goodwill method) Elizabeth receives an additional $10,000. Because Elizabeth receives 20 percent of profits and losses, this allocation yields total goodwill of $50,000. 20% of Goodwill = $10,000 Goodwill = $10,000 ÷ .20 = $50,000 Isabella‘s capital before withdrawal of Elizabeth $130,000 Isabella‘s share of goodwill recognition (30% × $50,000) 15,000 Isabella‘s capital balance after withdrawal of Elizabeth $145,000 14.(8 minutes) (Compute capital balance after withdrawal of a partner using bonus 15-17 © McGraw Hill LLC. All rights reserved. No reproduction or distribution without the prior written consent of McGraw Hill LLC.

Chapter 15 - Partnerships: Termination and Liquidation – Hoyle, Schaefer, Doupnik, Advanced Accounting, 15e

method) Under the bonus method, Elizabeth‘s $10,000 excess payment over her capital balance is deducted from the remaining partners‘ capital accounts according to their relative profit and loss ratios, 3:3:2. Isabella‘s capital balance before bonus to Elizabeth $130,000 Allocation of Elizabeth‘s bonus (3/8 × $10,000) (3,750) Isabella‘s capital balance after bonus to Elizabeth $126,250 15. (12 minutes) (Compute goodwill based on new partner‘s investment and capital balances) a.

Implied partnership value based on Del Mar‘s investment ($270,000  30%) $900,000 Total partnership capital before goodwill recognition 490,000 Goodwill recognized upon Del Mar‘s investment $410,000

b. Total partnership capital (implied value above) Del Mar‘s ownership pecentage Del Mar‘s capital balance

$900,000 30% $270,000

The implied value of the company is $900,000 ($270,000 ÷ 30%). Because the money is paid to the partners rather than into the business, the capital total is $490,000 before realigning the capital accounts. Thus, goodwill of $410,000 is recognized based on the implied value ($900,000 – $490,000). This goodwill is assumed to represent unrealized business gains and is attributed to the original partners according to their profit and loss ratio. They will then each convey 30 percent ownership of the $900,000 partnership to Del Mar for a capital balance of $270,000. 16. (12 minutes) (Compute partner‘s capital after admission of a new partner with no goodwill recognized)

Total partnership capital before Del Mar‘s investment $490,000 Del Mar‘s investment 250,000 Total partnership capital after Del Mar‘s investment 740,000 Del Mar‘s ownership pecentage 30% Del Mar‘s share of total capital $222,000 Bonus to original partners ($250,000 – $222,000) Boyd‘s ownership share Boyd‘s share of bonus Boyd‘s capital before bonus Boyd‘s capital after bonus

28,000 40% 11,200 160,000 $171,200

Chapter 15 - Partnerships: Termination and Liquidation – Hoyle, Schaefer, Doupnik, Advanced Accounting, 15e

Because the money goes into the business, total capital becomes $740,000 ($490,000 + $250,000). Del Mar is allotted 30 percent of this total or $222,000. Because Del Mar invested $250,000, the extra $28,000 is assumed to be a bonus to the original partners. Boyd will be assigned 40 percent of this extra amount or $11,200. This bonus increases Boyd‘s capital from $160,000 to $171,200. 17.(10 Minutes) (Compute capital balances under both goodwill and bonus methods) a. Goodwill Method Implied value of partnership ($80,000 ÷ 40%) ............ Total capital after investment ($70,000 + $40,000 + $80,000) Goodwill ........................................................................ Goodwill to Hamlet (7/10) ............................................. Goodwill to MacBeth (3/10) .......................................... Hamlet, capital (original balance plus goodwill) ........ MacBeth, capital (original balance plus goodwill) ..... Lear, capital (payment) (40% of total capital) .............

$200,000 190,000 $ 10,000 $ 7,000 $ 3,000 $ 77,000 $ 43,000 $ 80,000

b. Bonus Method Total capital after investment ($70,000 + 40,000 + $80,000) Ownership portion—Lear ............................................. Lear, capital ................................................................... Bonus payment made by Lear ($80,000 – $76,000) ... Bonus to Hamlet (7/10) ................................................. Bonus to MacBeth (3/10) .............................................. Hamlet, capital (original balance plus bonus) ............ MacBeth, capital (original balance plus bonus) ......... Lear, capital (40% of total capital) ...............................

$190,000 40% $ 76,000 $ 4,000 $ 2,800 $ 1,200 $ 72,800 $ 41,200 $ 76,000

18.(15 Minutes) (Prepare journal entries to record admission of new partner under both the goodwill and the bonus methods) Part a. Total capital is $300,000 ($85,000 + $60,000 + $55,000 + $100,000) after the new investment. As Sergio's portion is 25 percent, this partner's capital balance would be $75,000. Because $100,000 was paid, a bonus of $25,000 is given to the three original partners based on their profit and loss ratio: Tiger—$12,500 (50%), Phil—$7,500 (30%), and Ernie—$5,000 (20%). Cash ................................................................................ Sergio, capital ........................................................... Tiger, capital ............................................................. Phil, capital ............................................................... Ernie, capital .............................................................

100,000 75,000 12,500 7,500 5,000

Part b.

Chapter 15 - Partnerships: Termination and Liquidation – Hoyle, Schaefer, Doupnik, Advanced Accounting, 15e

Total capital is $260,000 ($85,000 + $60,000 + $55,000 + $60,000) after the new investment. As Sergio's portion is 25 percent, this partner's capital balance is $65,000. Because only $60,000 was paid, a bonus of $5,000 is taken from the three original partners based on their profit and loss ratio: Tiger—$2,500 (50%), Phil—$1,500 (30%), and Ernie—$1,000 (20%). Cash ........................................................................... Tiger, capital ............................................................. Phil, capital ................................................................ Ernie, capital ............................................................. Sergio, capital ......................................................

60,000 2,500 1,500 1,000 65,000

Part c. Total capital is $272,000 ($85,000 + $60,000 + $55,000 + $72,000) after the new investment. However, the implied value of the business based on the new investment is $288,000 ($72,000 ÷ 25%). Consequently, goodwill of $16,000 must be recognized with the offsetting allocation to the original partners based on their profit and loss ratio: Tiger—$8,000 (50%), Phil— $4,800 (30%), and Ernie—$3,200 (20%). Goodwill .................................................................... Tiger, capital ........................................................ Phil, capital .......................................................... Ernie, capital ........................................................ Cash ........................................................................... Sergio, capital ......................................................

16,000 8,000 4,800 3,200 72,000 72,000

19.(16 Minutes) (Determine capital balances after admission of new partner using both goodwill and bonus methods) Part a. Total capital is $490,000 ($200,000 + $120,000 + $90,000 + $80,000) after the new investment. However, the implied value of the business based on the new investment is only $444,444 ($80,000 ÷ 18%). According to the goodwill method, this situation indicates that the new partner must be bringing some intangible attribute to the partnership other than just cash. This contribution must be computed algebraically and is recorded as goodwill to the new partner. G's Investment = .18 ($200,000 + $120,000 + $90,000 + G's Investment) $80,000 + Goodwill = .18 ($410,000 + $80,000 + Goodwill) $80,000 + Goodwill = $88,200 + .18 Goodwill .82 Goodwill = $8,200 Goodwill = $10,000 The above goodwill balance indicates that Grant's total investment is $90,000 (cash of $80,000 and goodwill of $10,000). A $90,000 contribution raises the

Chapter 15 - Partnerships: Termination and Liquidation – Hoyle, Schaefer, Doupnik, Advanced Accounting, 15e

total capital to $500,000 so that Grant does, indeed, have an 18 percent interest ($90,000 ÷ $500,000). CAPITAL BALANCES: Nixon ......................................................................... Hoover ....................................................................... Polk ........................................................................... Grant ..........................................................................

$200,000 120,000 90,000 90,000

Part b. Total capital is $510,000 ($200,000 + $120,000 + $90,000 + $100,000) after the new investment. As Grant's portion is to be 20 percent, this partner's capital balance will be $102,000. Because only $100,000 was paid, a bonus of $2,000 is taken from the three original partners based on their profit and loss ratio: Nixon—$1,000 (50%), Hoover—$400 (20%), and Polk—$600 (30%). CAPITAL BALANCES Original

Nixon.................................... Hoover ................................. Polk ...................................... Grant .................................... Total ...............................

$200,000 120,000 90,000 -0-

Investment

Bonus

Total

100,000

$(1,000) (400) (600) 2,000

$199,000 119,600 89,400 102,000 $510,000

20.(10 Minutes) (Record admission of new partner and allocation of new income) Part a. Total capital is $167,000 ($70,000 + $60,000 + $37,000) after the new investment. However, the implied value of the business based on the new investment is $185,000 ($37,000 ÷ 20%). Consequently, goodwill of $18,000 must be recognized with the offsetting allocation to the original two partners based on their profit and loss ratio: Prince—$14,400 (80%) and Robbins— $3,600 (20%). Goodwill ..................................................................... Prince, capital ...................................................... Robbins, capital .................................................. Cash ........................................................................... Jeffrey, capital .....................................................

18,000 14,400 3,600 37,000 37,000

Part b. Prince Net income ..................................... Interest............................................ Remainder to allocate....................

Robbins

Jeffrey

$8,440

$6,360

$3,700

(1,750)

(1,050)

(700)

Total $15,000 (18,500) $ (3,500) 3,500

Chapter 15 - Partnerships: Termination and Liquidation – Hoyle, Schaefer, Doupnik, Advanced Accounting, 15e

Total allocation.........................

$6,690

$5,310

$3,000

-0-

21.(5 Minutes) (Allocation of income to partners) Jones Net income ..................................... Bonus (20%) ................................... Interest (15% of average capital) Remainder to allocate.................... Total allocation.........................

King

Lane

$18,000 15,000

$ -030,000

$ -045,000

(6,000) $27,000

(6,000) $24,000

(6,000) $39,000

Total $90,000 (18,000) (90,000) $(18,000) 18,000 -0-

22.(15 Minutes) (Allocate income and determine capital balances) ALLOCATION OF NET INCOME Alford Net income Interest (10%) Salary Remainder to allocate: Total allocation

Beeson

Carlton

Total

$ 6,600(below) 18,000

$ 4,000 25,000

$ 2,000 8,000

(16,000) $ 8,600

(8,000) $21,000

(16,000) $(6,000)

$23,600 (12,600) (51,000) $(40,000) 40,000 -0-

CALCULATION OF ALFORD'S INTEREST ALLOCATION Balance, January 1—April 1 ($60,000 × 3) ................... Balance, April 1—December 31 ($68,000 × 9) .............. Total ................................................................................ Months ............................................................................. Average monthly capital balance ................................. Interest rate .................................................................... Interest allocation (above) ............................................

$180,000 612,000 $792,000  12 $ 66,000 × 10% $ 6,600

STATEMENT OF PARTNERS' CAPITAL Beginning balances ....................... Additional contribution.................. Net income (above) ........................ Drawings ($1,000 per month) Ending capital balances ................

Alford

Beeson

Carlton

Totals

$60,000 8,000 8,600 (12,000) $64,600

$40,000 -021,000 (12,000) $49,000

$20,000 -0(6,000) (12,000) $ 2,000

$120,000 8,000 23,600 (36,000) $115,600

23.(30 Minutes) (Allocate income for several years and determine ending capital balances) NET INCOME ALLOCATION—2023 Angela Net income

Diaz

Krause

Total $70,000

Chapter 15 - Partnerships: Termination and Liquidation – Hoyle, Schaefer, Doupnik, Advanced Accounting, 15e

Interest (10% of beginning capital) Salary Remaining net income: Total allocation

$3,000 12,000

$ 5,800 9,000

$ 6,000 -0-

6,840 $21,840

13,680 $28,480

13,680 $19,680

(14,800) (21,000) $34,200 (34,200) -0-

STATEMENT OF PARTNERS' CAPITAL—DECEMBER 31, 2023 Angela

Diaz

Krause

Total

$30,000 21,840 (15,000) $36,840

$58,000 28,480 (15,000) $71,480

$60,000 19,680 (15,000) $64,680

$148,000 70,000 (45,000) $173,000

NET INCOME ALLOCATION—2024 Angela Diaz

Krause

Total $42,000 (17,300)

Beginning balances ....................... Net income allocation .................... Drawings......................................... Ending balance.........................

Net income Interest (10% of beginning capital above) Salary.............................................. Remaining net income:

$3,684

$7,148

$6,468

12,000

9,000

-0-

740 $16,424

1,480 $17,628

1,480 $7,948

(21,000) $ 3,700 (3,700) -0-

STATEMENT OF PARTNERS' CAPITAL—DECEMBER 31, 2024 Angela Diaz Krause

Total

Total allocation ...................

Beginning balances (above) Additional investment.................... Net income allocation .................... Drawings......................................... Ending balances

$ 36,840 -016,424 (15,000) $ 38,264

$71,480 -017,628 (15,000) $74,108

$64,680 5,000 7,948 (15,000) $62,628

$173,000 5,000 42,000 (45,000) $175,000

NET LOSS ALLOCATION—2025 Angela Diaz

Krause

Total $(25,000) (17,500)

23. (continued)

Net loss Interest (10% of beg. capital above)* Salary.............................................. Remainder to allocate:................... Total allocation............................... *Rounded

$ 3,826 12,000

$ 7,411 9,000

$6,263 -0-

(19,050) $(3,224)

(31,750) $(15,339)

(12,700) $(6,437)

STATEMENT OF PARTNERS' CAPITAL—DECEMBER 31, 2025 Angela Diaz Krause Beginning balances (above)

$38,264

$74,108

$62,628

(21,000) (63,500) 63,500 -0-

Total $175,000

Chapter 15 - Partnerships: Termination and Liquidation – Hoyle, Schaefer, Doupnik, Advanced Accounting, 15e

Income allocation......................... Drawings Ending balances

(3,224) (15,000) $20,040

(15,339) (15,000) $43,769

(6,437) (15,000) $41,191

(25,000) (45,000) $105,000

24.(12 Minutes) (Determine capital balances after retirement of a partner using both the goodwill and the bonus approaches) a. Fergie receives $30,000 more than her capital balance. Because Fergie is assigned 20 percent of all profits and losses, this extra allocation indicates total goodwill of $150,000, which must be split among all partners. 20% of Goodwill = $30,000 .20 G = $30,000 G = $150,000 CAPITAL BALANCES AFTER WITHDRAWAL Original Balance

Pineda Adams Fergie Gomez

Goodwill

$230,000 190,000 160,000 140,000

$45,000 45,000 30,000 30,000

Withdrawal

$(190,000)

Total

Final Balance

$275,000 235,000 -0170,000 $680,000

b. A $50,000 bonus is paid to Pineda ($280,000 is paid rather than the $230,000 capital balance). This bonus is deducted from the three remaining partners according to their relative profit and loss ratio (3:2:1). A reduction of 50 percent (3/6) is assigned to Adams or a decrease of $25,000 which drops this partner's capital balance from $190,000 to $165,000. A reduction of 33.3 percent (2/6) is assigned to Fergie or a decrease of $16,667 which drops this partner's capital balance from $160,000 to $143,333. A reduction of 16.7 percent (1/6) is assigned to Gomez or a decrease of $8,333 which drops this partner's capital balance from $140,000 to $131,667. 25.(10 minutes) (Hybrid method for recording a partner withdrawal) Because the continuing partners do not wish to record goodwill, a hybrid approach records identifiable asset fair value changes and corresponding capital adjustments, but no goodwill. The remaining excess payment to the withdrawing partner after the revaluation is then treated as a bonus. Building Matteson, capital Richton, capital O‘Toole, capital

40,000

O‘Toole, capital Matteson, capital Richton, capital

108,000 4,500 7,500

12,000 20,000 8,000

Chapter 15 - Partnerships: Termination and Liquidation – Hoyle, Schaefer, Doupnik, Advanced Accounting, 15e

Cash

120,000

26.(45 Minutes) (P&L allocations and admission of a new partner) a. The interest factor was probably inserted to reward Hugh for contributing $50,000 more to the partnership than Jacobs. The salary allowance gives an additional $20,000 to Jacobs in recognition of the full-time (rather than part-time) employment. The 40:60 split of the remaining income was probably negotiated by the partners based on other factors such as business experience, reputation, etc. b. The drawings show the assets removed by a partner during a period of time. A salary allowance is added to each partner's capital for the year (usually in recognition of work done) and is a component of net income allocation. The two numbers are often designed to be equal but agreement is not necessary. For example, a salary allowance might be high to recognize work contributed by one partner. The allowance increases the appropriate capital balance. The partner might, though, remove little or no money so that the partnership could maintain its liquidity. c. Hugh, drawings ......................................................... 7,500 Repair expense .................................................... (To reclassify payment made to repair personal residence.) Hugh, capital ............................................................. Jacobs, capital ........................................................... Hugh, drawings (adjusted for home repairs) ..... Jacobs, drawings ................................................. (To close drawings accounts for 2023.) Revenues .................................................................... Expenses (adjusted by first entry) ...................... Income summary .................................................. (To close revenue and expense accounts for 2023.)

7,500

16,500 14,000 16,500 14,000 175,000 138,500 36,500

Income summary ....................................................... 36,500 Hugh, capital ......................................................... 12,600 Jacobs, capital ..................................................... 23,900 (To close net income to partners' capital–see allocation plan shown below.) Allocation of Net Income

Hugh

Net income Interest (10% of beginning capital) Salary allowances Remainder to allocate Total allocation

Jacobs

$ 15,000 5,000

$ 10,000 25,000

(7,400)(40%) $12,600

(11,100) (60%) $23,900

Total $36,500 (25,000) (30,000) $(18,500) 18,500 -0-

Chapter 15 - Partnerships: Termination and Liquidation – Hoyle, Schaefer, Doupnik, Advanced Accounting, 15e

d. Total capital (original balances of $250,000 plus 2023

net income less drawings) ................................. $256,000 Investment by Thomas ............................................. 64,000 Total capital after investment ................................... $320,000 Ownership portion acquired by Thomas ................. 15% Thomas, capital ......................................................... $ 48,000 Amount paid ............................................................... 64,000 Bonus paid by Thomas—assigned to original partners $ 16,000 Bonus to Hugh (40%) ................................................

$6,400

Bonus to Jacobs (60%) .............................................

$9,600

Cash ............................................................................ Thomas, capital (20% of total capital) ............... Hugh, capital ........................................................ Jacobs, capital ....................................................

64,000 48,000 6,400 9,600

27.(40 Minutes) (Reporting a change in the composition of a partnership) a. Exact amount of investment can only be computed algebraically: E Investment El El .75 El E Investment

= = = = =

25% (Original Capital + E Investment) .25 ($270,000 + El) $67,500 + .25 El $67,500 $90,000

b. Implied value of partnership ($36,000 ÷ 10%) ......... Total capital after investment by E ($270,000 + $36,000) Goodwill ..................................................................... Allocation of Goodwill: A (30%) ................................................................. $16,200 B (10%) ................................................................. 5,400 C (40%) ................................................................. 21,600 D (20%) ................................................................. 10,800 Total ................................................................. $54,000

$360,000 306,000 $ 54,000

CAPITAL BALANCES Original balances Goodwill (above) Investment Capital balances

$20,000 16,200 -0$ 36,200

$40,000 5,400 -0$45,400

$ 90,000 21,600 -0$111,600

$120,000 10,800 -0$130,800

$-0-036,000 $36,000

c. Because E's investment of $42,000 is less than 20% of the resulting capital ($312,000). E is apparently bringing some other attribute to the partnership

Chapter 15 - Partnerships: Termination and Liquidation – Hoyle, Schaefer, Doupnik, Advanced Accounting, 15e

(goodwill) that must be computed: E Investment $42,000 + Goodwill $42,000 + Goodwill .80 Goodwill Goodwill

= = = = =

20% (Original Capital + E Investment) .20 ($270,000 + $42,000 + Goodwill) $62,400 + .20 Goodwill $20,400 $25,500

E's investment is, therefore, $42,000 in cash and $25,500 in goodwill for a total capital balance of $67,500; the other capital accounts remain unchanged. Note that E's capital of $67,500 is 20% of the new total capital $337,500 ($270,000 + $67,500). 27. (continued) d.

Total capital after investment ($270,000 + $55,000) Amount acquired by E ............................................. E's capital balance .................................................... E's payment .............................................................. Bonus given to E ......................................................

$325,000 20% $ 65,000 55,000 $ 10,000

Bonus from: A (10%) ...................................................................... B (30%) ....................................................................... C (20%) ....................................................................... D (40%) ......................................................................

$1,000 3,000 2,000 4,000

CAPITAL BALANCES A B C

$120,000 -0(4,000) $116,000

$-055,000 10,000 $65,000

Original balances Investment Bonus (above) Capital balances

$20,000 -0(1,000) $19,000

$40,000 -0(3,000) $37,000

$90,000 -0(2,000) $88,000

$10,000

e. C's capital balance C's collection (125%) Bonus paid to C Bonus from: A (1/3) B (1/3) D (1/3)

$ 90,000 112,500 $ 22,500 $7,500 7,500 7,500

$22,500

CAPITAL BALANCES A B Original balances

$20,000

$40,000

$ 90,000

$120,000

Chapter 15 - Partnerships: Termination and Liquidation – Hoyle, Schaefer, Doupnik, Advanced Accounting, 15e

Bonus (above) Payment Capital balances

(7,500) -0$12,500

(7,500) -0$32,500

22,500 (112,500) $ -0-

(7,500) -0$112,500

28.(55 Minutes) (Allocation of income to the partners and determination of capital balances) ALLOCATION OF NET INCOME—2022 Gorman Morton Net income ................................... Salary (8 months) ........................ Remaining income ...................... Total allocation.......................

$8,000 1,200 $9,200

Total

$-0(40%)

1,800 $1,800

(60%)

STATEMENT OF PARTNERS' CAPITAL—DECEMBER 31, 2022 Gorman Morton Beginning Balances ($114,000 Invested capital split evenly— market value used for assets) Net income allocation (above) Drawings ........................................ Ending balances.......................

$57,000 9,200 -0$66,200

$57,000 1,800 -0$58,800

$11,000 (8,000) 3,000 (3,000) -0-

Total

$114,000 11,000 -0$125,000

STEELE INVESTMENT JANUARY 1, 2023 Steele's $54,000 investment increases total capital to $179,000. Steele is credited with a 40% interest or $71,600, with the excess $17,600 as a bonus from the original partners. $10,560 of the bonus is allocated from Morton (60%) and $7,040 from Gorman (40%). ALLOCATION OF NET INCOME—2023 Gorman Morton Net income ..................................... Salary.............................................. Remainder to allocate:................... Total allocation.........................

Steele

$12,000

$-0-

$24,000

6,000 $18,000

24,000 24,000

20,000 $44,000

STATEMENT OF PARTNERS' CAPITAL—DECEMBER 31, 2023 Gorman Morton Steele Beginning balances ....................... Steele's contribution ..................... Income allocation (above) ............ Drawings ........................................ Ending balances.......................

$66,200 (7,040) 18,000 (25,000) $52,160

$58,800 (10,560) 24,000 (25,000) $47,240

$ -071,600 44,000 (20,000) $95,600

Total $86,000 (36,000) $(50,000) 50,000 -0-

Total $125,000 54,000 86,000 (70,000) $195,000

Chapter 15 - Partnerships: Termination and Liquidation – Hoyle, Schaefer, Doupnik, Advanced Accounting, 15e

Frank's payment was made directly to the partners. Therefore, neither goodwill nor bonus recognition is required. Instead, 10% of each capital balance shown above is reclassified to Frank. The journal entry is as follows: Gorman, capital .............................................................. Morton, capital ............................................................... Steele, capital. ................................................................. Frank, capital ............................................................

5,216 4,724 9,560 19,500

ALLOCATION OF NET INCOME—2024 Net income Salary Remaining net income Total allocation

Gorman

Morton

Steele

Frank

$12,000

$-0-

$24,000

$9,600

(756) $11,244

(2,268) $(2,268)

(2,016) $21,984

(560) $9,040

Total $40,000 (45,600) $ 5,600 (5,600) $ -0-

STATEMENT OF PARTNERSHIP CAPITAL—DECEMBER 31, 2024 Beginning balances Admission of Frank Allocation of net income (above) Drawings Ending balances

Gorman

Morton

Steele

Frank

Total

$52,160 (5,216) 11,244 (25,000) $33,188

$47,240 (4,724) (2,268) (25,000) $15,248

$95,600 (9,560) 21,984 (20,000) $88,024

$ -019,500 9,040 (14,000) $14,540

$195,000 -040,000 (84,000) $151,000

29.(60 Minutes) (Allocate income and prepare a statement of partners' capital) a. Net Income Allocation—2022 Kimble Net income Salary allowance ($55 per hour) Interest Bonus (not applicable because salary and interest would create a negative bonus) Remainder to allocate (split evenly): Total allocation

Sykes

Gerard

Totals $282,000 (244,200) (57,600)

$93,500 24,960

$79,200 21,600

$71,500 11,040

-0-

(6,600) $111,860

(6,600) $94,200

(6,600) $75,940

-0$(19,800) 19,800 $ -0-

Capital Account Balances—1/1/22 – 12/31/22 Beginning contributions Net income allocation (above) Drawing (10% of beginning balances) Ending balances

Kimble

Sykes

Gerard

Totals

$208,000 111,860 (20,800) $299,060

$180,000 94,200 (18,000) $256,200

$92,000 75,940 (9,200) $158,740

$480,000 282,000 (48,000) $714,000

Chapter 15 - Partnerships: Termination and Liquidation – Hoyle, Schaefer, Doupnik, Advanced Accounting, 15e

Before the 2023 allocations, Nichols' investment is computed as follows: Nichols' Investment Nichols' Investment .75 Nichols' Investment Nichols' Investment

= = = =

25% ($714,000 + Nichols' Investment) $178,500 + .25 Nichols' Investment $178,500 $238,000

Net Loss Allocation—2023 Kimble Net loss Salary allowance ($55 per billable hour) Interest (12% of beginning

Sykes

Gerard

Nichols

Totals $(12,400)

$99,000

$82,500

$75,900

$85,800

(343,200)

35,887 -0-

30,744 -0-

19,049 -0-

28,560 -0-

(117,460) $ 17,427

(117,460) $(4,216)

(117,460) $(22,511)

(117,460) $ (3,100)

(114,240) -0$(469,840) 469,840 -0-

capital balances for the year)

Bonus (not applicable) Remainder to allocate: (split evenly): Total allocation

Capital Account Balances 1/1/23 – 12/31/23 Kimble Beginning balances Loss allocation (from above) Drawings (10% of beginning balances) Ending balances

Sykes

Gerard

Nichols

Totals

$299,060 17,427 (29,906)

$256,200 (4,216) (25,620)

$158,740 (22,511) (15,874)

$238,000 (3,100) (23,800)

$952,000 (12,400) (95,200)

$286,581

$226,364

$120,355

$211,100

$844,400

Kimble

Sykes

Gerard

Nichols

Totals

Net Income Allocation—2024 Net income Salary allowance ($55 per billable hour) Interest (12% of beginning capital balances for the year) Bonus (Note A) Remaining net income (split evenly): Total allocation

$103,400

$89,100

$72,050

$85,250

$477,000 (349,800)

34,390

27,164

14,443

25,332

(101,328)

2,156

-0-

5,390 $145,336

5,390 $123,810

5,390 $91,883

5,390 $115,972

(4,312) $21,560 (21,560) -0-

Note A: Because each of the two partners is entitled to 10% of net income as defined, the total bonus is 20% and is computed as follows: Bonus B B B 1.2 B B

= = = = = =

20% (Net income – Salary – Interest – Bonus) .2 ($477,000 – $349,800 – $101,328 – B) .2 ($25,872 – B) $5,174.40 – .2B $5,174.40 $4,312 (or $2,156 per person)

Chapter 15 - Partnerships: Termination and Liquidation – Hoyle, Schaefer, Doupnik, Advanced Accounting, 15e

b. KIMBLE, SYKES, GERARD, and NICHOLS Statement of Partners' Capital For Year Ending December 31, 2024 Beginning balances Profit allocation (from above) Drawings (10% of beginning balances) Ending balances

Kimble

Sykes

Gerard

Nichols

Totals

$286,581 145,336 (28,658)

$226,364 123,810 (22,636)

$120,355 91,883 (12,035)

$211,100 115,972 (21,110)

$844,400 477,000 (84,440)

$403,259

$327,537

$200,202

$305,962

$1,236,960

30.(40 Minutes) (Recording admission and retirement of partners using both the bonus and goodwill methods) a. Porthos, capital ......................................................... 35,000 D'Artagnan, capital .............................................. 35,000 (To reclassify Porthos's capital balance to reflect transfer of interest to D'Artagnan.) b. Goodwill .................................................................... 50,000 Athos, capital (50%) ............................................. 25,000 Porthos, capital (30%) .......................................... 15,000 Aramis, capital (20%) ........................................... 10,000 (To record goodwill based on $250,000 implied value of partnership [$25,000 ÷ 10%]. Because current capital is only $200,000 [the $25,000 goes directly to the partners], goodwill of $50,000 has to be recorded and allocated using profit and loss ratio.) Athos, capital (10% of balance) ............................... 10,500 Porthos, capital (10% of balance) ........................... 8,500 Aramis, capital (10% of balance) ............................. 6,000 D'Artagnan, capital............................................... 25,000 (To reclassify 10% of each partner's capital to reflect transfer of interest to D'Artagnan.) c. Cash ........................................................................... 30,000 D'Artagnan, capital (10% of total capital) ........... 23,000 Athos, capital (50% of excess payment) ........... 3,500 Porthos, capital (30% of excess payment) ........ 2,100 Aramis, capital (20% of excess payment) ......... 1,400 (To record $30,000 payment by D'Artagnan which increases total capital to $230,000. D'Artagnan is credited for only 10% of that balance with the extra $7,000 payment recorded as a bonus to the original partners.) 15-31 © McGraw Hill LLC. All rights reserved. No reproduction or distribution without the prior written consent of McGraw Hill LLC.

Chapter 15 - Partnerships: Termination and Liquidation – Hoyle, Schaefer, Doupnik, Advanced Accounting, 15e

d. Cash ........................................................................... 30,000 Goodwill .................................................................... 70,000 D'Artagnan, capital .............................................. 30,000 Athos, capital (50% of goodwill) ........................ 35,000 Porthos, capital (30% of goodwill) ..................... 21,000 Aramis, capital (20% of goodwill) ...................... 14,000 (To record D'Artagnan's contribution to the partnership. The $30,000 payment for 10% interest indicates a $300,000 business value although the capital balances would only increase to $230,000. The $70,000 difference is recorded as goodwill, an amount assigned to the original partners.) 30. (continued) e. Cash ............................................................................ 12,222 Goodwill . ................................................................... 10,000 D'Artagnan, capital ............................................... 22,222 To record investment by D'Artagnan. The implied value of the investment as a whole would be only $122,220 ($12,222 ÷ 10%). Because the capital balances are well in excess of this figure, D'Artagnan is apparently bringing some other factor (goodwill) into the partnership. This goodwill can be computed as follows: $12,222 + Goodwill = $12,222 + Goodwill $12,222 + Goodwill .90 Goodwill Goodwill

= = = =

10% (Original Capital + $12,222 + Goodwill) 10% ($200,000 + $12,222 + Goodwill) $21,222 + .10 Goodwill $9,000 $10,000

f. Goodwill ..................................................................... 80,000 Athos, capital (50%) ............................................. 40,000 Porthos, capital (30%) .......................................... 24,000 Aramis, capital (20%) ........................................... 16,000 (To record goodwill of $80,000 based on $280,000 appraisal of business.) Aramis, capital ........................................................... 66,000 Cash ...................................................................... 66,000 (To distribute cash to retiring partner based on final capital balance.) 31. (75 Minutes) (Recording of changes in the composition of a partnership including allocation of income) a. 1/1/22

Building ....................................................... Equipment...................................................

52,000 16,000

Chapter 15 - Partnerships: Termination and Liquidation – Hoyle, Schaefer, Doupnik, Advanced Accounting, 15e

Cash ............................................................ 12,000 O'Donnell, capital ................................. 40,000 Reese, capital ....................................... 40,000 (To record initial investment. Assets recorded at fair value with two equal capital balances.) 12/31/22 Reese, capital ............................................. 22,000 O'Donnell, capital ................................. 12,000 Income summary .................................. 10,000 (The allocation plan specifies that O'Donnell receives 20% in interest [or $8,000 based on $40,000 capital balance] plus $4,000 more [Because that amount exceeds 15% of the profits from the period]. The negative remainder of $22,000 is assigned to Reese.) 1/1/23

Cash ............................................................ 15,000 O'Donnell, capital (15%) ............................ 300 Reese, capital (85%) .................................. 1,700 Dunn, capital ......................................... 17,000 (New investment by Dunn brings total capital to $85,000 after 2022 loss [$80,000 – $10,000 + $15,000]. Dunn's 20% interest is $17,000 [$85,000 × 20%] with the extra $2,000 coming from the two original partners [allocated between them according to their profit and loss ratio].)

12/31/23 O'Donnell, capital ....................................... 10,340 Reese, capital ............................................ 5,000 Dunn, capital .............................................. 5,000 O'Donnell, drawings.............................. 10,340 Reese, drawings ................................... 5,000 Dunn, drawings .................................... 5,000 (To close out drawings accounts for the year based on distributing 20% of each partner's beginning capital balances [after adjustment for Dunn's investment] or $5,000 whichever is greater. O'Donnell's capital is $51,700 [$40,000 + $12,000 – $300]) 12/31/23 Income summary ........................................ 44,000 O'Donnell, capital ................................. 16,940 Reese, capital ....................................... 16,236 Dunn, capital ......................................... 10,824 (To allocate $44,000 net income for 2023 as determined below.) 31. a. (continued) O'Donnell Interest (20% of $51,700 beginning capital balance) .................. 15% of $44,000 net income........................

Reese

Dunn

$10,340 6,600

Chapter 15 - Partnerships: Termination and Liquidation – Hoyle, Schaefer, Doupnik, Advanced Accounting, 15e

60:40 split of remaining $27,060 net income ............................................ Total ...........................................................

$16,940

Capital Balances as of December 31, 2023: O'Donnell Initial 2022 investment .............................. 2022 net loss allocation ............................ Dunn's investment .................................... 2023 drawings ........................................... 2023 net income allocation ....................... 12/31/23 balances ......................................

1/1/24

$40,000 12,000 (300) (10,340) 16,940 $58,300

$16,236 $16,236

$10,824 $10,824

Reese

Dunn

$40,000 (22,000) (1,700) (5,000) 16,236 $27,536

$17,000 (5,000) 10,824 $22,824

Dunn, capital .............................................. 22,824 22,824 Postner, capital .................................... (To reclassify balance to reflect acquisition of Dunn's interest.)

12/31/24 O'Donnell, capital ....................................... 11,660 Reese, capital ............................................ 5,507 Postner, capital .......................................... 5,000 O'Donnell, drawings ............................. 11,660 Reese, drawings ................................... 5,507 Postner, drawings ................................ 5,000 (To close out drawings accounts for the year based on 20% of beginning capital balances [above] or $5,000 [whichever is greater].) 12/31/24 Income summary......................................... 61,000 O'Donnell, capital ................................. Reese, capital ....................................... Postner, capital .................................... (To allocate net income for 2024 determined as follows) O'Donnell Interest (20% of $58,300 beg. capital) 15% of $61,000 net income ....................... 60:40 split of remaining $40,190 Totals ....................................................

20,810 24,114 16,076

Reese

Postner

$24,114 $24,114

$16,076 $16,076

$11,660 9,150 $20,810

31. a. (continued) 1/1/25

Postner, capital .......................................... 33,900 O'Donnell, capital (15%) ............................ 509 Reese, capital (85%) .................................. 2,881 Cash ...................................................... 37,290 (Postner's capital is $33,900 [$22,824 – $5,000 + $16,076]. Extra 10% payment is deducted from the two remaining partners' capital accounts.)

Chapter 15 - Partnerships: Termination and Liquidation – Hoyle, Schaefer, Doupnik, Advanced Accounting, 15e

b. 1/1/22

Building........................................................ 52,000 Equipment .................................................. 16,000 Cash ............................................................ 12,000 Goodwill ..................................................... 80,000 O'Donnell, capital ................................. 80,000 Reese, capital ....................................... 80,000 (To record initial capital investments. Reese is credited with goodwill of $80,000 to match O'Donnell's investment.)

12/31/22 Reese, capital ............................................. 30,000 O'Donnell, capital ................................. 20,000 Income summary .................................. 10,000 (Interest of $16,000 is credited to O'Donnell [$80,000 × 20%] along with a base of $4,000. The remaining amount is now a $30,000 loss that is attributed entirely to Reese.) 1/1/23

Cash ............................................................ 15,000 Goodwill ..................................................... 22,500 Dunn, capital ......................................... 37,500 (Cash and goodwill contributed by Dunn are recorded. Goodwill must be calculated algebraically.)

$15,000 + Goodwill $15,000 + Goodwill $15,000 + Goodwill .8 Goodwill Goodwill

= = = = =

20% (Current Capital + $15,000 + Goodwill) 20% ($150,000 + $15,000 + Goodwill) $33,000 + .2 Goodwill $18,000 $22,500

31. b. (continued) 12/31/23 O'Donnell, capital ....................................... 20,000 Reese, capital ............................................ 10,000 Dunn, capital .............................................. 7,500 O'Donnell, drawings.............................. 20,000 Reese, drawings ................................... 10,000 Dunn, drawings .................................... 7,500 (To close out drawings accounts for the year based on 20% of beginning capital balances: O'Donnell—$100,000, Reese—$50,000, and Dunn—$37,500.) 12/31/23 Income summary ........................................ O'Donnell, capital ................................. Reese, capital ....................................... Dunn, capital ......................................... (To allocate $44,000 net income as follows) O'Donnell

44,000 26,600 10,440 6,960 Reese

Dunn

Chapter 15 - Partnerships: Termination and Liquidation – Hoyle, Schaefer, Doupnik, Advanced Accounting, 15e

Interest (20% of $100,000 beginning capital balance) 15% of $44,000 net income 60:40 split of remaining $17,400 Totals

$20,000 6,600 $10,440 $10,440

$6,960 $6,960

O'Donnell

Reese

Dunn

$ 80,000 20,000

$80,000 (30,000)

(20,000) 26,600 $106,600

(10,000) 10,440 $50,440

$26,600

Capital balances as of December 31, 2023: Initial 2022 investment 2022 net loss allocation Additional investment 2023 drawings ........................................... 2023 net income allocation 12/31/23 balances ......................................

1/1/24

$37,500 (7,500) 6,960 $36,960

Goodwill ...................................................... 26,588 O'Donnell, capital (15%) ...................... 3,988 Reese, capital (51%) ............................. 13,560 Dunn, capital (34%) .............................. 9,040 (To record goodwill indicated by purchase of Dunn's interest.)

In effect, profits are shared 15% to O'Donnell, 51% to Reese – (60% of the 85% remaining after O'Donnell's income), and 34% to Dunn (40% of the 85% remaining after O'Donnell's income). Postner is paying $46,000, an amount $9,040 in excess of Dunn's capital ($36,960). The additional payment for this 34% income interest indicates total goodwill of $26,588 ($9,040 ÷ 34%). Because Dunn is entitled to 34% of the profits but only holds 19% of the total capital, an implied value for the company as a whole cannot be determined directly from the payment of $46,000. Thus, goodwill can only be computed based on the excess payment. 31. b. (continued) 1/1/24

Dunn, capital .............................................. 46,000 Postner, capital .................................... (To reclassify capital balance to new partner.)

46,000

12/31/24 O'Donnell, capital ....................................... 22,118 Reese, capital ............................................ 12,800 Postner, capital .......................................... 9,200 O'Donnell, drawings ............................. 22,118 Reese, drawings ................................... 12,800 Postner, drawings ................................ 9,200 (To close out drawings accounts for the year based on 20% of beginning capital balances [after adjustment for goodwill].) 12/31/24 Income summary ........................................ O'Donnell, capital .................................

61,000 31,268

Chapter 15 - Partnerships: Termination and Liquidation – Hoyle, Schaefer, Doupnik, Advanced Accounting, 15e

Reese, capital ....................................... Postner, capital .................................... To allocate net income for 2024 as follows: O'Donnell

17,839 11,893 Reese

Postner

$17,839 $17,839

$11,893 $11,893

O'Donnell

Reese

Postner

$106,600 3,988 (22,118) 31,268 $119,738

$50,440 13,560 (12,800) 17,839 $69,039

$36,960 9,040 (9,200) 11,893 $48,693

Interest (20% of $110,588 beginning capital balance) 15% of $61,000 net income 60:40 split of remaining $29,732 ........................................... Totals ..............................................

$22,118 9,150 $31,268

Capital Balances as of December 31, 2024: 12/31/23 balances...................................... Adjustment for goodwill .......................... Drawings.................................................... Net income allocation ............................... 12/31/24 balances......................................

Postner will be paid $53,562 (110% of the capital balance) for her interest. This amount exceeds her capital balance by $4,869. Because Postner is only entitled to a 34% share of profits and losses, the additional $4,869 indicates that the partnership as a whole is undervalued by $14,321 (4,869 ÷ 34%). Only in that circumstance is the extra payment to Postner justified: 31. b. (continued) 1/1/25

1/1/25

Goodwill ...................................................... O'Donnell, capital (15%) ...................... Reese, capital (51%) ............................. Postner, capital (34%) .......................... (To recognize implied goodwill.)

14,321

Postner, capital .......................................... Cash ....................................................... (To record final distribution to Postner.)

53,562

2,148 7,304 4,869

53,562

Chapter 15 - Partnerships: Termination and Liquidation – Hoyle, Schaefer, Doupnik, Advanced Accounting, 15e

Develop Your Skills Research Case

This assignment allows the student to make use of the SEC website and, then, the EDGAR system. It also provides a chance to use actual statements created for a partnership rather than those typically produced for a corporation. Probably the most noticeable characteristic of the statements for Enterprise Products Partners is that they resemble corporate financial statements in most ways. A casual overview might not bring any differences to mind. However, a close reading will show several differences including the following:    

On the income statement earnings per share is replaced with a figure labeled as ―earnings per partnership unit.‖ The balance sheet does not present a stockholders‘ equity section but rather partnership capital. That section is comprised of just two figures: one for the limited partners and the other for the noncontrolling interest. A statement of partners‘ capital replaces a statement of stockholders‘ equity. The first two paragraphs of Note One to the financial statements describe the partnership organization.

Analysis Case

An unlimited number of allocation plans can be developed for any partnership. Here, Carson will be interested in some reward for investing the capital used to create the business. Delaney will expect to be recognized for the work put into the operation. Erikson should seek some reward for any new clients that she is able to bring to the business. One possibility would be to accrue interest to Carson on her capital balance for the year based, perhaps, on the prime rate. Erikson could be assigned a particularly high share of any revenues generated from new clients. The amount of income left would result from Delaney‘s work in the day-to-day operations of the business so a large part of that remainder could be assigned to her. As an alternative, Carson could be allocated an interest factor but only based on the initial amount invested in the business rather than the capital balance as a whole. Delaney could be assigned some type of allowance for the number of hours of work put in each period. Any remaining income could be divided evenly among the three partners but only up to a certain level. Beyond that, perhaps only Erikson and Delaney would share in the income because they are doing the work, one in gaining new clients and the other in the day-to-day operations of the business. Communication Cases 1 and 2

These two cases ask the student to identify the types of factors that will lend themselves toward the organization becoming a corporation (in Case 1) or a 15-38 © McGraw Hill LLC. All rights reserved. No reproduction or distribution without the prior written consent of McGraw Hill LLC.

Chapter 15 - Partnerships: Termination and Liquidation – Hoyle, Schaefer, Doupnik, Advanced Accounting, 15e

partnership (in Case 2). Several issues should be considered when looking into a legal format for a business enterprise: 



Do state laws play any role in the decision? In some states, particular types of organizations are prohibited from operating as a corporation. Will state law come into play in making this decision? If so, the partnership form of organization will be required. How big do the owners expect the company to become? If the business will remain small, there may be no need to raise additional capital so that the ability to sell ownership may not be an issue. This favors creation of a partnership. However, if Fernandez and Webster expect the business to prosper and grow, they should consider which type of business will enable them to attract other capital or debt investments. Usually, it is a corporation that is best set up to enable growth through the issuance of securities. How risky is the business operation? If the company is operating in a business where liability is not a significant problem, the limited liability of a corporation might not be of much interest. However, if there is some risk involved, the two owners may need the corporate type of organization just for their own financial security. How well do the owners know and trust each other? As with the previous comment, potential liability can be greatly enhanced if the owners do not know each other well or if additional owners are expected to join at a later point in time. Under that circumstance, everyone may feel more comfortable if the business is created as a corporation or as one of the limited liability organizations. If the owners, though, are comfortable with each other, they may not feel the necessity of creating a formalized corporation. What changes will occur in the tax laws? At this writing, qualified dividends paid by a corporation to its owners are taxable at 15% for most taxpayers. However, from time to time various politicians have proposed the elimination of part or all of that tax. Corporations gain appeal if dividend income is not taxed. How much money do they have available to create a legal organization? In most states, creation of a partnership can be virtually free whereas the legal formality of a corporation can be costly. If finances are tight, the business could begin as a partnership and then convert to a corporation at a later date as monetary restrictions ease.

Excel Case: There are a variety of ways to create a spreadsheet to solve this particular problem. Here is one possible approach: In Cell A1, enter text ―Net Income‖ and in Cell B1 enter $200,000. In Cell A2, enter text ―Billable Hours–Ace‖. In Cell B2 enter 2,000. In Cell C2, enter $20 hourly rate. In Cell A3, enter text ―Billable Hours–Deuce‖. In Cell B3 enter 1,500. In Cell C3, enter $30 hourly rate. In Cell A4, enter text ―Investment–Ace‖ and in Cell B4 enter $80,000. In Cell C4, enter the rate of return of 10%. In Cell A5, enter text ―Investment–Deuce‖ and in Cell B5 enter $50,000. In Cell C5, enter the rate of return of 10%. Perform calculation: In Cell D2, enter formula to multiply number of hours by hourly rate. Formula: 15-39 © McGraw Hill LLC. All rights reserved. No reproduction or distribution without the prior written consent of McGraw Hill LLC.

Chapter 15 - Partnerships: Termination and Liquidation – Hoyle, Schaefer, Doupnik, Advanced Accounting, 15e =+B2*C2 The formula for the next three line items is identical to this first formula; copy the formula to Cells D3, D4, and D5. (To copy a formula across a range of cells, select the cell containing formula, then drag the fill handle, which is the small square in the lower right corner of this box, over the adjacent cells. Note that the formula will adjust automatically for the different lines.) In Cell A6, enter label text ―Subtotal‖ and SUM the amounts in Cells D2 through D5. Click in Cell D6, press the  symbol on the standard toolbar. Click and drag across the range of cells to be summed (D2 through D5) and press enter. Subtract the subtotal of the partner‘s initial allocations (Cell D6) from the Net Income (Cell B1) with the following formula: In Cell A8, enter the label text ―Profit to be Split‖ and in Cell D8, enter the following formula: =+B1-D6. Determine the distribution of Profit between partners: In Cell A10, enter label text ―Profit – Ace‖ and in Cell C10 enter ―50%‖. In Cell A11, enter label text ―Profit – Deuce‖ and in Cell C11 enter ―50%‖. Perform calculations: In Cell D10, enter formula to multiply Profit to be Split (Cell D8) by distribution percentage (Cell C10). Formula: =+D8*C10 Repeat this calculation for the other partner. In Cell D11, enter the formula: =+D8*C11 Once the spreadsheet is created, any variable may be changed and the results will adjust automatically. There are eleven variables that can be changed: B1, B2, B3, B4, B5, C2, C3, C4, and C5, as well as C10 and C11 (which must add up to 100%). Example: Net Income Billable Hours-Ace Billable Hours-Deuce Investment-Ace Investment-Deuce Subtotal

$200,000 2,000 1,500 $80,000 $50,000

$20 $30 10% 10%

Profit to be Split: Profit-Ace Profit-Deuce

$40,000 45,000 8,000 5,000 $98,000 $102,000

50% 50%

$51,000 $51,000

CHAPTER 15 PARTNERSHIPS: TERMINATION AND LIQUIDATION Chapter Outline I.

The termination of a partnership and liquidation of its property might take place for a number of reasons. For example: A. Partners might no longer get along with one another. B. The partnership might not be sufficiently profitable. 15-40 © McGraw Hill LLC. All rights reserved. No reproduction or distribution without the prior written consent of McGraw Hill LLC.

Chapter 15 - Partnerships: Termination and Liquidation – Hoyle, Schaefer, Doupnik, Advanced Accounting, 15e

II.

Because of the importance of liquidating and distributing assets fairly, all parties look to the accountant to play an important role in the process. A. The accountant provides timely financial information. B. The accountant works to ensure an equitable settlement of all claims.

III.

The procedures involved in liquidating a partnership are basically mechanical. A. Partnership noncash assets are converted into cash. B. Partnership liabilities as well as any liquidation expenses are paid. C. Any remaining cash is distributed to the individual partners based on their final capital balances. D. Once all cash has been distributed, the partnership‘s books are permanently closed.

IV.

A statement of partnership liquidation should be produced periodically by the accountant to summarize the transactions occurring during the liquidation. A. The statement discloses losses and gains that have been incurred, remaining assets and liabilities, and current capital balances.

IV.

Deficit capital balances can arise by the end of, or even during, the liquidation process. A. One or more partners may have a negative capital balance as a result of losses incurred in disposing of assets. B. In some cases, partners with deficit capital balances will make a cash contribution to the partnership to offset their deficit. C. When a deficit partner lacks sufficient cash or is simply unwilling to make a contribution, remaining partners must absorb that partner‘s deficit as losses to their capital accounts based on their relative profit and loss ratios.

Safe payments of cash can be made to individual partners during the liquidation process as cash becomes available. A. Safe payments are determined based on safe capital balances, that is, the amounts that will remain in the individual capital accounts even if all deficits and other assets prove to be complete losses that must be absorbed by the remaining partners.

VI.

There is some variability in the accounting treatment of a partner‘s loan to the partnership in the liquidation process. A. The Uniform Partnership Act states that, in a liquidation, partnership assets should be used to first settle claims of partnership creditors, including claims of partners who are creditors.  This implies that the partnership would first repay partners‘ loans before distributing any cash to partners based on their capital balances. B. However, in practice, to avoid making a cash distribution to a partner who subsequently develops a deficit capital balance, partners‘ loan accounts typically are combined with partners‘ capital accounts and funds are distributed accordingly. This book demonstrates the use of this practice. C. A partner‘s loan to the partnership is added to that partner‘s capital account balance. A partner‘s borrowing from the partnership is subtracted from that partner‘s capital account balance.

VII.

Preliminary distribution of cash to partners can be made as early as at the date of partnership termination. A. The liquidation process can extend over a lengthy period of time as business activities wind down and property is sold. 15-41 © McGraw Hill LLC. All rights reserved. No reproduction or distribution without the prior written consent of McGraw Hill LLC.

Chapter 15 - Partnerships: Termination and Liquidation – Hoyle, Schaefer, Doupnik, Advanced Accounting, 15e

B. When the partnership terminates activity, or during the course of the liquidation, more cash may be available than the amount needed to extinguish all potential liabilities and liquidation expenses. C. If possible, the distribution of excess cash amounts should be made as quickly as possible to enable the partners to make use of their funds. VIII.

The accountant may choose to produce a proposed schedule of liquidation to determine the equitable distribution of cash amounts that become available during the liquidation process. A. The proposed schedule of liquidation is developed based upon simulating the accounting recognition that would be required by a series of transactions with maximum losses in each case: Noncash assets are assumed to have no value; maximum possible liquidation expenses are included; all partners are considered personally insolvent; etc. B. Ending potential capital balances that remain on a proposed schedule of liquidation after simulating maximum losses determine the safe payments that can be immediately paid to each partner without running the risk of future deficit capital balances.

IX.

Accountants often prefer to produce a single predistribution plan at the start of a liquidation to provide guidance for all payments made to the partners throughout this process. A. A proposed schedule of liquidation (described above) can be used to determine safe payments but a newly revised schedule must be prepared each time a distribution of cash to partners is contemplated. B. Information for the predistribution plan is generated by assuming the occurrence of a series of losses, each just large enough to eliminate a partner's capital account balance. C. Once a series of losses has been simulated that would eliminate the capital balances of all partners, the actual plan is developed by measuring the effects that occur if the losses do not materialize. D. By working backwards through this series of possible losses, a predistribution plan can be produced that serves as a guide for all payments made during the liquidation.

Chapter 15 - Partnerships: Termination and Liquidation – Hoyle, Schaefer, Doupnik, Advanced Accounting, 15e

Answer to Discussion Question: What Happens if a Partner Becomes Insolvent? This case demonstrates one of the nightmares of a partnership: the apparent insolvency of a partner is threatening the future of a successful business. The problem is especially acute for Menchaca and Nguyen since this partnership was created solely for convenience; the partners share the facilities but do not actually work together. Therefore, the presence of St. Clair is not essential to the other partners except that St. Clair owns one-third of the building and one-third of the furniture, fixtures, and equipment, and pays one-third of the business's expenses. However, the claim that has been filed against partnerhip assets could lead to the liquidation of the entire business. Obviously, the partners should take no immediate action until they have spoken with St. Clair. The entire issue may prove to be a mistake. Conversely, numerous other claims against St. Clair may also be outstanding with the initial claim simply being the first to be filed. Because of the various possibilities, Menchaca and Nguyen should consult with an attorney to learn of the partnership laws that apply in their state. They should also begin considering possible alternatives to salvage their business if St. Clair is indeed insolvent. One alternative is for Menchaca and Nguyen to buy out St. Clair‘s partnership interest. St. Clair would receive a payment and the remaining partnership could be left intact. However, the remaining partners would have to prove—for legal reasons—that a fair price was being paid, and they would need to come up with a significant amount of cash in a short period of time. This alternative has the additional disadvantage that Menchaca and Nguyen would have a building that was probably larger than their needs. Unless they could utilize the space in some manner, they might have no way of recouping their additional investment. As a second possibility, a new dentist could be brought in to acquire St. Clair‘s interest in the partnership. Again, cash would be conveyed to St. Clair but now the original partners are not forced to make the payment. This alternative has the advantage that the building would continue to be fully utilized so that the individual partners' expenses would not escalate. In this case, though, a new partner may have to be identified in a short period of time. Furthermore, since the partners are sharing space, Menchaca and Nguyen will probably want to ensure that the new partner is someone with whom they can work comfortably. Because of time considerations, they may not have the opportunity of getting the new partner they would like. Finally, the partnership can be liquidated. Menchaca and Nguyen could then take their share of the proceeds and buy a new building for the continuation of their practices. This alternative has the disadvantage that, in liquidation, assets do not always bring fair market value. Thus, the partners may be forced to absorb significant losses as a result of St. Clair‘s insolvency. In addition, the moving of any business can disrupt service and have a possible adverse impact on profitability. Although Menchaca and Nguyen can take several possible actions, none of these is without problems. Therefore, partners should always include agreements within their Articles of Partnership to specify actions that will be taken in such cases. The insolvency of a partner is not a particularly unusual event. Hence, the partners (or their attorneys and accountants) should have the forethought to arrange the resolution of the business if insolvency of a partner does occur.

Chapter 15 - Partnerships: Termination and Liquidation – Hoyle, Schaefer, Doupnik, Advanced Accounting, 15e

Answers to Questions 1. Termination refers to the cessation of partnership activity. Once the partnership ceases operations, partnership noncash assets are liquidated (sold). Cash proceeds are used to pay partnership liabilities and liquidation expenses. Any remaining cash is distributed to partners with positive capital balances. 2. Many reasons can exist that would lead to the termination and liquidation of a partnership. The partners might no longer get along with another, the business might not be generating sufficient profits, or the partners may elect to enter other lines of work. Liquidation can also be required by the death, retirement, or withdrawal of one of the partners. In such cases, liquidation is often necessary to settle the partner's interest in the business. 3. During the liquidation process, monitoring the balance of the partners' capital accounts becomes of paramount importance. That amount will eventually indicate either the cash to be received by the partners as final distributions or the additional contributions that they are required to pay to the partnership. Consequently, all liquidation gains and losses are recorded directly as changes to the partners‘ capital balances. Such recording enhances the informational value of the accounts. As an additional factor, the computation of a net income figure is of diminished importance since normal operations have ceased. 4. Final distributions made to the various partners are based solely on their ending capital account balances unless the partners have agreed otherwise. If any partner has a deficit balance, that partner should make an additional contribution to the partnership to offset the negative capital balance. In some situations, a question may arise as to whether compensation for a deficit will ever be forthcoming from the responsible party. The remaining partners may choose to allocate the available cash immediately based on the assumption that the deficit balance eventually will prove to be a total loss. 5. A statement of partnership liquidation summarizes the financial effect of the liquidation process as it has progressed to date. Information to be presented includes the balances of all remaining assets, liabilities, and the capital accounts of each partner. In addition, the allocation of all gains and losses incurred in the liquidation process as well as the payment of liquidation expenses should be reflected in the statement. 6. Safe payments are calculated by determining the amount that remains in individual partners‘ capital accounts after simulating the allocation of any and all expenses and losses that could occur in the liquidation process. The capital balance that remains after simulating all possible expenses and losses is the amount that can be distributed as a safe payment of cash to partners. 7. In practice, a partner‘s loan balance usually is merged with that partner‘s capital balance rather than treating it as a partnership liability. This treatment minimizes the chance of a negative capital balance arising during the liquidation process. As a result, the partner with a loan to the partnership might receive less cash from the liquidation but the other partners are better protected. 8. A proposed schedule of liquidation is prepared by the accountant to determine the allocation of any cash available in the early stages of a liquidation (including at the date of termination) that exceeds the amount needed to pay all liabilities and estimated liquidation expenses. The schedule is based on anticipating a series of assumed losses from the current day forward: all 15-44 © McGraw Hill LLC. All rights reserved. No reproduction or distribution without the prior written consent of McGraw Hill LLC.

Chapter 15 - Partnerships: Termination and Liquidation – Hoyle, Schaefer, Doupnik, Advanced Accounting, 15e

remaining noncash assets are scrapped, maximum liquidation expenses are incurred, and each partner is personally insolvent. The ending balances that would result from these simulated transactions represent safe payments that can be made to individual partners, and the partnership will still retain enough capital to absorb all future losses. 9. A predistribution plan is produced based on an assumed series of losses. Each loss is calculated to eliminate in turn the capital balance of one of the partners. In this manner, the accountant can determine the vulnerability to losses exhibited by each capital account. When all capital balances have been reduced to zero, the accountant will have established a series of losses that exactly offsets each capital balance. The predistribution plan is then developed by measuring the effects that are created if the losses do not occur. In effect, the accountant works backwards through the assumed losses to create a pattern of cash that can be safely distributed to individual partners, thus creating the predistribution plan.

Chapter 15 - Partnerships: Termination and Liquidation – Hoyle, Schaefer, Doupnik, Advanced Accounting, 15e

Answers to Problems

1. C 2. A 3. D 4. B 5. C

Reported balances Potential loss from Desai deficit (split 5/8:3/8) Cash distributions

Barley, Capital (50%)

Carter, Capital (30%)

Desai, Capital (20%)

$44,000

$32,000

$(24,000)

(15,000) $29,000

(9,000) $23,000

24,000 $ -0-

6. (20 minutes) (Prepare a statement of partnership liquidation) BELL, HARDY, DENNARD, AND SUDDATH PARTNERSHIP Statement of Partnership Liquidation (Hypothetical)

Assets

Liabilities

Bell, Capital 40%

$300,000

$100,000

$50,000

$56,000

$14,000

$80,000

Sale of assets Subtotal

190,000 $190,000

(300,000) -

(100,000)

(44,000) 6,000

(33,000) 23,000

(22,000) (8,000)

(11,000) 69,000

Pay liabilities Subtotal

(100,000) $ 90,000

100,000 $-

$ 6,000

$23,000

$ (8,000)

$69,000

(4,000) $ 2,000

(3,000) $20,000

8,000 $-

(1,000) $68,000

(2,000)

(20,000)

Cash Balances

Allocate deficit Subtotal

$ 90,000

Distribute cash

(90,000)

Ending balances

$$0

Hardy, Capital 30%

Dennard, Capital 20%

Suddath, Capital 10%

(68,000) $0

Bell would receive $2,000 from the sale of partnership assets; this amount would be available for payment to Bell‘s creditors.

Chapter 15 - Partnerships: Termination and Liquidation – Hoyle, Schaefer, Doupnik, Advanced Accounting, 15e

7. (20 minutes) (Prepare a statement of partnership liquidation) PLAYA, BAHIA, AND ARCO PARTNERSHIP Statement of Partnership Liquidation Playa, Bahia, Other Capital Capital Assets Liabilities (40%) Cash (30%) Beg. balances Sale of assets Pay liabilities Pay liq. exp. Subtotal Distribution to partners Ending balances

$33,000 80,000 (50,000) (15,000) $48,000 (48,000) $0

$100,000 (100,000) $0 $0

$50,000 (50,000) $0 $0

Arco, Capital (30%)

$24,000 (8,000)

$29,000 (6,000)

$30,000 (6,000)

(6,000) $10,000 (10,000) $0

(4,500) $18,500 (18,500) $0

(4,500) $19,500 (19,500) $0

As a result of the liquidation, partners receive $48,000 in cash: Playa receives $10,000, Bahia receives $18,500, and Arco receives $19,500. 8. (10 minutes) (Calculate safe payments; partner has deficit) Because the partnership currently has total capital of $350,000, the $30,000 that is available indicates maximum potential losses of $320,000. X Reported balances Anticipated loss ($320,000) (split on a 5:3:2 basis) Potential balances Potential loss from X's deficit (split 3:2) Safe payments

$150,000 (160,000)

$120,000 (96,000)

$80,000 (64,000)

$(10,000) 10,000 $0

$ 24,000 (6,000) $18,000

$ 16,000 (4,000) $ 12,000

The $30,000 cash currently available can be safely paid to Y ($18,000) and Z ($12,000). 9. (30 minutes) (Prepare a predistribution plan) Beginning balances Assumed loss of $130,000 (see Schedule 1) (4:3:1:2 basis) Step one balances Assumed loss of $12,250 (see Schedule 2) (4:0:1:2 basis) Step two balances Assumed loss of $6,750 (see Schedule 3) (0:0:1:2 basis) Step three balances

Berzina Horvath

Markov Petronis

$59,000 (52,000)

$39,000 (39,000)

$34,000 (13,000)

$34,000 (26,000)

$7,000 (7,000)

$ -0$ -0-

$21,000 (1,750)

$8,000 (3,500)

$ -0-0-

$19,250 (2,250)

$4,500 (4,500)

$ -0-

$17,000

$ -0-

Schedule 1

Chapter 15 - Partnerships: Termination and Liquidation – Hoyle, Schaefer, Doupnik, Advanced Accounting, 15e

Partner Berzina Horvath Markov Petronis

Partner

Maximum Loss That Can Be Absorbed

Capital Balance/ Loss Allocation $59,000/40% $39,000/30% $34,000/10% $34,000/20%

Capital Balance/ Loss Allocation

Berzina Markov Petronis

Partner Markov Petronis

$147,500 $130,000 (most vulnerable) $340,000 $170,000

Schedule 2 Maximum Loss That Can Be Absorbed

$7,000/(4/7) $21,000/(1/7) $8,000/(2/7)

Capital Balance/Loss Allocation

$12,250 (most vulnerable) $147,000 $28,000

Schedule 3 Maximum Loss That Can Be Absorbed

$19,250/(1/3) $4,500/(2/3)

$57,750 $6,750 (most vulnerable)

Predistribution Plan

   

First $17,000 goes to Markov Next $6,750 goes to Markov (1/3) and Petronis (2/3) Next $12,250 goes to Berzina (4/7), Markov (1/7), and Petronis (2/7) All remaining cash goes to Berzina (40%), Horvath (30%), Markov (10%), and Petronis (20%)

Markov receives $17,000 before any of the other partners begins receiving cash. 10.(30 minutes) (Prepare a predistribution plan) Beginning balances Assumed loss of $90,000 (see Schedule 1) (4:3:2:1 basis) Step one balances Assumed loss of $42,000 (see Schedule 2) (4:0:2:1 basis) Step two balances Assumed loss of $15,000 (see Schedule 3) (0:0:2:1 basis) Step three balances

Partner

Capital

Chen

Korhonen

Lebuca

Swid

$60,000 (36,000)

$27,000 (27,000)

$43,000 (18,000)

$20,000 (9,000)

$24,000 (24,000)

$ -0$ -0-

$25,000 (12,000)

$11,000 (6,000)

$ -0-0-

$13,000 (10,000)

$ 5,000 (5,000)

$ -0-

$ 3,000

$ -0-

Schedule 1 Maximum Loss

Chapter 15 - Partnerships: Termination and Liquidation – Hoyle, Schaefer, Doupnik, Advanced Accounting, 15e

Balance/Loss Allocation Chen Korhonen Lebuca Swid

Partner Chen Lebuca Swid

That Can Be Absorbed

$60,000/40% $27,000/30% $43,000/20% $20,000/10%

$150,000 $ 90,000 $215,000 $200,000

Schedule 2 Capital Maximum Loss Balance/Loss That Can Be Allocation Absorbed $24,000/(4/7) $25,000/(2/7) $11,000/(1/7)

Partner Lebuca Swid

(most vulnerable)

$ 42,000 (most vulnerable) $ 87,500 $ 77,000

Schedule 3 Capital Maximum Loss Balance/Loss That Can Be Allocation Absorbed $13,000/(2/3) $ 5,000/(1/3)

$ 19,500 $ 15,000 (most vulnerable)

Predistribution Plan

   

First $3,000 goes to Lebuca Next $15,000 goes to Lebuca (2/3) and Swid (1/3) Next $42,000 goes to Chen (4/7), Lebuca (2/7), and Swid (1/7) All remaining cash goes to Chen (4/10), Korhonen (3/10), Lebuca (2/10), and Swid (1/10)

Lebuca receives $3,000 before any of the other partners receives any cash. 11.(10 minutes) (Calculate safe payments; two partners with deficit capital balances) The $16,000 available cash can be distributed but should be done under the assumption that all deficit balances will be total losses. After offsetting Molina's loan against Molina‘s deficit capital balance, both Molina and Ashman have deficits of $2,000; total $4,000. Pinckney and Diaz, the two partners with positive capital balances, share profits in a 30:20 relationship (the equivalent of a 60%:40% ratio). Pinckney would absorb $2,400 of the potential $4,000 loss with Diaz being allocated $1,600. The remaining capital balances ($10,600 and $5,400) are the amounts that can be immediately distributed.

Chapter 15 - Partnerships: Termination and Liquidation – Hoyle, Schaefer, Doupnik, Advanced Accounting, 15e

Reported balances Potential losses from Ashman and Molina (split on a 3:2 basis) Adjusted balances (safe payments)

Ashman (30%) $(2,000) 2,000

Molina (20%) $(2,000) 2,000

Pinckney (30%) $13,000 (2,400)

Diaz (20%) $7,000 (1,600)

$ -0-

$10,600

$5,400

12.(20 minutes) (Prepare statement of partnership liquidation) ALONSO, MANN, AND SUZUKI PARTNERSHIP Statement of Partnership Liquidation Alonso, Noncash Capital Assets Cash Liabilities (50%) Beginning balances Sale of noncash assets Pay liabilities Sale of remaining noncash assets Pay remaining liabilities Pay liquidation expenses Subtotal Distribution to partners Ending balances

$80,000

$660,000

400,000

(500,000)

(100,000) 130,000

$320,000

(120,000) (160,000)

(200,000)

Mann, Capital (30%)

Suzuki, Capital (20%)

$200,000

$120,000

$100,000

(50,000)

(30,000)

(20,000)

10,000

6,000

4,000

(15,000)

(9,000)

(6,000)

(200,000)

(24,000)

(12,000)

(7,200)

(4,800)

$286,000

$133,000

$79,800

$73,200

(286,000)

(133,000)

(79,800)

(73,200)

Alonso receives cash of $133,000, Mann receives cash of $79,800, and Suzuki receives cash of $73,200 from the partnership liquidation. 13.(20 minutes) (Final settlement of a partnership being liquidated; various amounts of loss on sale of assets) a. Ortega gets $21,000, Borek gets $12,000, and Stone gets $2,000. Capital balances ................................................... Loss on sale of land ($10,000) (split on a 4:3:3 basis) Cash distribution .................................................

Ortega

Borek

Stone

$25,000 (4,000) $21,000

$15,000 (3,000) $12,000

$5,000 (3,000) $2,000

Ortega

Borek

Stone

$25,000 (8,000) $17,000 (571)

$15,000 (6,000) $ 9,000 (429)

$5,000 (6,000) $(1,000) 1,000

b. Ortega gets $16,429 and Borek gets $8,571 Capital balances ................................................... Loss on sale of land ($20,000) (split on a 4:3:3 basis) Adjusted balances ............................................... Potential loss from Stone's deficit (split 4:3)

Chapter 15 - Partnerships: Termination and Liquidation – Hoyle, Schaefer, Doupnik, Advanced Accounting, 15e

Cash distribution .................................................

$16,429

$ 8,571

$ -0-

Ortega

Borek

Stone

$25,000 (12,000) $13,000 (2,286) $10,714

$15,000 (9,000) $ 6,000 (1,714) $ 4,286

$5,000 (9,000) $(4,000) 4,000 $ -0-

c. Ortega gets $10,714 and Borek gets $4,286 Capital balances ................................................... Loss on sale of land ($30,000) (split on a 4:3:3 basis) Adjusted balances ............................................... Potential loss from Stone's deficit (split 4:3) Cash distribution .................................................

14.(10 minutes) (Distribute cash contributed by partner with deficit balance) The entire $20,000 goes to Abbas.

Reported balances Capital contribution Adjusted balances Potential loss from Krishna and Urias ($80,000) (split on a 4:3 basis) Adjusted balances Potential loss from Baptiste ($4,286) Cash distribution

Abbas

Baptiste

Krishna

Urias

$70,000 -0$70,000

$30,000 -0$30,000

$(42,000) -0$(42,000)

$(58,000) 20,000 $(38,000)

(45,714) $24,286 (4,286) $20,000

(34,286) $(4,286) 4,286 $ -0-

42,000 $ -0-0$ -0-

38,000 $ -0-0$ -0-

15.(10 minutes) (Calculate safe payments) Correa gets $143, Getz gets $1,429, and Pham gets $3,428. Reported balances ............................................... Maximum losses on land and building ($85,000) (split on a 3:3:2:2 basis) Estimated liquidation expenses ($5,000) (split 3:3:2:2)................................................................... Potential balances ............................................... Potential loss from Kumar ($2,000) (split on a 3:2:2 basis) ............................................................ Safe payments ......................................................

Kumar

Correa

Getz

Pham

$25,000 (25,500)

$28,000 (25,500)

$20,000 (17,000)

$22,000 (17,000)

(1,500)

(1,000)

$(2,000) 2,000

$ 1,000 (857)

$ 2,000 (571)

$ 4,000 (572)

$ 143

$ 1,429

$ 3,428

16.(15 minutes) (Prepare a proposed schedule of liquidation)

Chapter 15 - Partnerships: Termination and Liquidation – Hoyle, Schaefer, Doupnik, Advanced Accounting, 15e

GULIAN, SINGH, AND ZAHIRI Proposed Schedule of Liquidation

Beginning balances Sold assets Adjusted balances Max loss on remaining noncash assets Paid liabilities Safe payments

Cash

Other Assets

Accounts Payable

Gulian, Loan &Capital

Singh, Capital

Zahiri,Loan &Capital

90,000

820,000

210,000

270,000

200,000

230,000

200,000

(328,000)

(51,200)

(38,400)

290,000

(492,000) (492,000)

(218,800) (196,800)

(161,600) (147,600)

(191,600) (147,600)

22,000

14,000

44,000

(210,000) 80,000

210,000

(210,000) 0

Of the available $80,000 in cash, $22,000 can be safely paid to Gulian, $14,000 to Singh, and $44,000 to Zahiri. 17.(15 minutes) (Calculate safe payments; determine amount for which other assets must be sold to assure payments to all partners) Calculation of Safe Payments

The amount of cash available for payment to partners prior to liquidation of ―other assets‖ is $8,000 ($50,000 - $42,000 in liabilities). The maximum amount of potential loss to be absorbed by the partners is a $150,000 loss on the noncash assets. Ludolf (60%)

Sambal (20%)

Urad (20%)

$69,000 (90,000)

$69,000 (30,000)

$20,000 (30,000)

($21,000) 21,000 $ -0-

$39,000 (31,000) $ 8,000

($10,000) 10,000 $ -0-

Beginning balances Allocation of potential loss of $150,000 Resulting balances Absorption of partners‘ deficits Safe payments

A safe payment of $8,000 can be made to Sambal prior to liquidation of the other assets. Amount for Which ―Other Assets‖ Must be Sold to Assure Payments to All Partners

Urad is the partner most vulnerable to a loss. A loss of only $100,000 would completely eliminate Urad's capital balance: Ludolf Sambal

$69,000/60% = $115,000 loss to eliminate capital $69,000/20% = $345,000 loss to eliminate capital

Chapter 15 - Partnerships: Termination and Liquidation – Hoyle, Schaefer, Doupnik, Advanced Accounting, 15e

Urad

$20,000/20% = $100,000 loss to eliminate capital

Thus, if the loss on disposal of ―other assets‖ is less than $100,000, all partners will retain positive capital balances and receive some cash in liquidation. Because of this, since "other assets" are $150,000, they must be sold for any amount over $50,000 for all partners to get some cash. 18.(10 minutes) (Calculate safe payments) a. The amount of cash that safely can be distributed to partners prior to liquidation of noncash assets is $8,000, determined as follows: Cash balance less: Liabilities less: Estimated liquidation expenses Cash that safely can be distributed

$60,000 (40,000) (12,000) $ 8,000

b. Calculation of Safe Payments The maximum amount of potential loss and liquidation expenses to be absorbed by the partners is $112,000: $12,000 in liquidation expenses and a $100,000 loss on the noncash assets. Such a loss would reduce the partner‘s capital balances as follows: Delphine Xavier (40%) (40%) Beginning balances Allocation of potential loss and liquidation expenses of $112,000 Resulting balances

Olivier (20%)

$60,000

$40,000

$20,000

(44,800)

(22,400)

$15,200

($4,800)

($2,400)

After allocation of potential loss and expenses, Xavier and Olivier would have deficit capital balances that would be absorbed by Delphine as follows: Delphine (40%)

Xavier (40%)

Olivier (20%)

$15,200 (7,200) $8,000

($4,800) 4,800 $ -0-

($2,400) 2,400 $ -0-

Resulting balances Absorption of partners‘ deficits Safe payments

A safe payment of $8,000 can be made to Delphine prior to liquidation of the noncash assets. 19.(15 minutes) (Determine amount to be contributed by partner with a deficit capital balance) Beck and Page are both personally insolvent and have negative capital balances (after offsetting the loan from Beck) totaling $10,000 (Beck‘s deficit, $4,000; 15-53 © McGraw Hill LLC. All rights reserved. No reproduction or distribution without the prior written consent of McGraw Hill LLC.

Chapter 15 - Partnerships: Termination and Liquidation – Hoyle, Schaefer, Doupnik, Advanced Accounting, 15e

Page‘s deficit, $6,000). Absorption by the other partners of these losses would be as follows (on a 40:10:20 basis): Partner

Current Capital Balance

Share of Loss

Adjusted Capital Balance

Cisneros Sadak Emerson

$ 5,000 $ (8,000) $13,000

40/70 × $10,000 = $5,714 10/70 × $10,000 = $1,429 20/70 × $10,000 = $2,857

$ (714) $ (9,429) $10,143

Cisneros, who also is personally insolvent, now has a capital balance of ($714) that would have to be absorbed by Sadak and Emerson (on a 10:20 or 1/3:2/3 basis): Partner

Adjusted Capital Balance

Share of Loss

Remaining Capital Balance

Sadak Emerson

$ (9,429) $10,143

1/3 × $714 = $238 2/3 × $714 = $476

$(9,667) $9,667

Thus, Sadak must contribute $9,667 that will go to Emerson. 20.(15 minutes) (Prepare a proposed statement of liquidation) ARCH, BIBB, AND DAO PARTNERSHIP Proposed Schedule of Liquidation Date of Termination Arch, Capital Noncash Assets Cash Liabilities 40% Beginning balances $130,000 $230,000 $50,000 $120,000 Pay liabilities (50,000) (50,000) Max. liquidation expenses (10,000) (4,000) Max. loss – noncash assets Initial safe payments

- (230,000) $70,000 $0

(92,000) $24,000

Bibb, Capital

Dao, Capital

20% 40% $60,000 $130,000 (2,000)

(4,000)

(46,000) $12,000

(92,000) $34,000

Safe payments totaling $70,000 can be made at the date of partnership termination; $24,000 to Arch, $12,000 to Bibb, and $34,000 to Dao. 21.(30 minutes) (Prepare journal entries for a partnership liquidation; calculate safe payments; prepare a final statement of partnership liquidation) Part A. Preparation of journal entries. a. The partnership has $50,000 in cash, liabilities of $40,000 and estimated liquidation expenses of $5,000. Thus, there is only $5,000 that can be safely paid to the partners before the liquidation of noncash assets. This amount is allocated to the two partners on the basis of their potential capital balances 15-54 © McGraw Hill LLC. All rights reserved. No reproduction or distribution without the prior written consent of McGraw Hill LLC.

Chapter 15 - Partnerships: Termination and Liquidation – Hoyle, Schaefer, Doupnik, Advanced Accounting, 15e

assuming that noncash assets are scrapped for a loss of $150,000 and liquidation expenses are $5,000: Partner

Current Capital Balance

Alex Bess

Share of Maximum Loss*

$90,000 $70,000

Potential Capital

60% × $155,000 = $93,000 40% × $155,000 = $62,000

$(3,000) $8,000

Because Alex has a potential deficit capital balance, the entire $5,000 currently available is distributed to Bess, which reduces this partner‘s capital balance to $65,000. Bess, Capital ............................................................... Cash ......................................................................

5,000

Liabilities .................................................................... Cash ......................................................................

30,000

Cash............................................................................. Alex, Capital (60% of gain) .................................. Bess, Capital (40%) ............................................... Noncash assets.....................................................

160,000

5,000

b. 30,000

c. 6,000 4,000 150,000

Alex and Bess now have capital balances of $96,000 and $69,000, respectively. 21. (continued) d. To determine the safe payments to be made at this point in the liquidation, the accountant prepares the following proposed schedule of liquidation: Cash Beginning balances Distribution to partners Paid liabilities Sold noncash assets Updated balances Maximum liabilities Max. liquidation expenses Safe payments

$50,000 (5,000) (30,000) 160,000 175,000 (10,000) (5,000) $160,000

Noncash Assets $150,000

Liabilities

-0-0(150,000) -0-

-0(30,000) -010,000 (10,000) -0-0-

-0-0-

$40,000

Alex, Capital (60%) $90,000

Bess, Capital (40%) $70,000

-0-06,000 96,000

(5,000) -04,000 69,000

(3,000) $93,000

(2,000) $67,000

Safe payments of $93,000 and $67,000 can be made to Alex and Bess, respectively, at this point in the liquidation. Alex, Capital .............................................................. Bess, Capital .............................................................

93,000 67,000

Chapter 15 - Partnerships: Termination and Liquidation – Hoyle, Schaefer, Doupnik, Advanced Accounting, 15e

Cash .....................................................................

160,000

e. Liabilities ................................................................... Cash .....................................................................

10,000

Alex, Capital (60% of expense) ................................ Bess, Capital (40%) ................................................... Cash ......................................................................

2,400 1,600

10,000

f. 4,000

g. The statement of partnership liquidation presented on the next page shows that $1,000 cash remains after paying liquidation expenses. The partners have positive capital balances of $600 and $400, respectively, and the remaining partnership cash can be distributed based on these ending balances. Alex, Capital .............................................................. Bess, Capital ............................................................. Cash .....................................................................

600 400 1,000

21. (continued) Part B. Prepare a final statement of partnership liquidation. Alex and Bess Partnership Statement of Partnership Liquidation Noncash Assets Cash Liabilities

Alex, Capital (60%)

Bess, Capital (40%)

Beginning balances Distribution to partners Paid liabilities

$ 50,000 (5,000) (30,000)

$150,000 -0-0-

$40,000 -0(30,000)

$90,000 -0-0-

$70,000 (5,000) -0-

Sold noncash assets Updated balances

160,000 175,000

(150,000) -0-

-010,000

6,000 96,000

4,000 69,000

Distribution to partners Updated balances Paid liabilities

(160,000) 15,000 (10,000)

-0-0-0-

-010,000 (10,000)

(93,000) 3,000 -0-

(67,000) 2,000 -0-

Paid liquidation expenses Updated balances

(4,000) 1,000

-0-0-

(2,400) 600

(1,600) 400

Distribution to partners Closing balances

(1,000) $ -0-

-0$ -0-

(600) $ -0-

(400) $ -0-

22.(30 minutes) (Prepare a predistributlon plan) An assumed series of losses is simulated which eliminates each partner's 15-56 © McGraw Hill LLC. All rights reserved. No reproduction or distribution without the prior written consent of McGraw Hill LLC.

Chapter 15 - Partnerships: Termination and Liquidation – Hoyle, Schaefer, Doupnik, Advanced Accounting, 15e

capital account in turn: Larson Beginning balances Assumed loss of $75,000 (Schedule 1) (2:3:2:3 basis) Step One balances Assumed loss of $50,000 (Schedule 2) (0:3:2:3 basis) Step Two balances Assumed loss of $31,250 (Schedule 3) (0:3:2:0 basis) Step Three balances

Schedule 1 Partner

Schedule 2 Partner

$15,000/20% $60,000/30% $75,000/20% $41,250/30%

Capital Balance/Loss Allocation

Rojas Spencer Tran

Schedule 3 Partner

Tran

$ 15,000 (15,000)

$ 60,000 (22,500)

$ 75,000 (15,000)

$ 41,250 (22,500)

$ -0-0-

$ 37,500 (18,750)

$ 60,000 (12,500)

$ 18,750 (18,750)

$ -0-0-

$ 18,750 (18,750)

$ 47,500 (12,500)

$ -0-0-

$ -0-

$ 35,000

$ -0-

Maximum Loss That Can Be Absorbed

Capital Balance/Loss Allocation

Larson Rojas Spencer Tran

Rojas Spencer

$ 75,000 (most vulnerable) $200,000 $375,000 $137,500

Maximum Loss That Can Be Absorbed

$37,500/(3/8) $100,000 $60,000/(2/8) $240,000 $18,750/(3/8) $ 50,000 (most vulnerable)

Capital Balance/Loss Allocation

Rojas Spencer

Maximum Loss That Can Be Absorbed

$18,750/(3/5) $ 31,250 (most vulnerable) $47,500/(2/5) $118,750

24. (continued) PREDISTRIBUTION PLAN

    

First $55,000 goes to pay liabilities ($47,000) and liquidation expenses (estimated at $8,000). Next $35,000 available goes to Spencer. Next $31,250 is split between Rojas and Spencer on a 3:2 basis. Next $50,000 is split among Rojas, Spencer, and Tran on a 3:2:3 basis. All remaining cash is split among Larson, Rojas, Spencer, and Tran on the original profit and loss ratio.

23.(20 minutes) (Prepare and use a predistribution plan)

Chapter 15 - Partnerships: Termination and Liquidation – Hoyle, Schaefer, Doupnik, Advanced Accounting, 15e

a. Maximum Losses That Can Be Absorbed Drysdale* Koufax Marichal

$80,000/50% $60,000/30% $50,000/20%

$160,000 (most vulnerable to losses) 200,000 250,000

*Drysdale's balance includes capital and the loan to the partnership. Assume that a $160,000 loss occurs: Reported balances Assumed loss ($160,000) split on a 5:3:2 basis Adjusted balances

Drysdale

Koufax

Marichal

$80,000 (80,000) $0

$60,000 (48,000) $12,000

$50,000 (32,000) $18,000

Maximum Losses That Now Can Be Absorbed (in 60%:40% ratio) Koufax Marichal

$12,000/.6 $18,000/.4

$20,000 $45,000

(most vulnerable to losses)

Assume that a $20,000 loss occurs: Adjusted balances Assumed loss ($20,000) split on a 6:4 basis Balances after assumed loss of $20,000

Koufax

Marichal

$12,000 (12,000) $0

$18,000 (8,000) $10,000

PREDISTRIBUTION PLAN    

The first $65,000 is used to pay liabilities ($50,000) and liquidation expenses ($15,000). The next $10,000 is paid entirely to Marichal. The next $20,000 is split between Koufax and Marichal on a 60%/40% basis ($12,000 to Koufax and $8,000 to Marichal). Remaining cash after payment of $30,000 to Koufax ($12,000) and Marichal ($18,000) will be split among the partners according to their profit and loss ratios.

23. (continued) b. Cash available for distribution: Beginning cash balance Sale of noncash assets Subtotal Payment of liabilities Payment of estimated liquidation expenses Cash available for distribution

$36,000 60,000 $96,000 (50,000) (15,000) $31,000

Chapter 15 - Partnerships: Termination and Liquidation – Hoyle, Schaefer, Doupnik, Advanced Accounting, 15e

Cash distribution to partners: Drysdale First $10,000 Next $20,000 Next $1,000 Total

$ 500 $ 500

Koufax

Marichal

Total

$12,000 300 $12,300

$10,000 8,000 200 $18,200

$10,000 20,000 1,000 $31,000

After the sale of assets for $60,000, the partnership has $96,000 in cash. The first $65,000 must be held for payment of liabilities and liquidation expenses, leaving $31,000 for distribution to partners. For the $31,000 distribution to partners, the first $10,000 goes to Marichal. The next $20,000 is divided between Koufax (60% = $12,000) and Marichal (40% = $8,000). The final $1,000 is divided between Drysdale (50% = $500), Koufax (30% = $300), and Marichal (20% = $200). Thus, Drysdale receives $500, Koufax receives $12,300, and Marichal receives $18,200 for a total cash distribution of $31,000. 24.(25 minutes) (Prepare a predistribution plan for a partnership liquidation) Maximum Losses That Can Be Absorbed Partner

Capital balance/Loss allocation

Bui Clemente Devian Toussaint

$18,000/20% $40,000/40% $48,000/20% $135,000/20%

Maximum loss that can be absorbed $ 90,000 (most vulnerable to losses) 100,000 240,000 675,000

The assumption is made that a $90,000 loss occurs: Bui Clemente Reported balances $18,000 $40,000 Assumed loss ($90,000) (split on a 2:4:2:2 basis Adjusted balances

Devian $48,000

Toussaint $135,000

(18,000)

(36,000)

(18,000)

$ 4,000

$30,000

$117,000

Maximum Losses That Now Can Be Absorbed Partner

Capital balance/Loss allocation

Clemente Devian Toussaint

$4,000/4/8 $30,000/2/8 $117,000/2/8

Maximum loss that can be absorbed $ 8,000 (most vulnerable to losses) 120,000 468,000

The assumption is made that an $8,000 loss occurs: Clemente

Devian

Toussaint

Reported balances

$30,000

$117,000

$4,000 15-59

Chapter 15 - Partnerships: Termination and Liquidation – Hoyle, Schaefer, Doupnik, Advanced Accounting, 15e

Assumed loss ($8,000) split on a 4:2:2 basis Adjusted balances

(4,000) $0

(2,000) $28,000

(2,000) $115,000

Maximum Losses That Now Can Be Absorbed Partner

Capital balance/Loss allocation

Devian Toussaint

$28,000/2/4 $115,000/2/4

Maximum loss that can be absorbed $56,000 (most vulnerable to losses) 230,000

The assumption is made that a $56,000 loss occurs: Reported balances Assumed loss ($56,000) (split on a 2:2 basis) Adjusted balances

Devian

Toussaint

$28,000 (28,000) $0

$115,000 (28,000) $ 87,000

PREDISTRIBUTION PLAN     

The first $59,000 goes to pay liabilities and expected liquidation expenses. The next $87,000 goes entirely to Toussaint. The next $56,000 is split evenly between Devian and Toussaint. The next $8,000 is split among Clemente (4/8), Devian (2/8), and Toussaint (2/8). All remaining cash is split among the partners according to their original profit and loss ratio.

25.(15 minutes) (Determine the ramifications of a partner with a deficit capital balance) (a) $42,000. Maximum losses of $135,000 on the noncash assets would increase Veloso's deficit balance by $27,000 (20%), to $42,000 ($15,000 + $27,000). (b) All $20,000 should go to Guerin. As Guerin and Moradi view the current situation, maximum potential losses total $150,000: $135,000 on the noncash assets and $15,000 on Veloso's deficit balance. In determining safe capital balances, these assumed losses would be allocated on a 4:4 basis or $75,000 to Guerin and $75,000 to Moradi. Since such a loss would entirely eliminate Moradi's capital account, only Guerin has a safe capital balance at the current time. (c) The minimum cash payment to Guerin would be $50,000. A loss of $85,000 on the noncash assets would result in the following capital balances: Guerin: $66,000 = $100,000 – (40% × $85,000) Moradi: $36,000 = $70,000 – (40% × $85,000) 15-60 © McGraw Hill LLC. All rights reserved. No reproduction or distribution without the prior written consent of McGraw Hill LLC.

Chapter 15 - Partnerships: Termination and Liquidation – Hoyle, Schaefer, Doupnik, Advanced Accounting, 15e

Veloso: ($32,000) = ($15,000) – (20% × $85,000) Allocation of Veloso‘s deficit further reduces the remaining partners‘ capital balances as follows: Guerin: $50,000 = $66,000 – (1/2 × $32,000) Moradi: $20,000 = $36,000 – (1/2 × $32,000) If noncash assets are sold for $50,000, a total of $70,000 (after deducting liabilities) is available for distribution to partners: Guerin receives $50,000 and Moradi receives $20,000. 26.(15 minutes) (Determine the ramifications of partners with deficit capital balances and personally insolvent) (a) Because Safar and Wong are personally insolvent, and therefore unable to make a cash contribution to the partnership, their combined $42,000 in deficit capital balances will have to be absorbed by Ramos and Rios on a 4:3 basis. Thus, Rios will be allocated $18,000 ($42,000 × 3/7), which creates a deficit for this partner of $6,000 ($12,000 - $18,000). Rios will have to contribute $6,000. (b) Because Wong is personally insolvent, and therefore unable to make a cash contribution to the partnership, the remaining partners will have to absorb the $25,000 deficit on a 4:3:2 basis. This allocation increases Safar's deficit by 2/9 of $25,000 or $5,556. Safar must contribute an amount equal to the new deficit balance of $22,556 [$17,000 + $5,556]. The first $10,000 contributed by Safar goes to pay the liabilities that remain after the $20,000 in partnership cash is distributed to creditors. The remaining $12,556 is distributed to the two remaining partners in accordance with their positive capital balances after absorbing Wong‘s deficit. After allocating 4/9 of Wong‘s deficit to Ramos and 3/9 to Rios, Ramos has a positive capital balance of $8,889 [$20,000 – ($25,000 × 4/9)] and Rios has a positive capital balance of $3,667 [$12,000 – ($25,000 × 3/9)]. Therefore, Ramos receives $8,889 and Rios receives $3,667 of the remaining $12,556. (c) If Safar is personally insolvent, and therefore unable to make a cash contribution to the partnership, the $17,000 deficit balance will have to be absorbed by the remaining three partners on a 4:3:1 basis. This loss would decrease Ramos's capital balance by $8,500 (4/8 × $17,000) to $11,500. Once Wong contributes $27,125 [$25,000 + (1/8 × $17,000)] to the partnership, Ramos should receive $11,500. 27.(25 minutes) (Prepare journal entries for a partnership liquidation) JOURNAL ENTRIES a. 15-61 © McGraw Hill LLC. All rights reserved. No reproduction or distribution without the prior written consent of McGraw Hill LLC.

Chapter 15 - Partnerships: Termination and Liquidation – Hoyle, Schaefer, Doupnik, Advanced Accounting, 15e

Cash ............................................................................ Agarwal, Capital (2/6 of loss) .................................... Bergeron, Capital (3/6) .............................................. Cishek, Capital (1/6) .................................................. Inventory ...............................................................

56,000 6,000 9,000 3,000

Agarwal, Capital (2/6 of expenses) ........................... Bergeron, Capital (3/6) .............................................. Cishek, Capital (1/6) .................................................. Cash ......................................................................

2,500 3,750 1,250

Liabilities .................................................................... Cash ......................................................................

40,000

Cash ............................................................................ Accounts Receivable ...........................................

45,000

74,000

7,500

c. 40,000

d. 45,000

e. Partner

Current Capital Adjusted

Share of Maximum Loss*

Agarwal Bergeron Cishek

$16,500 $62,250 $41,750

2/6 × $77,000 = $25,667 3/6 × $77,000 = $38,500 1/6 × $77,000 = $12,833

Potential Capital $ (9,167) $23,750 $28,917

*Maximum losses could be suffered on the remaining $39,000 in accounts receivable and the $38,000 in land, building, and equipment. Based on the above potential losses, Agarwal would have a deficit capital balance of $9,167 which in turn has to be allocated to the two partners having positive capital balances:

Partner Bergeron Cishek

Potential Capital (above) $23,750 $28,917

Share of Agarwal's Deficit 3/4 × $9,167 = $6,875 1/4 × $9,167 = $2,292

Potential Capital $16,875 $26,625

27. (continued) As the above amounts represent safe capital balances, payments can be presently made to these two partners. Bergeron, Capital ....................................................... 16,875 Cishek, Capital ........................................................... 26,625 15-62 © McGraw Hill LLC. All rights reserved. No reproduction or distribution without the prior written consent of McGraw Hill LLC.

Chapter 15 - Partnerships: Termination and Liquidation – Hoyle, Schaefer, Doupnik, Advanced Accounting, 15e

Cash ......................................................................

43,500

f. Cash (30%) ................................................................. Agarwal, Capital (2/6 of loss) .................................... Bergeron, Capital (3/6) ............................................... Cishek, Capital (1/6) ................................................... Accounts Receivable ...........................................

11,700 9,100 13,650 4,550

Cash ............................................................................ Agarwal, Capital (2/6 of loss) .................................... Bergeron, Capital (3/6) .............................................. Cishek, Capital (1/6) .................................................. Land, Building and Equipment ...........................

17,000 7,000 10,500 3,500

Liabilities .................................................................... Cash ......................................................................

21,000

39,000

38,000

h. 21,000

i. Because each partner has a positive capital balance, the $28,700 cash that remains can be distributed based on their ending capital balances. Agarwal, Capital ......................................................... Bergeron, Capital ....................................................... Cishek, Capital ........................................................... Cash ......................................................................

400 21,225 7,075 28,700

28.(30 minutes) (Prepare predistribution plan to determine liquidation proceeds necessary to give partner a specified amount) Answer: For Zed to be able to pay the personal creditor $10,000 from the distribution of partnership property, the partnership‘s other assets must be sold for at least $86,000, as explained below. $96,000 in cash is needed to pay liabilities and liquidation expenses. This is $56,000 more than the current cash balance. Based on the predistribution schedule below, the next $10,000 is received solely by Yang. The next $24,000 would be split 50/50 between Yang and Zed. Cash of $20,000 generated at this stage would provide Zed the $10,000 needed to pay Zed‘s personal creditor. Thus, for Zed‘s creditor to get $10,000, the other assets must be sold for $86,000 ($56,000 + $10,000 + $20,000). A predistribution plan must be developed to generate this information: Beginning capital Assumed loss of $200,000 (see

Winn

Xie

$100,000 (100,000)

$84,000 (60,000)

Yang

Zed

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

Chapter 15 - Partnerships: Termination and Liquidation – Hoyle, Schaefer, Doupnik, Advanced Accounting, 15e

Schedule 1) (5:3:1:1) Step One balances Assumed loss of $40,000 (see Schedule 2) (0:3:1:1) Step Two balances Assumed loss of $24,000 (see Schedule 3) (0:0:1:1) Step Three balances

$ -0-0-

$24,000 (24,000)

$30,000 (8,000)

$20,000 (8,000)

$ -0-0-

$22,000 $12,000 (12,000) (12,000)

$ -0-

$ 10,000

$ -0-

Schedule 1

Partner Winn Xie Yang Zed

Capital Balance/Loss Allocation

Maximum Loss to Be Absorbed

$100,000/50% $84,000/30% $50,000/10% $40,000/10%

$200,000 $280,000 $500,000 $400,000

Capital Balance/Loss Allocation

Maximum Loss to Be Absorbed

$24,000/(3/5) $30,000/(1/5) $20,000/(1/5)

$ 40,000 $150,000 $100,000

Partner

Capital Balance/Loss Allocation

Maximum Loss to Be Absorbed

Yang Zed

$22,000/(1/2) $12,000/(1/2)

$44,000 $24,000

(most vulnerable)

Schedule 2 Partner Xie Yang Zed

(most vulnerable)

28. (continued) Schedule 3

(most vulnerable)

PREDISTRIBUTION PLAN

     

Current cash of $40,000 goes to pay liabilities. Next $56,000 generated goes to pay remaining liabilities ($26,000) and to pay estimated liquidation expenses ($30,000). Next $10,000 goes to Yang. Next $24,000 goes to Yang and Zed on a 1:1 basis. Next $40,000 goes to Xie, Yang, and Zed on a 3:1:1 basis. Any remaining cash is split among all four partners based on a 5:3:1:1 basis.

Chapter 15 - Partnerships: Termination and Liquidation – Hoyle, Schaefer, Doupnik, Advanced Accounting, 15e

Balances - Jan. 1 Collected acc. rec. Sold inventory Paid liq. exp. Paid acc. pay.

MORI, LUX, AND KHAN PARTNERSHIP Proposed Schedule of Liquidation January 31 Mori, Capital and Loan Noncas h Liabiliti es Cash Assets 50% $28,00 $367,00 0 0 $93,000 $78,000 (86,000 (17,500 51,000 ) ) (72,000 (12,000 48,000 ) ) (4,000) (2,000) (88,00 0) 0 (93,000) 2,500

Subtotal (actual balances)

35,000 209,000 (209,00 0) (20,00 0) 0

Subtotal (potential balances) Allocation of deficit capital balance

15,000

49,000 (104,50 0) (10,000 ) (65,500 )

65,500

Safe payments to partners Jan. 31

$15,00 0

Max. loss on assets Max. liq. exp.

Lux, Capital and Loan

30% $140,0 00 (10,500 ) (7,200) (1,200) 1,500 122,60 0 (62,700 )

Khan, Capita l

20% $84,00 0 (7,000 ) (4,800 ) (800) 1,000

(6,000)

72,400 (41,80 0) (4,000 )

53,900 (39,300 )

26,600 (26,20 0)

$14,60 0

$ 400

Chapter 15 - Partnerships: Termination and Liquidation – Hoyle, Schaefer, Doupnik, Advanced Accounting, 15e

29. (continued) MORI, LUX, AND KHAN PARTNERSHIP Proposed Schedule of Liquidation February 28

Balances before Jan. 31 safe payments Safe payments to partners - Jan. 31 Balances - Feb. 1

Cash $ 35,000 (15,000) 20,000

Paid liq. exp. Subtotal (actual balances) Max. loss on assets

(5,000) 15,000

Max. liq. exp. Subtotal (potential balances)

(8,000) 7,000

Mori, Capital and Loan

Lux, Capital and Loan

50% $49,000 0 49,000

30% $122,600 (14,600) 108,000

20% $72,400 (400) 72,000

(2,500) 46,500 (104,500)

(1,500) 106,500 (62,700)

(1,000) 71,000 (41,800)

(4,000) (62,000)

(2,400) 41,400

(1,600) 27,600

62,000

(37,200)

(24,800)

$ 4,200

$ 2,800

Noncash Assets $209,000

Liabilities $0 -

209,000 209,000 (209,000) 0

Allocation of deficit capital balance Safe payments to partners - Feb. 28

$ 7,000

Khan, Capital

Chapter 17 – Accounting for State and Local Governments (Part Two) – Hoyle, Schaefer, Doupnik, Advanced Accounting, 15e

29. (continued) MORI, LUX, AND KHAN PARTNERSHIP Proposed Schedule of Liquidation March 31

Balances before Feb. 28 safe payments Safe payments to partners - Feb. 28 Balances - Mar. 1 Sold machinery Paid liq. exp. Subtotal (actual balances) Safe payments to partners - Mar. 31 Ending bal. - Mar. 31

Cash

Noncash Assets

Liabilitie s

$15,000

$209,000

(7,000) 8,000 156,000 (7,000)

Mori, Capital and Loan

Lux, Capital and Loan

Khan, Capital

50%

30%

20%

$46,500

$106,500

$71,000

46,500

(4,200) 102,300

(2,800) 68,200

(26,500) (3,500)

(15,900) (2,100)

(10,600) (1,400)

16,500

84,300

56,200

(16,500) $0

(84,300) $0

(56,200) $0

209,000 (209,000 )

157,000 (157,000 ) $0

30.(35 minutes) (Determine cash distributions for four different partnership liquidations; insolvent partners) Part A

Beginning balances Contribution by Vinicius Capital balances Elimination of Vinicius's deficit (50:25 basis) Final distribution

Buarque, Capital

Monte, Loan and Capital

Vinicius, Capital

$50,000 -0$50,000 (4,000)

$60,000 -0$60,000 (2,000)

($15,000) 9,000 ($ 6,000) 6,000

$46,000

$58,000

$ -0-

$104,000 is available for distribution to partners: $130,000 cash balance $35,000 in liabilities + $9,000 contribution from Vinicius. Buarque receives $46,000; Monte receives $58,000. Drawdy, Loan and Capital $60,000

Part B

Beginning balances $30,000 loss on disposal of assets

Langston, Loan and Capital

Pearl, Capital

$58,000

$12,000

Chapter 17 – Accounting for State and Local Governments (Part Two) – Hoyle, Schaefer, Doupnik, Advanced Accounting, 15e

(allocated on a 40:30:30 basis) Liquidation expenses (40:30:30 basis) Capital balances Allocation of Pearl's deficit (40:30 basis) Final distribution

(12,000) (6,000) 42,000 (857) $41,143

(9,000) (4,500) 44,500 (643) $43,857

(9,000) (4,500) (1,500) 1,500 $ 0-

$85,000 is available for distribution to partners: $20,000 cash balance - $40,000 in liabilities - $15,000 liquidation expenses + $120,000 from sale of assets. Drawdy receives $41,143; Langston receives $43,857. Part C

Beginning balances $30,000 loss on disposal of assets (allocated on a 2:4:4 basis) Liquidation expenses (2:4:4 basis) Capital balances Allocation of Pearl‘s deficit balance (2:4 basis) Final distribution

Drawdy, Langston, Loan Loan and and Capital Capital $60,000 $58,000 (6,000) (12,000)

$12,000 (12,000)

(1,200) $52,800 (800) $52,000

(2,400) ($2,400) 2,400 $ -0-

(2,400) $43,600 (1,600) $42,000

Pearl, Capital

$94,000 is available for distribution to partners: $20,000 cash balance - $40,000 in liabilities - $6,000 liquidation expenses + $120,000 from sale of assets. Drawdy receives $52,000; Langston receives $42,000. Part D

Beginning balances Allocation of Krups's deficit balance (30:20:20 basis) Capital balances $36,000 contribution by Lindau Final distribution

Krups, Lindau, Loan Capital and Capital ($14,000) ($30,000) 14,000 (6,000)

Riedel, Schnee, Capital Capital $15,000 (4,000)

$20,000 (4,000)

-0- ($36,000) -036,000 $ -0$ -0-

$11,000 -0$11,000

$16,000 -0$16,000

$27,000 is available for distribution to partners: $36,000 contribution from Lindau - $9,000 in liabilities. Riedel receives $11,000; Schnee receives $16,000. 31.(60 minutes) (Prepare a predistribution plan, a final statement of liquidation, and journal entries for a partnership liquidation) Part A

Preparation of Predistribution Plan

Chapter 17 – Accounting for State and Local Governments (Part Two) – Hoyle, Schaefer, Doupnik, Advanced Accounting, 15e

Schedule 1 Partner

Capital Balance/Loss Allocation

Maximum Loss That Can Be Absorbed

Bauer Ohtani Souza

$129,000/60% $ 35,000/20% $ 75,000/20%

$215,000 $175,000 $375,000

(most vulnerable to loss)

Schedule 2 Partner

Capital Balance/Loss Allocation

Maximum Loss That Can Be Absorbed

Bauer Souza

$24,000/(60/80) $40,000/(20/80)

$ 32,000 $160,000

(most vulnerable to loss)

Schedule 3 Bauer, Ohtani, Souza, Capital Capital Capital Beginning balances .............................................. Loss of $175,000 assumed—Schedule 1 (allocated on a 60:20:20 basis) .............................................. Step One balances ................................................ Loss of $32,000 assumed—Schedule 2 (allocated on a 60:20 basis) ................................................... Step Two balances................................................ Loss of $32,000 assumed ..................................... Final balances .......................................................

$129,000 (105,000)

$35,000 $75,000 (35,000) (35,000)

24,000 (24,000) -0-0$ -0-

-0-0-

40,000 (8,000)

-032,000 -0- (32,000) $ -0$ -0-

PREDISTRIBUTION PLAN    

First, payment of liabilities and liquidation expenses must be assured. Next $32,000 goes to Souza. Next $32,000 is split between Bauer and Souza on a 60:20 basis. Any further cash is split among Bauer, Ohtani, and Souza on a 60:20:20 basis.

31. (continued) Part B

Preparation of Final Statement of Partnership Liquidation BAUER, OHTANI, AND SOUZA Statement of Partnership Liquidation Final Balances

Cash

Noncash Assets

Liabilities

Bauer, Capital 60%

Ohtani, Capital 20%

Souza, Capital 20%

Chapter 17 – Accounting for State and Local Governments (Part Two) – Hoyle, Schaefer, Doupnik, Advanced Accounting, 15e

Beginning balances 1. Distribution of $12,000* in accordance with predistribution plan Updated balances 2. Noncash assets sold Updated balances 3. Liabilities paid Updated balances 4. Distribution of $60,000** in accordance with predistribution plan First $20,000 (remainder of first distribution of $32,000) Next $32,000 Next $8,000 Updated balances 5. Noncash assets sold Updated balances 6. Liquidation expenses paid Updated balances 7. Final distribution based on ending capital balances

$ 60,000 (12,000) $ 48,000 60,000 $108,000 (40,000) $ 68,000

Ending balance

$219,000

$(40,000) $(129,000) $(35,000) $(75,000)

$125,000

12,000 $(40,000) $(129,000) $(35,000) $(63,000) 20,400 6,800 6,800 $(40,000) $(108,600) $(28,200) $(56,200) 40,000 $ -0- $(108,600) $(28,200) $(56,200)

(20,000) (32,000) (8,000) $ 8,000 $125,000 51,000 (125,000) $ 59,000 $ -0(6,000) $ 53,000 $ -0-

20,000 8,000 1,600 $(26,600) 14,800 $(11,800) 1,200 $(10,600)

$219,000 (94,000) $125,000

$ -0$ -0$ -0-

53,000 $ -0-

$ -0-

24,000 4,800 1,600 $(79,800) $(26,600) 44,400 14,800 $(35,400) $(11,800) 3,600 1,200 $(31,800) $(10,600) 31,800

10,600

$ -0-

*$12,000 in cash is immediately available for distribution: Cash of $60,000 less Liabilities of $40,000 and Estimated Liquidation Expenses of $8,000. **$60,000 in cash is available for distribution: Cash of $68,000 less Estimated Liquidation Expenses of $8,000.

31. (continued) Part C

Journal Entries

Souza, Capital ............................................................ 12,000 Cash ...................................................................... 12,000 Cash payments are made to partners in accordance with predistribution plan. 2. Cash ............................................................................ 60,000 Bauer, Capital (60% of $34,000 loss) ....................... 20,400 Ohtani, Capital (20%) ................................................. 6,800 Souza, Capital (20%) ................................................. 6,800 Noncash Assets ...................................................

94,000

Chapter 17 – Accounting for State and Local Governments (Part Two) – Hoyle, Schaefer, Doupnik, Advanced Accounting, 15e

Noncash assets are sold with losses allocated to partners. 3. Liabilities .................................................................... Cash ...................................................................... All liabilities are paid.

40,000 40,000

4. Bauer, Capital ............................................................ 28,800 Ohtani, Capital ........................................................... 1,600 Souza, Capital ............................................................ 29,600 Cash ...................................................................... 60,000 Cash payments are made to partners in accordance with predistribution plan. 5. Cash ............................................................................ 51,000 Bauer, Capital (60% of $74,000 loss) ....................... 44,400 Ohtani, Capital (20%) ................................................. 14,800 Souza, Capital (20%) ................................................. 14,800 Noncash Assets ................................................... Noncash assets are sold with losses allocated to partners.

125,000

6. Bauer, Capital ............................................................ Ohtani, Capital ........................................................... Souza, Capital ............................................................ Cash ...................................................................... Liquidation expenses are paid.

3,600 1,200 1,200 6,000

7. Bauer, Capital ............................................................ 31,800 Ohtani, Capital ........................................................... 10,600 Souza, Capital ............................................................ 10,600 Cash ...................................................................... 53,000 Final cash payments are made to partners based on ending capital balances. 32.(50 minutes) (Prepare a predistribution plan and journal entries for a partnership liquidation) Part A Preparation of Predistribution Plan Schedule 1 Partner

Capital Balance/Loss Allocation

Maximum Loss That Can Be Absorbed

Wing

$120,000/30%

$400,000 17-5

Chapter 17 – Accounting for State and Local Governments (Part Two) – Hoyle, Schaefer, Doupnik, Advanced Accounting, 15e

Mehta Rodgers Yan

$ 88,000/10% $109,000/20% $ 60,000/40%

$880,000 $545,000 $150,000

(most vulnerable to loss)

Schedule 2 Partner

Capital Balance/Loss Allocation

Maximum Loss That Can Be Absorbed

Wing Mehta Rodgers

$75,000/(30/60) $73,000/(10/60) $79,000/(20/60)

$150,000 $438,000 $237,000

(most vulnerable to loss)

Schedule 3 Partner

Capital Balance/Loss Allocation

Maximum Loss That Can Be Absorbed

Mehta Rodgers

$48,000/(10/30) $29,000/(20/30)

$144,000 $ 43,500

(most vulnerable to loss)

32. (continued) Schedule 4

Beginning balances Loss of $150,000 assumed (al-located on a 30:10:20:40 basis) see Schedule 1 Step One balances Loss of $150,000 assumed (allocated on a 30:10:20 basis) see Schedule 2 Step Two balances Loss of $43,500 assumed (allocated on a 10:20 basis) see Schedule 3 Step Three balances

Wing, Capital

Mehta, Rodgers, Loan Capital and Capital

Yan, Capital

$120,000 (45,000)

$88,000 (15,000)

$109,000 (30,000)

$60,000 (60,000)

$ 75,000 (75,000)

$73,000 (25,000)

$ 79,000 (50,000)

$ -0-0-

$48,000 (14,500)

$ 29,000 (29,000)

$ -0-0-

$ -0-

$33,500

$ -0-

PREDISTRIBUTION PLAN     

Payment of all liabilities and liquidation expenses must be assured. Next $33,500 goes entirely to Mehta. Next $43,500 is allocated to Mehta (10/30) and Rodgers (20/30). Next $150,000 is allocated to Wing (30/60), Mehta (10/60), and Rodgers (20/60). Any further cash distributions are divided on the original profit and loss ratio: Wing (30%), Mehta (10%), Rodgers (20%), and Yan (40%).

Chapter 17 – Accounting for State and Local Governments (Part Two) – Hoyle, Schaefer, Doupnik, Advanced Accounting, 15e

32. (continued) Part B Journal Entries 1. Cash ............................................................................ 65,600 Wing, Capital (30% of $16,400 loss) ......................... 4,920 Mehta, Capital (10%) .................................................. 1,640 Rodgers, Capital (20%) ............................................. 3,280 Yan, Capital (40%) ..................................................... 6,560 Accounts Receivable ...................................... Receivables are collected with losses allocated to partners.

82,000

2. Cash ............................................................................ 150,000 Wing, Capital (30% of $103,000 loss) ....................... 30,900 Mehta, Capital (10%) .................................................. 10,300 Rodgers, Capital (20%) ............................................. 20,600 Yan, Capital (40%) ..................................................... 41,200 Land ................................................................. 85,000 Building and Equipment ................................. 168,000 Land, building and equipment are sold with losses allocated to partners. 3. Wing, Capital .............................................................. 31,800 Mehta, Capital ............................................................ 58,600 Rodgers, loan ............................................................. 35,000 Rodgers, Capital ........................................................ 15,200 Cash ................................................................. 140,600 Payments made to partners in accordance with the predistribution plan based on a current cash balance of $230,600. The first $35,000 paid to Rodgers extinguishes the loan made to the partnership.     

First $90,000 is held to pay liabilities ($74,000) and estimated liquidation expenses ($16,000); $140,600 is paid to partners. Next $33,500 goes entirely to Mehta. Next $43,500 is split between Mehta ($14,500) and Rodgers ($29,000). Remaining $63,600 is allocated to Wing ($31,800), Mehta ($10,600) and Rodgers ($21,200). Total payments: Mehta, $58,600; Rodgers, $50,200; Wing, $31,800.

32. (continued) 4. No journal entry is currently required by Yan's insolvency. 5. Liabilities ....................................................................

74,000

Chapter 17 – Accounting for State and Local Governments (Part Two) – Hoyle, Schaefer, Doupnik, Advanced Accounting, 15e

Cash ................................................................. All liabilities are paid.

74,000

6. Cash ............................................................................ Wing, Capital (30% of $30,000 loss) ......................... Mehta, Capital (10%) .................................................. Rodgers, Capital (20%) ............................................. Yan, Capital (40%) ..................................................... Inventory........................................................... Inventory is sold with loss allocated to partners.

71,000 9,000 3,000 6,000 12,000 101,000

7. 35,500 Wing, Capital............................................................... Mehta, Capital ............................................................. 11,833 Rodgers, Capital ......................................................... 23,667 Cash .................................................................. 71,000 Distribution of available cash according to predistribution plan. Although $87,000 in cash is held by the partnership, $16,000 must be retained to pay liquidation expenses. The remaining $71,000 is divided among Wing, Mehta, and Rodgers on a 30:10:20 basis. According to the predistribution plan, a total of $150,000 must be divided on this ratio but only $63,600 was allocated in this manner in the first distribution above. Therefore, all $71,000 (making a total of $134,600) is paid out on this 30:10:20 basis. 8. Wing, Capital (30% of expenses)............................... Mehta, Capital (10%)................................................... Rodgers, Capital (20%) .............................................. Yan, Capital (40%) ...................................................... Cash .................................................................. Liquidation expenses are paid.

3,300 1,100 2,200 4,400 11,000

9. a. Wing, Capital (30/60 of deficit) ............................. 2,080 Mehta, Capital (10/60) ........................................... 693 Rodgers, Capital (20/60) ....................................... 1,387 Yan, Capital ...................................................... 4,160 To eliminate the deficit balance of insolvent partner as computed on the next page. 32. (continued) CAPITAL ACCOUNT BALANCES Wing, Mehta, Rodgers, Yan, Capital Capital Loan Capital 17-8 © McGraw Hill LLC. All rights reserved. No reproduction or distribution without the prior written consent of McGraw Hill LLC.

Chapter 17 – Accounting for State and Local Governments (Part Two) – Hoyle, Schaefer, Doupnik, Advanced Accounting, 15e

and Capital Beginning balances Loss on accounts receivable Loss on land, building, and equipment Cash distribution Loss on inventory Cash distribution Liquidation expenses Subtotal Yan insolvent Current balances

$120,000 (4,920) (30,900)

$88,000 (1,640) (10,300)

$109,000 $60,000 (3,280) (6,560) (20,600) (41,200)

(31,800) (58,600) (9,000) (3,000) (35,500) (11,833)* (3,300) (1,100) 4,580 1,527 * (2,080) (693)* $2,500 $ 833 *

(50,200) -0(6,000) (12,000) (23,667)* -0(2,200) (4,400) 3,053 * (4,160) (1,387)* 4,160 $1,667 * $ -0-

* These amounts are rounded to the nearest whole dollar. As a result, due to rounding, the ―Current balances‖ for Mehta and Rodgers appear to be off by $1.00. b. Wing, Capital ......................................................... 2,500 Mehta, Capital........................................................ 833 Rodgers, Capital.................................................... 1,667 Cash .................................................................. To distribute remaining cash based on final capital balances.

5,000

Although not a problem requirement, the next page presents a Statement of Partnership Liquidation that summarizes the activity taking place during the liquidation of the Wing, Mehta, Rodgers, and Yan partnership. 32. (continued) WING, MEHTA, RODGERS, AND YAN Statement of Partnership Liquidation

Wing, Mehta, Capita Capita l 30% l 10% 120,00 0 88,000

Rodger s, Loan and Capital 20%

Cash

Other Assets

Liabiliti es

Beginning bal.

15,000

436,000

74,000

1. Collected rec. 2. Sold land, bldg. & equip.

65,600

(82,000)

150,000

(253,000)

(4,920) (30,90 0)

(1,640) (10,30 0)

(3,280) (20,600 )

Updated bal.

230,600

101,000

74,000

84,180

76,060

85,120

109,000

Yan, Capit al 40% 60,00 0 (6,560 ) (41,20 0) 12,24 0

Chapter 17 – Accounting for State and Local Governments (Part Two) – Hoyle, Schaefer, Doupnik, Advanced Accounting, 15e

3. Distributed cash per predist. plan

(140,600)

(31,80 0)

(58,60 0)

(50,200 )

12,24 0 (12,00 0) 240

Updated bal. 5. Paid liabilities

90,000 (74,000)

101,000 -

74,000 (74,000)

52,380 -

17,460 -

34,920 -

6. Sold inventory Updated bal.

71,000 87,000

(101,000) -0-

-0-

(9,000) 43,380

(3,000) 14,460

(6,000) 28,920

7. Distributed cash per predist. plan Updated bal.

(71,000) 16,000

-0-

(35,50 0) 7,880

(11,83 3)* 2,627*

(23,667 )* 5,253*

8. Paid liq. exp.

(11,000)

- (3,300)

(1,100)

(2,200)

Updated bal. 9.a. Allocated deficit capital balance Updated bal. 9.b. Distributed remaining cash

5,000

-0-

4,580

1,527*

3,053*

240 (4,400 ) (4,160 )

5,000

-0-

- (2,080) 2,500

(693)* 833*

(1,387)* 1,667*

4,160 -0-

(5,000)

- (2,500)

(833)*

(1,667)*

-0-

Closing bal.

-0-

* These amounts are rounded to the nearest whole dollar.

33.(40 minutes) (Prepare a predistribution plan and journal entries for a partnership liquidation) Part A Preparation of Predistribution Plan Partner

Schedule 1 Capital Maximum Balance/Loss Loss That Can Allocation Be Absorbed

Garcia Iglesias Kassabian

$80,000/25% $30,000/25% $70,000/50%

$320,000 $120,000 $140,000

Partner

Capital Balance/Loss Allocation

Schedule 2 Maximum Loss That Can Be Absorbed

Garcia Kassabian

$50,000/(25/75) $10,000/(50/75)

$150,000 $15,000

(most vulnerable to loss)

Schedule 3

Chapter 17 – Accounting for State and Local Governments (Part Two) – Hoyle, Schaefer, Doupnik, Advanced Accounting, 15e

Garcia, Loan and Capital Beginning balances ...................... Loss of $120,000 assumed (allocated on a 25:25:50 basis) see Schedule 1 Step One balances ......................... Loss of $15,000 assumed (allocated on a 25:50 basis) see Schedule 2 Step Two balances.........................

Iglesias, Kassabian Capital Capital

$80,000 (30,000)

$30,000 (30,000)

$70,000 (60,000)

$50,000 (5,000)

$-0-0-

$10,000 (10,000)

$45,000

$-0-

PREDISTRIBUTION PLAN     

Payment of all liabilities and liquidation expenses must be assured. Next $45,000 goes entirely to Garcia. Next $15,000 is allocated to Garcia (25/75 or 1/3) and Kassabian (50/75 or 2/3). Any further cash distributions are divided on the original profit and loss ratio: Garcia (25%), Iglesias (25%), and Kassabian (50%).

33. (continued) Part B Journal Entries 1. Cash ...................................................................... 54,000 Garcia, Capital (25% of $6,000 loss) ................... 1,500 Iglesias, Capital (25%) .......................................... 1,500 Kassabian, Capital (50%) ..................................... 3,000 Accounts Receivable ...................................... Receivables are collected with losses allocated to partners.

60,000

2. Cash ...................................................................... 220,000 Garcia, Capital (25% of $40,000 loss) ................. 10,000 Iglesias, Capital (25%) .......................................... 10,000 Kassabian, Capital (50%) ..................................... 20,000 Office equipment ............................................. 50,000 Building ............................................................ 110,000 Land .................................................................. 100,000 Office equipment, building, and land are sold with losses allocated to partners. 3. Garcia, Loan .......................................................... Garcia, Capital ...................................................... Iglesias, Capital ....................................................

30,000 30,000 10,000

Chapter 17 – Accounting for State and Local Governments (Part Two) – Hoyle, Schaefer, Doupnik, Advanced Accounting, 15e

Kassabian, Capital ............................................... 30,000 Cash ................................................................. 100,000 Payments made to partners in accordance with the predistribution plan based on a current cash balance of $304,000 ($30,000 + $54,000 + $220,000). The first $30,000 paid to Garcia extinguishes the loan made to the partnership. 

First $204,000 is held to pay liabilities ($170,000) and estimated liquidation expenses ($34,000); $100,000 is paid to partners.



Next $45,000 goes entirely to Garcia.



Next $15,000 is split between Garcia ($5,000) and Kassabian ($10,000).



Remaining $40,000 is allocated to Garcia (25% = $10,000), Iglesias ($10,000) and Kassabian ($20,000).



Total payments: Garcia, $60,000; Iglesias, $10,000; Kassabian, $30,000.

33. (continued) 4. Liabilities ............................................................... Cash ................................................................. All liabilities are paid.

170,000

Garcia, Capital (25% of $30,000 in expenses)..... Iglesias, Capital (25%)........................................... Kassabian, Capital (50%)...................................... Cash .................................................................. Final invoices for liquidation expenses are paid.

7,500 7,500 15,000

170,000

30,000

6. Garcia, Capital (25%) ............................................ 1,000 Iglesias, Capital (25%)........................................... 1,000 Rodgers, Capital (50%) ......................................... 2,000 Cash .................................................................. 4,000 Distribution of remaining cash of $4,000 according to predistribution plan: Garcia, 25%; Iglesias, 25%; Kassabian, 50%. CAPITAL ACCOUNT BALANCES Garcia, Iglesias, Loan and Capital Capital (25%) (25%) Beginning balances ............................ Loss on accounts receivable .............

$80,000 (1,500)

$30,000 (1,500)

Kassabian, Capital (50%) $70,000 (3,000)

Chapter 17 – Accounting for State and Local Governments (Part Two) – Hoyle, Schaefer, Doupnik, Advanced Accounting, 15e

Loss on sale of assets ........................ Cash distribution................................. Liquidation expenses.......................... Cash distribution................................. Ending balances..................................

(10,000) (60,000) (7,500) (1,000) $ -0-

(10,000) (10,000) (7,500) (1,000) $ -0-

(20,000) (30,000) (15,000) (2,000) $ -0-

Although not a problem requirement, the next page presents a Statement of Partnership Liquidation that summarizes the activity taking place during the liquidation of the Garcia, Iglesias, and Kassabian partnership. 33. (continued)

Beginning bal. 1. Collected rec. 2. Sold land, bldg. & equip.

GARCIA, IGLESIAS, AND KASSABIAN Statement of Partnership Liquidation Garcia, Loan and Other Capital Assets Cash Liabilities 25% 30,000 320,000 170,000 80,000 54,000 (60,000) (1,500)

Iglesias, Capital 25% 30,000 (1,500)

Kassabian, Capital 50% 70,000 (3,000)

220,000

(260,000)

(10,000)

(20,000)

68,500

18,500

47,000

(60,000)

(10,000)

(30,000)

Updated bal. 3. Distributed cash per predist. plan

304,000

-0-

170,000

(100,000)

Updated bal.

204,000

-0-

170,000

8,500

17,000

4. Paid liabilities

(170,000)

5. Paid liq. exp.

(30,000)

(7,500)

(15,000)

Updated bal. 6. Distributed remaining cash Closing bal.

4,000

-0-

1,000

2,000

(4,000) -0-

-0-

(1,000) -0-

(2,000) -0-

-0-0-

Chapter 17 – Accounting for State and Local Governments (Part Two) – Hoyle, Schaefer, Doupnik, Advanced Accounting, 15e

Chapter 15 Develop Your Skills Analysis Case

1. Cedar Fair, L.P. is ―one of the largest regional amusement park operators in the world with 13 properties in our portfolio consisting of amusement parks, water parks and complementary resort facilities‖ (2020 Form 10-K, page 3). Cedar Fair‘s parks include: Cedar Point (OH), Knott‘s Berry Farm (CA), Carowinds (NC), King‘s Dominion (VA), and Worlds of Fun (MO). 2. In looking at the financial statements of the Cedar Fair, L.P. partnership, several obvious differences can be spotted in comparison to the financial statements of a corporation. Specifically:  The balance sheet shows ―partners‘ deficit‖ rather than stockholders‘ equity.  The statement of operations (income statement) reports ―net (loss) income allocated to general partner‖ and ―net (loss) income allocated to limited partners.‖ This statement also reports ―(loss) income per limited partner unit‖ rather than earnings per share.  A ―consolidated statement of partners‘ equity (deficit)‖ is presented rather than a statement of stockholders‘ equity. A potential investor in this partnership would become one of the ―limited partners,‖ whose aggregate equity is disclosed on the balance sheet as a deficit (-$674,319 thousand on December 31, 2020). 3. Several notes to the financial statements provide information about the unique characteristics of a limited partnership. For example:  Note 2 – discusses the creation and structure of this partnership under the heading ―Partnership Organization‖ (page 39).  Note 10 – ―Partners‘ Equity and Equity Based Compensation,‖ describes, for example, the issuance of ―Special L.P. Interests‖ to certain partners, which will be converted into cash upon liquidation of the partnership (page 50).  Note 12 – ―Income and Partnership Taxes‖ explains that, as a publicly traded partnership, Cedar Fair is exempt from U.S. income tax and instead is subject to a publicly traded partnership tax on gross income (equal to ―net revenues less cost of food, merchandise and games‖) (page 53). In addition, in Item 5 (page 14), which precedes the financial statements, disclosures are provided related to the market for Cedar Fair‘s ―Depositary Units,‖ which represent limited partner interests. These are publicly traded on the New York Stock Exchange under the ticker symbol ―FUN.‖ Potential investors (other than the general partner) would probably view an investment in Cedar Fair as being fairly similar to that of holding shares in a corporation.

Chapter 17 – Accounting for State and Local Governments (Part Two) – Hoyle, Schaefer, Doupnik, Advanced Accounting, 15e

Communication Case 1 Memorandum It would be appropriate to distribute some cash to partners before other assets have been sold and creditors have been paid so long as the cash in the bank exceeds the sum of existing liabilities and estimated liquidation expenses. The amount of cash that could be safely distributed can be determined as follows: Cash in bank account – Liabilities – Estimated liquidation expenses = Safe payment It would not be appropriate to simply distribute cash equally amongst the partners. The amount of cash to be received by an individual partner is based upon the balance in that partner‘s capital account, after considering the impact that potential losses on sales of other assets and liquidation expenses have on that partner‘s capital account. In addition, simulating the effect that liquidation losses and expenses would have on partners‘ capital accounts could result in one or more partners having a deficit (negative) capital balance. In that case, allocation of the deficit(s) to the other partners‘ capital accounts must be simulated, with the resulting positive capital account balances representing the amount of safe payments that can be distributed to partners. Distributing cash equally amongst partners would be appropriate only if (1) partners have equal balances in their capital account at the date of partnership termination and (2) partners share equally in profits and losses. Communication Case 2

Memorandum The capital account of an individual partner is debited (decreased) for that partner‘s share of the following:  Loss on the sale of noncash assets – the loss is the difference between the assets‘ carrying value and cash proceeds from the sale of those assets.  Liquidation expenses – expenses that are incurred in the liquidation process, including sales commissions, and legal and accounting fees. An individual partner‘s share of losses on the sale of noncash assets and liquidation expenses is based upon the ratio in which the partners share profits and losses. For example, the capital account of a partner with a 20% profit and loss percentage will be charged (i.e., capital account is debited) for 20% of noncash asset losses and liquidation expenses. If noncash asset losses and liquidation expenses are large enough, the total amount debited to an individual partner‘s capital account could cause a positive (credit) balance to become a negative (debit) balance.

Chapter 17 – Accounting for State and Local Governments (Part Two) – Hoyle, Schaefer, Doupnik, Advanced Accounting, 15e

CHAPTER 16 ACCOUNTING FOR STATE AND LOCAL GOVERNMENTS (PART ONE) Chapter Outline I.

State and local government accounting is unique because state and local governments are different from for-profit entities in a number of specific ways. A. Governments serve a broader group of stakeholders from citizens to bondholders. B. Governments raise most revenues through involuntary taxes and tolls. C. Monitoring compliance with budgeted policy priorities is necessary to establish the government‘s accountability to the public. D. Governments normally exist for a longer time than for-profit businesses. E. The primary purpose of governments is to enhance or maintain the well-being of its citizens.

II.

State and local government units produce two complete and distinct sets of financial statements. A. User needs for governmental financial information are so diverse that the Governmental Accounting Standards Board (GASB) requires the reporting of two sets of statements. Fund financial statements are likely more interesting for the citizens whereas governmentwide statements provide information that investors, such as bondholders seek. B. Fund financial statements present information about the general fund and a variety of other funds. This approach stresses the government‘s fiscal accountability over its financial resources. a. For governmental funds, these statements present all current financial resources and claims to those financial resources using modified accrual accounting to guide the timing of recognition. b. For proprietary funds and fiduciary funds, these statements present all economic resources using accrual accounting for timing purposes. C. Government-wide financial statements (a statement of net position and a statement of activities) present an overview of the government as a whole. They emphasize operational accountability. a. In these statements, all economic resources are measured using accrual accounting for timing purposes. b. Governmental funds and most internal service funds are combined. The totals are reported together as ―governmental activities.‖ c. Enterprise funds and any remaining internal service funds are combined and reported as ―business-type activities.‖ d. Because a government does not have control over the use of the assets held in fiduciary funds, information for those funds is excluded from government-wide financial statements.

III.

For internal purposes, governmental accounting records its individual activities within a number of self-balancing sets of accounts known as funds. A. Governmental funds account for activities where service to the public is the main emphasis. a. General fund 17-16 © McGraw Hill LLC. All rights reserved. No reproduction or distribution without the prior written consent of McGraw Hill LLC.

Chapter 17 – Accounting for State and Local Governments (Part Two) – Hoyle, Schaefer, Doupnik, Advanced Accounting, 15e

b. Special revenue funds c. Capital projects funds d. Debt service funds e. Permanent funds B. Proprietary funds account for government activities where a user charge is assessed for use of the service. a. Enterprise funds b. Internal service funds C. Fiduciary funds account for assets held in a trustee capacity for external parties. a. Investment trust funds b. Private-purpose trust funds c. Pension trust funds d. Custodial funds IV.

In fund accounting, in reporting the current financial resources of a governmental fund and all claims to those current financial resources, Fund Balance accounts indicate the use that government officials can make of the resources on hand. A. Fund Balance—Nonspendable – indicates the amount of resources a fund reports that cannot be spent by government officials. B. Fund Balance—Restricted – indicates the amount of resources a fund reports that must be spent in a manner as designated by an external party. C. Fund Balance—Committed – indicates the amount of resources a fund reports that has been designated for a particular purpose by the highest level of decision-making authority in the government. D. Fund Balance—Assigned – indicates the amount of resources a fund reports that has been designated for a particular purpose by a party within the government but not by the highest level of decision-making authority. E. Fund Balance—Unassigned – indicates the amount of resources a fund reports that has not been designated or otherwise restricted. It can be spent at the discretion of government officials. This balance is normally found only in the general fund because resources only appear in other funds if there is an intended use.

Governmental accounting has traditionally stressed establishing control over current financial resources to ensure appropriate usage of the public‘s money. Formal budgets play a big role in meeting this priority. A. Typically, each year, the responsible representatives of the government must approve a budget. If later amendments are made to the budget, approval is again necessary. B. Budgetary entries are recorded within the accounting records for a number of the activities monitored within the governmental funds. a. The government records the budget at the start of the year and then reverses it to remove the balances at the end of the year. b. If passed, budget amendments are also recorded during the year. C. Governments record financial commitments (such as contracts and purchase orders) during the year as encumbrances. a. The entries help officials avoid the overspending of appropriated amounts. b. When a commitment becomes a liability, the government removes the encumbrances.

VI.

In government-wide financial statements, governments report the acquisition of an asset with a long-life as a capital asset. Expenses are reported in the same manner as in a for-profit business. In contrast, in reporting the governmental funds within fund financial statements, the purchase of a capital asset, incurrence of an expense, and payment of a noncurrent debt all 17-17 © McGraw Hill LLC. All rights reserved. No reproduction or distribution without the prior written consent of McGraw Hill LLC.

Chapter 17 – Accounting for State and Local Governments (Part Two) – Hoyle, Schaefer, Doupnik, Advanced Accounting, 15e

appear as ―expenditures‖ to reflect the reduction in current financial resources. Through this method of reporting, the fund statements for the governmental funds indicate the usage made of the current financial resources held by the government. A. Within fund financial statements, supplies and prepaid items can be reported by either the consumption method (expenditure is recorded as the item is consumed) or the purchases method (expenditure is recorded when liability is first incurred). The consumption method is required for government-wide statements. B. On government-wide financial statements, acquisitions of infrastructure items —such as bridges and sidewalks— are required to be recorded as capital assets in the same manner as machinery and equipment. VII.

Governments often have nonexchange transactions when revenues are received such as taxes and grants without a corresponding earning process. To guide the timing of recognition for such transactions, GASB has identified four separate categories. A. Derived tax revenues (such as income taxes and sales taxes) are recognized when the underlying event that is taxed takes place. B. Imposed nonexchange transactions (such as property taxes, fines, and penalties) are recognized as revenues when the resources are required to be used or in the first period when use is permitted. C. Government-mandated nonexchange transactions (usually a government grant to fulfill a legally required objective) are recognized when all eligibility requirements are met. D. Voluntary nonexchange transactions (such as most grants and gifts) are recognized when all eligibility requirements are fulfilled.

VIII.

Governments often raise significant amounts of financial resources by issuing long-term bonds. A. In government-wide financial statements, the debt is a liability that appears on the Statement of Net Position. B. In fund financial statements for the governmental funds, the inflow of financial resources is reported as an ―other financing source.‖ Eventual payment of the debt is shown as an expenditure. Noncurrent debt balances do not appear in the fund financial statements of the governmental funds because they are not claims to current financial resources.

IX.

Monetary transfers within a government are separated into three categories for reporting purposes: intra-activity transactions, interactivity transactions, and internal exchange transactions.

Answer to Discussion Question Is it an Asset or a Liability? Even after several decades, Mautz‘s comments go straight to the problem posed by government accounting. State and local governments are just fundamentally different from for-profit businesses. Some students seem to believe that the unique features of government financial reporting are more arbitrary than substantive. To them, accounting is accounting and the specific type of reporting entity should not be an important consideration. For that reason, this discussion question is placed early in the coverage of governmental accounting to point out that governments do not necessarily view transactions in the same manner as for-profit businesses. 17-18 © McGraw Hill LLC. All rights reserved. No reproduction or distribution without the prior written consent of McGraw Hill LLC.

Chapter 17 – Accounting for State and Local Governments (Part Two) – Hoyle, Schaefer, Doupnik, Advanced Accounting, 15e

Mautz‘s discussion of the construction of a new high school building is an excellent example of the accounting problems created by a government‘s unique perspective. The decision to build this facility virtually assures the government that it will incur significant cash outflows for years to come. In contrast, a business constructs a building in hopes of generating significant net cash inflows. Government officials are aware that the costs of maintenance, heating, etc. of the school will far outweigh any direct cash inflows. Hence, Mautz‘s question—is it an asset or a liability—is not easy to answer. Governmental accounting now addresses this quandary in a unique way. In fund financial statements, the government reports construction costs as expenditures that can be compared to budgeted appropriations. In government-wide financial statements, the government reports the cost of the high school as a capital asset. The reduction in current financial resources is the focus of one statement whereas the cost of construction is reported as an asset in the other set of statements. Prior to class discussion, the teacher can ask the students to read Mautz‘s entire article as additional background information. In class, students can be encouraged to discuss whether showing this high school building in two such different ways is misleading or actually provides the information needed by all parties. What are the benefits of having two completely different sets of financial statements? What are the problems of having two completely different sets of financial statements? A quality, in-depth discussion can certainly result from Mautz‘s article. Answers to Questions 1. Individuals and groups who seek information about a state or local government have needs that are often complex and contradictory. Specific procedures in the governmental reporting process are an outgrowth of those needs. GASB identifies three primary user groups: citizenry, legislative and oversight bodies, and investors and creditors. The needs of these users are broad and no single set of financial statements and accounting principles can meet all expectations. Satisfying diverse user needs is a constant focus (and challenge) of state and local governmental accounting. This need has led to the dual-perspective model which results in the production of two distinct types of financial statements. 2. Accountability and control have been a constant goal of governmental accounting over the decades. Governmental accounting provides the citizenry of a democracy with a method for evaluating the essential government activities of raising and allocating resources. Elected and appointed officials have authority over the public‘s money. Citizens should hold them accountable for first generating and then using those resources wisely in meeting the public‘s needs. Control is necessary to prevent waste and theft. A government should structure its accounting system to help citizens evaluate officials based on the honesty, wisdom, and stewardship of their actions. 3. The traditional approach of government accounting places its priority on individual accountability for the various separate government activities. Unfortunately, the resulting information has not necessarily met all user needs (especially the needs of bond investors who want to know whether a government will be able to repay its debts). Today, government reporting still focuses on current financial resources in the fund financial statements (for the governmental funds), but also provides extensive additional data about all assets and all liabilities in government-wide financial statements. Thus, in the present system, financial reporting is able to meet a broader range of user needs. 4. Two financial statements make up the government-wide financial statements: The (a) Statement of Net Position and the (b) Statement of Activities. In contrast, there are a number 17-19 © McGraw Hill LLC. All rights reserved. No reproduction or distribution without the prior written consent of McGraw Hill LLC.

Chapter 17 – Accounting for State and Local Governments (Part Two) – Hoyle, Schaefer, Doupnik, Advanced Accounting, 15e

of fund financial statements. The two fundamental fund financial statements covered in the current chapter are the Balance Sheet for the governmental funds and the Statement of Revenues, Expenditures, and Other Changes in Fund Balances for the governmental funds. The next chapter introduces additional fund financial statements. 5. In fund accounting, governmental funds use the current financial resources measurement focus and the modified accrual basis for the timing of revenue and expense recognition. Current financial resources include assets such as cash, receivables, and investments that can enable spending. Reported liabilities are claims to those current resources. These statements also report some deferred outflows of resources and deferred inflows of resources. The modified accrual basis recognizes revenues when they become available and measurable. Expenditures are recorded when they create a reduction in current financial resources. Governments must disclose the length of time used to determine availability. A period of 60 days is common although not required except for property tax revenues. Proprietary and fiduciary funds generally use the economic resources measurement focus and the accrual basis for the timing of revenue and expense recognition. The economic resources measurement focus reports all assets (including capital and other noncurrent assets) as well as all liabilities (including long-term obligations). Deferred outflows of resources and deferred inflows of resources also might require recognition. 6. Government-wide financial statements use the economic resources measurement focus and accrual accounting for the timing of revenue and expense recognition. The accounting is very similar to that of for-profit organizations. 7. Current financial resources are primarily cash, investments, and receivables because the government can quickly turn them into cash for spending purposes. These resources are available to meet the current period spending needs of the governmental funds. 8. Under the current financial resources focus, a government recognizes liabilities when there is a claim against current financial resources. That normally means the government owes a debt and will make a payment during the current period or a short time into the subsequent period. Disclosure is required for the number of days applied for that time extension. Often, 60 days is used, a time period that is mandated for property taxes. 9. Governmental Funds: Account for activities with a service orientation a. General Fund b. Special Revenue Fund c. Capital Projects Fund d. Debt Service Fund e. Permanent Fund Proprietary Funds: Account for functions that are financed (at least in part) by user charges. a. Enterprise Fund b. Internal Service Fund Fiduciary Funds: Account for monies held by the government in a trustee capacity. a. Investment Trust Fund b. Private-Purpose Trust Fund c. Pension Trust Fund d. Custodial Fund 17-20 © McGraw Hill LLC. All rights reserved. No reproduction or distribution without the prior written consent of McGraw Hill LLC.

Chapter 17 – Accounting for State and Local Governments (Part Two) – Hoyle, Schaefer, Doupnik, Advanced Accounting, 15e

10. The following fund types fall within the governmental funds classification: a. The General Fund accounts for ongoing activities such as public safety and sanitation. More specifically, the General Fund records any activities that do not fall under one of the other fund types. b. Special Revenue Funds account for financial resources that have been restricted as to expenditure for a specified operating purpose (other than debt service and capital asset construction or acquisition). This money often comes from sources such as grants, taxes, and gifts. c. Capital Projects Funds account for monies (and their eventual expenditure) that have been designated (either externally or internally) for the acquisition or construction of government facilities or other capital assets. d. Debt Service Funds account for the accumulation of resources the government will use to pay the principal and interest of long-term debts incurred by the service activities. e. Permanent Funds account for assets conveyed to a government with the stipulation that the principal cannot be spent but any income should be used by the government, often for a designated purpose. 11. The following fund types fall within the proprietary funds classification: a. An Enterprise Fund accounts for any governmental activity that is open to the public and financed in whole or in part by user charges, such as a subway system or a toll road. b. An Internal Service Fund is used to record any activity that provides service to other departments or agencies within the government on a cost-reimbursement basis. A motor pool, a centralized computer operation, or a print shop are examples of Internal Service Funds assuming that a user fee is charged and the activity only exists to serve other functions of government. 12. Fiduciary Funds: Account for monies held by the government in a trustee capacity. a. Investment Trust Fund. Accounts for the outside portion of investment pools where the reporting government has accepted funds from other governments resulting in a larger investment and hopefully a higher return. b. Private-Purpose Trust Fund. Accounts for money held in a trustee capacity, for example, unclaimed property, specifically designated external parties, or money confiscated from illegal operations. c. Pension Trust Fund. Accounts for the employee retirement system. d. Custodial Fund. Accounts for resources held by the government as an agent for individuals, private organizations, or other government units. 13. In government-wide financial statements, financial figures appear as either (a) governmental activities or (b) business-type activities. All governmental funds and most internal service funds are included within the governmental activities. The government combines all enterprise funds and any remaining internal service funds to form the business-type activities. Internal service funds are viewed as governmental activities or business-type activities based on the funds that they primarily service. Fiduciary funds do not appear in government-wide financial statements because those resources are not available in any way to government officials. 14. In fund financial statements, for governmental funds, a government creates a separate column for (a) the General Fund, (b) any other fund that qualifies as major, and (c) all remaining funds accumulated as a whole.

Chapter 17 – Accounting for State and Local Governments (Part Two) – Hoyle, Schaefer, Doupnik, Advanced Accounting, 15e

15. Fund balance—nonspendable – provides the balance for all current financial resources that cannot be spent by government officials. Prepaid items and supplies, for example, cannot be spent by their very nature. Resources conveyed to a government where only subsequent income can be spent also fall into this category. ---Fund balance—restricted – provides the balance for all current financial resources that must be used in a designated fashion as specified by a party outside the government. Amounts usually come from gifts or grants from other organizations, charities, or governments. ---Fund balance—committed – provides the balance for all current financial resources that must be used in a designated fashion as specified by the highest level of decision-making authority within the government. --Fund balance—assigned – provides the balance for all current financial resources that must be used in a designated fashion as specified by individuals within the government but who do not possess the highest level of decision-making authority. --Fund balance—unassigned – provides the balance for all current financial resources that have not been designated in some fashion. Government officials are free to use these assets as they see fit. 16. The physical recording of a budget discloses government policies and financial intent, providing a financial plan for the period. The budget establishes spending limitations, which enhances financial planning and control. Adoption of a budget for each activity anticipates the inflow of financing resources and sets approved expenditure levels. Subsequently, interested parties can draw comparisons between actual and budgeted figures at any time during the fiscal period to enable evaluation of the performance of the government. The governing body can approve subsequent amendments as amounts available and government needs change. 17. Comparisons between the original budget, the final budget (as amended), and actual figures are reported in the required supplemental information presented after the notes to the financial information in the comprehensive annual financial report. Alternatively, the government can present the information as a separate statement within the government‘s fund financial statements. 18. An encumbrance is the recording of a purchase commitment (such as a contract or a purchase order). The government records an encumbrance entry at the time a commitment is made. This recording shows the spending control emphasis of the fund financial statements. At any point in time, summation of the Expenditures and the Encumbrances provides the total amount of current financial resources spent and committed to date. Thus, chances decrease that the government will over commit its resources. The government removes the encumbrance when this commitment becomes a legal liability. Until then, no transaction has taken place, so encumbrances are not included in government-wide financial statements. 19. Expenditures include outflows or reductions of net current financial resources from the acquisition of goods or services (or the payment of a noncurrent liability). Modified accrual accounting recognizes these expenditures when a claim against current financial resources is incurred that will be paid from resources that are available. Fund accounting for the governmental funds records expenditures instead of both expenses and capital assets as a way of disclosing the use made of a fund‘s financial resources during the current period. 20. Modified accrual accounting recognizes expenditures when a claim against the current financial resources is incurred that will be paid from financial resources that are available. Governments must disclose the length of time (often 60 days) used to determine availability.

Chapter 17 – Accounting for State and Local Governments (Part Two) – Hoyle, Schaefer, Doupnik, Advanced Accounting, 15e

21. Within the governmental funds, fund financial statements focus on expenditures rather than expenses or capital assets. Expenditures should be recorded when the related liability is incurred. Therefore, the government records the entire cost of capital assets as an expenditure when the liability is incurred. Government-wide financial statements record capital assets in a manner similar to that in the reporting of for-profit organizations. The government capitalizes the cost of buildings, machines, and other capital assets and depreciates the cost as an expense over their useful lives. 22. Governments can use the purchases method to report prepaid items and supplies. The government records cost as an expenditure when it incurs the liability. The government inserts any assets that remain at the end of the period into the records along with an offsetting increase to ―Fund Balance-Nonspendable.‖ Another method that GASB allows for reporting these items is the consumption method. It is similar to the approach used by for-profit organizations and is used in the government-wide financial statements and by the proprietary and fiduciary funds. The government records supplies and prepayments as assets when acquired even though they are not current financial resources. As consumed, the cost is reclassified as an expenditure. At the end of the period, an amount equal to the remaining assets is reclassified from fund balance-unassigned to fund balance—nonspendable. On fund financial statements for the governmental funds, a government can use either the purchases method or the consumption method. 23. GASB lists four classifications of nonexchange revenues that a state or local government can report: a. Derived tax revenues. An underlying exchange takes place and a tax assessment is levied. The government records revenue at the time of the underlying event. For example, a government recognizes revenues for a sales tax when a sale occurs and the tax is imposed. b. Imposed nonexchange revenues. The government imposes an assessment but no underlying transaction takes place. Examples include property taxes and fines or penalties. The government recognizes revenues in the period when resources are required to be used or in the first period in which use is permitted. c. Government-mandated nonexchange transactions. Monies are provided from one government to another to help pay for legally required programs or actions. Examples include grants from the federal government to a city that must be used to help achieve a mandated legal requirement such as an improvement in the school system. Revenues are recognized when all eligibility requirements have been met. d. Voluntary nonexchange transactions. Monies conveyed willingly to a state or local government by an individual, another government, or an organization usually for a specific purpose but without legally mandated requirements. Revenues are recognized when all eligibility requirements have been met. An example would be money donated to the city for the beautification of the local parks. 24. A receivable is not recorded for property taxes until the demand for money represents an enforceable legal claim, which is normally specified by state or local laws. Many governments encourage early payment of property taxes (by sending out bills early or by giving some type of a cash discount). Thus, cash can actually be reported before the government even records 17-23 © McGraw Hill LLC. All rights reserved. No reproduction or distribution without the prior written consent of McGraw Hill LLC.

Chapter 17 – Accounting for State and Local Governments (Part Two) – Hoyle, Schaefer, Doupnik, Advanced Accounting, 15e

the initial receivable. Revenue from the property tax is reported net of estimated uncollectible amounts in the period in which the money is supposed to be used or the first period in which it can be used. For example, property taxes assessed to finance the government's costs in 2024 should be reported as revenue in 2024. Because the receivable and the revenue recognition are split, it is possible to record the receivable (or cash, if collected early) before the revenue. In that case, an unavailable property tax account is established which is eventually reclassified when revenue recognition is appropriate. This is not a liability (the money will not have to be repaid) so it is reported as a deferred inflow of resources. 25. No revenues are recognized in either set of financial statements because the proceeds of bonds must be repaid. In fund financial statements, Cash is increased along with an ―Other Financing Sources‖ figure. For example, if the bonds were issued for a construction project, this entry is likely to be recorded in a Capital Projects Fund. Payments of both interest and debt are then recorded when they become a claim on current financial resources. An Expenditure account is recognized for the debt and for the related interest and is usually shown in the Debt Service Fund. In government-wide financial statements, the cash and debt are both increased when issued and the subsequent payment of debt and interest is reported in a manner similar to that of a for-profit enterprise. 26. A special assessment project is an improvement made to property by a government, which is paid for (in part or in whole) by the owners of the property being benefited. Adding curbing and sidewalks to a local street is an example of a special assessment if the residents of that street are required to pay a portion of the cost. Typically, the government places a lien on the property to insure payment. Accounting for special assessment projects depends on the level of liability accepted by the government. If the government is in no way liable for the work done and any debt that is incurred, a Custodial Fund is used to record the monetary inflows and outflows. The government is simply serving as a conduit to get the project completed and the debt paid. If the government is responsible (even secondarily responsible) for the cost of the project, a more elaborate method of accounting is necessary. In the government-wide financial statements, both the debt and the infrastructure asset are recorded. Amounts are assessed, reported as revenues, collected, and used to pay the debt. Even if the government has liability, the infrastructure asset and long-term debt are not recorded in the fund financial statements. Instead, expenditures for the work are recorded in a Capital Projects Fund while cash collected from citizens is recorded as revenue and accumulated in a Debt Service Fund to pay off any amount borrowed to finance the work. 27. In fund financial statements, interfund transactions are recorded in both funds simultaneously at the time of authorization. For example, monetary transfers from the General Fund to another fund such as the Debt Service Fund are recorded in both funds. The recipient records this transfer as an ―Other Financing Source‖ and the party making the

Chapter 17 – Accounting for State and Local Governments (Part Two) – Hoyle, Schaefer, Doupnik, Advanced Accounting, 15e

transfer records an ―Other Financing Use.‖ These balances both appear in the statement of revenues, expenditures, and other changes in fund balance but are not offset in arriving at totals for the government. If the transfer is being made to a proprietary fund, it is shown in the statement of revenues, expenses, and other changes in net position for that fund usually as a ―capital contribution‖ or as a ―transfer in.‖ 28. Intra-activity transactions occur totally within the governmental activities or totally within the business-type activities so that no net effect is created for that group of funds. Therefore, these transfers do not appear in the reporting of government-wide financial statements. Interactivity transactions occur between a governmental activity and a business-type activity so that they affect the balances in each. Consequently, the impact of these transactions is reported in both columns on the government-wide financial statements but are then offset so that no figure is reported in the total column. 29. An internal exchange transaction is a transfer within the government that is recorded as if the transaction had actually occurred with an outside party. Such transactions occur between one of the government activities and an internal service or enterprise fund and are paid for work or services rendered. These exchanges are reported as revenues and as either expenditures or expenses. An example would be a payment from a police department to the city‘s motor pool for vehicle maintenance. This exchange is included by both departments in the fund financial statements as if it were a transaction with an outside party. On government-wide financial statements, any such transactions between a governmental fund and a related internal service fund is considered an intra-activity transaction because both fund types are classified as governmental activities and, therefore, there is no effect on overall figures.

Chapter 17 – Accounting for State and Local Governments (Part Two) – Hoyle, Schaefer, Doupnik, Advanced Accounting, 15e

Answers to Problems

B (Internal service fund is a proprietary fund)

A (The term ―interperiod equity‖ refers to incurring a cost in one period that is paid for in a later period.)

D (Capital assets are not reported as assets in the fund financial statements of the governmental funds. Only current financial resources as well as prepaid items and supplies are reported as assets in this set of financial statements.)

10.

B (Because the assistant treasurer was not the highest level of decisionmaking authority, his decision to use the money in this way was indicated by showing a Fund Balance-Assigned. The city council is the highest level of authority. Therefore, council‘s designation switches the fund balance amount from assigned to committed.

11.

C (When the budget is passed, Estimated Revenue is debited and the Appropriations account is credited. That entry is reversed off the records at the end of the year.)

12.

B (As a governmental fund, the General Fund records expenditures rather than expenses.)

13.

C (The claim on current financial resources [the expenditure] is actually $3,020.)

14.

15.

B (Depreciation is an expense and not a reduction in current financial resources. Therefore, it is not recorded in the fund financial statements for the governmental funds.)

16.

C (Under the consumption method, the inventory is recorded when acquired 17-26 © McGraw Hill LLC. All rights reserved. No reproduction or distribution without the prior written consent of McGraw Hill LLC.

Chapter 17 – Accounting for State and Local Governments (Part Two) – Hoyle, Schaefer, Doupnik, Advanced Accounting, 15e

and then reclassified as an expenditure as consumed.) 17.

18.

C (A law was passed and then a government provided money to meet the requirements of that law. That is a government-mandated nonexchange revenue.)

19.

C (Because of the reimbursement clause, the grant is actually earned by making appropriate expenditures.)

20.

B (This is not a long-term liability and is, therefore, reported the same in the fund financial statements as in the government-wide financial statements.)

21.

22.

C (Debt issuance costs are not capitalized in state and local government accounting; thus, for government-wide financial statements, the amount is expensed.)

23.

C (Any loss on the refunding of a debt is reported as a deferred outflow of resources and amortized over time.)

24.

C (As a noncurrent liability, the balance is not reported in the fund financial statements.)

25.

D (Because the city has a liability in connection with this project, all amounts must be recorded as with normal governmental fund transactions.)

26.

27.

D (The transfer here is between a Government Activity and a Business-Type Activity.)

28.

A (The transfer occurred entirely within the Government Activities and created no net impact on the total amounts reported.)

29.

30.

D (This transaction was the same as might have occurred with an outside party and is accounted for in the same manner.)

31.

C (This transaction was the same as might have occurred with an outside party and is accounted for in the same manner.)

32.

(5 Minutes) (Budgetary entries) Beginning of Year-Recording of budget GENERAL FUND 17-27 © McGraw Hill LLC. All rights reserved. No reproduction or distribution without the prior written consent of McGraw Hill LLC.

Chapter 17 – Accounting for State and Local Governments (Part Two) – Hoyle, Schaefer, Doupnik, Advanced Accounting, 15e

Estimated Revenues ....................................................... 1,000,000 Estimated Other Financing Sources—Bond Proceeds 400,000 Appropriations Control............................................. Appropriations-Other Financing Uses—Operating Transfers Out............................................................. Budgetary Fund Balance .......................................... End of Year-Removal of budget GENERAL FUND Appropriations .............................................................. 900,000 Appropriations-Other Financing Uses—Operating Transfers Out................................................................. 300,000 Budgetary Fund Balance .............................................. 200,000 Estimated Revenues ........................................... Estimated Other Financing Sources—Bond Proceeds............................................................... 33.

900,000 300,000 200,000

1,000,000 400,000

(8 Minutes) (Order of a capital asset and subsequent receipt) GOVERNMENT-WIDE FINANCIAL STATEMENTS GOVERNMENTAL ACTIVITIES Computer Vouchers (or Accounts) Payable Vouchers (or Accounts) Payable Cash

89,400 89,400 89,400 89,400

As a result of the purchase and payment, capital assets have gone up by the cost of the computer and cash has been reduced by the same amount. FUND FINANCIAL STATEMENTS GENERAL FUND Encumbrances – Computer Encumbrances Outstanding

88,000 88,000

Encumbrances Outstanding Encumbrances – Computer

88,000

Expenditures – Computer Vouchers Payable

89,400

Vouchers Payable Cash

89,400

88,000 89,400 89,400

On the statement of revenues, expenditures, and other changes in fund balance, an expenditure of $89,400 will be shown. Cash will also decrease by 17-28 © McGraw Hill LLC. All rights reserved. No reproduction or distribution without the prior written consent of McGraw Hill LLC.

Chapter 17 – Accounting for State and Local Governments (Part Two) – Hoyle, Schaefer, Doupnik, Advanced Accounting, 15e

that amount. 34.

(10 Minutes) (Issuance of bond to finance construction project) GOVERNMENT-WIDE FINANCIAL STATEMENTS GOVERNMENTAL ACTIVITIES (Intra-activity transfer from the General Fund to the Capital Projects Fund is not reported because Governmental Activities totals are not affected.) Issuance of Bonds Cash Bonds Payable

1,800,000

Completion of Construction Buildings Cash

1,890,000

1,800,000

1,890,000

On the statement of net position, for the governmental activities, the Buildings account goes up by $1,890,000, Bonds Payable go up by $1.8 million, and cash goes down by $90,000. FUND FINANCIAL STATEMENTS To Record Transfer GENERAL FUND Other Financing Uses—Transfers Out Cash

90,000 90,000

CAPITAL PROJECTS FUND Cash Other Financing Sources—Transfers In

90,000

Sale of Bonds Cash Other Financing Sources—Bond Proceeds

1,800,000

Completion of Construction Expenditures Cash

1,890,000

90,000

1,800,000

1,890,000

On the statement of revenues, expenditures, and other changes in fund balances-governmental funds, the General Fund reports an other financing uses – transfers out of $90,000. On its balance sheet, it reports $90,000 less cash. For the capital projects fund, there is an expenditure of $1,890,000 and two other financing sources: $90,000 as a transfer-in and $1.8 million from bond proceeds.

Chapter 17 – Accounting for State and Local Governments (Part Two) – Hoyle, Schaefer, Doupnik, Advanced Accounting, 15e

35.

(12 Minutes) (Reporting of fund balance amounts) Fund Balance—Nonspendable ---Prepaid items $ 7,000 ---Supplies 5,000

$ 12,000

Fund Balance—Restricted ---Cash from bond issuance ---Investments donated by citizen ---State grant for kindergarten teachers

166,000

$80,000 33,000 53,000

Fund Balance—Committed ---Cash to be used for renovation

62,000

Fund Balance—Assigned ---Cash to upgrade roads

40,000

Fund Balance—Unassigned

25,000

Total Fund Balance

$305,000

The Fund Balance—Unassigned amount ($25,000) was determined by taking the net current financial resources of the governmental funds ($445,000 less $140,000 or $305,000) and then subtracting the fund balance amounts that were nonspendable, restricted, committed, and assigned. 36.

(8 Minutes) (Reporting of commitments)

In the government-wide financial statements, the commitment for this computer will not be formally reported because no liability has yet been incurred. A disclosure note is likely to allow readers of the statements to understand that these funds have been committed. In the fund financial statements, a $6,400 balance will be shown as a Fund BalanceCommitted. This will enable readers to see that this portion of the governmental fund‘s current financial resources have to be used to satisfy this obligation when incurred. This recognition reduces the amount otherwise labeled as Fund BalanceUnassigned. 37.

(20 Minutes) (Recording of basic journal entries) FUND FINANCIAL STATEMENTS

a. General Fund Estimated Revenues Estimated Other Financing Sources Budgetary Fund Balance Appropriations

Chapter 17 – Accounting for State and Local Governments (Part Two) – Hoyle, Schaefer, Doupnik, Advanced Accounting, 15e

b. Capital Projects Fund (could also be recorded initially in the General Fund with a subsequent transfer to the Capital Projects Fund) Cash Other Financing Sources—Bond Proceeds c. General Fund Encumbrances - Computer Encumbrances Outstanding d. General Fund Encumbrances Outstanding Encumbrances - Computer Expenditures - Computer Vouchers Payable e. General Fund Vouchers Payable Cash f. General Fund Other Financing Uses—Transfers Out—Capital Projects Due to Capital Projects Fund (Special Assessment) Capital Projects Fund Due from General Fund Other Financing Sources—Transfers In—General Fund g. General Fund Other Financing Uses—Transfers Out—Motor Pool Cash Internal Service Fund Cash Contributed Capital h. General Fund Property Taxes Receivable Revenues—Property Taxes Allowance for Uncollectible Taxes i. Special Revenue Fund Cash Grant Revenue Collected in Advance j. Special Revenue Fund Expenditures—Salaries Cash Grant Revenue Collected in Advance Revenues—Grant 17-31 © McGraw Hill LLC. All rights reserved. No reproduction or distribution without the prior written consent of McGraw Hill LLC.

Chapter 17 – Accounting for State and Local Governments (Part Two) – Hoyle, Schaefer, Doupnik, Advanced Accounting, 15e

GOVERNMENT-WIDE FINANCIAL STATEMENTS a. No entry b. Governmental Activities Cash Bonds Payable c. No entry d. Governmental Activities Equipment Vouchers Payable e. Governmental Activities Vouchers Payable Cash f. No entry (it is an intra-activity transfer within the governmental activities) g. No entry (assuming the internal service fund is treated as a governmental activity so that this is an intra-activity transaction) h. Governmental Activities Property Taxes Receivable Revenues—Property Taxes Allowance for Uncollectible Taxes i. Governmental Activities Cash Grant Revenue Collected in Advance j. Governmental Activities Expense—Public Safety Cash Grant Revenue Collected in Advance Revenue 38.

(17 Minutes) (Recording of basic journal entries) FUND FINANCIAL STATEMENTS a. General Fund Encumbrances - Truck Encumbrances Outstanding b. General Fund Expenditures (or Supplies)

94,000 94,000 1,200

Chapter 17 – Accounting for State and Local Governments (Part Two) – Hoyle, Schaefer, Doupnik, Advanced Accounting, 15e

Due to Internal Service Fund

1,200

c. Capital Projects Fund Cash 11,000,000 Other Financing Sources—Bonds Proceeds d. General Fund Other Financing Uses—Transfers Out— Swimming Pool Cash e. General Fund Encumbrances Outstanding Encumbrances - Truck

11,000,000

140,000 140,000 94,000 94,000

Expenditures - Truck Vouchers Payable

96,000 96,000

f. General Fund Other Financing Uses—Transfers Out Cash Capital Projects Fund Cash Other Financing Sources—Transfers In

32,000 32,000 32,000 32,000

g. Special Revenue Fund Cash Unearned Grant Revenue

30,000

h. Special Revenue Fund Unearned Grant Revenue Revenues

5,000

30,000

5,000

Expenditures Cash

5,000 5,000

GOVERNMENT-WIDE FINANCIAL STATEMENTS a. No entry b. No entry (Assuming print shop is a governmental activity.) c. Governmental Activities Cash Bonds Payable

11,000,000 11,000,000

Chapter 17 – Accounting for State and Local Governments (Part Two) – Hoyle, Schaefer, Doupnik, Advanced Accounting, 15e

d. Governmental Activities Transfers Out—Swimming Pool Cash

140,000

Business Type Activities Cash Transfers In—General Fund

140,000

e. Governmental Activities Equipment—Trucks Vouchers or Accounts Payable

96,000

140,000

96,000

f. No entry – intra-activity transfer g. Governmental Activities Cash Unearned Grant Revenue

30,000

h. Governmental Activities Expense—Public Service Cash

5,000

30,000

5,000

Unearned Grant Revenue Revenues 39.

5,000 5,000

(15 Minutes) (Prepare basic journal entries) FUND FINANCIAL STATEMENTS

a. Capital Projects Fund (could also be recorded in the General Fund followed by a transfer into the Capital Projects Fund) Cash 900,000 Other Financing Sources—Bonds Proceeds 900,000 b. Capital Projects Fund Encumbrances - Warehouse Encumbrances Outstanding c. General Fund Other Financing Uses—Transfers Out Cash Debt Service Fund Cash Other Financing Sources—Transfers In d. General Fund Encumbrances Outstanding

1,100,000 1,100,000 130,000 130,000 130,000 130,000 11,800

Chapter 17 – Accounting for State and Local Governments (Part Two) – Hoyle, Schaefer, Doupnik, Advanced Accounting, 15e

Encumbrances - Equipment Expenditures —Machinery and Equipment Vouchers Payable

11,800 12,000 12,000

e. General Fund Inventory of Supplies Cash

2,000

f. Special Revenue Fund Grant Receivable Unavailable Grant Revenue

90,000

2,000

g. General Fund Taxes Receivable Revenues – Property Taxes Allowance for Uncollectible Current Taxes

90,000 600,000 576,000 24,000

GOVERNMENT-WIDE FINANCIAL STATEMENTS

a. Governmental Activities Cash Bonds Payable

900,000 900,000

b. No entry (commitments are not recorded) c. No entry (this is an intra-activity transfer) d. Governmental Activities Machinery and Equipment Vouchers or Accounts Payable

12,000

e. Governmental Activities Inventory of Supplies Cash

2,000

f. Governmental Activities Grant Receivable Unearned Grant Revenue

90,000

2,000

90,000

g. Governmental Activities Taxes Receivable Revenues – Property Taxes Allowance for Uncollectible Current Taxes 40.

12,000

600,000 576,000 24,000

(25 Minutes) (Answer questions about ledger account balances)

Chapter 17 – Accounting for State and Local Governments (Part Two) – Hoyle, Schaefer, Doupnik, Advanced Accounting, 15e

a. As the Appropriations account balance in the General Fund shows a total of $171,000, that amount of money has been authorized for expenditure during this fiscal period. Thus, only that total can be expended or committed. To date, a total of $119,000 has been spent or committed ($110,000 of expenditures and $9,000 in encumbrances). The remaining $52,000 is still available. Of course, if the budget is amended, additional amounts could be spent. b. The governmental funds are all designed to monitor current financial resources and their inflows and outflows. Therefore, the Capital Projects Fund records expenditures made to acquire or construct capital assets and the sources of that money. The purpose of that fund is not to record the asset itself. Consequently, these assets are reported in the government-wide financial statements but not in the fund statements created for the governmental funds. c. The Appropriations balance represents the amount that government officials have authorized to be spent on a particular construction project. The amount was established by the passage of a formal budget. d. At the end of the year, any remaining commitments will be removed from the accounting records by reversing the original encumbrance entry (which eliminates both the encumbrance and the encumbrance outstanding). The government might agree to pay for these commitments even though they did not arrive until the following fiscal year. If so, in creating a balance sheet for the governmental funds, this amount is shown as a fund balance restricted, committed, or assigned, depending on who made the decision to spend the resources in this manner. e. Money is not recorded in any of the governmental funds (except for the General Fund) without some explicit reason. It comes from a tax, perhaps, or a gift or grant. These amounts are only put into these funds because each has a particular purpose. Thus, a fund balance-unassigned is not possible in any fund other than the General Fund. The asset could simply not be in another fund unless some designation (either externally or internally) had been made. Whether the fund balance is restricted, committed, or assigned depends on the party that made the decision to spend the money in this particular way. f. Two reasons are most likely for the $150,000 Other Financing Sources balance. First, a bond may have been issued to finance the construction project. Because the debt itself is not recorded in the fund financial statements, the governmental fund must record the receipt by means of an Other Financing Sources designation. 17-36 © McGraw Hill LLC. All rights reserved. No reproduction or distribution without the prior written consent of McGraw Hill LLC.

Chapter 17 – Accounting for State and Local Governments (Part Two) – Hoyle, Schaefer, Doupnik, Advanced Accounting, 15e

Second, the $150,000 may have come from a transfer (most likely from the General Fund). Such transfers are not considered revenue by the recipient and, therefore, the inflow of current financial resources is recorded as an Other Financing Source. g. The Debt Service Fund is utilized to accumulate money to pay off the principal and interest of any long-term liability incurred by the governmental funds. Payment of both debt and interest is made from the Debt Service Fund and those payments are recorded as expenditures. Noncurrent debt is not maintained in the fund financial statements but does appear in the government-wide financial statements. h. Special assessment projects are undertaken by a government to benefit particular properties with the owners bearing part (or all) of the cost. Curbing, as an example, or the installation of lights can be special assessment projects. If the government has no responsibility for costs, recording of all financial resources inflows and outflows is made in a Custodial Fund. However, if the government does maintain some responsibility (if, for example, the government is secondarily liable for debts incurred), the construction is recorded in a Capital Projects Fund. Thus, the receivable balance shown here would indicate that this project is being recorded in this manner. Collection of the receivable will be made from the citizens being benefited. The money will be used in paying for the construction. i. This designation indicates that the government is reporting one or more assets that are not free to be spent for future expenditures. In the asset section of the trial balance, a $4,000 figure is included as the government‘s Inventory of Supplies. That amount is reported but is not available to be spent. Thus, an equal portion of the fund balance is shown as nonspendable. j. Budgetary entries are optional for Debt Service Funds and are not typically used. Expenditure levels (for principal and interest) are set contractually by the debt indenture. Thus, additional financial control is not obtained by the inclusion of budgetary amounts. 41.

(25 Minutes) (Analyzing and reporting government transactions for fund financial statements) a. Estimated Revenues Appropriations Budgetary Fund Balance

$232,000 225,000 $ 7,000

Because estimated revenues exceed the appropriations, a surplus is anticipated which is mirrored through a credit balance in the Budgetary 17-37 © McGraw Hill LLC. All rights reserved. No reproduction or distribution without the prior written consent of McGraw Hill LLC.

Chapter 17 – Accounting for State and Local Governments (Part Two) – Hoyle, Schaefer, Doupnik, Advanced Accounting, 15e

Fund Balance account. The government expects the size of the fund to grow by that much over the course of the year. b. Initially, under the consumption method, all of the school supplies are recorded in an asset account such as ―Inventory of Supplies.‖ As the supplies are used, the cost is reclassified into an Expenditures account. On the balance sheet, a portion of the Fund Balance-Unassigned is separated and reported as nonspendable to show that this amount of the reported assets does not represent current financial resources that can be spent by government officials. c. At the end of the year, both the encumbrance balance and the encumbrance outstanding are removed from the financial records. They do not represent actual transactions. In creating a balance sheet for the governmental funds, if this amount has already been set up as a fund balance restricted, committed, or assigned, no further action is needed. This shows that this money cannot be freely spent but must be held to meet the financial commitment. However, if no amount has been disclosed in the fund balance, then the expected monetary amount to be paid should be reclassified from fund balance-unassigned to either fund balance-committed or fund balanceassigned depending on the level of authority that made the commitment. A fund balance-restricted designation cannot be established internally. d. FUND FINANCIAL STATEMENTS General Fund Encumbrances Outstanding

111,000

Encumbrances - Ambulance Expenditures - Ambulance

111,000 120,000

Vouchers Payable

120,000

e. General Fund Other Financing Uses—Transfers Out Cash Debt Service Fund Cash Other Financing Sources—Transfers In f. REVENUES: Government grant appropriately expended Property taxes to be received Business licenses and parking meters Total revenues

33,000 33,000 33,000 33,000 $ 24,000 190,000 14,000 $228,000

Chapter 17 – Accounting for State and Local Governments (Part Two) – Hoyle, Schaefer, Doupnik, Advanced Accounting, 15e

Salary for police officers Rent on equipment (assuming payments are from current financial resources) City hall acquisition Salary for ambulance drivers Supplies (60% of $16,000) Ambulance acquisition School bus acquisition Total expenditures

$ 21,000 3,000 1,044,000 24,000 9,600 120,000 40,000 $1,261,600

h. FUND FINANCIAL STATEMENTS Capital Projects Fund (or this entry could be recorded in the General Fund with the money then transferred to the Capital Projects Fund) Cash 300,000 Other Financing Sources – Transfers Out 300,000 42.

(22 Minutes) (Prepare basic journal entries for both fund financial statements and government-wide financial statements) FUND FINANCIAL STATEMENTS a. General Fund Estimated Revenues Appropriations Estimated Other Financing Uses— Operating Transfers Budgetary Fund Balance

834,000 540,000 242,000 52,000

b. Capital Projects Fund (encumbrances for these types of contracts are optional but are more likely to be made when budgetary entries are being used) 8,000,000 Encumbrances – Office Building 8,000,000 Encumbrances Outstanding c. Capital Projects Fund Cash 8,000,000 Other Financing Sources – Bond Proceeds

8,000,000

d. Capital Projects Fund Encumbrances Outstanding Encumbrances – Office Building

8,000,000

Expenditures Contracts Payable

8,000,000

Contracts Payable Cash

8,000,000

8,000,000 8,000,000

Chapter 17 – Accounting for State and Local Governments (Part Two) – Hoyle, Schaefer, Doupnik, Advanced Accounting, 15e

e. General Fund Other Financing Uses – Transfers Out Cash Debt Service Fund Cash Other Financing Resources – Transfers In f. Debt Service Fund Expenditures—Bonds Expenditures—Interest Cash

1,000,000 1,000,000 1,000,000 1,000,000 900,000 100,000 1,000,000

g. General Fund Property Taxes Receivable Revenues – Property Taxes Allowance for Uncollectible Taxes (4%) h. Special Revenue Fund Cash Revenues – Toll Receipts

800,000 768,000 32,000 120,000 120,000

i. Permanent Fund (when the government creates the balance sheet, a Fund Balance-Nonspendable of $300,000 must be reported because only the income can be spent.) Investments 300,000 Contribution Revenue 300,000 GOVERNMENT-WIDE FINANCIAL STATEMENTS

a. No entry (budgets are not reported) b. No entry (commitments are not reported) c. Governmental Activities Cash Bonds Payable

8,000,000

d. Governmental Activities Buildings Cash

8,000,000

e. No entry (transfer is within the governmental activities) f. Governmental Activities Bonds Payable Interest Expense

900,000 100,000 17-40

Chapter 17 – Accounting for State and Local Governments (Part Two) – Hoyle, Schaefer, Doupnik, Advanced Accounting, 15e

Cash

1,000,000

g. Governmental Activites Proprety Taxes Receivable Revenues – Property Taxes Allowance for Uncollectible Taxes

800,000 768,000 32,000

h. This entry is made in Governmental Activities unless toll road is reported as an Enterprise Fund (a business-type activity). Cash 120,000 Revenues—Reserved for Highway Maintenance i. Governmental Activities Investments Revenues—Donations 43.

120,000

300,000 300,000

(15 Minutes) (Prepare fund financial statements) CITY OF JENNINGS GENERAL FUND Statement of Revenues, Expenditures, and Other Changes in Fund Balance (Condensed) Year Ending December 31, 2024 Revenues Expenditures Excess (deficiency) of revenues over expenditures Other financing sources (uses): Bond proceeds $300,000 Transfers in 50,000 Transfers out (470,000) Total Other Financing Sources and Uses Change in Fund Balance Fund Balance, Beginning Fund Balance, Ending

$ 760,000 530,000) 230,000

(120,000) 110,000 170,000 $280,000

Chapter 17 – Accounting for State and Local Governments (Part Two) – Hoyle, Schaefer, Doupnik, Advanced Accounting, 15e

CITY OF JENNINGS GENERAL FUND Balance Sheet (condensed) December 31, 2024 Assets Cash Investments Taxes Receivable Due from Capital Projects Fund Total Assets

$ 30,000 410,000 220,000 60,000 $720,000

Liabilities Accounts Payable Vouchers Payable Contracts Payable Due to Debt Service Fund Total Liabilities

$ 90,000 180,000 90,000 40,000 $400,000

Deferred Inflows of Resources Unavailable Revenues Total Deferred Inflows of Resources

$ 40,000 $ 40,000

Fund Balances Unassigned

$280,000

Total Fund Balance

$280,000

Total Liabilities, Deferred Inflows of Resources, and Fund Balances 44.

$720,000

(40 Minutes) (Prepare government-wide and fund financial statements) The most difficult aspect of this problem is gathering the information for both the government-wide financial statements and the fund financial statements. One way to overcome this difficulty is to make journal entries for the transactions that are described in the question.

Government-wide financial statements: 1 Property Tax Receivable Cash

80,000 320,000 17-42

Chapter 17 – Accounting for State and Local Governments (Part Two) – Hoyle, Schaefer, Doupnik, Advanced Accounting, 15e

General Revenues—Property Taxes 2 Salary Expense Rent Expense Equipment Land Maintenance Expense Cash

400,000 100,000 70,000 50,000 30,000 20,000 270,000

Depreciation Expense Accumulated Depreciation—Equipment 3 Building Noncurrent Liability

10,000 10,000 200,000 200,000

Neither depreciation nor interest is recognized on these two balances because this transaction took place on the last day of the year. 4 Computers Vouchers Payable

8,000 8,000

No depreciation is recognized on the computer since this transaction occurred on the last day of the year. 5 Cash Program Revenues—Student Fees

3,000 3,000

Fund financial statements: 1 Property Tax Receivable Cash Revenues—Property Taxes Unavailable Revenues

80,000 320,000 370,000 30,000

The $30,000 is not viewed as revenue in 2024 because it will not be available within 60 days after year-end to pay claims against current financial resources. This balance is not a liability because there is no chance of repayment. Instead, it is a deferred inflow of resources. 2 Expenditures—Salaries Expenditures—Rent

100,000 70,000 17-43

Chapter 17 – Accounting for State and Local Governments (Part Two) – Hoyle, Schaefer, Doupnik, Advanced Accounting, 15e

Expenditures—Equipment Expenditures—Land Expenditures—Maintenance Cash

50,000 30,000 20,000 270,000

3 No entry is made on the building acquisition since there was no impact on current financial resources. 4 Expenditures—Computer Vouchers Payable

4,000 4,000

The second computer is not included here because payment will not be made within 60 days of the end of the year so there is no effect on current financial resources. 5 Cash Revenues—Student Fees

3,000 3,000

Part a GOVERNMENT-WIDE FINANCIAL STATEMENTS

STATEMENT OF ACTIVITIES For the Year Ended December 31, 2024

Governmental Activities: —School System

Direct Expenses

Program Revenues

$200,000

$3,000

General Revenues: —Property Taxes Change in Net Position Beginning Net Position Ending Net Position

Governmental Activities (net expense) $(197,000) 400,000 $ 203,000 0$ 203,000

STATEMENT OF NET POSITION December 31, 2024 Governmental Activities Assets —Cash —Property Tax Receivable —Computers

$ 53,000 80,000 8,000 17-44

Chapter 17 – Accounting for State and Local Governments (Part Two) – Hoyle, Schaefer, Doupnik, Advanced Accounting, 15e

—Building —Equipment Less: Accumulated Depreciation —Land Total Assets

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

40,000 30,000 $411,000

Liabilities —Vouchers Payable —Long-Term Liabilities

$ 8,000 200,000

$208,000

Net Position —Net investment in capital assets —Unrestricted

$ 78,000 125,000

$203,000

Part b -- FUND FINANCIAL STATEMENTS STATEMENT OF REVENUES, EXPENDITURES AND CHANGES IN FUND BALANCE For the Year Ended December 31, 2024 General Fund Revenues —Property Taxes —Student Fees Total Revenues

$370,000 3,000 $373,000

Expenditures —Salaries —Rent —Equipment —Land —Maintenance —Computer Total Expenditures

$100,000 70,000 50,000 30,000 20,000 4,000 $274,000 $ 99,000

Change in Fund Balance -0Fund Balance—Beginning of Year Fund Balance—End of Year

$ 99,000

BALANCE SHEET December 31, 2024 General Fund Assets —Cash —Property Tax Receivable Total Assets

$ 53,000 80,000 $133,000 17-45

Chapter 17 – Accounting for State and Local Governments (Part Two) – Hoyle, Schaefer, Doupnik, Advanced Accounting, 15e

Liabilities —Voucher Payable Deferred Inflows of Resources —Unavailable Revenues Total Deferred Inflows and Liabilities

$ 4,000 $ 30,000 $ 34,000

Fund Balance —Unassigned Total Liabilities, Deferred Inflows of Resources, and Fund Balance

45.

$ 99,000 $133,000

(25 Minutes) (Assessing the impact of various government transactions.) a. This statement is false. Internal service funds are included in governmental accounting within the proprietary funds. However, most internal service funds are reported in government-wide financial statements as governmental activities. Therefore, the proprietary funds will almost always be larger than the business-type activities.

b. This statement is false because not enough information is available to say that this fund ―must be‖ reported as a major fund. The asset balance ($32,000) for this governmental fund is larger than 10 percent of the total assets held by all governmental funds ($300,000). This is one of the criteria for being judged a major fund. (The same threshold can also be used with liabilities, revenues, or expenditures/expenses.) However, a second criterion also must be met. The asset (or other) balance ($32,000) for this fund must be at least 5 percent of the total for both the governmental funds and the enterprise funds. No separate information is provided here about the enterprise funds. Thus, there is not enough information available to make the required determination. c. This statement is false. If (a) the user charge is the sole security for debts of the bus system or (b) the activity‘s costs are required to be recovered through the fee or (c) the fee is set to recover the activity‘s costs, then reporting as an Enterprise Fund is required. Otherwise, if a user charge is present, recording as an Enterprise Fund is allowed but that classification is not required. None of the requirements are met in this case so the city has the option of recording the bus system either in an Enterprise Fund or in the General Fund. d. This statement is true. To record a budget so that the projected increase or decrease in the fund balance will be obvious (a credit shows an anticipated surplus and a debit is an anticipated deficit), estimated revenues are debited and appropriations are credited. e. This statement is false. To record a budget so that the projected increase or decrease in fund balance will be obvious (a credit is an anticipated 17-46 © McGraw Hill LLC. All rights reserved. No reproduction or distribution without the prior written consent of McGraw Hill LLC.

Chapter 17 – Accounting for State and Local Governments (Part Two) – Hoyle, Schaefer, Doupnik, Advanced Accounting, 15e

surplus and a debit is an anticipated deficit), estimated revenues are debited and appropriations are credited. Expenditures are not recorded in a budgetary entry because no reduction in current financial resources has yet occurred. f. This statement is true. In the purchases method, the total prepaid expenses or supplies acquired is recorded as an expenditure. In the consumption method, only the amount used or consumed during the period is recorded as an expenditure. Three years of insurance has been bought, but only one year has been used. The expenditure is larger for the purchases method. g. This statement is true. Income taxes and sales taxes are both derived tax revenues because the tax is assessed based on a specific event (the earning of income or the making of a sale). h. This statement is true. Accrual accounting is used for government-wide financial statements. Derived taxes (like income taxes) are recognized at the time of the underlying event (the earning of income). Therefore, the revenue is recognized in Year Five and is $98,000, the amount expected to be collected. i. This statement is false. The encumbrance (commitment) is removed and an expenditure and liability is then recognized. However, the encumbrance is removed at its original $43,000 balance before the $44,000 expenditure and liability are recorded. j. This statement is false. ―Fund balance - committed‖ is used when financial resources have been designated by the highest level of government authority. Here, the city council has that authority rather than the police chief. This amount should be recorded as a ―fund balance assigned‖ to reflect the difference in this level of authority. k. This statement is false. This is an intra-activity transaction between two governmental funds. Total balances for the governmental activities are not affected. Within the governmental funds, the inflow and outflow of the transfer cancel each other out. Therefore, no reporting is necessary. 46.

(25 Minutes) (The handling of various government transactions.) a. This statement is false. This transfer is an internal exchange transaction; it is payment for work done. Because the purchase and sale of printing services was the same as with an outside party, the transaction will be handled in that way. The school system records an expenditure rather than an other financing use. The print shop records revenue for the work done. b. This statement is false. No increase in net position is recognized in Year 17-47 © McGraw Hill LLC. All rights reserved. No reproduction or distribution without the prior written consent of McGraw Hill LLC.

Chapter 17 – Accounting for State and Local Governments (Part Two) – Hoyle, Schaefer, Doupnik, Advanced Accounting, 15e

Five because these resources come from an imposed nonexchange revenue that cannot be used until Year Six. No change in net position occurs in Year Five. c. This statement is false. No increase in fund balance is recognized in Year Five because these resources come from an imposed nonexchange revenue that cannot be used until Year Six. No change in fund balance occurs in Year Five. d. This statement is false. The $5,000 cannot be used at this time. However, revenue recognition will occur after the passage of time. The government has no reason to expect to have to repay this amount. The balance is shown as ―unavailable property tax collections‖ which is reported as a deferred inflow of resources following the liability section of the balance sheet. e. This statement is false. The $5,000,000 can never be spent so a fund balance – nonspendable figure is appropriate. Use of the $480,000 (the subsequent income) has been restricted by an outside party and is labeled as a fund balance – restricted. f. This statement is false. This grant is a government-mandated nonexchange transaction. g. This statement is false. Custodial (formerly agency) funds fall within the fiduciary funds. Fiduciary funds are not included in government-wide financial statements. h. This statement is false. All eligibility requirements have been met and the money will be received within 75 days of the end of the year. It is revenue recognized on both government-wide financial statements and fund financial statements. 47.

(25 Minutes) (Prepare a statement of revenues, expenditures, and other changes in fund balance) One way to approach this problem is to make the journal entries for the transactions that are described as the basis for gathering the information needed for the financial statement to be produced. In this problem, the journal entries are prepared based on the rules for creating fund financial statements for the General Fund. a. Cash Property Taxes Receivable Revenues—Property Taxes

700,000 100,000 750,000 17-48

Chapter 17 – Accounting for State and Local Governments (Part Two) – Hoyle, Schaefer, Doupnik, Advanced Accounting, 15e

Unavailable Property Tax Revenues

50,000

The second $50,000 to be collected is not viewed as revenue in 2024 because it will not be available within 60 days to pay claims against current financial resources.

b. Expenditures—Police Cars Cash

200,000 200,000

If previously recorded, an encumbrance would also have to be removed. However, that possible entry does not affect the statement of revenues, expenditures, and other changes in fund balance. No depreciation is recorded on the police cars because fund financial statements are being produced for the General Fund. c. Other Financing Uses—Transfers Out Cash

90,000 90,000

Because the statements being prepared here are only for the General Fund, the entry for the Debt Service Fund is not included. d. Cash 200,000 Other Financing Sources—Bond Proceeds 200,000 No interest is accrued because current financial resources will not be required in this period. Payment will not be until next June 30. e. Encumbrances—Computer Encumbrances Outstanding

40,000 40,000

f. Expenditures— Salaries Cash Salary Payable

40,000 30,000 10,000

g. Encumbrances Outstanding Encumbrances—Computer

40,000

Expenditures—Computer

41,000

40,000

Chapter 17 – Accounting for State and Local Governments (Part Two) – Hoyle, Schaefer, Doupnik, Advanced Accounting, 15e

Vouchers Payable

41,000

h. Expenditures—Supplies Cash

10,000

i. Supplies Fund Balance—Nonspendable

2,000

10,000

2,000

FUND FINANCIAL STATEMENTS

CITY OF LOST ANGELS STATEMENT OF REVENUES, EXPENDITURES AND OTHER CHANGES IN FUND BALANCE For the Year Ended December 31, 2024 General Fund Revenues —Property Taxes Total Revenues Expenditures —Police cars —Salaries —Computer —Supplies Total Expenditures Excess of revenues over expenditures Other Financing Sources (Uses) —Transfer to Debt Service Fund —Issued Long-Term Bond Net Other Financing Sources Change in Fund Balance Fund Balance—Beginning of Year Fund Balance—End of Year

48.

$750,000 $750,000 $200,000 40,000 41,000 10,000 $291,000 $459,000 $ (90,000) 200,000 $110,000 $569,000 180,000 $749,000

(25 Minutes) (Prepare a statement of net position for governmental activities) One way to approach this problem is to make the journal entries for the transactions that are described as the basis for gathering information for the financial statement to be produced. Here the journal entries are prepared based on the need to create government-wide financial statements for the General Fund (a governmental activity). a. Cash

700,000 17-50

Chapter 17 – Accounting for State and Local Governments (Part Two) – Hoyle, Schaefer, Doupnik, Advanced Accounting, 15e

100,000

Property Taxes Receivable Property Tax Revenue

800,000

b. Police Cars Cash

200,000

Depreciation Expense Accumulated Depreciation

10,000

200,000 10,000

c. The government needs no entry because no change occurs in the total net position of the governmental activities. It is an intra-activity transaction. d. Cash Bonds Payable

200,000 200,000

Interest Expense Interest Payable

10,000 10,000

Interest is accrued here based on $200,000 x 10 percent x 1/2 year. e. No entry—this is a commitment and not a transaction. f. Salary Expense Cash Salary Payable

40,000 30,000 10,000

g. Computer Vouchers Payable

41,000

Depreciation Expense Accumulated Depreciation

4,100

h. Supplies Cash

10,000

i. Supplies Expense Supplies

8,000

41,000 4,100

10,000

8,000

Chapter 17 – Accounting for State and Local Governments (Part Two) – Hoyle, Schaefer, Doupnik, Advanced Accounting, 15e

This problem indicates that the General Fund held $180,000 in cash at the start of the year. The following account balances have been determined based on the above journal entries. GOVERNMENT-WIDE FINANCIAL STATEMENTS CITY OF LOST ANGELS

STATEMENT OF NET POSITION December 31, 2024

Governmental Activities

Assets —Cash —Property Tax Receivable —Supplies —Computers Less: Accumulated Depreciation —Police Cars Less: Accumulated Depreciation Total Assets Liabilities —Vouchers Payable —Salary Payable —Interest Payable —Bonds Payable Net Position —Net investment in capital assets —Unrestricted

$ 840,000 100,000 2,000 $ 41,000 (4,100) 200,000 (10,000)

36,900 190,000 $1,168,900

$ 41,000 10,000 10,000 200,000

261,000

$226,900 681,000

$ 907,900

The total net position figure of $907,900 can also be found by taking the opening balance of $180,000 and then adding the revenues for the period and subtracting the expenses. 49.

(10 Minutes) (The budgetary process) A. True—The initial approval of spending was $380,000 and that amount should be recorded immediately. The budgetary entry debits Estimated Revenues and credits Appropriations. B. False—The budgetary information is normally presented as required supplemental information in the annual comprehensive financial report. However, it can also be shown as a separate statement within the fund financial statements. Government officials have that choice. C. True—At one time, only the final budget and the actual figures for the period were reported. That was considered somewhat misleading since the budget could be revised near the end of the year to establish

Chapter 17 – Accounting for State and Local Governments (Part Two) – Hoyle, Schaefer, Doupnik, Advanced Accounting, 15e

agreement. Now, the original budget must also be disclosed. D. False—A Budgetary Fund Balance account has to be set up as part of the budget entry to indicate that a surplus (or deficit) is anticipated. However, an expected surplus requires a credit to the Budgetary Fund Balance rather than a debit. E. False—Budgetary information only relates to fund financial statements to show the inflows and outflows of current financial resources and has no impact on the government-wide financial statements. 50.

(10 Minutes) (The recording of grants) A. False—This grant appears to be voluntary exchange transaction. Revenue should be recognized when all eligibility requirements have been met. Here, the eligibility requirements, if any, could have been met during 2024. It is certainly possible that the eligibility requirements have not been met but that is not necessarily the case. B. False—If no eligibility requirements are included with the grant, the revenue should be recognized immediately in December 2024 when the award is made. C. False—A grant is a government-mandated nonexchange transaction if the award was made to help the recipient government meet legal requirements. That is not specified here and cannot be assumed. However, if the state government had passed a law whereby all school children had to receive hot lunches and had then furnished this grant to help meet that requirement, it would have been a government-mandated nonexchange transaction. D. True—Cash is recognized because it had been received but no revenue is reported because all eligibility requirements have not yet been met. Thus, unavailable revenue should be established for the amount received.

51.

(20 Minutes) (The effect of various government transactions) a. Fund financial statements – the fund balance goes up by $6 million because of the inflow of current financial resources. Government-wide financial statements – the net position balance does not change. Both assets (cash) and liabilities (bonds payable) go up by the same $6 million amount. No increase is created in net position. b. Fund financial statements – the fund balance goes down by $149,000 17-53 © McGraw Hill LLC. All rights reserved. No reproduction or distribution without the prior written consent of McGraw Hill LLC.

Chapter 17 – Accounting for State and Local Governments (Part Two) – Hoyle, Schaefer, Doupnik, Advanced Accounting, 15e

because of the outflow of current financial resources. Government-wide financial statements – the net position balance does not change. One asset (truck) goes up while a second asset (cash) goes down. c. Fund financial statements – the fund balance goes down for the General Fund by $17,000 because of the outflow of current financial resources. Government-wide financial statements – the net position balance does not change. This is an internal exchange transaction within the governmental activities so that no net change is created. The motor pool is an internal service fund that is part of governmental activities because it services the vehicles of the fire and police departments. d. Fund financial statements – the fund balance is not affected because the resources will not be collected quickly enough to be available in the current period. An asset (receivable) is recognized along with a liability (unearned revenue) so that the size of the fund balance is not affected. Government-wide financial statements – a $75,000 receivable and related revenue are recognized; the net position balance goes up by that amount. e. Fund financial statements – the fund balance is not affected. The grant is not recognized as revenue until all eligibility requirements have been met. Because that does not appear to be the case here, the cash will go up along with a liability for the amount being held that might have to be returned. Government-wide financial statements – the net position balance does not change. The accounting is the same as explained for the fund financial statements. f. Fund financial statements – the fund balance should go up by $500,000. Sales took place in the current year but only half of the financial resources will all be received within the 75-day period being used to define available resources. The remainder will be unavailable revenue. Government-wide financial statements – the net position balance goes up by $1 million because the sales were made in the current period. g. Fund financial statements – the fund balance is not affected. Although an encumbrance may be recorded to avoid spending more than the appropriated amount, that entry has no impact on the total amount reported for the fund balance. The commitment might change the way the fund balance is labeled, but not the total amount of the fund balance to be reported. 17-54 © McGraw Hill LLC. All rights reserved. No reproduction or distribution without the prior written consent of McGraw Hill LLC.

Chapter 17 – Accounting for State and Local Governments (Part Two) – Hoyle, Schaefer, Doupnik, Advanced Accounting, 15e

Government-wide financial statements – a purchase order or other commitment has no impact on the net position balance. h. Fund financial statements – the fund balance for the General Fund goes down by $18,000 because the transfer has been approved and will remove current financial resources from this fund. Government-wide financial statements – no impact occurs on the net position balance of the governmental activities because this is an intraactivity transfer from one Governmental Fund to another. There is no net effect. 52.

(12 Minutes) (The financial effect of fund transfers) A. False—A transfer-out will be shown by the governmental activities and a transfer-in will be reported by the business-type activities. Those two figures will be netted together so that no overall impact is shown in the total column for the government as a whole. However, both figures do appear in their own separate columns. B. True—Because only funds within the governmental activities are involved, the transfer creates no difference in the overall total of that column. This is an intra-activity transfer.

C. True—The General Fund reports the resource outflow as an other financing use. Financial resources were reduced but it was not for an expenditure. The transfer-in is not recorded within the governmental funds. D. False—The General Fund will report the transfer-out as an other financing use and the column for "all other funds" will show the transfer-in as an other financing source. E. False—The General Fund does not report expenses in the fund financial statements but rather expenditures. An expenditure of this amount is reported. 53.

(15 Minutes) (Special assessment project) A. Correct change in the fund balance is a $40,000 increase—According to the information provided, the Capital Projects Fund reported an increase in its fund balance for the year of $40,000. In arriving at that figure, $10,000 in revenue and the related expenditure were both recorded in that fund for this bus stop construction. 17-55 © McGraw Hill LLC. All rights reserved. No reproduction or distribution without the prior written consent of McGraw Hill LLC.

Chapter 17 – Accounting for State and Local Governments (Part Two) – Hoyle, Schaefer, Doupnik, Advanced Accounting, 15e

Because the government had no obligation, these cash flows should actually have all been reported in the Custodial Fund. The auditing firm will remove both the revenue of $ 10,000 and the expenditure of $10,000 from the Capital Projects Fund. Because they are of the same amount but have an opposite effect on current financial resources, this removal leaves the overall increase in the fund balance unaffected at $40,000. B. Correct change in net position is a $140,000 increase—According to the information provided, the overall change in the net position of the city reported on the government-wide financial statements was a $150,000 increase. As a result of the special assessment, revenue of $10,000 was reported within the government-wide statements. However, because the city had no obligation, that revenue should have been reported as a liability to the contractor in a Custodial Fund. Removing this revenue (and the asset that was recorded at the same time) from the governmental activities reduces the net position increase for the city from $150,000 to $140,000.

54.

(5 Minutes) (Issuance of short-term note) The correct change in the fund balance for 2024 is an increase of $10,000. According to the information provided, the General Fund reported an increase in its fund balance for the year of $30,000. However, the $20,000 gained from the issuance of the debt should have increased liabilities since payment was due in just 60 days. Removing the other financing source of $20,000 reduces the increase in the fund balance from $30,000 to $10,000.

55.

(15 Minutes) (Reclassifying an activity as an enterprise fund) A. The correct change in the fund balance for the General Fund is a $66,000 increase. According to the information provided, the General Fund reported an increase in its fund balance of $30,000. However, the $9,000 revenue and $45,000 in expenditures were erroneously recorded in that fund. Together, those transactions caused a net reduction in the fund balance of $36,000. These transactions must be removed from the General Fund (in order to record them within an enterprise fund) which causes the overall increase in the fund balance to rise from $30,000 to $66,000. B. The correct change in the net position on the government-wide financial statements is a $150,000 increase. According to the information provided, the overall increase in net position during the year (on the government-wide financial statements) was $150,000. An error has been 17-56 © McGraw Hill LLC. All rights reserved. No reproduction or distribution without the prior written consent of McGraw Hill LLC.

Chapter 17 – Accounting for State and Local Governments (Part Two) – Hoyle, Schaefer, Doupnik, Advanced Accounting, 15e

made in that this art display was reported in the governmental activities (General Fund) rather than in the business-type activities (Enterprise Fund). Fixing that mistake decreases one column in the statement of net position (the business-type activities) and increases the other (the governmental activities) by exactly the same amount. The art display had a loss for the period. That is why the business-type activities will now decrease while the governmental activities increase. Moving these transactions does not change the overall totals for the government as a whole. C. The correct change in the Enterprise Fund is a $54,000 increase. According to the information provided, the overall change in net position of the Enterprise Fund on the fund financial statements was a $60,000 increase. However, the art display was not included as it should have been. Even for fund financial statements, proprietary funds are accounted for like government-wide financial statements (and for-profit businesses). Adding in the $9,000 revenue and deducting the $15,000 expense creates a $6,000 net reduction that drops the positive change from $60,000 to $54,000. The acquisition of the land increases one asset and decreases another so that no change occurs in net position. 56.

(12 Minutes) (Property tax assessments) A. The correct change in the net position of the city on the statement of net position is a $42,000 increase. According to the information provided, the increase in net position on the government-wide financial statements was $150,000. The government, though, has recognized revenue for the amount received in the current period. The amount of the assessment received is $300,000 times 40% or $120,000. However, the discount reduces that figure by $12,000 (10 percent) to $108,000. This money cannot be spent until 2025 and must be reported in 2024 as unavailable revenue (a deferred inflow of resources) and not as revenue. Removing this revenue reduces the overall increase in net position by $108,000 from $150,000 to $42,000. B. The correct change in the fund balance reported for the General Fund is a $78,000 decrease. According to the information provided, the General Fund reported an increase in its fund balance for the year of $30,000. The government, though, had recognized revenue for the amount of cash received. As shown in explanation A above, the amount received should have been $300,000 times 40% or $120,000. However, the discount reduces that figure by $12,000 to $108,000. This money cannot be spent until 2025. It must be reported in 2024 as unavailable revenue and not as revenue. Removing this $108,000 revenue reduces the overall change in the fund balance from an increase of $30,000 to a decrease of $78,000.

57.

Chapter 17 – Accounting for State and Local Governments (Part Two) – Hoyle, Schaefer, Doupnik, Advanced Accounting, 15e

A. The correct change in the net position reported in the government-wide financial statements is a $42,000 increase. According to the information provided, the overall change in the net position of the city on the government-wide financial statements was a $150,000 increase. However, as shown above in 56 (part A), $108,000 was received that should have been recorded as deferred revenue until the period when it can be used (2025). Incorrectly, the city recorded the $108,000 immediately as revenue. When this amount is removed, the increase in net position drops from $150,000 to $42,000. Recognition (and removal) of the $180,000 receivable and the unavailable revenue cause no change in net position since one is an asset and the other is a deferred inflow of resources. B. The correct change in the fund balance for the General Fund is a $78,000 decrease. According to the information provided, the General Fund reported an increase in its fund balance for the year of $30,000. However, as shown above, $108,000 was received that should have been recorded as an unavailable revenue until the period when it can be used (2025). The city incorrectly recorded the $108,000 as revenue. When removed, the increase in net position drops from an increase of $30,000 to a decrease of $78,000. Recognition (and removal) of the $180,000 receivable and the deferred revenue cause no change in net position since one is an asset and the other a liability. 58.

(12 Minutes) (Recording the receipt of grant money) A. The correct change in the fund balance reported by the General Fund is a $290,000 decrease. According to the information provided, the General Fund reported an increase in its fund balance for the year of $30,000. However, $320,000 was recognized here as revenue although an eligibility requirement does remain (lowering air pollution by 25 percent). No part of this revenue can be recognized until all eligibility requirements have been met. Changing the $320,000 from revenue to unavailable revenue reduces the $30,000 increase in the fund balance to a $290,000 decrease. B. The correct change in the net position reported on the government-wide financial statements is a $170,000 decrease. According to the information provided, the change in net position of the city on government-wide financial statements was a $150,000 increase. However, $320,000 was recognized as revenue although an eligibility requirement remains (lowering air pollution by 25 percent). No revenue can be recognized until that time. Changing $320,000 from revenue to unearned revenue reduces the $150,000 increase in the fund balance to a $170,000 decrease. Depreciation of the machine is being handled properly.

59.

(9 Minutes) (Reporting of program revenues)

Chapter 17 – Accounting for State and Local Governments (Part Two) – Hoyle, Schaefer, Doupnik, Advanced Accounting, 15e

A. The correct change in the net position on the government-wide statements is a $150,000 increase. According to the preliminary information, the overall change in the net position of the city on the government-wide financial statements was a $150,000 increase. Moving revenue from general revenue to program revenue does not affect the overall change in net position. B. The correct amount of net expenses reported by the parks is $90,000. According to the preliminary information, the parks reported net expenses of $100,000. This net expense figure is computed as direct expenses less program revenues. The $10,000, though, should have been a program revenue. If this revenue had been appropriately included, net expenses would have been $90,000 rather than $100,000.

Develop Your Skills Research Case 1 No textbook is ever able to cover all of the many areas discussed within complex authoritative accounting pronouncements. The subtle nuances of such rules can only be experienced and appreciated through the study of the official literature. Students need to be aware of the extent of the guidance that is available and gain confidence by working directly with these pronouncements. Here, an issue has been raised in connection with the handling of several unusual transactions. In real life, no better method of resolving such questions exists than to actually study the official standard itself. A review of the GASB Codification indicates that Section 2200 covers the ―Comprehensive Annual Financial Report.‖ Paragraphs 143 through 149 are labeled as ―Special and Extraordinary Items‖ and paragraph 168 is also shown as ―Special and Extraordinary Items.‖ Paragraph 143 defines extraordinary items as "transactions or other events that are both unusual in nature and infrequent in occurrence." The paragraph directs the reader to paragraphs 145 through 149 for further information on the exact nature of the terms "unusual in nature" and "infrequent in occurrence." Paragraph 144 defines special items as "significant transactions or other events within the control of management that are either unusual in nature or infrequent in occurrence." Paragraph 168 indicates that special and extraordinary items ―should be reported separately after ‗other financing sources and uses.‘‖ The pronouncement goes on to state that ―significant transactions or other events that are either unusual or infrequent but not within the control of management should be separately identified within the appropriate revenue or expenditure category.‖

Chapter 17 – Accounting for State and Local Governments (Part Two) – Hoyle, Schaefer, Doupnik, Advanced Accounting, 15e

In this case, the GASB Codification provides clear guidance as to the identity of these two accounts as well as their placement in the financial statements. In practice, accountants rarely refer to textbooks when official guidelines are available. Students, therefore, need to become comfortable with locating the source of authoritative information about a topic in order to become proficient at reading and understanding the material provided. Research Case 2 Here, the accountants and officials of the City of Danmark are looking for assistance in classifying a revenue as either a program revenue (reported directly with a specific activity) or a general revenue (shown for the government as a whole). 1. A search of the GASB Codification provides extensive assistance in this case. Section 2200.136 spells out that "program revenues derive directly from the program itself or from parties outside the reporting government's taxpayers or citizenry, as a whole; they reduce the net cost of the function to be financed from the government's general revenues. The statement of activities should separately report three categories of program revenues: (a) charges for services, (b) program-specific operating grants and contributions, and (c) program-specific capital grants and contributions.‖ 2. Examples of program revenues are then given in Section 2200.137-139 that include:  Revenue collected for garbage collection.  Building permits.  A state grant for the sheriff‘s department to participate in a drug awareness and enforcement program.  Earnings on endowments if the money is restricted to a program specifically identified in the endowment agreement 3. In contrast, general revenues are defined in the negative in Section 2200.140 as: "all revenues are general revenues unless they are required to be reported as program revenues." Thus, if any revenue does not meet the specific definition of program revenue, it is labeled automatically as general revenue. 4. Sales taxes and property taxes are included in this category as well as any other revenues of the government that do not meet the program revenue criteria.

Analysis Case 1) Here is the independent auditor‘s report for the financial statements of Raleigh, North Carolina, for June 30, 2021, and the year then ended. In addition, the independent audit report for the Coca-Cola Company for December 31, 2020, 17-60 © McGraw Hill LLC. All rights reserved. No reproduction or distribution without the prior written consent of McGraw Hill LLC.

Chapter 17 – Accounting for State and Local Governments (Part Two) – Hoyle, Schaefer, Doupnik, Advanced Accounting, 15e

and the year then ended is also included. Setting the two side-by-side can lead to a fascinating discussion about the structure of the two reports and the information provided.

Report of Independent Auditor To the Honorable Mayor and Members of the City Council City of Raleigh, North Carolina Report on the Financial Statements We have audited the accompanying financial statements of the governmental activities, the business-type activities, each major fund, and the aggregate remaining fund information of the City of Raleigh, North Carolina (the ―City‖) as of and for the year ended June 30, 2021, and the related notes to the financial statements, which collectively comprise the City‘s basic financial statements as listed in the table of contents. Management‘s Responsibility for the Financial Statements Management is responsible for the preparation and fair presentation of these financial statements in accordance with accounting principles generally accepted in the United States of America; this includes the design, implementation, and maintenance of internal control relevant to the preparation and fair presentation of financial statements that are free from material misstatement, whether due to fraud or error. Auditor‘s Responsibility Our responsibility is to express opinions on these financial statements based on our audit. We conducted our audit in accordance with auditing standards generally accepted in the United States of America and the standards applicable to financial audits contained in Government Auditing Standards, issued by the Comptroller General of the United States. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free from material misstatement. An audit involves performing procedures to obtain audit evidence about the amounts and disclosures in the financial statements. The procedures selected depend on the auditor‘s judgment, including the assessment of the risks of material misstatement of the financial statements, whether due to fraud or error. In making those risk assessments, the auditor considers internal control relevant to the City‘s preparation and fair presentation of the financial statements in order to design audit procedures that are appropriate in the circumstances, but not for the purpose of expressing an opinion on the effectiveness of the City‘s internal 17-61 © McGraw Hill LLC. All rights reserved. No reproduction or distribution without the prior written consent of McGraw Hill LLC.

Chapter 17 – Accounting for State and Local Governments (Part Two) – Hoyle, Schaefer, Doupnik, Advanced Accounting, 15e

control. Accordingly, we express no such opinion. An audit also includes evaluating the appropriateness of accounting policies used and the reasonableness of significant accounting estimates made by management, as well as evaluating the overall presentation of the financial statements. We believe that the audit evidence we have obtained is sufficient and appropriate to provide a basis for our audit opinions. Opinions In our opinion, the financial statements referred to above present fairly, in all material respects, the respective financial position of the governmental activities, the business-type activities, each major fund, and the aggregate remaining fund information of the City, as of June 30, 2021, and, the respective changes in financial position and, where applicable, cash flows thereof and the respective budgetary comparison for the General Fund for the year then ended in accordance with accounting principles generally accepted in the United States of America. Other Matters Required Supplementary Information Accounting principles generally accepted in the United States of America require that the management‘s discussion and analysis and the required supplemental information as listed in the table of contents be presented to supplement the basic financial statements. Such information, although not a part of the basic financial statements, is required by the Governmental Accounting Standards Board, who considers it to be an essential part of financial reporting for placing the basic financial statements in an appropriate operational, economic, or historical context. We have applied certain limited procedures to the required supplementary information in accordance with auditing standards generally accepted in the United States of America, which consisted of inquiries of management about the methods of preparing the information and comparing the information for consistency with management‘s responses to our inquiries, the basic financial statements, and other knowledge we obtained during our audit of the basic financial statements. We do not express an opinion or provide any assurance on the information because the limited procedures do not provide us with sufficient evidence to express an opinion or provide any assurance. Supplementary and Other Information Our audit was conducted for the purpose of forming opinions on the financial statements that collectively comprise the City‘s basic financial statements. The introductory section, combining and individual fund statements and schedules, other schedules, the schedule of expenditures of federal and state awards and statistical section are presented for purposes of additional analysis and are not a required part of the basic financial statements. The accompanying schedule of expenditures of federal and state awards is presented for purposes of additional 17-62 © McGraw Hill LLC. All rights reserved. No reproduction or distribution without the prior written consent of McGraw Hill LLC.

Chapter 17 – Accounting for State and Local Governments (Part Two) – Hoyle, Schaefer, Doupnik, Advanced Accounting, 15e

analysis as required by Title 2 U.S. Code of Federal Regulations Part 200, Uniform Administrative Requirements, Cost Principles, and Audit Requirements for Federal Awards (Uniform Guidance), and the State Single Audit Implementation Act, and is also not a required part of the financial statements. The combining and individual fund statements and schedules and other schedules are the responsibility of management and were derived from and relate directly to the underlying accounting and other records used to prepare the basic financial statements. Such information has been subjected to the auditing procedures applied in the audit of the basic financial statements and certain additional procedures, including comparing and reconciling such information directly to the underlying accounting and other records used to prepare the basic financial statements or to the basic financial statements themselves, and other additional procedures in accordance with auditing standards generally accepted in the United States of America. In our opinion, the combining and individual fund statements and schedules and other schedules are fairly stated in all material respects in relation to all of the statements and schedules included within the financial section of the Annual Comprehensive Financial Report. The introductory information and the statistical sections have not been subjected to the auditing procedures applied in the audit of the basic financial statements, and accordingly, we do not express an opinion or provide assurance on them. Other Reporting Required by Government Auditing Standards In accordance with Government Auditing Standards, we have also issued our report dated October 29, 2021, on our consideration of the City‘s internal control over financial reporting and on our tests of its compliance with certain provisions of laws, regulations, contracts, and grant agreements and other matters. The purpose of that report is to describe the scope of our testing of internal control over financial reporting and compliance and the results of that testing, and not to provide an opinion on internal control over financial reporting or on compliance. That report is an integral part of an audit performed in accordance with Government Auditing Standards in considering the City‘s internal control over financial reporting and compliance. ** Board of Directors and Shareowners The Coca-Cola Company Opinion on the Financial Statements We have audited the accompanying consolidated balance sheets of The Coca-Cola Company and subsidiaries (the Company) as of December 31, 2020 and 2019, the related consolidated statements of income, comprehensive income, shareowners‘ equity and cash flows for each of the three years in the period ended December 31, 2020, and the related notes (collectively referred to as the ―consolidated financial

Chapter 17 – Accounting for State and Local Governments (Part Two) – Hoyle, Schaefer, Doupnik, Advanced Accounting, 15e

statements‖). In our opinion, the consolidated financial statements present fairly, in all material respects, the financial position of the Company as of December 31, 2020 and 2019, and the results of its operations and its cash flows for each of the three years in the period ended December 31, 2020, in conformity with U.S. generally accepted accounting principles. We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States) (PCAOB), the Company‘s internal control over financial reporting as of December 31, 2020, based on criteria established in Internal Control-Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (2013 framework) and our report dated February 25, 2021 expressed an unqualified opinion thereon. Basis for Opinion

These financial statements are the responsibility of the Company‘s management. Our responsibility is to express an opinion on the Company‘s financial statements based on our audits. We are a public accounting firm registered with the PCAOB and are required to be independent with respect to the Company in accordance with the U.S. federal securities laws and the applicable rules and regulations of the Securities and Exchange Commission and the PCAOB. We conducted our audits in accordance with the standards of the PCAOB. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement, whether due to error or fraud. Our audits included performing procedures to assess the risks of material misstatement of the financial statements, whether due to error or fraud, and performing procedures that respond to those risks. Such procedures include examining, on a test basis, evidence regarding the amounts and disclosures in the financial statements. Our audits also included evaluating the accounting principles used and significant estimates made by management, as well as evaluating the overall presentation of the financial statements. We believe that our audits provide a reasonable basis for our opinion. Critical Audit Matters

The critical audit matters communicated below are matters arising from the current period audit of the consolidated financial statements that were communicated or required to be communicated to the audit committee and that: (1) relate to accounts or disclosures that are material to the consolidated financial statements and (2) involved our especially challenging, subjective or complex judgments. The communication of critical audit matters does not alter in any way our opinion on the consolidated financial statements, taken as a whole, and we are not, by communicating the critical audit matters below, providing separate opinions on the critical audit matters or on the accounts or disclosures to which they relate. Accounting for uncertain tax positions

Chapter 17 – Accounting for State and Local Governments (Part Two) – Hoyle, Schaefer, Doupnik, Advanced Accounting, 15e

Description of the Matter As described in Note 11 and Note 14 to the consolidated financial statements, the Company is involved in various income tax matters for which the ultimate outcomes are uncertain. As of December 31, 2020, the gross amount of unrecognized tax benefits was $915 million. As described in Note 11, on September 17, 2015 the Company received a Statutory Notice of Deficiency from the Internal Revenue Service for the tax years 2007 through 2009 in the amount of $3.3 billion for the period, plus interest. On November 18, 2020, the U.S. Tax Court issued an opinion predominantly siding with the IRS related to the Company‘s transfer pricing between its U.S. parent company and certain of its foreign affiliates for tax years 2007 through 2009. While the Company continues to disagree with the IRS positions and the portions of the opinion affirming such positions, it is possible that some portion or all of the adjustment proposed by the IRS could ultimately be upheld. As a result of the application of ASC 740, Accounting for Income Taxes, the Company recorded a tax reserve of $438 million for this matter for the year ended December 31, 2020. Auditing management‘s evaluation of uncertain tax positions, including the uncertain tax position associated with the IRS notice and opinion, was especially challenging due to the level of subjectivity and significant judgment associated with the recognition and measurement of the tax positions that are more likely than not to be sustained. We obtained an understanding, evaluated the design, and tested the effectiveness of controls over the Company‘s accounting process for uncertain tax positions. Our procedures included testing controls addressing the completeness of uncertain tax positions, controls relating to the identification and recognition of the uncertain tax positions, controls over the measurement of the unrecognized tax benefit, and controls over the identification of developments related to existing uncertain tax positions. How We Addressed the Matter in Our Audit Our audit procedures included, among others, evaluating the assumptions the Company used to assess its uncertain tax positions and related unrecognized tax benefit amounts by jurisdiction. We also tested the completeness and accuracy of the underlying data used in the identification and measurement of uncertain tax positions. We evaluated evidence of management‘s assessment of the opinion, including inquiries of tax counsel, inspection of technical memos, and written representations of management. We involved professionals with specialized skill and knowledge to assist in our evaluation of the tax technical merits of the Company‘s assessment, including the assessment of whether the tax positions are more likely than not to be sustained, the amount of the potential benefits to be realized, and the application of relevant tax law. We also assessed the Company‘s disclosure of uncertain tax positions included in Note 11 and Note 14.

Chapter 17 – Accounting for State and Local Governments (Part Two) – Hoyle, Schaefer, Doupnik, Advanced Accounting, 15e

Valuation of trademarks with indefinite lives and goodwill Description of the Matter As described in Note 1 of the Company‘s consolidated financial statements, the Company performs an annual impairment assessment of its indefinite-lived intangible assets, including trademarks with indefinite lives and goodwill, or more frequently if events or circumstances indicate that assets might be impaired. Each impairment assessment may be qualitative or quantitative. Trademarks with indefinite lives and goodwill were $10.4 billion and $17.5 billion, respectively, at December 31, 2020. Auditing the valuation of trademarks with indefinite lives and reporting units with goodwill involved complex judgment due to the significant estimation required in determining the fair value of the trademarks with indefinite lives and related reporting units with goodwill, respectively. Specifically, the fair value estimates were sensitive to significant assumptions about future market and economic conditions. Significant assumptions used in the Company‘s fair value estimates included sales volume, pricing, royalty rates, cost of raw materials, inflation, cost of capital, marketing spending, foreign currency exchange rates, and tax rates, as applicable. How We Addressed the Matter in Our Audit We obtained an understanding, evaluated the design and tested the operating effectiveness of controls over the Company‘s annual impairment assessments for trademarks with indefinite lives and reporting units with goodwill. For example, we tested management‘s risk assessment process to determine whether to perform a quantitative or qualitative assessment and management‘s review controls over the valuation models and underlying assumptions used to develop such estimates. For impairment assessments of reporting units with goodwill, we also tested controls over the determination of the carrying value of the reporting units. We tested the estimated fair values of the trademarks with indefinite lives and reporting units with goodwill based on our risk assessments. Our audit procedures included, among others, comparing significant judgmental inputs to observable third party and industry sources, considering other observable market transactions, and evaluating the reasonableness of management‘s projected financial information by comparing to third party industry projections, third party economic growth projections, and other internal and external data. We performed sensitivity analyses of significant assumptions to evaluate the change in the fair value of the trademarks with indefinite lives and reporting units with goodwill and also assessed the historical accuracy of management‘s estimates. In addition, we involved specialists to assist in our evaluation of certain significant assumptions used in the Company‘s discounted cash flow analyses. We also assessed the Company‘s disclosure of its annual impairment assessments included in Note 1.

Chapter 17 – Accounting for State and Local Governments (Part Two) – Hoyle, Schaefer, Doupnik, Advanced Accounting, 15e

2) A number of items are shown in order to reconcile the net changes in fund balances for the governmental funds and the changes in net position. Here are the reconciliation items for the City of Raleigh for the year ended June 30, 2021. The reconciliation appears on page 7 of the annual comprehensive financial report. Governmental funds report capital outlays as expenditures. However, in the statement of activities the cost of those assets is allocated over their estimated useful lives and reported as depreciation expense. This is the amount by which capital outlays exceeded depreciation in the current period. +$41,791,004 Revenues in the statement of activities that do not provide current financial resources are not reported as revenues in the funds. +$4,893,138 Bond proceeds provide current financial resources to governmental funds, but issuing debt increases long-term liabilities in the statement of net position. Repayment of bond principal is an expenditure in the governmental funds, but the repayment reduces long-term liabilities in the statement of net position. ($4,222,393) Some expenses reported in the statement of activities do not require the use of current financial resources and therefore are not reported as expenditures in governmental funds. Changes in these expenses are shown below. ($8,843,733) Governmental funds report premiums on bonds issued as an other financing source. In the governmental activities bond premiums are recorded as a liability and amortized over the life of the debt. Amortization for bond issue costs, deferred refunding and premium on bonds are expenses or reduction of expenses in the governmental activities. +$3,340,818 Internal service funds are used by management to charge the costs of certain activities, such as risk management, equipment replacement, and central garage to individual funds. The net expense of certain activities of internal service funds is reported with governmental activities. +$9,112,024 3) The largest sources of general revenues for many cities are property taxes and sales taxes. However, a wide variety of revenue sources are possible. According to the statement of activities for the City of Raleigh for the year ended June 30, 2021, the largest source of general revenues was property taxes levied for general purposes of $275.6 million followed by local sales taxes of $123.2 million and franchise taxes of $28.6 million. The largest source of program revenue was charges for services generated by the water and sewer system of $271.0 million. 4) The amount of expenditures will vary widely based on the size of government. Classifications usually include public safety, sanitation, and the like. According to the statement of revenues, expenditures, and changes in fund 17-67 © McGraw Hill LLC. All rights reserved. No reproduction or distribution without the prior written consent of McGraw Hill LLC.

Chapter 17 – Accounting for State and Local Governments (Part Two) – Hoyle, Schaefer, Doupnik, Advanced Accounting, 15e

balance for the governmental funds of the City of Raleigh for the year ended June 30, 2021, total expenditures for the general fund was $417.3 million. That total was divided as follows: public safety - $183.7 million, general government - $54.2 million, community development - $26.2 million, public infrastructure - $42.1 million, leisure services - $49.0 million, economic development programs - $1.6 million, debt service—principal - $41.3 million, debt service—interest - $18.1 million, and other debt service expenditures - $1.0 million 5) According to the balance sheet for the governmental funds, the general fund primarily shows current financial resources as its assets: cash and investments, various receivables, and amounts due from other funds. Although not current financial resources, the City of Raleigh reported inventories of $1.7 million are reported as of June 30, 2021. On that date, the City of Raleigh reported total assets of $426.5 million in its general fund. The largest amounts of assets as shown by the general fund of the City of Raleigh were cash and cash equivalents of $337.3 million, sales tax receivables of $35.7 million, and due from other funds of $23.5 million. 6) Most governments will indicate in a note to their financial statements that payables and receivables are viewed as available if collected within 60 days of the end of the year. Other lengths of time, though, can be used. A note to the 2021 financial statements for the City of Raleigh states: ―Revenues are recognized as soon as they are both measurable and available. Revenues are considered to be available when they are collectible within the current period or soon enough thereafter to pay liabilities of the current period. For this purpose, the City considers all revenues to be available if they are collected within 90 days after year-end, except for property taxes.‖ 7). According to the statement of revenues, expenditures and changes in fund balances for the governmental funds for the City of Raleigh for the year ended June 30, 2021, the total fund balance for the general fund at the beginning of the year was $348.7 million and at the end of the year was $405.2 million. That indicates an increase in the fund balance of $56.5 million.

Communication Case 1 Students need to continue updating their knowledge throughout their careers. One method for staying current is to become familiar with the information available on the GASB website. This assignment directs the students to look at any major projects being studied by the GASB for the possibility of updating and improving generally accepted accounting. By looking at this site on a regular basis, an accountant can keep up with all issues studied by the Board as well as the authoritative evolution of accounting pronouncements as new standards are produced. 17-68 © McGraw Hill LLC. All rights reserved. No reproduction or distribution without the prior written consent of McGraw Hill LLC.

Chapter 17 – Accounting for State and Local Governments (Part Two) – Hoyle, Schaefer, Doupnik, Advanced Accounting, 15e

For example, at the time of this writing, by going to www.gasb.org and then clicking on projects and then current projects & pre-agenda research, the reader can look at changes relating to (a) the conceptual framework, (b) comprehensive projects, and (c) practice issues. Under comprehensive projects, one especially interesting project is the Financial Reporting Model. The present financial reporting model which utilizes both government-wide and fund financial statements has now been in use for more than two decades. GASB has opted to re-examine that model. According to the website, research has shown the board that most areas of the reporting model work well but several offer an opportunity for improvement. Included within those discussions are the following: --Enhancement of Management‘s Discussion & Analysis (MD&A) to make it more beneficial. --Possible modifications of the current financial resources basis for the reporting of governmental fund financial statements. --Evaluating improved operating indicators for the proprietary funds and for the business-type activities. --Better reporting of actual figures to budgetary figures for comparison purposes.

Communication Case 2 Most accountants and accounting students understand that GASB and FASB set official standards for the accounting and financial reporting applied by state and local governments (GASB) and by for-profit entities and not-for-profit entities (FASB). Probably only a small portion of either of these groups truly know the established vision and mission of these two authoritative groups. The following information comes from the strategic plan of the Financial Accounting Foundation as of April 2015. Information in this document shows the bodies understanding and aspirations for the two official groups. VISION ―OUR COLLECTIVE VISION IS TO BE A RECOGNIZED LEADER IN FINANCIAL ACCOUNTING AND REPORTING‖ The key to our vision is that the FASB, the GASB, the FAF Trustees, and the FAF management will be best-in-class in their respective roles. For the FASB and the GASB, that means setting accounting standards of the highest quality through a comprehensive process that exemplifies our commitment to integrity, objectivity, independence, transparency, inclusiveness, and leadership. For the FAF management, that means furnishing high-quality, strategic counsel and support services for the standard-setting Boards. For the FAF Trustees, that means providing proactive, engaged, and purposeful oversight. By highest-quality standards, we mean standards that promote the reporting of financial 17-69 © McGraw Hill LLC. All rights reserved. No reproduction or distribution without the prior written consent of McGraw Hill LLC.

Chapter 17 – Accounting for State and Local Governments (Part Two) – Hoyle, Schaefer, Doupnik, Advanced Accounting, 15e

information that is relevant, representationally faithful, understandable, verifiable, timely, and comparable. We also mean standards for which the costs incurred by financial statement preparers to provide that information are justified by the benefits provided. In developing these standards, the FASB will first consider the best interests of those who provide capital to companies and not-for-profit organizations (investors, lenders, other creditors, and donors) both in the U.S. and other markets that use or reference Generally Accepted Accounting Principles (GAAP). The GASB will first consider the best interests of those who use financial statements prepared by state and local governments, including citizens, the elected officials who represent them, and investors in municipal bonds.

To enable them to achieve their objective, the FASB and the GASB are accountable to stakeholders and to those organizations that oversee their activities. For the FASB, those organizations include the FAF Board of Trustees, the Securities and Exchange Commission (SEC), and through the SEC, the Congress of the United States. The GASB is accountable to the FAF Board of Trustees and to U.S. state and local governments. By producing the highest-quality standards through a best-in-class, independent standard-setting process—outreach, review, and standard-writing—the FASB and the GASB will establish a reference point and benchmark by which other standard setters may judge the quality of their own work. The Boards will lead by setting an example of excellence that others may seek to emulate. MISSION ―OUR COLLECTIVE MISSION IS TO ESTABLISH AND IMPROVE FINANCIAL ACCOUNTING AND REPORTING STANDARDS TO PROVIDE USEFUL INFORMATION TO INVESTORS AND OTHER USERS OF FINANCIAL REPORTS AND EDUCATE STAKEHOLDERS ON HOW TO MOST EFFECTIVELY UNDERSTAND AND IMPLEMENT THOSE STANDARDS.‖

The FASB, the GASB, the FAF Trustees, and the FAF management each contributes to our collective mission according to its specific role. The FASB and the GASB are charged with setting the highest-quality standards through a process that is robust, comprehensive, and inclusive. The FASB is responsible for standards for public and private companies and not-for-profit organizations. The GASB is responsible for standards for state and local governments. The FAF management is responsible for providing strategic counsel and services that support the work of the standard-setting Boards. The FAF Trustees are responsible for providing oversight and promoting an independent and effective standardsetting process. The FASB and the GASB are committed to following an open, orderly process for setting standards. Their comprehensive due process procedures promote thorough and open study of financial accounting and reporting issues. The procedures also encourage broad public participation in the standard-setting process by creating opportunities to hear all points of view at all stages of the process. 17-70 © McGraw Hill LLC. All rights reserved. No reproduction or distribution without the prior written consent of McGraw Hill LLC.

Chapter 17 – Accounting for State and Local Governments (Part Two) – Hoyle, Schaefer, Doupnik, Advanced Accounting, 15e

CORE VALUES In realizing our vision and carrying out our mission, the FASB, the GASB, the FAF Trustees, and the FAF management rely on our core values to guide our activities. These values, which have been identified and articulated over the years, are: INTEGRITY – Integrity means that the FASB, the GASB, the FAF Trustees, and the FAF management each will carry out their respective role with honesty, commitment, and transparency. For the Boards, integrity means adherence to the Boards‘ due process, respecting all stakeholders‘ views, and ensuring that confidential information shared with the Boards is carefully protected and remains private. The Boards‘ due process is central to our mission. OBJECTIVITY – The Boards‘ due process seeks to ensure that diverse views are heard and carefully considered. Objectivity requires the Boards to evaluate and consider differing views—with no stake in any particular viewpoint or outcome— and to promote the neutrality of information resulting from their standards. INDEPENDENCE – Accounting standards must be developed in an environment free of special interests, one that is focused on bringing investors, citizens, and other users of financial reports the highest-quality financial reporting information possible while balancing those benefits with the costs of implementing new standards. TRANSPARENCY – The Boards operate ―in the sunshine.‖ The ability for stakeholders to see what the standard-setting Boards are doing at any given time fosters greater stakeholder involvement and confidence in the process. INCLUSIVENESS – Actively encouraging all stakeholders to participate in the development of standards and listening to a wide range of views with thoughtful attention are prerequisites of the Boards‘ ability to develop standards that are generally accepted. LEADERSHIP – Our stakeholders expect the FASB and the GASB to lead the way in developing the highest-quality accounting standards through an independent process that, in turn, strengthens confidence in our capital markets, both domestically and globally. Communication Case 3 Students do not always appreciate the amount of discussion, debate, and compromise that FASB and GASB often must go through to arrive at official accounting pronouncements. Because they often lack experience, students sometimes see the creation of accounting standards as a quest for the one true and correct path. For them, one way of accounting is right for each situation and all other ways are necessarily wrong. In practice, though, many possible "right" ways usually exist as potential solutions 17-71 © McGraw Hill LLC. All rights reserved. No reproduction or distribution without the prior written consent of McGraw Hill LLC.

Chapter 17 – Accounting for State and Local Governments (Part Two) – Hoyle, Schaefer, Doupnik, Advanced Accounting, 15e

to any accounting problem. Because of the public debate created by many of these issues, authoritative bodies often receive numerous recommendations during the discussion of any new standard. The Board studies a wide range of suggestions before it arrives at the approach that best fits with the members' conceptual understanding of accounting and reporting. Within this process, the Board also considers possible political and economic ramifications as members attempt to arrive at a final solution that addresses the accounting concerns while it also pacifies the qualms of various interested parties. Nevertheless, the Board does attempt to explain its standards by presenting extensive background information. In this assignment, students have the opportunity of look at some of the alternatives examined by GASB prior to establishing Statement No. 34. This pronouncement was a revolutionary standard that created the present-day dual system of reporting government financial statements through government-wide financial statements and fund financial statements. Probably no other GASB statement has had such a significant overall impact on the financial reporting of a state or local government. The paragraphs assigned here present a number of different approaches suggested by members of the public and considered by GASB. In all cases, individuals who had knowledge of government accounting felt that these alternatives were better solutions than the dual system of government-wide financial statements and fund financial statements mandated by GASB 34. 

Many respondents preferred a single set of financial statements rather than the dual approach finally chosen. However, GASB found that there was no consensus that any one set of statements was preferable or provided the needed information by itself.



Other respondents felt that no significant change was necessary in government accounting and that the system in use at that time (very similar to the current fund financial statements) was adequate. GASB justifies its decision to move away from the previous model by stating (in paragraph 245) that "some of the information that today's users need surpasses the capabilities of the previous reporting model, particularly for governmental activities."



The suggestion was also made that fund financial statements for governmental funds not be based on measuring and reporting current financial resources. Rather, each government would use the basis of accounting utilized for budgetary purposes (such as a cash system or a modified cash system). This argument held that fund financial statements are created to provide control and financial accountability which is established by the budgetary process and should, therefore, reconcile with the budget. GASB rejected this idea because the wide variety of possible budgetary methods would eliminate consistency and comparability.

Chapter 17 – Accounting for State and Local Governments (Part Two) – Hoyle, Schaefer, Doupnik, Advanced Accounting, 15e



Another solution put forth was to leave the current model as it is but make significant changes to it. Basically, GASB responded that one set of statements could simply not expand to suit the wide array of user needs that had arisen over the years.



Other suggestions encompassed trying to adapt the basis of accounting utilized for the governmental funds to be more useful to a wider array of financial statement users. In other words, significant changes were recommended for this portion of the fund financial statements. GASB indicated here that the Board felt that useful information was being provided by the previous model which focused on current financial resources and that such information should not be lost by the creation of a new model.

Communication Case 4 One of the truly significant additions to state and local government accounting in recent years has been the requirement of the Management‘s Discussion and Analysis (MD&A). The MD&A is meant to be a discussion of the financial information reported by the government in a verbal rather than purely quantitative fashion. Students often do not understand the range of information that can be uncovered within an MD&A. Here, the student can read the MD&A for an actual city. The information that is provided is quite extensive and often covers a wide range of subjects such as the following:            

An explanation of fund financial statements. An explanation of government-wide financial statements. An explanation of governmental funds, proprietary funds, and fiduciary funds. The purpose of the various funds such as the general fund and the debt service fund. A comparison of the governmental activities and the business-type activities. The method by which the government generates revenues. The diversity of expenditures made within the governmental funds. The bond rating for the government. A discussion of the budgetary process. Information about both capital assets and long-term liabilities. The reporting of infrastructure assets that were acquired before the creation of government-wide financial statements. Information about proprietary operations.

Here is just a small sample of the information provided in the Management‘s Discussion & Analysis for the City of Winston-Salem, NC, for the June 30, 2021, and the year then ended. Highlights of the City‘s fiscal year ended June 30, 2021, include: 

City of Winston-Salem total net position increased approximately $113 17-73

Chapter 17 – Accounting for State and Local Governments (Part Two) – Hoyle, Schaefer, Doupnik, Advanced Accounting, 15e

million from $1.102 billion to $1.215 billion. 

At June 30, 2021, total net position of $1.215 billion included $233 million (unrestricted net position), which in large part, have been reserved for specific purposes or needed for working capital to meet the City‘s ongoing obligations to citizens and creditors. The unrestricted net position should not be used to fund ongoing operations other than working capital because major financial stress would be likely as the assets are depleted.



At June 30, 2021, the City‘s governmental funds reported combined fund balances of $217.9 million. Approximately 15.18% of this amount is unassigned and is available for spending at the government‘s discretion.



Unassigned fund balance of the general fund (approximately $33.1 million) continues to meet working capital requirements. The City has adopted a financial policy to maintain a minimum unassigned fund balance of 14% of estimated expenditures in the general fund. The fiscal year 2022 budget includes a fund balance appropriation of $1.35 million, a decrease of $4.05 million compared to the fiscal year 2021 appropriation. The unassigned fund balance was 16.4% of 2022 estimated expenditures. Legal provisions and financial policies of the City restrict fund balances in other funds to the purposes of those funds.



The City‘s total long-term liabilities decreased by $25.4 million to $967.3 million. Several key factors contributed to this decrease: the retirement of $13.3 million in general obligation bonds, the issuance of $90.6 million in general obligation bonds, including refunding of $24.1 million general obligation bonds, the retirement of $640 thousand in special obligation bonds, the retirement of $18.8 million in revenue bonds, retirement of $20.8 million limited obligation bonds, and retirement of $11.25 million in installment financing contracts. The City received funding from Clean Water State Revolving Loan Fund for $2.9 million and retired $6.1 million. The City had a decrease in net pension and OPEB liabilities of $35.8 million.



Property taxes supported 58% of governmental services to citizens and the community, and 48.5% of mass transportation expenses in 2021. The City maintained the tax rate of $.6374 for fiscal year 2021.



City of Winston-Salem maintained its AAA bond rating from all three major rating agencies

Excel Case Creation of this type of spreadsheet would appear to be very helpful in budget planning because city officials could plug in various increase and decrease rates and see the impact on the fund balance over time. There are a number of different ways that a spreadsheet could be created to solve this particular problem. Here is 17-74 © McGraw Hill LLC. All rights reserved. No reproduction or distribution without the prior written consent of McGraw Hill LLC.

Chapter 17 – Accounting for State and Local Governments (Part Two) – Hoyle, Schaefer, Doupnik, Advanced Accounting, 15e

one possible approach: Create Column Headings: In Cell A4, enter label text "Year" In Cell B4, enter label text "Revenue Change" In Cell C4, enter label text "Revenues" In Cell D4, enter label text "Expenditures Change" In Cell E4, enter label text "Expenditures" In Cell F4, enter label text "Ending Fund Balance" In Cell G4, enter label text "Projected Change in Revenue" In Cell H4, enter label text "Projected Change in Expenditures" Click and drag across Cells A4 to H4. Select Format, Cells, Alignment, and click the "Wrap Text" box. Click OK. If needed, place the cursor on the line between the Column Letters and drag the boundary on the right side of the column headings until the columns are the width you want. In Cell A5, enter label text "2023" for the end of the opening year. In Cell C5, enter Revenues of $1,400,000. In Cell E5, enter Expenditures of $1,480,000. In Cell F5, enter beginning Fund Balance of $400,000 In Cell G5, enter -2% for Projected Change in Revenue Per Year. In Cell H5, enter +3% for Projected Change in Expenditures Per Year. In Cell A6, enter label text "2024." Perform Calculations: In Cell B6, enter formula to calculate Revenue Change (Revenue times Projected Revenue Change): =+C5*$G$5. Note here that adding the $ symbol to Column and Row addresses creates an "absolute" reference which will remain static throughout the spreadsheet. In Cell C6, enter formula to adjust Revenues by Revenue Change: =+C5+B6 In Cell D6, enter formula to calculate Expenditures Change (Expenditures times Projected Expenditures Change): =+E5*$H$5 In Cell E6, enter formula to change Expenditures by Expenditures Change: =+E5+D6 In Cell F6, enter formula to calculate the new ending Fund Balance (initial Fund Balance plus Revenue minus Expenditures): =+F5+C6-E6 Copy formulas to adjacent rows: Click and drag across Cells A6 through F6 and release. Place cursor on Fill Handle (small black box in lower right corner of selection box) and click and drag down through Row 8. At that point, you should see that the city will have a negative fund balance of $277,539 at the end of 2026. Simply, by changing cells G5 and H5, the impact of any different level of rate 17-75 © McGraw Hill LLC. All rights reserved. No reproduction or distribution without the prior written consent of McGraw Hill LLC.

Chapter 17 – Accounting for State and Local Governments (Part Two) – Hoyle, Schaefer, Doupnik, Advanced Accounting, 15e

changes can be ascertained. For example, if revenues decrease 5% and expenditures decrease 3% each year, changing those two cells will show that the fund balance will be a positive $14,937 at the end of 2026. Or, by assuming revenues increase by 4% and expenditures increase by 7%, the fund balance will be a negative $146,066 at the end of 2026. Any other combination of changes can be examined in the same way.

CHAPTER 17 ACCOUNTING FOR STATE AND LOCAL GOVERNMENTS (PART TWO) Chapter Outline I.

In the financial reporting for a state or local government, officials can encounter transactions and other events where they are unsure about the reporting that would be in conformity with U.S. generally accepted accounting principles. To help resolve such problems, the Governmental Accounting Standards Board (GASB) established a hierarchy of generally accepted accounting principles (U.S. GAAP) that lists both authoritative and nonauthoritative sources for guidance. A. Authoritative sources of GAAP are divided into two categories with Category A having more authority than Category B. a. Category A contains GASB Statements of Governmental Accounting Standards b. Previously issued GASB Interpretations are also included in Category A although the Board does not anticipate issuing additional interpretations in the future c. Category B is made up of GASB Technical Bulletins, GASB Implementation Guides, and any literature of the American Institute of Certified Public Accountants (AICPA) that has been cleared by GASB. B. Nonauthoritative sources of GAAP can be used if authoritative GAAP does not provide a definitive answer. The list of these sources includes GASB Concepts Statements, pronouncements of other accounting bodies such as FASB and the IASB, practices that are prevalent in state and local governments, published literature of professional associations and regulatory agencies, and accounting textbooks and articles.

II.

Governments often reduce or eliminate a business‘s tax burden as an incentive for entering, staying, or expanding operations in the area. The details of such tax abatements must now be disclosed as part of the financial reporting process. Disclosed information should include the following A. The purpose of the tax abatement program. B. The tax being abated. C. Dollar amount of taxes abated. D. The type of commitments made by the tax abatement recipients. E. Other commitments made by the government such as agreeing to build infrastructure assets such as roads.

III.

Many state and local governments maintain defined benefit pension plans for their employees such as school teachers, police officers, and sanitation workers. Pension trust funds are often set up as fiduciary funds to manage the money and investments held to pay for these

Chapter 17 – Accounting for State and Local Governments (Part Two) – Hoyle, Schaefer, Doupnik, Advanced Accounting, 15e

pensions. As fiduciary funds, these pension trust funds are not included in government-wide financial statements. A. Government-wide financial statements must report a net pension liability if the present value of the estimated future payments that relate to past work is greater than the net position of the pension trust fund. That is a net pension liability. B. GASB requires that in most cases, but not all, the present value is calculated for the future cash benefits that have been earned to date based on the estimated long-term investment yield for plan assets. Use of that rate has created a significant amount of controversy because it is often high which mathematically leads to more interest included in the future cash payments and lowers the amount of currently-reported debt. C. The components to be reported as pension expense are the service cost for the current period, interest expense on the total pension liability, and projected earnings on plan investments. In addition, any increases or decreases in the liability caused by changes in benefit terms are also included in pension expense immediately. IV.

For both a lessor and lessee, state and local governments use a single-model that differs appreciably from the method developed by FASB to be used by for-profit businesses. Unless a lease is for a maximum of one year or less, it is reported in only one way. A. For a lessee that is reporting government-wide financial statements, the lessee records the leased property and the related liability at the present value of the future payments based on its incremental borrowing rate unless the lessor‘s implicit rate is known. Over time, the lessee recognizes interest expense in connection with the liability balance for the year and records amortization for the reported cost of the asset. B. For a lessee reporting fund financial statements, the lessee reports an expenditure and an other financing source for the present value of the lease payments. Subsequently, the lessee reports an additional expenditure at the time of each new payment. C. For a lessor reporting government-wide financial statements, the asset is not removed. A receivable is recorded at present value using the lessor‘s implicit rate along with a deferred lease revenue. Over time, the asset is amortized to expense while the deferred lease revenue is reclassified to lease revenue in a systematic and rational manner. Interest revenue is recognized on the lease receivable as the balance for the period is multiplied by the implicit rate. D. In fund financial statements for governmental funds, the entries for a lessor are virtually identical except that the asset is not present within the financial records so depreciation is not appropriate.

Governments often maintain solid waste landfills for use by local citizens and businesses. These facilities can be recorded either within the proprietary funds, if a user fee is assessed, or as part of the General Fund if the landfill is open to the public without a substantial charge. A. A landfill can eventually create a large liability for a government because of closure costs and postclosure maintenance and monitoring. B. On government-wide financial statements, recognition of this liability is based on accrual accounting and the economic resource measurement focus. The eventual costs are estimated and the liability is recognized proportionally as the available space fills. If the landfill is recorded as an Enterprise Fund, this same reporting is also appropriate for fund financial statements. C. If the landfill is reported within the General Fund, a liability is only reported on the fund statements when a claim to current financial resources comes into existence.

VI.

Works of art and historical treasures A. Artworks, historical treasures, and similar assets should be capitalized at cost (or fair value 17-77 © McGraw Hill LLC. All rights reserved. No reproduction or distribution without the prior written consent of McGraw Hill LLC.

Chapter 17 – Accounting for State and Local Governments (Part Two) – Hoyle, Schaefer, Doupnik, Advanced Accounting, 15e

at the date of donation) in government-wide financial statements. If donated, a revenue is also reported. B. An expense rather than an asset can be recorded but only if the item does not generate economic benefits and meets the following three criteria. a. Held for public exhibition, education, or research in furtherance of public service, rather than financial gain. b. Protected, kept unencumbered, cared for, and preserved. c. Subject to the policy that revenues generated from sales of items in the collection must be used to add to the collection. C. If capitalized, depreciation is appropriate but is not required if this asset (a bronze sculpture, for example) is considered to be inexhaustible. D. On fund financial statements for the governmental funds, expenditures are recognized for any purchases because the acquired property is not a current financial resource. Such donations do not affect current financial resources and are not reported. VII.

Infrastructure Assets and Depreciation A. Infrastructure assets (such as roads, bridges, and sidewalks) are capitalized at historical cost in government-wide financial statements and also in fund financial statements for any proprietary funds. B. In fund financial statements for the governmental funds, the costs of these acquisitions and constructions are recorded as expenditures because they reduce current financial resources. C. In government-wide statements, depreciation of all capital assets other than land and inexhaustible artworks is required. D. Infrastructure assets are also subject to depreciation. Nevertheless, the ―modified approach‖ allows the government to expense its maintenance costs in lieu of depreciation for infrastructure assets but only if specified criteria are met. a. The government establishes a minimum acceptable condition level for a network of infrastructure assets. Documentation must be provided to verify that this minimum condition level is maintained. b. An asset management system must be in place to monitor the condition of the items in the system of assets.

VIII.

Primary governments produce an annual comprehensive financial report (ACFR) which includes three distinct sections. A. Management‘s discussion and analysis (MD&A) which provides a broad range of information to help decision-makers evaluate the operations and financial position of the government. B. Financial statements a. Government-wide financial statements. b. Fund financial statements. c. Notes to the financial statements. C. Other required supplementary information.

IX.

In governmental accounting, a general-purpose government (such as a city, town, county, state or the like) is a primary government that produces and distributes an ACFR. In creating this ACFR, many governments must include component units which are legally separate organizations or activities. A. Any agency, board, or the like that meets either of the following two criteria is reported as a component unit within the ACFR of the primary government even though the separate

Chapter 17 – Accounting for State and Local Governments (Part Two) – Hoyle, Schaefer, Doupnik, Advanced Accounting, 15e

organization is an independent operation. a. It must be fiscally dependent on the primary organization and the primary government and the component unit must be financially interdependent (there is a relationship of potential financial benefit or burden between the two of them) or b. The primary government must appoint a voting majority of the governing board and either be able to impose its will on the board or the separate organization provides a financial benefit or imposes a financial burden on the primary government. B. Once identified, component units can be (a) discretely presented in a separate column on the right side of the government-wide statements or (b) blended within the primary government as if it was actually one of the funds within the primary government. C. A special purpose government (such as a school board, university, or water commission) qualifies as a primary government if it meets the following three criteria: a. It has a separately elected governing body. b. It is legally independent. c. It is fiscally independent of any other state and local governments. X.

Government entities occasionally combine. These transactions can be recorded as (a) mergers or (b) acquisitions. A. In a merger, no significant consideration is exchanged. The governments simply come together legally—often to form a new government unit. The net carrying value of all assets, liabilities, deferred outflows of resources, and deferred inflows of resources are retained. No excess consideration is paid nor recognized. The net book values are simply combined. B. In an acquisition, significant consideration is exchanged. Assets, liabilities, deferred outflows of resources, and deferred inflows of resources are recorded at acquisition value—the amount that would be required to buy or dispose of the items on that day. Any excess consideration is recorded as a deferred outflow of resources and amortized to expense over a period of time determined based on a number of factors.

XI.

Public colleges and universities are required to meet GASB standards for reporting purposes, whereas private schools follow FASB standards. A. Private colleges and universities generally depend more on tuition and usually have larger endowments whereas governments generally provide a major part of the support for public schools. B. GASB assumes public colleges and universities are special purpose entities so that they must use the same reporting model as a state or local government. However, many of these schools assume that they function solely as an Enterprise Fund (open to the public for a user charge). Thus, they are allowed to produce fund financial statements (for a proprietary fund) without need for government-wide statements. The government-wide statements are viewed as redundant.

Answer to Discussion Question Is It Part of the County? In financial accounting for a for-profit organization, the boundary that defines the reporting entity and its various activities (or subsidiaries) is relatively easy to determine. US GAAP provides the basis for inclusion in consolidated financial statements, which includes all entities over which a company has control by holding more than 50 percent of the voting stock.

Chapter 17 – Accounting for State and Local Governments (Part Two) – Hoyle, Schaefer, Doupnik, Advanced Accounting, 15e

In accounting for state and local governments, the distinction is not so clear. What constitutes a reporting entity? Obviously, a primary government such as a city or county is a reporting entity. What about other governmental operations and activities that affect the primary government, but which are separate from it? When do those operations qualify as special purpose governments and when should they be viewed as component units to be reported along with a primary government? A special purpose government is also a primary government for reporting purposes. To qualify, it must have a separately elected governing body, be legally independent, and be fiscally independent. The entity can demonstrate its fiscal independence by setting its own budget, levying taxes, and/or issuing bonds without outside approval. Here, the industrial development commission is not fiscally independent of Harland County. Harland County has the ability to impose its will on the separate organization because it has the right to approve the commission‘s budget. Therefore, the industrial development commission is not a special purpose government. Is the industrial development commission a component unit? An activity qualifies as a component unit if it is fiscally dependent on a primary government. In addition, the primary government and the component unit must be financially interdependent (there is a relationship of potential financial benefit or burden between the two of them). Here, because the commission‘s budget must be approved by the county government and deficits will be covered by the county, the commission appears to qualify as a component unit for Harland County. Can the commission also be a component unit of the state? Fiscal dependence is not present, but a component unit does exist if the primary government appoints a voting majority of the board and (a) the primary government can impose its will on that board or (b) the separate organization provides a financial benefit for the primary government or imposes a financial burden. The state appoints 15 out of 20 of the board members. Appointment of that number of board members indicates state control. However, no evidence or information is presented here that indicates that the state can impose its will on the board or that the separate organization provides a financial benefit or imposes a financial burden on the state (as it does on the county). Therefore, unless other information becomes available indicating that one of these requirements is present, the industrial commission is not a component unit of the state. However, because of the appointment of the majority of the board, the commission is a related organization to the state. In that case, the state must disclose the nature of the relationship in its financial statements. Answers to Questions 1. All sources of authoritative US GAAP for state and local governments can be divided into two categories with Category A having more authority than Category B. Category A is made up of the official statements of the GASB. In addition, previously released interpretations still remain in effect and are also included in this highest level of authority. Category B is made up of GASB Technical Bulletins, GASB Implementation Guides, and any literature of the American Institute of Certified Public Accountants (AICPA) that has been cleared by GASB. 2. If specific guidance cannot be found in either Category A or Category B, accountants and auditors should consider guidance for similar transactions or events. In addition, GASB has identified non-authoritative sources that can be considered in determining the reporting most consistent with generally accepted accounting principles. This list includes GASB Concepts Statements, pronouncements of other accounting bodies (such as FASB and the IASB), 17-80 © McGraw Hill LLC. All rights reserved. No reproduction or distribution without the prior written consent of McGraw Hill LLC.

Chapter 17 – Accounting for State and Local Governments (Part Two) – Hoyle, Schaefer, Doupnik, Advanced Accounting, 15e

practices that are prevalent in state and local governments, published literature of professional associations and regulatory agencies, and accounting textbooks and articles. 3. According to GASB, a state or local government must disclose significant information about abatement agreements that should include the following. Note that the governments are not required to identify specific companies that are involved.  The purpose of the tax abatement program.  The tax being abated.  Dollar amount of taxes abated.  The type of commitments made by the tax abatement recipients.  Other commitments made by the government such as agreeing to build infrastructure assets such as roads. 4.

The money set aside by this government for its retirement program is maintained in a pension trust fund that will likely have a positive net position because of the money and investments being held for future payments. At the same time, an estimate is made of the future amount of money that will have to be paid as a result of the defined benefit plan. The portion of that total that relates to work that has already been provided is then determined. The present value of that part of those future cash payments is calculated. If the resulting pension liability is greater than the net position of the pension trust fund, the excess amount is reported in the government-wide financial statements as a net pension liability.

5. For state and local government units, pension expense begins with the service cost for the current year and is increased by interest expense on the amount of the obligation. The resulting figure is then reduced by any projected earnings on plan investments. In addition, any increases or decreases in the liability caused by changes in benefit terms are included in pension expense immediately. Numerous assumptions are also necessary in order to arrive at a total amount to be paid (such as the life expectancy of retired individuals). The impact of (a) any changes in those assumptions and (b) differences between previous assumptions and actual experience is not included immediately by the government within pension expense. Instead, those amounts are recorded as either deferred outflows of resources or deferred inflows of resources and amortized to pension expense over time. 6. The present value of an annuity due of $1 over five periods at an annual interest rate of 8 percent is 4.31213 or $388,092 for the series of $90,000 payments. On government-wide financial statements for governmental activities, the right-of-use assets and the lease liability are each recorded as $388,092. Annual amortization expense is $388,092/5 years or $77,618. The liability is immediately reduced by the first $90,000 payment down to $298,092. Using the 8 percent rate, interest expense for the first year is $23,847. The interest is not paid directly but rather added to the liability balance for a reported figure of $321,939. On fund financial statements for the general fund, an expenditure for the lease contract of $388,092 is reported at the date of signing along with an other financing sources of $388,092. Although these two balances offset on the statement of revenues, expenditures, and other changes in fund balance, they are both shown for disclosure purposes. When the first payment is made, a $90,000 expenditure is reported for the leased truck. 7. Pittston, as the lessor, records the lease receivable at the $700,000 present value along with a deferred lease revenue balance of the same amount. Although leased for its entire life, the 17-81 © McGraw Hill LLC. All rights reserved. No reproduction or distribution without the prior written consent of McGraw Hill LLC.

Chapter 17 – Accounting for State and Local Governments (Part Two) – Hoyle, Schaefer, Doupnik, Advanced Accounting, 15e

asset remains on the financial records of the lessor. Pittston records amortization expense on this asset, likely $700,000/10 years or $70,000. The lessor reclassifies the deferred lease revenue as lease revenue using a systematic and rational method. If the straight-line method is applied, that figure will also be $70,000. The receivable balance falls from $700,000 to $596,435 as a result of the first $103,565 payment. At the 10 percent annual rate, the lessor recognizes interest revenue of $59,644. Thus, for the first year, the lessor reports lease revenue of $70,000, amortization expense of $70,000, and interest revenue of $59,644 on government-wide financial statements. The lessee records the right-of-use asset as $700,000. Over 10 years, annual amortization expense is $70,000. The first payment reduces the liability balance to $596,435. At 10 percent, interest expense is $59,644. For the first year, the lessee reports amortization expense of $70,000 and interest expense of $59,644 on government-wide financial statements. 8. Solid waste landfills can be a significant source of liability for many local governments. The federal government has strict rules on closure of a landfill as well as groundwater monitoring and postclosure activities. All of these legal obligations can necessitate large payments over an extended period of time to close and then maintain the landfill into the future. 9. Government-wide financial statements recognize expenses using accrual accounting and the economic resource measurement basis. Therefore, seven percent of the expected landfill closure liability cost is accrued during the current year as an expense along with the related liability. In fund financial statements, the entry is the same as above if an Enterprise Fund is involved. However, in fund statements, if the landfill is recorded in the General Fund, the only charge to expenditures is for any current payment or for any claim against current financial resources. The eventual liability is ignored unless it will be paid from current financial resources. 10. Government-wide financial statements recognize expenses on the accrual and economic resource measurement basis. At the end of the first year, 11 percent is multiplied times the expected closing and other related costs and that figure is recognized as both an expense and a liability. Current costs are used for this estimation process. At the end of the second year, 24 percent is multiplied times the expected costs (which may have changed since the end of year one) and the liability to be reported is then raised to this new amount. It is the change in the liability that creates the amount of expense reported for the second year. For fund financial statements, assuming the landfill is reported in the General Fund, no recording is made unless (a) an actual payment is made because of the eventual closure or (b) some part of that liability represents a claim to current financial resources in this period. 11. Governments should capitalize donated works of art, historical treasures, and similar assets at the fair value at the date of the gift. However, if no charge is assessed for admission to see the art, it is difficult to consider it an asset in a traditional sense because no direct economic benefit is raised for the government. Thus, the artwork does not have to be capitalized if all of the following criteria are met: a. Held for public exhibition, education, or research in furtherance of public service, rather than financial gain. b. Protected, kept unencumbered, cared for, and preserved. 17-82 © McGraw Hill LLC. All rights reserved. No reproduction or distribution without the prior written consent of McGraw Hill LLC.

Chapter 17 – Accounting for State and Local Governments (Part Two) – Hoyle, Schaefer, Doupnik, Advanced Accounting, 15e

c. Subject to an organizational policy that requires the proceeds from sales of collection items to be used to acquire other items for collections. If capitalized, depreciation is only required if the asset is viewed as exhaustible (the asset is used up by display, education, or research). Otherwise, depreciation is not required. 12. Revenue still must be reported because of the donation. If the government chooses not to record the qualifying asset in the government-wide financial statements, an expense is reported in place of the asset (whether the item was purchased or received as a gift). If received by donation, the revenue portion of the entry is still required. 13. The modified approach is an alternative to depreciating infrastructure assets. This option allows the government to expense all maintenance costs rather than record depreciation, but only if specified guidelines are met. The government must accumulate certain information about the infrastructure assets within either a network or subsystem of a network. The government must establish a minimum acceptable level for the network or subsystem of the network and maintain documentation that this level is being maintained. An asset management system has to be in place to monitor and provide records of the infrastructure assets. The ongoing condition is assessed and an annual estimation made of the cost of maintaining and preserving the infrastructure to meet the established condition levels. Government officials must decide whether this amount of effort and cost should be incurred simply to avoid the recording of depreciation. To date, use of the modified approach has not been widespread. 14. If the modified approach is applied, depreciation of infrastructure assets is not recorded but all maintenance costs are expensed. Certain disclosures are required on the government-wide financial statements. This requirement includes disclosure that the government is accumulating certain information about particular infrastructure assets within either a network or subsystem of a network. The disclosure must include specific information about the minimum acceptable level for the network or subsystem of the network and that this level is being maintained and monitored by an asset management system. 15. A Management‘s Discussion and Analysis (MD&A) similar to that found in for-profit financial statements is required for state and local governments. The MD&A is presented before the financial statements and provides the following information:

(1) A brief discussion of the financial statements and information provided and their relationships to each other.

(2) Condensed financial information at least including

a. Total capital and other assets b. Total long-term and other liabilities c. Total net position, including amounts invested, in capital assets net of debt, restricted and unrestricted amounts d. Program revenues, by major source e. General revenues, by major source f. Total revenues g. Program expenses, by function h. Total expenses i. Excess or deficiency before contributions to term and permanent fund principal, special and extraordinary items, and transfers 17-83

Chapter 17 – Accounting for State and Local Governments (Part Two) – Hoyle, Schaefer, Doupnik, Advanced Accounting, 15e

j. Contributions k. Special and extraordinary items l. Transfers m. Change in net position n. Ending net position (3) Overall financial position and results of operations (4) Balances and transactions analyses with an explanation of significant changes (5) Analysis of significant variations between original and final budget amounts (6) Description of significant capital asset and long-term debt activity (7) Information about the modified approach for infrastructure assets (8) Any known facts, decisions, or conditions that are expected to significantly impact financial position or results of operations. 16. The Annual Comprehensive Financial Report (ACFR) includes three sections a. Introductory Section 1. Letter of transmittal 2. Organizational chart 3. List of principal officers b. Financial Section 1. MD&A (Management‘s Discussion & Analysis) 2. General purpose financial statements 3. Auditor‘s report 4. Other required supplementary information c. Statistical Section 17. A general-purpose government is a traditional government such as a city, county, or state. A special purpose government (such as a school system or transit authority) can also be a primary government for reporting purposes if it meets certain requirements. Classification as a special purpose government requires meeting three criteria: a. It has a separately elected governing body. b. It is legally independent. It can sue and be sued and buy, sell, and lease property. c. It is fiscally independent of other state and local governments. It can determine its own budget, levy and set tax rates, and issue bonded debt without outside approval. 18. Classification as a component unit requires an organization to meet one of two criteria: a. The activity is fiscally dependent on a primary government. It cannot determine its own budget, levy and set tax rates, or issue bonded debt without outside approval. Further, the primary government and the component unit must be financially interdependent (a relationship exists of potential financial benefit or burden between the two). or b. An outside primary government appoints a voting majority of the governing board of the activity. The primary government must also be able to do one or more of the following: impose its will on the board of the other organization, or provide a financial benefit to the component organization, or the component provides a financial benefit to the primary government. 19. If blended, component units are included in the primary government as if they were part of the government (the same as one of its own funds). The component unit is legally separate but so intertwined and substantially the same as the primary government that inclusion is necessary for appropriate presentation. A component unit will be blended if its total debt will be repaid 17-84 © McGraw Hill LLC. All rights reserved. No reproduction or distribution without the prior written consent of McGraw Hill LLC.

Chapter 17 – Accounting for State and Local Governments (Part Two) – Hoyle, Schaefer, Doupnik, Advanced Accounting, 15e

entirely, or almost entirely, from resources of the primary government. A discretely presented component unit is shown separately on the far-right side of the government-wide financial statements because the organization is not substantially the same as the government and can stand alone. 20. The two government-wide financial statements are the Statement of Net Position and the Statement of Activities. The Statement of Net Position includes: a. All assets and long-term liabilities. b. Capital assets net of accumulated depreciation including newly acquired infrastructure assets. c. Deferred outflows of resources and deferred inflows of resources. d. The primary government is divided into governmental activities and business-type activities. e. The internal balances reflect inter-activity transactions between governmental activities and business-type activities. These balances are offset in coming up with totals for the government. f. Discretely presented component units are shown to the far right of the statement. The Statement of Activities includes: a. Expenses reported by function for governmental activities, business-type activities and component units. b. Interest expense on long-term debt, often shown as a function. c. Related program revenues including charges for services, operating grants and contributions, and capital grants and contributions. d. Net expense or net revenue for each function. e. Net expense or net revenue for each category of the government. f. General revenues for governmental activities, business-type revenues, or component units. g. Special items that are significant transactions or other events within the control of management that are either unusual or infrequent in nature. h. Transfers between governmental activities and business-type activities. 21. The two fund financial statements for the governmental funds are the Balance Sheet and the Statement of Revenues, Expenditures, and Other Changes in Fund Balance. The Balance Sheet measures current financial resources and uses modified accrual accounting and includes: a. Separate columns are included for the general fund and every other major fund. They report current financial resources and claims against current financial resources. b. Non-major funds are combined and reported as ―other governmental funds.‖ c. Totals for the government funds. d. Fund Balance amounts should be classified as nonspendable, restricted, committed, assigned, or unassigned. The Statement of Revenues, Expenditures, and Other Changes in Fund Balance includes: a. The general fund and each major fund in separate columns, with all other funds combined in another column. b. Revenues. c. Expenditures. 17-85 © McGraw Hill LLC. All rights reserved. No reproduction or distribution without the prior written consent of McGraw Hill LLC.

Chapter 17 – Accounting for State and Local Governments (Part Two) – Hoyle, Schaefer, Doupnik, Advanced Accounting, 15e

d. Other financing sources and uses. e. Special items. f. A reconciliation between the ending change in fund balances and the ending change in net position for governmental activities in the government-wide financial statements. 22. Program revenues are those revenues derived from a specific program (such as parks and recreation) or from outsiders seeking to contribute to reduce the cost of that function. They include charges rendered for services, operating grants and contributions, and capital grants and contributions. General revenues are those from the population as a whole including property taxes, sales taxes, unrestricted grants, and investment income. They are not traced to any individual program, activity, or function. This distinction is important because program revenues are matched with expenses for each activity providing a net expense or net revenue figure to disclose the cost or the benefit of providing each activity. 23. The net expense or net revenue format allows the readers of a government‘s financial statements to determine the relative financial burden (or benefit) that each of its reporting functions has on its taxpayers. In other words, the users of the statement can determine what it costs for the government to provide benefits such as public safety or a library. 24. On government-wide financial statements, internal service funds are combined with the governmental activities (or business-type activities if that connection is more appropriate). Their placement is based on the identity of the functions that they primarily serve. If an internal service fund is mainly used to assist one or more governmental funds, then it should be included with the governmental activities. 25. A combination is viewed as a merger if two legally separate entities are brought together to form a new entity and no significant consideration is exchanged. A merger is also formed if one of those entities ceases to exist while the other continues. In a merger, the net carrying values for all assets, deferred outflows of resources, liabilities, and deferred inflows of resources are combined. No additional account balances are recognized. However, in an acquisition, a significant amount of consideration is exchanged. For government-wide financial statements, the acquiring government records all of the acquired assets, deferred outflows of resources, liabilities, and deferred inflows of resources (other than a few specific exceptions such as landfills) at acquisition value. Acquisition value is the market-based entry price—the amount that would have to be paid to acquire or discharge each item at this time. Any excess consideration is reported as a deferred outflow of resources on the statement of net position. This balance is written off to expense over a period of time that is determined based on several factors including the service life of capital assets, technology, and contracts acquired. When an acquisition takes place, fund financial statements record all of the acquired current financial resources and claims against those resources at acquisition value. 26. In for-profit accounting, excess consideration paid in an acquisition is reported as goodwill and then tested periodically for impairment. For a state or local government, excess consideration paid in an acquisition is not reported on the statement of net position as an asset but rather as a deferred outflow of resources. That balance is then allocated to expense over a period of time determined by an examination of several factors such as the service life of capital assets and technology. 17-86 © McGraw Hill LLC. All rights reserved. No reproduction or distribution without the prior written consent of McGraw Hill LLC.

Chapter 17 – Accounting for State and Local Governments (Part Two) – Hoyle, Schaefer, Doupnik, Advanced Accounting, 15e

27. From an external reporting perspective, FASB sets accounting standards for private colleges and universities whereas GASB sets standards for public schools. Operationally, public schools receive signficant funding from the government (usually a state government). Private universities rely more on tuition charges and endowment income. Because of the ability to generate funding from the government, public colleges and universities generally have smaller endowments. 28. Many public colleges and universities make the assumption that they are solely an Enterprise Fund because they are open to the public and have a user charge (tuition and other fees). An Enterprise Fund is a proprietary fund. For proprietary funds, government-wide financial statements and fund financial statements are quite similar. Consequently, authoritative guidelines allow such schools to produce only fund financial statements and avoid the redundancy of also creating government-wide statements. Answers to Problems

C (GASB Concepts Statements are nonauthoritative accounting literature.)

B (GASB Implementation Guides have a higher level of authority than does GASB Concepts Statements and should be followed. These implementation guides are classified as Category B authoritative literature. GASB Concepts Statements are classified as nonauthoritative.)

C (If no authoritative answer is available, accountants and auditors should look at how the authoritative literature handles similar transactions and events. Hopefully, the logic of those rules can be expanded to solve other accounting problems. In addition, accountants and auditors should study non-authoritative sources of GAAP such as GASB Concepts Statements and the official standards produced by FASB.)

A (A wide range of information must be disclosed about tax abatement agreements but the specific identity of the outside company receiving the benefits of the abatement does not have to be released.)

D (Tax abatements do not create an actual transaction. Therefore, only disclosure of the relevant facts is required.)

Chapter 17 – Accounting for State and Local Governments (Part Two) – Hoyle, Schaefer, Doupnik, Advanced Accounting, 15e

(The present value of the pension payments that have been earned to date is $49.8 million. The net position of the pension trust fund is $32.7 million. Thus, the $17.1 million difference is the net pension liability.) 7.

D (Changes in the amount of the pension liability that are necessary because of a change in economic or demographic assumptions are not expensed immediately. Instead, those amounts are recorded as either deferred outflows of resources or deferred inflows of resources and amortized to pension expense over a length of time that is set based on a number of factors.)

B (Because both parties have the same cash flows and the same interest rate, the present value will be $600,000 for both the lessor and the lessee. The life of the asset is six-years so amortization is $600,000/6 years or $100,000 per year. The first payment reduces the $600,000 liability by $112,581 down to $487,419. At a 5 percent annual rate, interest expense $24,371. Total expense is $124,371.)

C (As shown in 8, the liability is $487,419 after the first payment. Interest for the period at a 5 percent rate is $24,371. Adding that interest to the liability balance increases it to $511,790).

10.

D (The lessee recognizes an initial expenditure of $600,000, the present value of the cash flows. Nevertheless, when the first payment of $112,581, the lessee recognizes a second expenditure for the payment giving a total of $712,581.)

11.

C (The asset remains within the financial records of the lessor [despite the lease for the remaining life]. Net book value is $600,000 with a six year remaining life for amortization of $100,000 each year.)

12.

C (The original deferred lease revenue is $600,000. It must be reclassified as lease revenue over the six-year period in a systematic and rational manner. Because the straight-line method is applied, $100,000 is reported as lease revenue in the first year leaving $500,000 as the deferred lease revenue.) 17-88 © McGraw Hill LLC. All rights reserved. No reproduction or distribution without the prior written consent of McGraw Hill LLC.

Chapter 17 – Accounting for State and Local Governments (Part Two) – Hoyle, Schaefer, Doupnik, Advanced Accounting, 15e

13.

D (Because of the user charge, this landfill is most likely to be maintained as an enterprise fund.)

14.

C (The liability must be increased from 8 percent of $1 million to 19 percent. The 11 percent jump is recorded as expense.)

15.

C (The liability must be increased from 8 percent of $1 million to 19 percent. The 11 percent jump is recorded as expense.)

16.

A (The landfill creates no claim to current financial resources)

17.

18.

19.

20.

A (Sidewalks do not have an indefinite life and are depreciated unless the modified approach is used.)

21.

22.

23.

B (Special purpose governments do not have boundaries in the traditional way as general purpose governments do.)

24.

25.

26.

B (In a merger, these assets are combined at their net carrying amounts.)

27.

Chapter 17 – Accounting for State and Local Governments (Part Two) – Hoyle, Schaefer, Doupnik, Advanced Accounting, 15e

28.

29.

30.

31.

32.

(15 Minutes) (The reporting of a defined benefit pension plan by a state or local government) a. To determine the balance to be reported as a state or local government‘s net pension liability, an estimate is made of the total benefits that will have to be eventually paid. The portion of that amount that relates to employee past performance (or work that has already been done) is then determined. The present value of that part of the future cash flows is calculated. If this amount is greater than the net position reported by any related pension trust fund, the excess is reported in the government-wide financial statements as the net pension liability. b. For a state or local government, the amount of pension expense to be recognized in the current period is made up of several components including the service cost for the current period, interest expense on the debt, and projected earnings on plan investments. Any increases or decreases in the pension liability caused by changes in benefit terms are included in pension expense immediately. Finally, numerous assumptions are also necessary to arrive at a total amount to be paid (such as the life expectancy of retired individuals). The effect of any changes in those assumptions and differences between previous assumptions and actual experience is not included immediately within pension expense. Instead, such amounts are recorded as either deferred outflows of resources or deferred inflows of resources and amortized to pension expense over time (with the number of years based on several factors). c. Because pension plans often establish payments that will not be made until far into the future, reporting on the fund financial statements for governmental funds is often quite limited. Monetary amounts transferred to a pension trust fund must obviously be recorded. Otherwise, unless additional payments reduce current financial resources, no other reporting is necessary.

33.

(20 Minutes) (Recording leases by a state and local government as both a lessee and a lessor.) a. GOVERNMENT-WIDE FINANCIAL STATEMENTS Accounted for within the General Fund (within the Governmental Activities) 17-90 © McGraw Hill LLC. All rights reserved. No reproduction or distribution without the prior written consent of McGraw Hill LLC.

Chapter 17 – Accounting for State and Local Governments (Part Two) – Hoyle, Schaefer, Doupnik, Advanced Accounting, 15e

January 1, 2024 Right-of-Use Assets ($100,000 × 3.5771) Lease Liability Lease Liability Cash

357,710 357,710 100,000 100,000

December 31, 2024 Amortization Expense ($357,710/4 years) Right-of-Use Asset

89,428 89,428

Interest Expense ($257,710 × 8 percent) ................. 20,617 Lease Liability ............................................................................ 20,617 January 1, 2025 Lease Liability Cash

100,000 100,000

33. (continued) December 31, 2025 Amortization Expense ($357,710/4 years) Right-of-Use Asset

89,428 89,428

Interest Expense ($257,710 plus $20,617 less $100,000 × 8 percent) ..............................14,266 Lease Liability ............................................................................ 14,266 b. FUND FINANCIAL STATEMENTS Accounted for within the General Fund January 1, 2024 Expenditures – Lease Contract Other Financing Sources – Lease Contract

357,710 357,710

January 1, 2024 Expenditures – Leased School Desks .................. 100,000 Cash .......................................................................................... 100,000 January 1, 2025 Expenditures – Leased School Desks .................. 100,000 Cash .......................................................................................... 100,000 34.

(25 Minutes) (Calculate lease payments and make journal entries for lessor for both government-wide financial statements and fund financial statements.)

Chapter 17 – Accounting for State and Local Governments (Part Two) – Hoyle, Schaefer, Doupnik, Advanced Accounting, 15e

a. The lessor wants to make an implicit annual interest rate of 12 percent over the 18 year remaining life of the warehouse. The present value of an annuity due of $1 at a 12 percent annual rate for 18 periods is 8.11963. The net book value of the warehouse is $1.4 million. To earn the desired rate of return, the lessor charges $1,400,000/8.11963 or $172,422. b. GOVERNMENT-WIDE FINANCIAL STATEMENTS Accounted for within the Governmental Activities January 1, 2024 Lease Receivable ................................................. 1,400,000 Deferred Lease Revenue ...................................................... 1,400,000 34. (continued) (Because the $172,400 payments are assumed to be correctly determined, they have a present value equal to the net book value of the warehouse. The actual present value is slightly different, but the problem assumes it was calculated properly.) Cash ......................................................................... 172,400 Lease Receivable ..................................................................... 172,400 December 31, 2024 Deferred Lease Revenue ($1,400,000/18 years) Lease Revenue Depreciation Expense ($1,400,000/18 years) Accumulated Depreciation

77,778 77,778 77,778 77,778

Lease Receivable 147,312 Interest Revenue 147,312 (Lease receivable balance is $1,400,000 less payment of $172,400 leaves a balance for the year of $1,227,600. Interest at 12% is $147,312.) c. FUND FINANCIAL STATEMENTS

Accounted for within the General Fund January 1, 2024 Lease Receivable ................................................. 1,400,000 Deferred Lease Revenue ...................................................... 1,400,000 (Because the $172,400 payments are assumed to be correctly determined, they have a present value equal to the net book value of the warehouse. The actual present value is slightly different but the problem assumes 17-92 © McGraw Hill LLC. All rights reserved. No reproduction or distribution without the prior written consent of McGraw Hill LLC.

Chapter 17 – Accounting for State and Local Governments (Part Two) – Hoyle, Schaefer, Doupnik, Advanced Accounting, 15e

it was calculated properly.) Cash ......................................................................... 172,400 Lease Receivable ..................................................................... 172,400 December 31, 2024 Deferred Lease Revenue ($1,400,000/18 years) ..... 77,778 Lease Revenue

77,778

Depreciation is not recorded. The warehouse is not reported in the fund financial statements for the governmental funds. It is not a current financial resource. 34. (continued) Lease Receivable .................................................... 147,312 Interest Revenue 147,312 (Lease receivable balance is $1,400,000 less payment of $172,400 leaves a balance for the year of $1,227,600. Interest at 12% is $147,312.) 35.

(20 Minutes) (Journal entries for landfill on government-wide financial statements and fund financial statements) a. GOVERNMENT-WIDE FINANCIAL STATEMENTS Accounted for as an Enterprise Fund (within the Business-type Activities) December 31, 2024 Expense—Landfill Closure (3% of $1.9 million) Landfill Closure Liability Landfill Closure Liability Cash

57,000 57,000 50,000 50,000

December 31, 2025 Expense—Landfill Closure (9% of $2.1 million less $57,000) Landfill Closure Liability

132,000 132,000

Landfill Closure Liability Cash

50,000 50,000

b. GOVERNMENT-WIDE FINANCIAL STATEMENTS Accounted for within the General Fund (part of the Governmental Activities) December 31, 2024 17-93 © McGraw Hill LLC. All rights reserved. No reproduction or distribution without the prior written consent of McGraw Hill LLC.

Chapter 17 – Accounting for State and Local Governments (Part Two) – Hoyle, Schaefer, Doupnik, Advanced Accounting, 15e

Expense—Landfill Closure Landfill Closure Liability

57,000

Landfill Closure Liability Cash

50,000

57,000 50,000

December 31, 2025 Expense—Landfill Closure Landfill Closure Liability

132,000 132,000

35. (continued) Landfill Closure Liability Cash

50,000 50,000

c. FUND FINANCIAL STATEMENTS

Accounted for as an Enterprise Fund (within the Proprietary Funds) December 31, 2024 Expense—Landfill Closure Landfill Closure Liability

57,000 57,000

Landfill Closure Liability Cash

50,000 50,000

December 31, 2025 Expense—Landfill Closure Landfill Closure Liability

132,000

Landfill Closure Liability Cash

50,000

132,000 50,000

d. FUND FINANCIAL STATEMENTS Accounted for within the General Fund (one of the Governmental Funds) December 31, 2024 Expenditures—Landfill Closure Cash

50,000

December 31, 2025 Expenditures—Landfill Closure Cash

50,000

There are no other claims to the current financial resources held by the government.

Chapter 17 – Accounting for State and Local Governments (Part Two) – Hoyle, Schaefer, Doupnik, Advanced Accounting, 15e

36.

(10 Minutes) (Reporting a landfill in both government-wide financial statements and fund financial statements) a. GOVERNMENT-WIDE FINANCIAL STATEMENTS December 31, 2024 Landfill Closure Liability....... $1,296,000 (54 percent of $2.4 million) Expense—Landfill Closure$1,296,000 (amount needed to establish above liability) b. FUND FINANCIAL STATEMENTS December 31, 2024 Despite the huge eventual liability, nothing is reported at the end of 2024 because no claim to current financial resources exists at this time.

37.

(8 Minutes) (Reporting the donation of an artwork) a. GOVERNMENT-WIDE FINANCIAL STATEMENTS (recognize donation at fair value) Museum Piece—Artwork Revenue—Donation

$300,000 $300,000

b. GOVERNMENT-WIDE FINANCIAL STATEMENTS (Depreciation recognized) Museum Piece—Artwork $300,000 Accumulated Depreciation—Museum Piece (30,000) Net Book Value $270,000 Revenue—Donation $300,000 Depreciation Expense

$ 30,000

c. GOVERNMENT-WIDE FINANCIALSTATEMENTS (gift not recognized as an asset) Revenue – Donation $300,000 Expense – Artwork $300,000 38.

(5 Minutes) (Purchase of artwork with capitalization required) a. GOVERNMENT-WIDE FINANCIAL STATEMENTS (Governmental Activities)

Chapter 17 – Accounting for State and Local Governments (Part Two) – Hoyle, Schaefer, Doupnik, Advanced Accounting, 15e

January 1, 2024 Museum Piece—Artwork Cash

60,000

December 31, 2024 Depreciation Expense Accumulated Depreciation

3,000

60,000

3,000

b. FUND FINANCIAL STATEMENTS (General Fund) January 1, 2024 Expenditures—Artwork Cash 39.

60,000 60,000

(8 Minutes) (Accounting for infrastructure in government-wide financial statements) GOVERNMENT-WIDE FINANCIAL STATEMENTS One possibility: Infrastructure assets are capitalized with depreciation recorded Infrastructure Assets—Street Lights Cash Subsequent Entries Depreciation Expense Accumulated Depreciation —Infrastructure Assets

300,000 300,000 30,000 30,000

Maintenance Expense—Infrastructure Assets Cash

48,000 48,000

(There is no indication that any part of this cost should be capitalized. If this work extends the life of the assets beyond the original expectation, the debit here would be to Accumulated Depreciation.) Infrastructure Assets—Street Lights Cash

78,000 78,000

39. (continued) Second possibility: Infrastructure assets capitalized with government using the modified approach Infrastructure Assets—Street Lights 300,000 Cash 300,000

Chapter 17 – Accounting for State and Local Governments (Part Two) – Hoyle, Schaefer, Doupnik, Advanced Accounting, 15e

40.

Subsequent Entries (no depreciation reported) Maintenance Expense—Infrastructure Assets Cash

48,000

Infrastructure Assets—Street Lights Cash

78,000

48,000 78,000

(12 Minutes) (The reporting of a special purpose government and a component unit) a. The major criterion for inclusion in a government‘s annual comprehensive financial report (ACFR) is financial accountability. b. An activity is viewed as a special purpose government if it meets the following criteria: 1. Has a separately elected governing board 2. Is legally separate 3. Is fiscally independent of other governments c. Legal separation is usually demonstrated by having corporate powers such as the right to buy and sell property and the right to sue and be sued. Corporate powers depend on state law; thus, determination of legal separation may differ from one state to another. d. The fiscal independence of a government is indicated by having authority to do specific actions: 1. Determine and modify its budget without having to get the approval of another government 2. Levy taxes and set rate fees without having to get the approval of another government 3. Issue bonded debt without having to get the approval of another government e. A component unit is any activity that is legally separate from a primary government but so closely tied to that government that some inclusion in the government‘s ACFR is necessary. The account balances of the component unit are included along with the financial statements of the primary government. However, these reported figures are normally

40. (continued) discretely presented separate from the balances of the primary government. The financial information for the components is usually reported to the right side of the primary government in government-wide statements. All component units may be shown individually, combined into a single 17-97 © McGraw Hill LLC. All rights reserved. No reproduction or distribution without the prior written consent of McGraw Hill LLC.

Chapter 17 – Accounting for State and Local Governments (Part Two) – Hoyle, Schaefer, Doupnik, Advanced Accounting, 15e

column, or combined into separate columns for governmental and business-type operations. As indicated in (g) below, blending is also a possible method for reporting a component unit by including the activity as if it were a fund of the separate government. f. One of the criteria for identifying a component unit includes the primary government‘s ability to impose its will on the component unit. A primary government is assumed to have this ability if it can (1) remove an appointed board member at will, (2) modify or approve budgets, (3) override decisions of the board, or (4) hire as well as dismiss the individuals in charge of the day-to-day activities of the component unit. g. Normally, as indicated above, the financial position and operations of a component unit are shown separately from the primary government. However, if the component unit is sufficiently intertwined with the primary government, it can be included within the government figures (as if it were a fund). Inclusion in this manner is referred to as blending. A component unit must be blended if its total debt will be repaid entirely, or almost entirely, from resources of the primary government. 41.

(15 Minutes) (Journal entries for an enterprise fund)

1/1/24

Cash

160,000 Capital Contributions

2/1/24 3/1/24 4/1/24 5/1/24 6/1/24 7/1/24

160,000

Cash

130,000

Notes Payable No Journal Entry—Only a Commitment Truck Cash Cash Deferred Revenue Prepaid Rent Cash Accounts Receivable Revenues--Services Cash Accounts Receivable

130,000

110,000 110,000 20,000 20,000 12,000 12,000 13,000 13,000 11,000 11,000

41. (continued) 8/1/24

9/1/24

Interest Expense (130,000 × 12% × 6/12) Notes Payable ($10,000 –$7,800) Cash Salaries Expense

7,800 2,200 10,000 18,000

Chapter 17 – Accounting for State and Local Governments (Part Two) – Hoyle, Schaefer, Doupnik, Advanced Accounting, 15e

10/1/24 11/1/24

12/31/24

Cash Deferred Revenue Revenue—Grant Maintenance Expense Cash Salaries Expense Cash Deferred Revenue Revenue—Grant Accounts Receivable Revenues—Services Cash Accounts Receivable

18,000 18,000 18,000 1,000 1,000 10,000 10,000 2,000 2,000 19,000 19,000 3,000 3,000

ADJUSTING ENTRIES 12/31/24 Interest Expense (127,800 × 12% × 5/12) Interest Payable 12/31/24 Depreciation Expense (110,000 × 1/10 × 9/12) Accumulated Depreciation 12/31/24 Rent Expense ($1,000 × 7 months) Prepaid Rent 12/31/24 Expense-Landfill Closure Landfill Closure Liability (12% of current cost total of $4 million)

6,390 6,390 8,250 8,250 7,000 7,000 480,000 480,000

Chapter 17 – Accounting for State and Local Governments (Part Two) – Hoyle, Schaefer, Doupnik, Advanced Accounting, 15e

42.

(65 Minutes) (Prepare financial statements for government-wide financial statements and fund financial statements) a. CITY OF WILLIAMSON STATEMENT OF ACTIVITIES For Year Ended December 31, 2024

Functions/Programs Governmental activities General Government Public Safety Health and Sanitation Interest on Debt Total governmental activities

Expenses $149,000 90,000 70,000 16,000 $325,000

Program Revenues Operating Charges for Grants and Services Contributions

Net (Expense) Revenue and Changes in Net Position Capital Grants and Contributions

Governmental Activities

$ 5,000 3,000 42,000

$14,000

$50,000

$14,000

($130,000) ( 87,000) (28,000) (16,000) ($261,000)

Business-type Activities

Total $130,000) (87,000) (28,000) (16,000) $261,000

General Revenues: Property taxes Franchise taxes Investments (gain)

$401,000 42,000 13,000

Total general revenues Change in net position Net position—beginning Net position—ending

$456,000 195,000 0 $195,000

Chapter 17 – Accounting for State and Local Governments (Part Two) – Hoyle, Schaefer, Doupnik, Advanced Accounting, 15e

42. a. (continued) Computations: General Governmental -- [$66,000 + 11,000 + 21,000 + 8,000 + 4,000 (salaries payable) + 13,000 (compensated absences) + 14,000 (art work) + 12,000 (depreciation on building: $120,000/10 years)] = $149,000 Public Safety - [$39,000 + 18,000 + 5,000 + 9,000 (expired insurance) + 12,000 (supplies used) + 7,000 (salaries payable)] = $90,000 Health and Sanitation -- [$22,000 + 3,000 + 9,000 + 12,000 + 8,000 (salaries payable) + 16,000 (depreciation on equipment: $80,000/5 years)] = $70,000

CITY OF WILLIAMSON STATEMENT OF NET POSITION December 31, 2024 Governmental Activities Assets Cash and cash equivalents Prepaid expenses Investments Receivables (net) Inventories Capital assets (net) Total assets Liabilities Salaries payable Compensated absences liability Noncurrent liabilities Net position Invested in capital assets, net of related debt Unrestricted (deficit) Total net position

Business-type Activities

Total

$ 62,000 2,000 103,000 81,000 3,000 172,000 $ 423,000

$ 62,000 2,000 103,000 81,000 3,000 172,000 $423,000

19,000 13,000 196,000 $228,000

(24,000) 219,000 $195,000

Chapter 17 – Accounting for State and Local Governments (Part Two) – Hoyle, Schaefer, Doupnik, Advanced Accounting, 15e

42. (continued) b. CITY OF WILLIAMSON STATEMENT OF REVENUES, EXPENDITURES, AND OTHER CHANGES IN FUND BALANCES Governmental Funds For Year Ended December 31, 2024 General Fund

Total Government Funds

$401,000 42,000 50,000 13,000 $506,000

$110,000 90,000 54,000

4,000 16,000

Capital Outlay Total Expenditures Excess (Deficiency) of Revenues over Expenses Other Financing Sources: Proceeds from Long-term Note

200,000 $474,000 32,000

200,000

Total Other Sources

200,000

Net Changes in Fund Balance Fund Balances (Beginning) Fund Balances (Ending)

232,000 -0$232,000

Revenues: Property Taxes Franchise Taxes Charges for Services Investments (Gain) Expenditures: General Government Public Safety Health and Sanitation Debt Service: Principal Payment on Debt Interest on Debt

Chapter 17 – Accounting for State and Local Governments (Part Two) – Hoyle, Schaefer, Doupnik, Advanced Accounting, 15e

42. b. (continued) CITY OF WILLIAMSON BALANCE SHEET Governmental Funds December 31, 2024 General Fund

Total Governmental Funds

Assets Cash and cash equivalents Prepaid expenses Investments Receivables, net Inventories Total assets

$ 62,000 2,000 103,000 81,000 3,000 $251,000

Liabilities Salaries payable Total Liabilities

19,000 $ 19,000

Fund Balances —Nonspendable —Committed for Equipment —Unassigned Total Fund Balances

5,000 12,000 215,000 232,000

Total Liabilities and Fund Balances

$251,000

Chapter 17 – Accounting for State and Local Governments (Part Two) – Hoyle, Schaefer, Doupnik, Advanced Accounting, 15e

43.

(70 Minutes) (Prepare financial statements for government-wide financial statements and fund financial statements)

a. CITY OF BERNARD STATEMENT OF ACTIVITIES For Year Ended December 31, 2024 Functions/Programs

Governmental Activities: General Government Public Safety Public Works Health and Sanitation Interest on Debt Total Governmental Activities

Expenses

Program Revenues Charges Grants and for Contributions Services

Net (Expense) Revenue and Changes in Net Position Governmental Activities Total

$180,000

$15,000

($165,000)

158,000 159,500 37,000

8,000 12,000 31,000

$25,000

( 150,000) (147,500) 19,000

42,000 $576,500

$66,000

$25,000

(42,000) ($485,500)

General Revenues: Property Taxes Sales Taxes Dividend Income Gain on Sale of Investments Gain on Value of Investments Total general revenues

$630,000 99,000 20,000 14,000 5,000 $768,000

Change in net position: Change during 2024 Net position—beginning Net position—ending

$282,500 120,000 $402,500

Chapter 01 - The Equity Method of Accounting for Investments – Hoyle, Schaefer, Doupnik, Advanced Accounting, 15e

43. a. (continued) Computations: General Governmental -- [$90,000 + 9,000 + 25,000 + 12,000 + 14,000 (salaries payable) + 30,000 depreciation] = $180,000 Public Safety -- [$94,000 + 16,000 + 12,000 + 10,000 + 17,000 (salaries payable) + 9,000 depreciation] = $158,000 Public Works -- [$69,000 + 13,000 + 9,000 + 5,000 (salaries payable) + 14,000 supplies expense + 39,000 landfill closing costs + 10,500 depreciation] = $159,500 Health and Sanitation -- [$22,000 + 4,000 + 4,000 + 7,000] = 37,000 Landfill -- [260,000 × 15%] = $39,000 CITY OF BERNARD STATEMENT OF NET POSITION December 31, 2024 Governmental Activities

Totals

Assets Current Assets: Cash and Cash Equivalents Prepaid Insurance Investments Receivables (net) Supplies Total Current Assets Capital Assets: Building-General Government (net of depreciation) Building-Public Works (net of depreciation) Equipment (net of depreciation) Truck Total Assets

$139,000 6,000 116,000 120,000 6,000 387,000

$240,000

199,500

81,000 64,000

$971,500

$ 36,000

43 a. (continued) Liabilities Current Liabilities: Salaries Payable Noncurrent Liabilities:

Chapter 17 – Accounting for State and Local Governments (Part Two) – Hoyle, Schaefer, Doupnik, Advanced Accounting, 15e

Bank Loan Payable Closure Liability Landfill Long-term Notes Payable Total Liabilities

$ 64,000 39,000 430,000 569,000

154,500

3,000 245,000 $402,500

Net Position Invested in Capital Assets, Net of Related Debt Restricted for Salaries (Grant) Unrestricted (deficit) Total Net Position 43. (continued) b. CITY OF BERNARD STATEMENT OF REVENUES, EXPENDITURES, AND OTHER CHANGES IN FUND BALANCES - Governmental Funds For Year Ended December 31, 2024 General Fund Revenues: Property taxes Sales taxes Dividend income Charges for services Grant Investments (realized gain) Investments (unrealized gain) Total

$630,000 99,000 20,000 66,000 25,000 14,000 5,000 $859,000

Expenditures: Current: General governmental Public safety Public works Health and sanitation

$150,000 149,000 122,000 37,000

Debt Service: Principal payment on debt Interest on debt

10,000 42,000

Capital Outlay: Building Equipment Truck

210,000 90,000 64,000 1-2

Chapter 01 - The Equity Method of Accounting for Investments – Hoyle, Schaefer, Doupnik, Advanced Accounting, 15e

Total expenditures Excess (deficiency) of revenues over expenses) Other Financing Sources: Proceeds from long-term note Proceeds from bank loan

$874,000 $(15,000)

200,000 64,000

Total other financing sources

264,000

Net changes in fund balance

249,000

Fund balance—beginning

90,000

Fund balance—ending (other than nonspendable)

$339,000*

*The fund balance shown here is $339,000. Of that amount, $31,000 is committed for the encumbrances for supplies and equipment. Another $3,000 is restricted for the payment of salaries for health care workers ($25,000 grant less $22,000 spent this year). That leaves $305,000 as unassigned. Because the government applies the purchases method to supplies and prepaid expenses, neither asset nor fund balance has yet been recorded for the $12,000 amount still held at the end of the year. Those balances are recorded at year-end. This recording increases the assets by that amount as well as the fund balance classified as nonspendable. CITY OF BERNARD BALANCE SHEET Governmental Funds December 31, 2024 General Fund ASSETS Cash and cash equivalents Investments Receivables, net Supplies Prepaid Insurance

$139,000 116,000 120,000 6,000 6,000

Total Assets

$387,000

LIABILITIES AND FUND BALANCES Liabilities: Salaries Payable

$ 36,000

Fund Balances: --Nonspendable ..................................................... 12,000

Chapter 17 – Accounting for State and Local Governments (Part Two) – Hoyle, Schaefer, Doupnik, Advanced Accounting, 15e

--Restricted for Salaries .......................................... 3,000 --Committed for Equipment and Supplies........... 31,000 --Unassigned ....................................................... 305,000

$351,000

Total Liabilities and Fund Balance

$387,000

44.

(75 Minutes) (Prepare government-wide financial statements) One way to accumulate the information here for the government-wide financial statements is to prepare journal entries for the listed transactions. a. The transfer is within the governmental activities and is not recorded. Governmental Activities—Parks and Recreation Land Cash

20,000 20,000

b. Governmental Activities—Parks and Recreation Cash 110,000 Bonds Payable

110,000

c. Governmental Activities—General Cash Property Tax Receivable General Revenues—Property Taxes

600,000

510,000 90,000

d. Governmental Activities—Parks and Recreation Building 80,000 Cash

80,000

e. Governmental Activities—Parks and Recreation Sidewalk Cash

10,000

f. Governmental Activities—Parks and Recreation Cash Program Revenues—Park g. Business-Type Activities—Civic Auditorium Parking Deck

10,000

8,000 8,000

200,000

Chapter 01 - The Equity Method of Accounting for Investments – Hoyle, Schaefer, Doupnik, Advanced Accounting, 15e

Cash Notes Payable

20,000 180,000

h. Governmental Activities—Education Cash Deferred Revenues

100,000 100,000

Expenses—School Lunches Cash

37,000

Deferred Revenues Program Revenues—Operating Grant

37,000

i. Governmental Activities—Education Cash Receivables—School Fees Program Revenues—School Fees j. Governmental Activities—Education Supplies Cash Expenses—Supplies Supplies

37,000

5,400 600 6,000

22,000 22,000 17,000 17,000

k. Governmental Activities—Education Expenses—Art Program Revenues—Capital Gift l. Governmental Activities—General Transfers Cash

80,000 80,000

20,000 20,000

Business-Type Activities—Civic Auditorium Cash Transfers

20,000 20,000

m. No entry n. Governmental Activities—Education School Bus

102,000

Chapter 17 – Accounting for State and Local Governments (Part Two) – Hoyle, Schaefer, Doupnik, Advanced Accounting, 15e

Cash

102,000

o. Governmental Activities—Education Expenses—Salaries Expenses—Vacations Cash Salary Payable Vacations Payable p. Business-Type Activities—Civic Auditorium Expenses—Salaries Expenses—Vacations Cash Salary Payable Vacations Payable q. Business-Type Activities—Civic Auditorium Cash Rent Receivable Program Revenues—Rent r. Governmental Activities—Parks and Recreation Expenses—Maintenance Cash 45.

270,000 23,000 240,000 30,000 23,000

45,000 5,000 42,000 3,000 5,000

110,000 20,000 130,000

9,000 9,000

(continued) s. Governmental Activities—Parks and Recreation Expenses—Interest Bonds Payable Cash

9,000 5,000

t. Business-Type Activities—Civic Auditorium Expenses— Interest 13,000 Interest Payable

14,000

13,000

No entries are needed for the financial information from the museum. The totals for the period are provided for reporting purposes. Also: Depreciation Entries:

Chapter 01 - The Equity Method of Accounting for Investments – Hoyle, Schaefer, Doupnik, Advanced Accounting, 15e

Governmental Activities—Education (School Building—$1,000,000/20 years) Expenses—Depreciation Accumulated Depreciation Governmental Activities—Parks and Recreation (Building—$80,000/10 years × 1/2) Expenses—Depreciation Accumulated Depreciation Business-Type Activities—Civic Auditorium ($600,000/30 years) Expenses—Depreciation Accumulated Depreciation Governmental Activities—Education (School Bus—$102,000/5 years × 3/12) Expenses—Depreciation Accumulated Depreciation Business-Type Activities—Parking Deck ($200,000/20 years × 1/2) Expenses—Depreciation Accumulated Depreciation

50,000 50,000

4,000 4,000

20,000 20,000

5,100 5,100

5,000 5,000

Balances for all of the above accounts can be determined by posting each of these entries.

Chapter 17 – Accounting for State and Local Governments (Part Two) – Hoyle, Schaefer, Doupnik, Advanced Accounting, 15e

44.

(continued City of Pfeiffer Statement of Activities Government-Wide Financial Statements Year ending December 31, 2024

Expenses

Program Revenues

—Education —Parks and Recreation Total for Governmental

$482,100

$ 6,000

22,000

8,000

Activities Business-Type Activities —Civic Auditorium Total for Primary

$504,100

$14,000

88,000

130,000

Government Component Unit: —Museum

$592,100

$144,000

$ 42,000

$ 50,000

Net (Expenses)/R evenues Government al

Grants and Gifts

BusinessType

Componen t Unit

Total

Governmental Activities

General Revenues —Property Taxes Transfers Total General Revenues and Transfers Change in Net Position Net Position, Beginning of Year Net Position, End of Year

$117,000

$117,0 00

$117,000

$ (359,100)

( 14,000)

$(373,100)

$ (373,100)

$ 42,000

42,000

$ 42,000

$ (331,100) $ 8,000

600,000 (20,000) $ 80,000

20,000 $ 20,000

600,000 -0$ 600,000

-0-

$ 206,900 1,123,000 $1,329,900

$ 62,000 662,000 $724,000

$ 268,900 1,785,000 $2,053,900

$ 8,000 106,000 $114,000

Chapter 01 - The Equity Method of Accounting for Investments – Hoyle, Schaefer, Doupnik, Advanced Accounting, 15e

44.

(continued) City of Pfeiffer Statement of Net Position Government-Wide Financial Statements Decem ber 31, 2024 Governmental Activities

Business-Type Activities

Total

Component Unit

Assets: —Cash —Property Tax Receivables —Receivables-School Fees —Rent Receivable —Supplies —Land —Sidewalk —School Bus —Parking Deck (net) —Buildings (net)

$ 302,400 90,000 600 -05,000 20,000 10,000 96,900 -01,026,000

$130,000 -0-020,000 -0-0-0-0195,000 580,000

$ 432,400 90,000 600 20,000 5,000 20,000 10,000 96,900 195,000 1,606,000

$ 24,000 -0-0-0-0-0-0-0-0300,000

Total Assets

$1,550,900

$925,000

$2,475,900

$324,000

Liabilities: —Salary Payable —Vacation Payable —Interest Payable —Deferred Revenues (*) —Bonds and Notes Payable

$ 30,000 23,000 -063,000 105,000

$ 3,000 5,000 13,000 -0180,000

$ 33,000 28,000 13,000 63,000 285,000

$ -0-0 -0-0210,000

Total Liabilities

$221,000

$201,000

$422,000

$210,000

$1,047,900 282,000 $1,329,900

$582,000 142,000 $724,000

$1,629,900 424,000 $2,053,900

$ 90,000 24,000 $114,000

Net Position: —Capital Assets, less Related Debt —Unrestricted Total Net Position

(*) The deferred revenue is a liability and not a deferred inflow of resources because an action is required rather than the simple passage of time. 45.

(70 Minutes) (Prepare fund financial statements) One way to accumulate the information for the fund financial statements is to prepare journal entries for the listed transactions. a. General Fund Other Financing Uses—Transfer Cash Capital Projects Fund Cash Other Financing Sources—Transfer

70,000 70,000 70,000 70,000

Chapter 17 – Accounting for State and Local Governments (Part Two) – Hoyle, Schaefer, Doupnik, Advanced Accounting, 15e

45. (continued) Expenditures—Land Cash

20,000 20,000

b. Capital Projects Fund Cash Other Financing Sources—Bond c. General Fund Cash Property Tax Receivable Revenues—Property Taxes Unavailable Property Tax Collections d. Capital Projects Fund Expenditures—Building Cash

110,000 110,000

510,000 90,000 560,000 40,000

80,000 80,000

e. Capital Projects Fund Expenditures—Sidewalk Cash

10,000 10,000

f. General Fund Cash Revenues—Park

8,000 8,000

g. Enterprise Fund Parking Deck Cash Notes Payable

200,000 20,000 180,000

h. Special Revenue Fund Cash Deferred Revenues

100,000 100,000

Expenditures—School Lunches Cash

37,000 37,000

Chapter 01 - The Equity Method of Accounting for Investments – Hoyle, Schaefer, Doupnik, Advanced Accounting, 15e

Deferred Revenues Revenues—Operating Grant i. General Fund Cash Receivables—School Fees Revenues—School Fees

37,000 37,000

5,400 600 6,000

j. General Fund Expenditures—Supplies Cash

22,000 22,000

k. No entry because there is no impact on current financial resources. l. General Fund Other Financing Uses—Transfer Cash Enterprise Fund Cash Other Financing Sources - Transfers-in m. General Fund Encumbrances - School Bus Encumbrances Outstanding n. General Fund Encumbrances Outstanding Encumbrances – School Bus Expenditures—School Bus Cash

20,000 20,000 20,000 20,000

99,000 99,000

99,000 99,000 102,000 102,000

o. General Fund Expenditures—Salaries Cash Salary Payable

270,000 240,000 30,000

p. Enterprise Fund Expenses—Salaries

45,000 1-11

Chapter 17 – Accounting for State and Local Governments (Part Two) – Hoyle, Schaefer, Doupnik, Advanced Accounting, 15e

Expenses—Vacations Cash Salary Payable Vacations Payable

5,000 42,000 3,000 5,000

q. Enterprise Fund Cash Rent Receivable Program Revenues—Rent

110,000 20,000 130,000

r. General Fund Expenditures—Maintenance Cash

9,000 9,000

45. (continued) s. General Fund (mention is made that no separate Debt Service Fund is used) Expenditures—Interest 9,000 Expenditures—Bonds Payable 5,000 Cash 14,000 t. Enterprise Fund Expenses—Interest Interest Payable

13,000 13,000

Also: Recognition of remaining supplies (from j above) General Fund Supplies Fund Balance—Nonspendable

5,000 5,000

Depreciation Entries: Enterprise Fund—Civic Auditorium ($600,000/30) Expenses—Depreciation 20,000 Accumulated Depreciation

20,000

Enterprise Fund—Parking Deck [($200,000/20) x ½] Expenses—Depreciation 5,000 Accumulated Depreciation

5,000

Chapter 01 - The Equity Method of Accounting for Investments – Hoyle, Schaefer, Doupnik, Advanced Accounting, 15e

Balances for the above accounts can be determined by posting each of these entries into the appropriate ledger account.

Chapter 17 – Accounting for State and Local Governments (Part Two) – Hoyle, Schaefer, Doupnik, Advanced Accounting, 15e

45.

(continued) City of Pfeiffer Statement of Revenues, Expenditures, and Changes in Fund Balance Fund Financial Statements – Governmental Funds Year ending December 31, 2024

General Fund Revenues Property Taxes -Park -Operating Grant -School Fees Total Revenues Expenditures -Land -Buildings -Sidewalk -School Lunches -Supplies -School Bus -Salaries -Maintenance -Interest -Bond Payment Total Expenditures Excess (deficiency) of revenues over expenditures

Special Revenue Funds

Capital Projects Funds

Total Governmental Funds

$560,000 8,000 -06,000 $574,000

$ -0-037,000 -0$ 37,000

$ -0-0-0-0$ -0-

$560,000 8,000 37,000 6,000 $611,000

$ -0-0-0-022,000 102,000 270,000 9,000 9,000 5,000 $417,000

$ -0-0-037,000 -0-0-0-0-0-0$37,000

$ 20,000 80,000 10,000 -0-0-0-0-0-0-0$110,000

$ 20,000 80,000 10,000 37,000 22,000 102,000 270,000 9,000 9,000 5,000 $564,000

$157,000

$ -0-

$(110,000)

$ 47,000

Other Financing Sources (Uses) -Other Financing Sources -Other Financing Uses

-0-

180,000

(90,000)

-0-

(90,000)

Total Other Financing Sources (Uses)

$(90,000)

$ -0-

$180,000

$ 90,000

Change in Fund Balance

$ 67,000

$ -0-

$ 70,000

$137,000

Fund Balance – Beginning

123,000

-0-

123,000

Fund Balance – Ending

$190,000

$ -0-

$70,000

$260,000

Chapter 01 - The Equity Method of Accounting for Investments – Hoyle, Schaefer, Doupnik, Advanced Accounting, 15e

45.

(continued) City of Pfeiffer Balance Sheet Fund Financial Statements - Governmental Funds December 31, 2024

General Fund Assets -Cash -Property Tax Receivable -Receivables – School Fees -Supplies

Special Revenue Funds

Capital Projects Funds

Total Governmental Funds

$169,400

$63,000

$70,000

90,000

-0-

$302,400 X 90,000

600 5,000

-0-0-

600 5,000

Total Assets

$265,000

$63,000

$70,000

$398,000

Liabilities -Salary Payable -Deferred Revenues

$ 30,000 40,000

$ -063,000

$ -0-0-

$ 30,000 103,000

Total Liabilities

$ 70,000

$63,000

$ -0-

$133,000

Fund Balances -Nonspendable -Committed -Unassigned

$ 5,000 -0190,000

$ -0-0-0-

$ -070,000 -0-

$ 5,000 70,000 190,000

Total Fund Balances

$195,000

$ -0-

$70,000

$265,000

Total Liabilities And Fund Balances

$265,000

$63,000

$70,000

$398,000

Chapter 17 – Accounting for State and Local Governments (Part Two) – Hoyle, Schaefer, Doupnik, Advanced Accounting, 15e

45.

(continued) City of Pfeiffer Statement of Revenues, Expenses, and Changes in Net Position Fund Financial Statements—Proprietary Funds Year Ending December 31, 2024 Enterprise Fund (Civic Auditorium)

Operating Revenues —Rent Revenues

$130,000

Operating Expenses —Salaries —Vacations —Depreciation

$ 45,000 5,000 25,000

Total Operating Expenses

$ 75,000

Operating Income

$ 55,000

Non-operating Expenses —Interest Expense

$ 13,000

Income before Capital Contribution

$ 42,000

Capital Contribution

20,000

Change in Net Position

$ 62,000

Total Net Position—Beginning

662,000

Total Net Position—Ending

$724,000

Chapter 01 - The Equity Method of Accounting for Investments – Hoyle, Schaefer, Doupnik, Advanced Accounting, 15e

45.

(continued) City of Pfeiffer Statement of Net Position Fund Financial Statements—Proprietary Funds December 31, 2024 Enterprise Fund (Civic Auditorium)

Assets Current Assets —Cash —Rent Receivable

$130,000 20,000

Total Current Assets

$150,000

Noncurrent Assets —Parking Deck (net) —Buildings (net)

$195,000 580,000

Total Noncurrent Assets

$775,000

Total Assets

$925,000

Liabilities Current Liabilities —Salary Payable —Vacation Payable —Interest Payable

$ 3,000 5,000 13,000

Total Current Liabilities

$ 21,000

Noncurrent Liabilities —Notes Payable

$180,000

Total Liabilities

$201,000

Net Position —Invested in Capital Assets, less related debt —Unrestricted

$582,000 142,000

Total Net Position

$724,000

Chapter 17 – Accounting for State and Local Governments (Part Two) – Hoyle, Schaefer, Doupnik, Advanced Accounting, 15e

46.

(24 Minutes) (Impact of various government transactions) a. False – A pension trust fund is one of the fiduciary funds because the money cannot be used by city officials for the benefit of the government. Fiduciary funds do not appear in the government-wide financial statements although separate statements are presented as part of the fund financial statements. Any net pension liability does appear in the government-wide financial statements but that is not the question here. b. True – The permanent funds are included within the governmental funds because the income generated from the resources being held is to be used by the government. Although the principal amount cannot be spent by government officials, the income can. c. True – A commitment of current financial resources was made when this order was placed. Thus, an encumbrance should have been recognized at that time. However, the actual amount of the obligation proved to be slightly higher. When the liability was incurred, the original encumbrance should have been removed and the expenditure recorded for the actual amount of current financial resources required. d. True – The expense to be recognized each year is the adjustment required to establish the proper liability. At the end of Year 1, that liability should be $96,000 or 12 percent of $800,000. At the end of the second year, the liability has grown to $172,000 (20 percent of $860,000). Increasing the liability from $96,000 to $172,000 necessitates an expense of $76,000. Even though the question relates to the fund financial statements, Enterprise Funds accrue expenses as incurred in the same way as in government-wide financial statements. e. True – The expense to be recognized each year is the adjustment required in the liability. At the end of Year 1, that liability should be $99,000 or 11 percent of $900,000. At the end of the second year, the liability has grown to $170,000 (20 percent of $850,000). Increasing the liability from $99,000 to $170,000 necessitates an expense of $71,000. Although the question relates to the General Fund, government-wide financial statements always accrue expenses as incurred. f. False – A Custodial (Agency) Fund is used when passing money through the government to a specified recipient. Thus, the only two accounts typically found in a Custodial Fund are cash (or similar monetary assets) and the liability to indicate where that cash is destined.

46. (continued) g. False – State and local government accounting does not divide lease 1-18 © McGraw Hill LLC. All rights reserved. No reproduction or distribution without the prior written consent of McGraw Hill LLC.

Chapter 01 - The Equity Method of Accounting for Investments – Hoyle, Schaefer, Doupnik, Advanced Accounting, 15e

contracts between operating and financing leases. State and local governments use a single model unless a lease is for a maximum of one year or less. h. False – When serving as a lessor, state and local governments do not remove leased assets from the financial records. Depreciation continues to be determined to reflect the cost of the lease. i. True – The handling of a lease on fund financial statements parallels the acquisition of a capital asset by the signing of a long-term note. The present value of the payments is shown as both an expenditure and an other financing source. A second expenditure is recorded to reflect the actual payments. 47.

(12 Minutes) (Recording the gift of a work of art) a. This gift did not involve a current financial resource and should not have been recorded in the fund financial statements (for the governmental funds). In this problem, nothing indicates that it was recorded in the fund financial statements. Recording of the asset and depreciation is only made in the government-wide statements. Thus, the increase in the fund balance of $30,000 was correct and should not be changed. b. Apparently, in the government-wide financial statements, revenue of $15,000 was reported when the asset was recognized at that value. Depreciation recognized for the first year would have been $500 ($15,000 capitalized amount allocated over a 30-year life) so that an increase in the net position was reported as $14,500. That was the result of the reporting process. If the allowed alternative had been followed as officials wished, both revenue and expense would have been increased initially by $15,000 for no net effect. The increase and decrease cancel out each other. Consequently, removing the $14,500 increase that was reported (so that no net effect is shown) changes the net expense figure for this function from $130,000 to $144,500. c. Government officials wanted to use the alternative which was to record an expense (rather than an asset) along with a revenue for the donation. However, no entry was made by the art museum. Thus, there was no change created in the net position figure. Had the desired entry been made, both revenue and expense would have risen by $15,000, but then, again, no net effect would result because they would have off set each other. Although the individual totals are wrong, the increase in net position stays at $140,000

48.

(5 Minutes) (Reporting a component unit)

Chapter 17 – Accounting for State and Local Governments (Part Two) – Hoyle, Schaefer, Doupnik, Advanced Accounting, 15e

The revenue of $30,000 and the expense of $42,000 were not included within the primary government figures for the government-wide financial statements. They were discretely presented but should have been blended. Adding these two figures to the primary government-wide totals reduces the overall increase in net position by $12,000 ($30,000 minus $42,000) from $140,000 to $128,000. 49.

(10 Minutes) (Recording a city landfill) a. Apparently, the amounts recorded this year (in the parks which is within the General Fund) were in the wrong fund. The landfill should have continued to be reported as an Enterprise Fund. By itself, that does not have any net impact on the net position reported for the entire government on the government-wide statements. The amounts are simply in the wrong columns. However, the clean-up liability has not been reported for the current year (the problem says that no other recording was made this year). An additional 8 percent was filled in the current year so that the liability to be reported should have increased by $16,000 (8 percent of $200,000). That needed adjustment reduces the overall increase in net position from $140,000 to $124,000. b. Revenues ($4,000) and expenses ($15,000) for the current year must now be moved from the General Fund to the Enterprise Funds ($11,000 net reduction). In addition, the $16,000 clean-up liability computed in (a) above should be recorded here so that the overall decrease in net position in connection with the landfill is $27,000 ($11,000 + $16,000). For the Enterprise Funds, the net increase is net position is not $60,000 but rather $33,000. c. Revenues and expenditures have been correctly reported this year within the General Fund. In addition, there is no indication that the clean-up costs for the landfill will require any current financial resources. Thus, no part of that cost needs to be reported in the fund financial statements. The increase in the fund balance of the General Fund of $30,000 appears to be correct.

50.

(6 Minutes) (Recording and depreciating capital assets) a. The modified approach only applies to infrastructure assets and not to machines and the like that have a definite life. Thus, $4,000 in depreciation expense for the year ($20,000/5 years) has been incorrectly omitted. Including the recording of depreciation reduces the increase in net position from $140,000 to $136,000. b. The depreciation expense discussed in (a) above increases the net 1-20 © McGraw Hill LLC. All rights reserved. No reproduction or distribution without the prior written consent of McGraw Hill LLC.

Chapter 01 - The Equity Method of Accounting for Investments – Hoyle, Schaefer, Doupnik, Advanced Accounting, 15e

expenses for education from $710,000 to $714,000. 51.

(10 Minutes) (Reporting by a government of a solid waste landfill) a. False – The handling in the government-wide financial statements will be the same whether the landfill is reported as a part of the General Fund or as an Enterprise Fund. b. False – Because the city has a December 31 year-end, no claim to current financial resources exists at that time. Payments will not be required for six months. c. False – The Enterprise Fund should report a liability equal to 26 percent of $2 million less the amount of cash that has already been paid. d. True – Enterprise Funds are generally reported the same in the government-wide financial statements and in the fund financial statements. e. True – The liability is $2 million times 26 percent or $520,000. However, payments of $100,000 have already been made by this time so the reported liability is only $420,000. f. True – In either case, $2 million will be spent. That will show up as an expense in the government-wide financial statements and as an expenditure in the fund financial statements (because the landfill is reported in the General Fund).

52.

(10 Minutes) (Reporting by a government of a landfill) a. True – The amount of the liability to be reported in each of the past years would then have been based on $3 million rather than on $2 million. b. True – The government-wide financial statements accrue all liabilities whether they are governmental activities or business-type activities. The government has to report the current obligation for closing the landfill. That liability is 40 percent of $3 million or $1.2 million. c. True – At the end of Year 2, a liability of $420,000 is reported (26 percent of $2 million less $100,000 in payments). The Year 2 payment reduces that balance to $370,000. At the end of Year 3, a liability of $1,050,000 is reported (40 percent of $3 million less $150,000 in payments). Adjusting the liability balance of $370,000 to $1,050,000 necessitates recognizing an expense of $680,000. d. False – Present value is not used for landfill closure costs. The current 1-21 © McGraw Hill LLC. All rights reserved. No reproduction or distribution without the prior written consent of McGraw Hill LLC.

Chapter 17 – Accounting for State and Local Governments (Part Two) – Hoyle, Schaefer, Doupnik, Advanced Accounting, 15e

cost of closure (rather than estimation of future cash payments) is the basis for recognition so that present value is not necessary. 53.

(12 Minutes) (Reporting the gift of a historical treasure to a government) a. True – One of the requirements for being able to choose to not capitalize an art work or historical treasure is that a formal policy must be in place requiring that any proceeds from a future sale be used for a similar purchase. Thus, the item is not actually a kind of disguised investment. b. False – If the asset is viewed as being inexhaustible (this document is already over 200 years old), depreciation is not required. c. False – The city can record the $10,000 value as an expense immediately but it can also choose to capitalize the asset and then depreciate it over its expected useful life. d. False – Revenue recognition is required for gifts of this type. It is only the decision as to whether to record an asset or an expense that is at the option of the government. e. True – Both revenue and an equal expense can be reported for this donation so that net position is not impacted.

54.

(8 Minutes) (The presentation of component units) a. False – Although the city here appoints a majority of the board members, nothing here indicates that (a) the city can impose its will on this board, (b) that the library provides a financial benefit or a financial burden for the city, or (c) that the library is financially dependent on the city. Appointing a majority of the board makes the library a related organization but not necessarily a component unit. b. True – If the results of the component unit are included within the governmental activities (in the same manner as a fund), this reporting is known as blending the component unit. Blending is appropriate when the component unit is closely entwined with the government. c. False – Blending of a component unit is a judgment made when financial statements are being prepared based on how entwined the activity is with the government. In addition, a component unit will need to be blended if its total debt will be repaid entirely, or almost entirely, from resources of the primary government. That responsibility is not mentioned here.

55.

Chapter 01 - The Equity Method of Accounting for Investments – Hoyle, Schaefer, Doupnik, Advanced Accounting, 15e

a. False – The $900,000 will be added and not subtracted. On the fund-based financial statements, an expenditure is reported which reduces the fund balance. On the government-wide financial statements, the cost is capitalized so that no change occurs in the government‘s overall net position. The reconciliation starts with the total change in fund balances for the governmental funds (including this $900,000 reduction) and moves to the total change in net position in the governmental activities (no change for this transaction). To go from a $900,000 reduction to no change, an addition of $900,000 is required. b. False – Appointing the governing board alone is not sufficient to be labeled as a component unit. In addition, either the primary government must be able to impose its will on that board or the separate organization provides a financial benefit or imposes a financial burden on the primary government. c. False – A separate body is a component unit if it fiscally depends on the primary government. In addition, the primary government and the component unit must be financially interdependent. These rules do not necessarily require the appointment of members of the board. d. False – The election of the board fulfills one of the requirements for a special purpose government but not all. It must also be legally independent and fiscally independent. e. True – The modified approach was developed because many infrastructure assets (such as streets and bridges) have lives that can be extended for virtually an unlimited period of time through appropriate maintenance. The modified approach enables governments to avoid recording depreciation for these particular items. f. False – The textbook indicates some use of the modified approach but not a significant amount. Apparently, the cost of the work necessitated by the application of the modified approach is more than the value to government officials of avoiding the recording of depreciation. g. False – The fee here is assessed directly by this function to the individuals being benefited. Therefore, the money received is reported as a program revenue and not a general revenue. h. True – Both works of art meet the three criteria that are necessary before such items can be recorded as expenses rather than as assets. i. False – Because this debt will be paid in only 30 days (and will, thus, use current financial resources), it is recorded as a debt on the fund financial statements rather than as an other financing source. The handling is the same in the government-wide financial statements and the fund financial statements so that no adjustment is needed for reconciliation purposes. 1-23 © McGraw Hill LLC. All rights reserved. No reproduction or distribution without the prior written consent of McGraw Hill LLC.

Chapter 17 – Accounting for State and Local Governments (Part Two) – Hoyle, Schaefer, Doupnik, Advanced Accounting, 15e

Develop Your Skills Research Case 1

In the Basis for Conclusions (Appendix B) section of GASB Statement No. 87, the Board describes the many alternatives that it considered in arriving at the final pronouncement. The Board includes the rational for the various decisions that were made. In paragraph B47, the Board discusses the measurement of the lease asset. ―The Board considered whether the lease asset should be measured independently of the lease liability (for example, on a fair value basis) but decided against that approach. Capital assets generally are measured at historical cost, which is the amount paid for those assets. The lease liability generally represents the amount to be paid for the lease asset, except as noted in paragraph 30. Therefore, basing the measurement of the lease asset on the lease liability is consistent with the accounting for most capital assets at historical cost. Additionally, it recognizes the relationship between the liability and the asset because they arise from the same transaction.‖ Students should use this information to create a professional memo to the audit client to explain that the leased asset must be reported at the $98,031 present value of the lease payments and not at the fair value. Where appropriate, students can use direct quotes from the Statement No. 87 to explain that this decision comes from an authoritative pronouncement.

Research Case 2 The reason for this question is rather obvious: The transit authority will lose money for some time and city officials are concerned by how those negative financial results will alter the financial picture reported by the city. The reporting rules for component units were first created by GASB Statement No. 14, The Reporting Entity. Those rules are now part of the GASB Codification: ―Financial statements of the reporting entity should provide an overview of the entity, yet allow users to distinguish between the primary government and its component units. (Section 2600.105) ―Most component units should be included in the financial reporting entity by discrete presentation. Discrete presentation entails reporting component unit financial data in columns and rows separate from the financial data of the primary government.‖ (Section 2600.107) ―Even though it is desirable for users to be able to distinguish between the primary government and its component units, there are nevertheless some component 1-24 © McGraw Hill LLC. All rights reserved. No reproduction or distribution without the prior written consent of McGraw Hill LLC.

Chapter 01 - The Equity Method of Accounting for Investments – Hoyle, Schaefer, Doupnik, Advanced Accounting, 15e

units that, despite being legally separate from the primary government, are so intertwined with the primary government that they are, in substance, the same as the primary government. These component units should be reported as part of the primary government in both fund financial statements and the government-wide financial statements. That is, the component unit's balances and transactions should be reported in a manner similar to the balances and transactions of the primary government itself. This method of inclusion is known as blending.‖ (Section 2600.112) In the case presented here, the facts should be easy to determine so that the decision about reporting can be made. Is the transit authority fiscally dependent on the city? Does the transit authority create a financial benefit or financial burden for the city? Do transit authority officials have to get permission from the city to adopt its budget or set rates for passenger use? Can the transit authority issue bonds without having to get approval of city officials? These questions should be fairly easy to answer. The transit authority can also be a component unit of the city if city officials appoint a voting majority of the transit authority‘s board. In that case, the transit authority is viewed as a component unit if (a) city officials can impose their will on this board or (b) the transit authority provides a potential financial benefit or burden for the city. The question of potential financial burden is especially relevant because the transit authority has been losing money. Eventually, if that situation does not improve, what responsibility will the city have? Analysis Case 1 Students often appear to believe that the financial reporting presented in a textbook has actually been applied and unchanged for decades. They often do not fully appreciate the speed of evolution that can take place in the applicable generally accepted accounting principles. Accounting for state and local governments provides an excellent example of the change that can occur, even over a relatively short period of time. GASB 34 was issued in June of 1999 and became mandatory a few years later. That pronouncement provides a clear line of demarcation between the financial statements that are currently reported and those that were traditionally used for many decades. Many cities such as Pittsburgh have their previous ACFRs available online. An ACFR from 1995 will provide students with a look back at a time when state and local government financial statements were markedly different than today. In looking at any source of information prior to 2000, several significant differences should be evident: 1-25 © McGraw Hill LLC. All rights reserved. No reproduction or distribution without the prior written consent of McGraw Hill LLC.

Chapter 17 – Accounting for State and Local Governments (Part Two) – Hoyle, Schaefer, Doupnik, Advanced Accounting, 15e

--Only one set of financial statements was reported. Government-wide financial statements did not exist. --The financial statements prior to 2000 will look quite a bit like the fund financial statements that are still prepared today. --The columnar presentation will include fund types (General Fund, Special Revenue Fund, Capital Projects Fund, and the like) rather than showing specific major funds within these categories. --Because only current financial resources were reported, at least in the governmental funds, no capital assets or long-term liabilities are reported. However, columns identified as ―general fixed asset account group‖ and ―general long-term debt account group‖ were included as a listing of capital assets and long-term debts. --Some of the fund type names have changed over the years. For example, the Permanent Fund within the governmental funds did not exist prior the passage of GASB 34. --Depreciation was not reported in connection with the reporting of capital assets by the governmental funds. --Infrastructure assets were reported as expenditures as those costs were incurred and, then, probably in no other way. In most cases, no inclusion at all could be seen of bridges, sidewalks, and the like. --Certain liabilities such as landfill costs were probably ignored. --Budgetary information was reported but through the use of a different type of format. --A management‘s discussion and analysis is now included in government financial statements to provide a verbal explanation of the financial events of the period. Analysis Case 2 One of the most significant changes in governmental accounting created by GASB 34 in 1999 was the requirement that the Management‘s Discussion and Analysis be included as part of the ACFR. This written report is meant to be a discussion of the financial information for the government in a verbal rather than a purely quantitative fashion. Students often do not understand the range of information provided by the MD&A. In this assignment, the student can read the MD&A for an actual city. Here are just a few of the pieces of information discussed in the 2020 MD&A for the City of Phoenix, Arizona. --The City's capital assets for the fiscal year ended June 30, 2020, totaled $12.8 billion, net of accumulated depreciation. This represents an increase from the prior fiscal year of $454.0 million, an increase of $104.1 million for Governmental Activities and an increase of $349.9 million for Business-Type Activities. --The City received $293.3 million from the Coronavirus Relief Fund, established by the CARES Act, in April 2020. -- Major additions to capital assets during the fiscal year included the following: Various street and storm sewer projects throughout the City valued at $197.3 1-26 © McGraw Hill LLC. All rights reserved. No reproduction or distribution without the prior written consent of McGraw Hill LLC.

Chapter 01 - The Equity Method of Accounting for Investments – Hoyle, Schaefer, Doupnik, Advanced Accounting, 15e

million and aviation terminal 3 modification project valued at $72.3 million. -- The City‘s total financial obligations increased by $1.3 billion. This was primarily due to the issuance of $762.5 million in airport revenue bonds. -- Excise taxes made up 36.3 percent of the revenues generated by the governmental activities. Grants and contributions not restricted to specific programs made up another 17.2 percent. -- Charges for services made up 90.9 percent of the revenues reported for the business type activities. -- The city uses enterprise funds to account for the operation of Sky Harbor International Airport and two regional airports, Phoenix Convention Center, the water system, the wastewater system and solid waste disposal. Communication Case 1 Students do not always fully comprehend the evolutionary nature of financial accounting and reporting. In connection with for-profit businesses, ongoing changes have occurred over a number of decades under the Financial Accounting Standards Board, the Accounting Principles Board, and a variety of other organizations. In comparison, the Governmental Accounting Standards Board has been in operation for a shorter period and has produced fewer official standards. The changes that governmental accounting has gone through over the years may be a bit easier for a student to grasp. This assignment is simply intended to provide the student with an overview of the recent history of governmental accounting. The listed articles (and any others that the students may find through their own library and Internet searches) show how governmental accounting is gradually building up an official set of generally accepted accounting principles to provide a structure for reporting that, up until recently, has been very unstructured. The amount of authoritative guidance has gone from almost nonexistent just a few decades ago to a fairly well-developed system of financial reporting. Communication Case 2 If the city assesses a user charge, then officials always have the right to record the landfill as an Enterprise Fund. However, such a classification is not required unless the fee (a) is set at an amount intended to cover the various costs of the service or (b) serves as the sole security for debts of the activity. If the city records the landfill as an Enterprise Fund, then accounting in the government-wide financial statements and fund financial statements is quite similar. The statements measure all economic resources and accrual accounting is the basis for the timing of recognition. Perhaps most importantly, a portion of the anticipated cost of closure and post-closure activities must be accrued in both sets of financial statements. Conversely, if the city records the landfill within the General Fund, there is no 1-27 © McGraw Hill LLC. All rights reserved. No reproduction or distribution without the prior written consent of McGraw Hill LLC.

Chapter 17 – Accounting for State and Local Governments (Part Two) – Hoyle, Schaefer, Doupnik, Advanced Accounting, 15e

change in the government-wide financial statements except that all transactions and balances are shown as governmental activities rather than as business-type activities. However, in the fund financial statements, as a governmental fund, only current financial resources and the changes in those financial resources are reported. Capital assets, in these statements, as well as long-term liabilities such as closure costs are omitted. Excel Case This spreadsheet would be extremely helpful for a government attempting to determine the historical cost (less depreciation) of infrastructure assets not previously reported. This spreadsheet is designed along the guidelines established in GASB Codification, Section 1400.167-175. There are a number of different ways that a spreadsheet could be created to solve this particular problem. Here is one possible approach: In Cell A1, enter text label ―City of Loveland—Reported Value of Each Mile of Road‖ In the next three rows, enter the criteria on which calculations will be based: In Cell A3, enter text label of ―Per 1 Mile of Road as of 12/31/2024‖ and in Cell E3 enter ―$2,300,000‖ In Cell A4, enter text label of ―Yearly Inflation‖ and in Cell E4 enter ―8%‖ In Cell A5, enter text label of ―Depreciation‖ and in Cell E5 enter ―2%‖ Any of the above three variables can be changed to develop different schedules. Enter Column Headings: In Cell A7, enter text label of ―# of Years.‖ In Cell B7, enter text label of ―Date.‖ In Cell C7, enter text label of ―Inflation Reduced Cost.‖ In Cell D7, enter text label of ―Total Depreciation.‖ In Cell E7, enter text label of ―Reported Value.‖ Enter Row Headings: In Cell A8, enter text label ―1‖ and in Cell A9, enter text label ―2.‖ Once you establish a pattern, Excel can automatically fill in a series of numbers. To continue the numbering for Years 3-20, click and drag across Cells A8 and A9. Once these cells are highlighted, you will see a small black box in the lower right corner of this selection, which is the ―fill handle.‖ Click on the fill handle and drag across Cells A10 through A27 and release to display numbers 3 through 20. The numbers will be displayed in increasing order since that is the criteria that was established in Cells A8 and A9. In Cell B8, enter text label ―12/31/2023‖ and in Cell B9, enter text label ―12/31/2022.‖ Perform the same click and drag operation above to fill the date in Cells B10 through B27. The dates will be displayed in decreasing order since that is the criteria that was established in Cells B8 and B9.

Chapter 01 - The Equity Method of Accounting for Investments – Hoyle, Schaefer, Doupnik, Advanced Accounting, 15e

Enter Formulas: In Cell C8, enter formula to calculate Inflation Reduced Cost as of 12/31/2024. Reduce Per Mile figure established on 12/31/2024 (in Cell E3) by Yearly Inflation Rate (in Cell E4): =+E3/($E$4+100%) (NOTE: Absolute references, which are cell references that always refer to cells in a specific location, can be created by placing a $ symbol before the Column letter and/or the Row number. In this problem, we need to always refer to the Yearly Inflation figure in Cell E4 and the Depreciation figure in Cell E5.) In Cell D8, enter formula to calculate Total Depreciation. Multiply Inflation Reduced Cost figure on 12/31/2023 by Yearly Depreciation Rate: =+C8*($E$5*A8) In Cell E8, enter formula for Reported Value of road for current year by deducting Depreciation from Inflation: =+C8-D8. In Cell C9, enter formula to calculate Inflation Reduced Cost figure as of 12/31/2019: Reduce Inflation on 12/31/2023 (in Cell C8) by Yearly Inflation Rate (in Cell E4): =+C8/($E$4+100%) Copy formulas from Cells D8 and E8 to Cells D9 and E9 by clicking and dragging fill handle. Format Cells to display currency. Click and drag across Cells C8 to E9. Select Format, Cells, and under the Number tab, select Currency. Change the Decimal places to 0 and click OK. Copy Formulas: Click and drag across Cell C9 through Cell E9. Place the cursor on the ―fill handle‖ in the lower right corner of this section box and drag the cursor down to Cell E27 and release. The formulas are automatically adjusted to correspond to the current year information.

CHAPTER 18 ACCOUNTING AND REPORTING FOR PRIVATE NOT-FORPROFIT ENTITIES Chapter Outline I.

Not-for-profit entities (NFPs) include many different types of organizations such as charities, foundations, colleges and universities, health care entities, cultural institutions, religious organizations, and the like.

II.

The ‗Master Glossary‘ within FASB‘s Accounting Standards Codification (ASC) states that a not-for-profit entity ―possesses the following characteristics, in varying degrees, that distinguish it from a business entity. A. Contributions of significant amounts of resources from resource providers who do not expect commensurate or proportionate pecuniary return B. Operating purposes other than to provide goods or services at a profit C. Absence of ownership interests like those of business entities‖

Chapter 17 – Accounting for State and Local Governments (Part Two) – Hoyle, Schaefer, Doupnik, Advanced Accounting, 15e

III.

Private NFPs follow the rules established in the Accounting Standards Codification (ASC). FASB designated Topic 958 specifically for not-for-profit entities. The remaining rules in the ASC that are used in reporting business entities normally also apply to NFPs unless Topic 958 otherwise addresses a particular issue. A. Reporting goals for private NFP entities have remained consistent for decades. 1. Financial statements should focus on the entity as a whole. 2. Reporting requirements for private NFP entities should be comparable to those applied to for-profit businesses unless critical differences exist in the nature of the transactions or the informational needs of financial statement users. B. Accounting standards for NFPs continue to evolve as FASB periodically releases new updates such as Accounting Standards Update 2019-03, Updating the Definition of "Collections," (released in March 2019), Accounting Standards Update 2019-06, Extending the Private Company Accounting Alternatives on Goodwill and Certain Identifiable Intangible Assets to Not-for-Profit Entities, (released in May 2019), and Accounting Standards Update 2020-07, Presentation and Disclosures by Not-for-Profit Entities for Contributed Nonfinancial Assets (released in September 2020).

IV.

Financial statements for a private NFP include a statement of financial position, a statement of activities, and a statement of cash flows. Information is also required to describe an entity‘s functional expenses. An NFP can provide this disclosure through a separate statement, within the statement of activities, or as note disclosure. A. A private NFP classifies all net asset totals into two categories: without donor restrictions and with donor restrictions. 1. Donors can make purpose restrictions (the gift must be spent for a particular reason), time restrictions (the gift can only be spent at a stipulated point in time), or permanent restrictions (the gift must be held indefinitely and only subsequent income can be spent.). 2. When a private NFP spends restricted funds as stipulated by the donor, the statement of activities reports a reclassification, that is an increase in net assets without donor restrictions and a decrease in net assets with donor restrictions. 3. When net assets are spent for a cost to be recorded as an expense (whether donor restricted or not), the expense is shown under net assets without donor restrictions on the statement of activities. B. NFPs classify functional expenses as program service expenses (to fulfill the mission of the entity) or supporting service expenses (fundraising, administrative costs, and the like). C. Disclosures are required to explain how the NFP expects to handle liquidity issues over the subsequent year. D. On the statement of cash flows, NFPs can elect to use the direct method to report operating activity cash flows without having to include a supplementary indirect method reconciliation. FASB apparently wants to encourage use of the direct method by easing the reporting requirements.

A NFP must draw a distinction between exchange transactions and contributions because the timing of the recognition is different. A. In an exchange transaction, the NFP provides a commensurate value to the outside party to earn the money being conveyed. If the entity receives any of that amount in advance, the entity reports a deferred revenue until the performance obligation is eventually satisfied. B. If the NFP will not need to provide a commensurate value, the conveyance is deemed a contribution. The NFP reports the gift as an increase in net assets unless it is 1-30 © McGraw Hill LLC. All rights reserved. No reproduction or distribution without the prior written consent of McGraw Hill LLC.

Chapter 01 - The Equity Method of Accounting for Investments – Hoyle, Schaefer, Doupnik, Advanced Accounting, 15e

conditional. Two criteria indicate a conditional donation. 1. The donor stipulates that the NFP must overcome a barrier before being entitled to the promised resources. FASB provides guidance to determine the establishment of a barrier. 2. Failure of the NFP to surmount the barrier gives the donor a right of release from making further payment and the right to demand return of any amount already paid. C. If a donation is unconditional, the entity reports an increase in net assets on the statement of activities as either an increase in (a) net assets without donor restrictions or (b) net assets with donor restrictions depending on the stipulations of the donor. For a gift not yet received, the NFP reports the pledge as a receivable if the gift is unconditional. D. The term ―in-kind donations‖ is a label used to refer to gifts of assets or services other than cash or investment securities. The entity records these donations at fair value. Nonfinancial contributions should be reported on a separate line in the statement of activities. E. NFPs recognize contributed services but only if one of criteria below are met. Many donated services go unrecorded because neither criteria is applicable. 1. The donated service creates or enhances a nonfinancial asset (such as a computer or a building). 2. The donated service requires a specialized skill that the NFP would have to acquire if not donated. F. NFPs need not report (but merely disclose) works of art and historical treasures if three criteria are met. 1. The NFP adds the piece to a collection for public exhibition, research, or education. 2. The NFP protects and preserves the piece. 3. A policy is in place stating that if the piece is ever sold, the NFP will use the money to acquire a replacement for the collection or provide direct care for the remaining works in the collection. G. A NFP might well accept a donation that it must convey to a separate outside beneficiary. The NFP normally records the asset along with an accompanying liability to reflect the accepted responsibility. If the NFP receives variance powers that allows it to change the beneficiary, it recognizes a contribution (an increase in net assets) instead of a liability because the NFP gains control over the property. VI.

A number of tax-exempt statuses are available that establish what qualifying entities can and cannot do. Section 501(c)(3), Section 501(c)(4), and Section 501(c)(6) of the Internal Revenue Code are three of the most common in the U.S. Most of these entities must file a Form 990 each year to disclose extensive information so that the NFP can maintain its taxexempt status.

VII.

Mergers and acquisitions occur among private not-for-profit entities as a way for them to expand their influence or reduce costs. Accounting rules for recording these combinations differ from those applied to a for-profit business because the transaction is either an acquisition or a merger. A. In an acquisition, one entity gains control over another 1. The acquiring NFP combines all identifiable assets and liabilities of the acquired NFP at their fair values on the date of acquisition. 2. If the acquisition value of the acquired company is greater than the sum of the net fair values of all identified assets and liabilities, the combined entity reports the difference as goodwill but only if earned revenue is expected to provide 1-31 © McGraw Hill LLC. All rights reserved. No reproduction or distribution without the prior written consent of McGraw Hill LLC.

Chapter 17 – Accounting for State and Local Governments (Part Two) – Hoyle, Schaefer, Doupnik, Advanced Accounting, 15e

predominate support for the acquired company in the future. FASB recently allowed NFPs to opt out of doing an annual goodwill impairment test and, instead, write off goodwill on a straight-line basis over a 10-year period (or less if a shorter period is more appropriate). 3. If the acquisition value of the acquired company is greater than the sum of the net fair values of all identified assets and liabilities, the combined entity charges off the excess as a reduction in net assets but only if contributions and investment income are expected to provide the predominate support for the acquired company in the future. B. In a merger, two NFPs come together to form a new entity with a new governing board. All identifiable assets and liabilities retain their previous carrying amounts with no adjustments made to fair value. VIII.

Financial reporting for health care entities provides especially unique challenges. Many of these entities are for-profit rather than NFPs. In both cases, third-party payors such as government programs and insurance companies pay much of the amount charged for patient services. Significant discounts are necessary because the standard charges are expensive. Contracts allow many of these third parties to adjust the amount to be paid based on outside factors. The final balance is often undetermined until a later date. A. NFPs allow explicit price concessions based on the terms of the contracts and payment amounts. This is especially true for payments from a government agency or insurance company. B. NFPs also allow implicit price concessions if patients are unable to pay the entire amount. The NFP must estimate the amount that is likely to be paid. C. Because of the uncertainty, a single amount expected from this variable consideration might be difficult to compute. The entity can calculate a weighted average balance or use the most likely number to be collected. The result of the calculation is the revenue balance recognized for the period. 1. Due to the uncertainty of the reported figure, the NFP still recognizes a provision for bad debts based on the results of previous years and other pertinent factors. 2. Charity care occurs when the NFP does not intend to seek collection usually because the patient lacks adequate financial resources, The NFP does not recognize charity care although related cost figures should be disclosed.

Answers to Discussion Questions Is This Really an Asset? Theoretically, accounting for a pledge is a straightforward process. If unconditional, the NFP records the receivable (at present value unless the money is expected within a year) along with an adequate allowance for doubtful collections. In practice, the reporting process might well be more complicated. For example, this case raises a number of questions. Was a pledge actually made or was this a superfluous statement spoken at a moment of overwhelming emotions? Is this a promise to give or an intention to give? Are any conditions attached to the gift? Can the donor change his mind? Does this potential donor really own land in Idaho and, if so, can it be sold for $30 million? What if the individual can only sell the land for $29 million or even $15 million? How can an adequate allowance be determined for this pledge? If the individual's mother should die, might he lose interest in supporting the hospital? If the hospital reports the $10 million as a receivable and then the money is not collected, what is the effect on the readers of the financial statements? How 1-32 © McGraw Hill LLC. All rights reserved. No reproduction or distribution without the prior written consent of McGraw Hill LLC.

Chapter 01 - The Equity Method of Accounting for Investments – Hoyle, Schaefer, Doupnik, Advanced Accounting, 15e

much time and energy should the hospital invest in attempting to arrive at a proper method of financial reporting for this item? The accountant must address all of these questions (and more) to determine the appropriate method of reporting. At a minimum, hospital officials need to contact the potential donor and have a serious discussion. He needs to understand their reasons for attempting to establish a valuation of this promise. In class discussion, students can be asked to identify questions that should be posed to this person. They would probably include the following: — Does he really plan to give $10 million to the hospital? — When does he project that the land will be sold and the monetary gift conveyed? — How did he establish a $30 million price? Could the land ultimately be sold for less and, if so, how will that impact the gift to the hospital? — How does the donor want the $10 million to be used? — Is there any chance that he will change his mind? — What other charities has he supported? Has he previously made such large gifts? — Would he be willing to furnish financial statements as well as a list of references who could verify his intentions and his ability to carry out those intentions? — Does the hospital have legal recourse to force fulfillment of the promise since it is in writing and signed? If this individual has supported other charities over the years, is committed to the work of Mercy Hospital, has adequate financial resources, and the land appears to be worth $30 million, the hospital should report the pledge as a receivable. However, a large allowance should probably be established because of the uncertainties involved in collecting this money. Conversely, if too much uncertainty exists (a value for the land cannot be determined or the donor refuses to provide information about his ability to meet the commitment), the hospital may decide that there is no pledge but merely the promise of a possible future pledge. In that case, the information can be spelled out in a disclosure note. Unless clear evidence exists to substantiate the pledge, disclosure is most likely. Are Two Sets of GAAP Really Needed for Colleges and Universities? Over the years, a number of differences have appeared between the accounting for public colleges and universities and for those that are private. A number of those differences are evident in the comparison of financial reporting for the University of Southern California and the University of Arizona. GASB holds authority over the reporting of public schools whereas FASB has authority over private educational institutions. Consequently, GASB standards do not apply to private schools and FASB standards do not apply to public schools unless specifically made applicable by GASB. For this reason, FASB pronouncements on depreciation, pledges, contributions, and financial statement format for not-for-private entities do not affect public schools until and unless so stated by GASB. Because of this division of responsibility, the financial statements for these two types of schools have developed independently. GASB states that public schools must follow the guidelines appropriate for the financial statements of state and local governments. However, these guidelines are not as radically different from those applied to private schools as might be imagined. Public colleges and universities are allowed to identify themselves as solely Enterprise Funds if they meet required criteria. By making this decision, a public school reports only fund financial 1-33 © McGraw Hill LLC. All rights reserved. No reproduction or distribution without the prior written consent of McGraw Hill LLC.

Chapter 17 – Accounting for State and Local Governments (Part Two) – Hoyle, Schaefer, Doupnik, Advanced Accounting, 15e

statements as would be produced by a proprietary fund. These statements have a resemblance to the statements prepared by private schools. Important distinctions do continue to exist. Accounting students can be asked to address the question of whether a public and a private school need to have comparable financial statements. Net income is not an issue. It is often the sources and uses of resources that are emphasized in such discussions. Is the adoption of a single set of generally accepted accounting principles necessarily essential? Will a decision-maker care if the University of North Carolina at Chapel Hill (a public school) has one statement format while Duke University (a private school) has another? Should the financial statements for the College of William & Mary (a public school) reflect the same reporting as the University of Richmond (a private school)? This debate leads to the important question of user needs. Why does a company or individual study the financial statements of a college or university? Donors might have one answer to that question while creditors could have an entirely different response. Once that question is addressed, the need for comparability is easier to assess. No ultimate answer for that query currently exists. Students can be asked to develop their own list of user needs and then note whether the existence of two different sets of GAAP has an adverse impact on those needs. Answers to Questions 1. The Financial Accounting Standards Board (FASB) has authority for establishing accounting standards for private not-for-profit (NFP) entities. In addition, audit and accounting guides produced by the AICPA provide guidance for the preparation of financial statements by these entities, although those sources are nonauthoritative. 2. If a user of financial statements is a potential donor, that party is interested in assessing whether a gift to a private NFP is a wise use of resources. To make that assessment, the individual needs to know whether the entity uses its resources effectively to achieve stated goals. In this way, donors can decide which entity deserves to receive support and how much to donate. For this reason, the reported division between the amount spent on program services and supporting services can be helpful. If a user of financial statements is a creditor, the company or person is primarily interested in whether the entity can generate sufficient cash flows to pay its debts as they come due. 3. According to FASB, all private NFPs must produce three financial statements: a statement of financial position, a statement of activities, and a statement of cash flows. An NFP must also disclose its functional expenses. The NFP can meet this last requirement by a separate financial statement, within the statement of activities, or through note disclosure. 4. As the name implies, net assets without donor restrictions is the amount of net assets held by a private NFP that has no binding designation by its donor. These resources are available to be used at the discretion of the board. 5. Net assets with donor restrictions are resources held by the NFP that must be used in a manner stipulated by the donor. For example, a donor might place a purpose restriction on a cash donation stating that money had to be spent for that particular purpose. Net assets could also be subject to a time restriction so that spending was only allowed after a designated time or during a specified period. Net assets can be restricted permanently. In that case, expenditure other than for investment purposes is not allowed although

Chapter 01 - The Equity Method of Accounting for Investments – Hoyle, Schaefer, Doupnik, Advanced Accounting, 15e

subsequent income can be spent as indicated by the donor or at the discretion of the board. 6. The two general types of functional expenses are (a) program service expenses and (b) supporting service expenses. Program service expenses are those that relate to the goals, objectives, and mission of the NFP. Supporting service expenses encompass the costs of operating the entity (general and administrative) and costs of fundraising. All NFPs must disclose their functional expenses. An NFP can meet that requirement by including the expenses in a separate financial statement, within the statement of activities, or through note disclosure. 7. Donors and other interested parties frequently evaluate NFPs based in part on the ratio of program service expenses to total expenses. This ratio informs statement readers as to the portion of each dollar of expense the NFP spent to achieve its identified goals. 8. When the governing board of a private NFP sets aside money or other assets for a designated purpose, the action creates no effect on either net assets without donor restrictions or net assets with donor restrictions. The decision was made internally and not by a donor. Therefore, the only change in reporting is within the Net Assets section of the statement of financial position. Under net assets without donor restrictions, the NFP discloses the appropriate amount as ―board-designated funds‖ to reflect the board‘s decision and its purpose. 9. FASB rules require a private NFP to disclose the amount of available liquid resources. The entity must also indicate its plans if additional liquid resources are needed during the upcoming year. Furthermore, to aid readers of its financial statements, the NFP indicates how it manages liquidity risks. This standard requires the NFP to show the amount of financial assets available for general expenditures within one year of the balance sheet date. These reporting changes dictated by FASB are intended to make it easier to see, by looking at a nonprofit‘s financial statements, any potential liquidity issues. 10. In an exchange transaction, a private NFP must provide a return to the financial resource provider of commensurate value. For example, if an outsider pays money and the NFP provides a service of commensurate value (such as educational classes) in return, an exchange transaction has taken place. If the NFP does not give commensurate value in return, the provider is apparently making a donation. 11. When the private NFP receives the money initially, it increases net assets with donor restrictions on the statement of activities. This donor restricted the use to payment of the salary of the new administrator. When spent as designated, a reclassification increases net assets without donor restrictions while decreasing net assets with donor restrictions. The expenditure fulfills the stipulation. In addition, the NFP recognizes salary expense on the statement of activities under the net assets without donor restrictions. 12. When the NFP receives the money initially, net assets with donor restrictions increases on the statement of activities. The donor restricted the use of this money to acquisition of a particular piece of equipment. When later spent as designated, a reclassification increases net assets without donor restrictions while decreasing net assets with donor restrictions. The expenditure fulfills the stipulation. In addition, the NFP recognizes the cost of the equipment as an asset on its statement of financial position and reduces its cash balance so that no overall change occurs in net assets. 1-35 © McGraw Hill LLC. All rights reserved. No reproduction or distribution without the prior written consent of McGraw Hill LLC.

Chapter 17 – Accounting for State and Local Governments (Part Two) – Hoyle, Schaefer, Doupnik, Advanced Accounting, 15e

13. Both a for-profit business and a private NFP can use the indirect method of reporting cash flows from operating activities. Likewise, both can use the direct method of reporting cash flows from operating activities. If a private NFP chooses to report by presenting the direct method, a separate reconciliation using the indirect method is no longer mandated. Some accountants reason that this additional reporting burden is a factor in the limited application of the direct method by for-profit businesses. Reducing the amount of work and disclosure might lead to an increase in the application of the direct method by private NFPs. 14. If the $20,000 donation is conditional, the NFP records it as an increase in cash and an increase in liabilities. The donor can force the return of the money unless the NFP meets the conditions established. Because the NFP might still have to return the money, it reports a liability of $20,000. If the donation is unconditional, the NFP increases cash and increases the contribution revenue reported within the ―net assets with donor restrictions‖ column because the donor has stipulated the purpose. 15. A NFP should judge a gift as conditional if it meets two criteria. First, the donor stipulates that the NFP must overcome a barrier before being entitled to the promised resources. Second, failure of the NFP to surmount that barrier gives the donor a right of release from making any further payment and the right to demand return of amounts already paid. 16. If a pledge of resources is unconditional, the NFP records a receivable. If payment will take longer than one year, the NFP reports the balance at present value. An allowance for uncollectible accounts is also shown based on collection expectations. The contribution revenue is an increase in net assets with donor restrictions on the statement of activities because it was for a stipulated purpose. If a pledge is conditional, no recording is necessary until the NFP meets the conditions although disclosure is likely unless the amounts are small. 17. An in-kind donation is a gift other than cash and investments. An NFP reports in-kind donations based on fair value if one can be determined. The receipt of nonfinancial donations should be reported as a separate line item on the NFP‘s statement of activities. 18. An NFP reports contributed services if a fair value can be determined and the work meets one of two criteria: (1) It qualifies if the services create or enhance a nonfinancial asset or (2) if the services require a specialized skill possessed by the contributor that the NFP would typically purchase if not donated. 19. Art works and historical treasures are not assets in a normal sense because they often lead to future resource outflows rather than inflows. Consequently, recognition is not required if (a) the property is added to a collection for public exhibition, education, or research, (b) it is protected and preserved, and (c) it is covered by an official policy whereby any proceeds generated from a future sale will be used to acquire other collection items or will be used to maintain the remaining items in the collection. 20. If a donor gives resources to a private NFP to convey to a separate beneficiary, the reporting is straightforward if the donor has not retained control over the property and has not given the NFP variance power over the ultimate use of the property. In that case, the donor records an expense at the time of conveyance. The NFP records a liability at that same moment because it must pass the property along to the designated beneficiary. At the same time, the beneficiary records a contribution revenue. The donor has lost control 1-36 © McGraw Hill LLC. All rights reserved. No reproduction or distribution without the prior written consent of McGraw Hill LLC.

Chapter 01 - The Equity Method of Accounting for Investments – Hoyle, Schaefer, Doupnik, Advanced Accounting, 15e

over the gift and the NFP has no purpose except conveyance. 21. If a donor gives resources to a NFP to convey to a separate beneficiary but retains the power to redirect or revoke the gift, the donor records an asset (such as Refundable Gift) rather than a donation expense. The NFP still records receipt of the property as a liability but now as a liability to the donor rather than as a liability to the beneficiary. Finally, the beneficiary has no reason to make any reporting of the gift because receipt remains uncertain. 22. If a donor gives resources to a NFP to convey to a separate beneficiary but also gives variance powers so that the NFP can redirect the use of the resources, the donor immediately records an expense. The contributed property is out of its control. The NFP now has control of the property and reports a contribution revenue rather than a liability because the final destination is still to be determined. The beneficiary is not yet certain whether it will receive the gift and, therefore, reports nothing until more information is available. 23. In an acquisition, one entity gains control over another. In a merger, two not-for-profits come together to form a new entity with a new governing board. 24. Because one entity gains control over the other, this transaction qualifies as an acquisition for reporting purposes. Here, the acquisition value is in excess of the fair value of all identifiable assets and liabilities by $300,000 ($2.5 million less $2.2 million). In a for-profit consolidation, the combination reports an excess of this type as goodwill. The same handling is often true for combined statements created when one not-for-profit entity gains control over another. Nevertheless, if contributions and investment income provide the predominate support for the acquired entity, the extra $300,000 appears on the statement of activities as a reduction in net assets without donor restrictions. In that situation, the combined statements report no goodwill. 25. If Helping Hand acquires Fancy Fingers, then the reported value of the equipment on consolidated statements is $2.3 million. That figure is the net carrying value reported by Helping Hand ($1.1 million) plus the fair value of the property held by Fancy Fingers ($1.2 million). If Fancy Fingers acquires Helping Hand, then the reported value for the equipment will be $2.4 million. That figure is the net carrying value reported by Fancy Fingers ($1.0 million) plus the fair value of the property held by Helping Hand ($1.4 million). If the two NFPs are brought together to form a new entity under a new governing board, the equipment is reported at $2.1 million. This transaction is a merger and the carryover method is appropriate. The reported figure is the summation of the net carrying value of the assets from both sets of financial statements ($1.1 million plus $1.0 million). 26. An organization that receives tax-exempt status as a 501(c)(3) entity pays no federal income tax unless it earns unrelated business income, (income outside of the mission of the entity). In addition, NFPs with this status usually pay no state income taxes. They are able to use reduced postal mailing rates. Furthermore, within limits, donors are able to reduce their federal taxable incomes by the value of contributions made to these qualifying charities.

Chapter 17 – Accounting for State and Local Governments (Part Two) – Hoyle, Schaefer, Doupnik, Advanced Accounting, 15e

27. Hospitals and other health care entities often charge enormous amounts for their services. The decision of what amount to report as revenue can be quite complicated. Rather than analyze the charge to each individual patient separately, these NFPs can group their patients into separate but often large portfolios. These portfolios frequently classify the balances according to the party responsible for payment. The NFP determines reported amounts for each portfolio based on averages rather than on patient-by-patient predictions. This approach requires less time and cost and likely produces reasonably accurate figures. 28. This type situation is common in health care because third-party payors often have the right to adjust patient charges even after the passage of time. The term variable consideration indicates that the NFP is not sure of the ultimate amount the responsible parties will pay. The NFP can report the most likely outcome that, in this case, is $1.9 million. As an allowed alternative, the NFP can compute an expected amount based on a weighted-average computation: ($1.9 million × 60 percent) + ($1.7 million × 40 percent) for a total of $1.82 million. Using the first method, the journal entry is: Accounts receivable – government programs Patient service revenues

1,900,000 1,900,000

Using the second method, the journal entry is: Accounts receivable – government programs Patient service revenues

1,820,000 1,820,000

29. If patients have some ability to pay, the NFP applies implicit price concessions for reporting purposes to reduce the balance to the amount that is reasonable under the circumstances. The NFP reports this net figure as the receivable and the net patient service revenue. If patients have no ability to pay, the work is charity care and not reported. Footnote disclosure is necessary. An NFP cannot record amounts where collection is not expected. Answers to Problems 1. A (In earlier times, private NFP accounting reflected the various funds maintained to keep restricted funds safe. External reporting demonstrated stewardship rather than aiding in decision-making by outside parties. In recent decades, the focus has been on reporting the entity as a whole and on transactions and events where critical differences exist between for-profit and not-for-profit entities.) 2. C 3. B 4. B (This change was recently made in the financial reporting for private NFPs. It is likely to encourage additional application of the direct method.) 5. A (Because the money has now been spent as designated, a $112,000 reclassification should be shown on the statement of activities that decreases net assets with donor

Chapter 01 - The Equity Method of Accounting for Investments – Hoyle, Schaefer, Doupnik, Advanced Accounting, 15e

restrictions by $112,000 and increases net assets without donor restrictions by the same amount.) 6. C (Because the money has now been spent as designated, a $112,000 reclassification should be shown on the statement of activities to decrease net assets with donor restrictions by $112,000 and increase net assets without donor restrictions by the same amount. Because this money was for a salary, the NFP also reports salary expense of $112,000 as a reduction in the net assets without donor restrictions.) 7. C (This money is not donor-restricted. Thus, it remains within the net assets without donor restrictions. The net asset section of the statement of financial position will identify this portion of the net assets without donor restrictions as board designated. (The question is asking for the statement that is not true. This decision will not be reflected within net assets with donor restrictions which makes C the answer.) 8. D (The $70,000 gift is time-restricted. The $90,000 gift is purpose-restricted. The $120,000 gift is permanently-restricted. The $10,000 income is purpose-restricted.) 9. B (The school offsets the tuition revenue of $1.0 million with the $220,000 in financial aid for a net revenue of $780,000. Because the university is in charge of providing financial aid, the school is expecting to collect $780,000 and not the $1.0 million that it charged.) 10. A (Functional expenses must now be reported by all private NFPs. The format used for this reporting is optional. The NFP can create a separate statement of functional expenses. As an alternative, it can report the information within the statement of activities or as footnote disclosure.) 11. A (The cost of the research and the work to help the disabled are program service expenses. The cost of fundraising and administrative salaries are supporting service expenses.) 12. D (A portion of the cost of a fundraising solicitation can be deemed program services rather than supporting services if a call for specific action is included and the mailing goes to more than just financial donors.) 13. B (A portion of the cost of a fundraising solicitation can be deemed program services rather than supporting services but only if a call for specific action is included and the mailing goes to more than just financial donors.) 14. C (Contributed services are recognized if (1) a nonfinancial asset is created or enhanced or (2) a specialized skill is required that would need to be purchased if not donated. The donated work meets neither criteria in C.) 15. B (The donor did not specifically designate the gift for this particular family so the NFP recognizes both the contribution revenue and the eventual expense.) 16. A (The work performed requires a specialized skill that the NFP would otherwise have to acquire. Thus, both a revenue and an expense are recognized.) 17. D (These volunteer services, although important, do not meet the criteria for recognition. They do not require a specialized skill that the NFP would otherwise purchase. They do

Chapter 17 – Accounting for State and Local Governments (Part Two) – Hoyle, Schaefer, Doupnik, Advanced Accounting, 15e

not enhance a nonfinancial asset.) 18. C (Whenever a private NFP has to provide items or services of commensurate value, it reports an exchange revenue. Otherwise, a contribution revenue is appropriate.) 19. D (The charity must convey the donation to the designated beneficiary. Unless the donor gave variance powers to the charity that allowed it to change the beneficiary, this donation represents a liability to the Jones family. The gift merely passes through the charity to the ultimate beneficiary.) 20. D (Because the accountant has a specialized skill that would otherwise have to be acquired, the donated service is reported. The amount paid by the affiliated entity provides the fair value for recording purposes.) 21. B (By this policy, no financial benefit accrues to the charity from the sale of the artifact.) 22. B (The donor continues to have control and reports an asset [a receivable] until the gift is conveyed to Charity Two. Because of this uncertainty, Charity One reports a liability and Charity Two reports nothing until Charity One conveys the money to Charity Two.) 23. B (Contributions and pledges are conditional if the NFP must overcome a barrier or the money will have to be returned [and future payments will not have to be made].) 24. A (Money has been conveyed to the NFP but the contribution is conditional. Because the NFP may have to return the money unless it is able to overcome the barrier associated with the gift, a liability is recognized.) 25. B (Because the contribution is conditional, no recognition is made until either the resources are conveyed or the conditions stipulated by the donor are met. Here, the NFP makes no journal entry because it has yet to receive the promised money.) 26. C (C is a time restriction on the use of the money. It is not a barrier that the NFP must overcome in order to retain the money.) 27. A (The key factor here is that YZ is expected to be predominantly supported by contributions. Thus, future exchange revenues will likely be minor. The acquisition value ($1 million) in excess of the fair value of all assets and liabilities held by YZ ($700,000) is $300,000. Because most support comes from contributions and investment income, this $300,000 reduces net assets without donor restrictions on the statement of activities. No goodwill is recognized.) 28. A (When two not-for-profit entities come together to form a new not-for-profit entity with a new governing board, a merger has occurred. In reporting a merger, the carryover method is used. Thus, the combined companies retain the book value of each individual asset and liability. The $300,000 book value for BC‘s land plus the $500,000 book value for OP‘s land gives a reported land account of $800,000 for LM.) 29. B (This transaction is an acquisition and contributions or investment income do not provide the predominate means of support for the acquired entity. Thus, Southwest reports the difference in the acquisition value of Northeast ($980,000) and the fair value of the two recognized assets ($150,000 plus $800,000 or $950,000) as goodwill of $30,000.) 30. A (Form 990 is the annual informational form that most tax-exempt organizations are required to file with the IRS.) 31. A (As an educational institution, Belwood College will qualify as a 501(c)(3) tax-exempt 1-40 © McGraw Hill LLC. All rights reserved. No reproduction or distribution without the prior written consent of McGraw Hill LLC.

Chapter 01 - The Equity Method of Accounting for Investments – Hoyle, Schaefer, Doupnik, Advanced Accounting, 15e

organization.) 32. B (Third-party payors such as government programs or insurance companies pay most of the health care costs in the U.S. They establish contractual relationships that create significant discounts. In some cases, NFPs will not attempt to collect from patients, especially if those individuals cannot afford the services performed. Health care entities refer to this practice as charity care and do not formally record the amounts on their financial statements.) 33. D (Discounts created formally by contractual arrangements are referred to as explicit price concessions.) 34. B (Previously, bad debts were reported to reflect, in part, discounts provided to government programs and insurance companies. For that reason, they were shown as a contra-revenue amount. Now, health care entities report revenues based on expected collections. Bad debts indicate a failure to collect anticipated amounts and appear as expenses.) 35. C (The expected amount is a weighted average based on what the NFP expects to collect. A $70,000 deduction from $170,000 means the NFP expects to collect $100,000. A $100,000 deduction from $170,000 means the NFP expects to collect $70,000. The expected amount is (60% times $100,000) plus (40% times $70,000) for a total of $88,000. 36. D (The most likely event is that the discount will be $40,000 reducing the revenue from $140,000 to $100,000.) 37. (10 minutes) (Reporting of various account balances by a not-for -profit health care entity) --Donated medicines = an asset is reported (on the statement of financial position) as is an increase in contribution revenue under net assets without donor restrictions (on the statement of activities). Nonfinancial donations should be reported on a separate line of the statement of activities. --Donated services (replacing salaried workers) = the fair value of the services causes an increase in contribution revenue under net assets without donor restrictions (on the statement of activities) along with the recognition of salary expense in the same column. --Donated services (not replacing salaried workers) = not recorded because it does not appear to meet either criteria for recognition but, if one of the two criteria are met, contribution revenue and salary expense are both increased under net assets without donor restrictions (on the statement of activities). --Charges to patients = explicit price concessions and implicit price concessions are taken into consideration and then either the expected amount or the most likely amount of the remaining variable consideration is reported as an increase in receivables (or cash if already collected) and an increase in patient service revenues --Charity care = not recorded if the entity does not intend to seek collection. --Provision for bad debts = an anticipated amount to be collected is anticipated after (1) both explicit price concessions and implicit price concessions are included and (2) a determination is made of the variable consideration. However, some amount of bad debts can still occur. The entity estimates that amount (likely based on experience) and recognizes it as an expense. 38. (65 Minutes) (Preparation of statements for a private not-for-profit entity) a.

Statement of Activities Net Assets Net Assets Without Donor Restrictions With Donor Restrictions

Contributions 1- Contribution revenue

$210,000

$ 78,000

Chapter 17 – Accounting for State and Local Governments (Part Two) – Hoyle, Schaefer, Doupnik, Advanced Accounting, 15e

2- Contribution—interest

5,000

Earned revenue 3- Membership dues 4- Investment income 5Net assets released from restrictions: Satisfaction of donor restrictions

2,500 3,900

9,100

72,000

(72,000)

Total contributions and earned revenue

$288,400

$ 20,100

Expenses Program service expenses —Cure disease 6- Salaries 7- Depreciation 8- Supplies Total

(26,500) (16,000) (93,000) (135,500)

Supporting service expenses – General and administrative 9- Salaries 10- Depreciation Total – Fundraising 11- Salaries 12- Advertising 13- Depreciation Total

(32,000) (2,000) (34,000) (26,500) (2,000) (2,000) (30,500) (200,000)

Total Expenses Change in Net Assets Net Assets – Beginning of Year Net Assets – End of Year

$ 88,400

$ 20,100

400,000

300,000

$488,400

$320,100

Explanation of Balances 1- Contribution revenue. The two balances here are the unrestricted gifts ($210,000 from a.) plus present value of the pledge ($78,000 from h.). Pledge is included in net assets with donor restrictions because the NFP will not collect the money for three years. 2- Contribution-Interest. The NFP records the pledge (from h.) at its present value of $78,000. The entity then recognizes interest to begin raising the asset balance to the pledge amount by the time of collection. An NFP recognizes the interest on a pledge as a contribution. 3- Membership dues. The NFP reports the amount received in d. as revenue and not as a contribution because the members receive rights equal in value to the amount collected. To date,

Chapter 01 - The Equity Method of Accounting for Investments – Hoyle, Schaefer, Doupnik, Advanced Accounting, 15e

the NFP has only earned 1/12 of the $30,000 so the revenue is $2,500. 4- Investment income. Because the NFP earns this income ($13,000 in f.) on its permanently restricted net assets, 70 percent ($9,100) is classified as net assets with donor restrictions. The donor specified (according to the introductory information) that this portion be for advertising. The NFP reports the remaining 30 percent as net assets without donor restrictions. 5- Net assets released from restriction. The NFP spent three restricted amounts properly during the period: $20,000 for salaries (in b.), $50,000 for equipment (in c.), and $2,000 for advertising (in g.) for a total of $72,000. The statement shows a reduction in the total for net assets with donor restrictions and an increase in the net assets without donor restrictions. 6- Salaries. During the period, $24,000 in salaries were paid (30 percent of $80,000 was assigned here according to b.) and another $2,500 was owed at the end of the year (50 percent of year-end accrual according to k.). 7- Depreciation. Of the total expense ($20,000) for the period (according to i.), 80 percent was allocated to program service expenses because that amount of the equipment was used for that purpose (according to c.) 8- Supplies. The NFP acquired and used a total of $93,000 during the year (according to j.). 9- Salaries. Administrative salaries amounted to $32,000 for the year (40 percent of overall total according to b.). 10- Depreciation. Of the total for the period (in i.), 10 percent was allocated to general and administrative expenses (according to c.). 11- Salaries. During the period, the NFP assigned $24,000 of the salaries here (30 percent of $80,000 paid according to b.) and another $2,500 was owed at the end of the year (50 percent of year-end accrual at k.). 12- Advertising. The NFP incurred only $2,000 in advertising costs during the period (according to g.) 13- Depreciation. Of the total for the period ($20,000 from i.), the NFP assigns 10 percent to fundraising expenses (according to c.). ---Because the painting at l. qualifies as a museum piece, formal reporting is optional. Officials do not want to report the painting, and they are not required to do so. ---The NFP must convey the $10,000 gift in e. to an outside beneficiary so it is shown as a liability. b. Statement of Financial Position Assets 1- Cash 2- Pledge Receivable 3- Equipment 4- Accumulated Depreciation

$300,000 (20,000)

$738,000 83,000 280,000

Chapter 17 – Accounting for State and Local Governments (Part Two) – Hoyle, Schaefer, Doupnik, Advanced Accounting, 15e

Total Assets

$1,101,000

Liabilities 5- Salaries Payable 6- Notes Payable 7- Deferred Revenue 8- Donated Amount Due to Separate Entity

$ 5,000 250,000 27,500 10,000

$ 292,500

Net Assets (see Statement of Activities) Without Donor Restrictions With Donor Restrictions

$488,400 320,100

$ 808.500

Explanation of Balances: 1- Cash. The reported balance is the beginning cash figure of $700,000 plus $210,000 in contributions, less $80,000 for salaries, less $50,000 for equipment, plus $30,000 in membership dues, plus $10,000 contribution that must be conveyed to a separate entity, plus $13,000 investment income, less $2,000 paid for advertising, and less $93,000 paid for supplies. 2- Pledges receivable. The reported amount is the present value as of the end of the year (the original $78,000 plus the $5,000 interest recognized for the period). 3- Equipment. Entity acquired equipment at a cost of $300,000 during the year. 4- Accumulated Depreciation. The $20,000 balance is the amount of depreciation recorded for this initial year of ownership. 5- Salaries Payable. The balance is the amount owed to employees as of the end of the year. 6- Notes Payable. This balance is the liability incurred in acquiring equipment. 7- Deferred Revenue. Membership dues of $30,000 were exchange transactions but the NFP has only earned 1/12 of the total to date ($2,500). The entity will earn the remaining $27,500 in the future. 9- Donated Amount Due to Separate Entity. A donor gave this money and stipulated that the NFP convey it to a separate beneficiary. The amount is a liability because there is no mention that the NFP holds variance powers that would allow it to change the beneficiary. 39. (25 minutes) (A private NFP records various donations) a. A pledge is a promise of a future conveyance of resources. It is conditional if some specific barrier exists that the private NFP must overcome or the donor can refuse to make further payments (and can ask for a refund of amounts already conveyed). An NFP does not record conditional pledges because of the uncertainty. b. The pledge for the automotive equipment is recorded as a receivable. Depending on the length of time until expected collection, the NFP might report the amount at present value. On the statement of activities, the entity reports the increase as a contribution revenue under the net assets with donor restrictions. If recorded at present value, the NFP calculates interest over time. It increases the additional contribution revenue under net assets with donor restrictions. When 1-44 © McGraw Hill LLC. All rights reserved. No reproduction or distribution without the prior written consent of McGraw Hill LLC.

Chapter 01 - The Equity Method of Accounting for Investments – Hoyle, Schaefer, Doupnik, Advanced Accounting, 15e

collected, the NFP increases cash and removes the receivable. Finally, when the entity acquires the equipment, equipment goes up and the cash balance falls. At the same time, the NFP reclassifies this same amount from net assets with donor restrictions to net assets without donor restrictions. This reclassification is at the time of purchase unless the donor specifies that the movement from net assets with donor restrictions to net assets without donor restrictions be gradual over the life of the asset in an amount equal to annual depreciation expense. c. Board-designated funds are still under the control of the board and not an external party. Thus, little special reporting is made of the amount. In the ―net assets‖ section of the statement of financial position, the net assets without donor restrictions include the board-designated amount. d. Donors can restrict the use of amounts conveyed to a private NFP. Some gifts have a purpose restriction. The donor directs the entity to use the resources for a particular expenditure such as a salary or equipment. Others have a time restriction that limits expenditure until after a designated date or during a specified period. Some donors require their donations be held permanently with subsequent income used as noted by the donor. The NFP must report all of these as net assets with donor restrictions. Any remaining net assets are without donor restrictions. e. Any remaining pledges that are not conditional are reported as receivables. Because donors did not restrict these amounts, the contribution revenue appears within net assets without donor restrictions. If the NFP expects payment beyond one year, the NFP reports the balances at present value. Over time, the entity adds interest to the receivable causing contribution revenue to increase. The NFP uses its experience (and other factors such as change in economic conditions) to estimate and record a provision for bad debts. In this case, the amount is $5,000. All expenses appear within the net assets without donor restrictions. f. Donated services are recorded if the fair value of those services can be determined in a reasonable manner and the service meets one of two criteria: (1) It creates or enhances a nonfinancial asset. (2) The service requires a specialized skill that the NFP would otherwise have had to buy. It appears in this situation that the donated service is likely to meet the second requirement. g. The NFP reports salary expense of $18,000 (600 hours at $30 per hour) along with contribution revenue of the same amount. Both balances appear in the statement of activities within net assets without donor restrictions. 40. (30 Minutes) (Series of questions about private not-for-profit entities) a. Many private non-for-profit entities depend heavily on gifts and grants from outside parties. The NFP does not provide a good or service of commensurate value. The NFP reports such conveyances as contribution revenue. These same entities, however, do sometimes provide a good or service of commensurate value. Membership dues, for example, are not solely gifts if the member receives rights that have value. A not-for-profit university provides educational benefits in exchange for tuition and other fees. An increase in net assets derived in this fashion is not a donation. It is an exchange revenue. b. All private NFPs must now provide information about their functional expenses. The NFP can provide this information in a footnote or within the statement of activities. However, a statement of functional expenses also fulfills this requirement. This statement identifies the ultimate usage of the money raised by an NFP. The statement of functional expenses separates all expenses

Chapter 17 – Accounting for State and Local Governments (Part Two) – Hoyle, Schaefer, Doupnik, Advanced Accounting, 15e

according to program services (used in activities that relate to the entity‘s goals and mission) and supporting services (dealing with the cost of running the entity and raising funds). This statement permits interested parties, such as potential donors, to see the application made of the not-forprofit entity‘s resources. c. Some charities (Goodwill Industries and the Salvation Army, for example) receive a large amount of donations in the form of materials (known as in-kind contributions) such as clothing and furniture. If the value of these goods has a clearly measurable basis, recording such gifts as contribution revenue is appropriate. If the NFP cannot determine fair value, the contribution goes unrecorded although the entity can convey information about the gifts in its footnote disclosure. d. A not for profit entity may receive gifts (or unconditional promises to give) from outside parties that (1) must be expended for a particular purpose, (2) cannot be expended until a particular point in the future, or (3) must be held permanently (with subsequent income available to be spend). Because the organization does not have free use of these assets, the NFP reports them as "net assets with donor restrictions." The NFP classifies net assets held without any donor requirements or stipulations as ―net assets without donor restrictions.‖ When the NFP meets the stipulation in (1) or (2), it reclassifies the amount into ―net assets without donor restrictions.‖ e. Donated services are extremely common in the operation of many not-for-profit entities. Literally thousands of individuals solicit funds for entities such as the Heart Fund, Salvation Army, and March of Dimes. In addition, individuals often voluntarily fill positions of responsibility in many of these not-for-profits. The NFP must recognize the value of donated services but only if the gift meets one of two specific circumstances: 1.

The service creates or enhances a nonfinancial asset or,

The service requires a specialized skill possessed by the donor that the entity would have purchased if not donated.

f. Contributions and pledges are conditional if the donor specifies a barrier that must be overcome before the NFP is truly entitled to the donation. If the NFP does not overcome the barrier, the donor has the right to avoid future payments and seek a refund for any conveyed amounts. If an actual contribution is conditional, the NFP reports it as a liability. The donor can recover the donation if the NFP fails to overcome the barrier. If a pledge is conditional, the NFP makes no recording because of the uncertainty of receipt. g. Accounting for the mailing costs of a fundraising appeal have evolved over the years. At one time, NFPs had to record the costs of direct mailings and other solicitations for support as fundraising expenses even if educational materials were included. This requirement was then modified so that an allocation of the joint costs could be made between educational expenses (a program service cost) and fundraising (a supporting service cost). Some entities took advantage of this rule. They included educational materials with their fundraising appeals in order to allocate a significant portion of the mailing and other distribution costs to program services. This allocation made their statements look better. These entities appeared to be spending more to meet their goals. In 1998, the AICPA issued its Statement of Position 98-2 ―Accounting for Costs of Activities of Not-for-Profit Organizations and State and Local Governmental Entities That Include FundRaising‖ which is now part of the FASB Accounting Standards Codification. This rule stated that direct mailing costs should be assigned entirely to fundraising costs unless a specific call for action was being included that was not limited to potential donors. This call for action had to be one that would further the mission of the not-for-profit. By meeting these requirements, an NFP 1-46 © McGraw Hill LLC. All rights reserved. No reproduction or distribution without the prior written consent of McGraw Hill LLC.

Chapter 01 - The Equity Method of Accounting for Investments – Hoyle, Schaefer, Doupnik, Advanced Accounting, 15e

was able to assign a logical portion of the direct mailing costs to program service expenses. Otherwise, the entity includes the entire cost within fundraising. h. Donated materials are normally reported as assets at their fair value accompanied by an increase in contribution revenue (see answer [c] above). However, the recording of art works, historical treasures, museum pieces, and the like is optional. An item qualifies for such treatment if (1) it is part of a collection for public exhibition, education, or research, (2) it is protected and preserved, and (3) if sold, the money received must be used to acquire other collection items, the direct care of existing collections, or both. If a donation meets all of these criteria, no recording is required (although the NFP may report the amount). 41. (70 minutes) (Prepare journal entries for a private university as well as a statement of activities) a. Tuition receivable Tuition revenues and fees (no donor restrictions)

1,200,000 1,200,000

b. Investments Contribution revenue (with donor restrictions)

300,000 300,000

c. Cash 700,000 Contribution revenue (with donor restrictions) 700,000 Because the question does not talk about refunds if the equipment is not acquired, the contributions is probably not conditional. If it is conditional, a liability rather than revenue is recorded. d.

Scholarships—financial aid Tuition receivable

100,000

Salary expenses—teaching Salary expenses—research Salary expenses—administrative Salary expenses—fundraising Cash

140,000 80,000 50,000 40,000

Salary expenses—teaching Salary expenses—research Contribution revenue (without donor restrictions)

56,000 24,000 80,000

Equipment Cash Net assets with donor restrictions—reclassification Net assets without donor restrictions—reclassification

200,000

100,000

310,000

200,000 200,000 200,000

Chapter 17 – Accounting for State and Local Governments (Part Two) – Hoyle, Schaefer, Doupnik, Advanced Accounting, 15e

Investments Investment income (with donor restrictions)

30,000 30,000

Cash Dividend revenues (without donor restrictions)

9,000 9,000

Depreciation expense—research Depreciation expense—teaching Accumulated depreciation

25,600 6,400 32,000

Cash—internally restricted Cash

100,000 100,000

Pledge 7,513 Contribution revenue (with donor restrictions) 7,513 A time restriction is assumed here since the pledge will not be collected for three years. Pledge receivable 376 Contribution revenue (with donor restrictions) 376 Interest is recognized on present value balance. Amount is $7,513 times 10 percent times 1/2 year.

m. No entry because of choice made by officials n.

Utilities and other expenses—teaching Utilities and other expenses—research Utilities and other expenses—fundraising Utilities and other expenses—administrative Cash

74,000 45,000 43,000 50,000 212,000

o. No entry—does not require a specialized skill. p. No entry—conditional pledges are not recorded. University of Danville Statement of Activities Net assets without donor restrictions

Net assets with donor restrictions

Chapter 01 - The Equity Method of Accounting for Investments – Hoyle, Schaefer, Doupnik, Advanced Accounting, 15e

Exchange revenues and gains -Tuition -Scholarships

$1,200,000 (100,000)

-Unrealized gain on investments -Dividend revenues

$1,100,000 $ 30,000 9,000

Contribution revenue -Cash and other assets -Pledges -Dividends and interest -Services

1,000,000 7,513 376 80,000

Total revenues, gains, and contributions

1,189,000

1,037,889

Net assets released from restriction

200,000

(200,000)

1,389,000

837,889

Totals Operating Expenses -Salaries Teaching Research Administrative Fund raising -Depreciation Teaching Research -Utilities and other expenses Teaching Research Fundraising Administrative

196,000 104,000 50,000 40,000

390,000

6,400 25,600

32,000

74,000 45,000 43,000 50,000

212,000

Total expenses

634,000 755,000

837,889

400,000

300,000

$1,155,000

$1,137,889

Increase in net assets Net assets—beginning of year Net assets—end of year

Chapter 17 – Accounting for State and Local Governments (Part Two) – Hoyle, Schaefer, Doupnik, Advanced Accounting, 15e

42. (25 Minutes) (Determine impact of various transactions on a private college.) (1)---False. The January 1, Year 1, restriction is an internal action. Board decisions create no changes in the reported balance of net assets without donor restrictions. (2)---True. The stipulation attached to the April 1, Year 1, gift is that only subsequent cash income can be used for the designated purpose. The interest income earned during the year is donor restricted for the purpose of stadium construction. Changes in the value of the investments increase the net assets with donor restrictions but this amount is permanently restricted and not purpose restricted. (3)---True. As indicated in (2), the donor has indicated that the college use only the cash income for the football stadium. The $44,000 change in value increases the net assets with donor restrictions. The donor has stipulated that the changes in value of the investments affect the amount of net assets held permanently. (4)---True. The school has properly spent the $500,000 earned on the donated investments. No policy has been set that assumes a time restriction on the use of this stadium. Therefore, the school makes the reclassification to net assets without donor restrictions at the time of proper expenditure. Spending of the board-designated $1.9 million (from [1]) does not change the amount of net assets without donor restrictions—just the composition. (5)---False. Depreciation expense is appropriate for all long-lived assets with a finite life regardless of the policy of the school. (6)---False. This is the same answer as in (5). Depreciation expense is appropriate for all longlived assets with a finite life regardless of the policy of the school. (7)---False. The acquisition of the football stadium seat has two effects. Because the value of that seat for watching football games is $12,000, the school should recognize that amount as a deferred revenue until earned. Dr. Johnson paid an extra $18,000, apparently as a gift to the school. That amount is a contribution revenue. The increase in net assets without donor restrictions is $18,000 until the football team plays its games and the other $12,000 is recognized. (8)---True. This answer returns to the explanation in (7). Dr. Johnson paid an extra $18,000, apparently as a gift to the school. There is no indication that this gift is conditional. (9)---True. These donated services meet the requirement for financial reporting so that the school recognizes contribution revenue and a salary expense for the $14,000 value of these services. The school includes both amounts under net assets without donor restrictions. (10)---False. Based on the information given, the school must report both the contribution revenue and the expense as discussed in (9). ―Might‖ implies an option, which is not available for this type of donation. If a donated service meets one of two criteria, the NFP must report it. (11)---False. This answer is the same as in (10). The school must report both the contribution revenue and the expense. Net assets without donor restrictions go up (for the contribution revenue) and go down (for the salary expense). (12)---False. If this painting does not qualify as a work of art, the school must record the asset at $30,000 along with a contribution revenue of that same amount. However, if the painting qualifies

Chapter 01 - The Equity Method of Accounting for Investments – Hoyle, Schaefer, Doupnik, Advanced Accounting, 15e

as a work of art, the school can either make this entry or simply make no entry. Therefore, under one set of circumstances, recognition of this contribution is not required. (13)---False. As in answer (12), the handling depends on whether this painting qualifies as a work of art. Nevertheless, because the value of the donated gift is $30,000, the school can recognize a contribution revenue. The option is to leave the gift unrecorded. 43. (30 Minutes) (Determine net asset changes for different types of transactions) Part I --Net Assets Without Donor Restrictions – No net change. When the university spent the $22,000 in funds as designated, it reclassified that amount from Net Assets With Donor Restrictions to Net Assets Without Donor Restrictions. At the same time, salary expense of $22,000 is also recognized. The two amounts offset each other leaving no net effect on Net Assets Without Donor Restrictions. The $150,000 amount internally designated by the board creates a change in the labeling of this balance but does not alter the amount of Net Assets Without Donor Restrictions. --Net Assets With Donor Restrictions – Category increases by $409,000. The $400,000 donation creates an immediate increase. The $31,000 earned as investment income also increases this category. Both amounts are restricted. However, when the college spent $22,000 as designated, it reclassified that amount into Net Assets Without Donor Restrictions. Because the school spent the money as stipulated, it removed the restriction. Part II --Net Assets Without Donor Restrictions – No net change. Because of the restriction on the use of the $90,000 for listening rooms, the school reports the gift as an increase in Net Assets With Donor Restrictions until properly spent. The $50,000 gift is time restricted and also increases Net Assets With Donor Restrictions. The other two donations are conditional. Thus, for the cash received, the school reports a corresponding liability. For the conditional pledge, no reporting is yet appropriate. --Net Assets With Donor Restrictions – Category Increases by $140,000. The school reports the $90,000 gift as an increase in Net Assets With Donor Restrictions because of the purpose restriction. The $50,000 gift is time restricted and it also increases Net Assets With Donor Restrictions. Part III --Net Assets Without Donor Restrictions – Category increases by $1.6 million. The school records tuition revenue of $2 million but then reduces the amount by the $700,000 in financial aid, for a net increase of $1.3 million. Because the school uses $300,000 of previously restricted net assets, a reclassification of that amount from Net Assets With Donor Restrictions to Net Assets Without Donor Restrictions causes the overall increase to be $1.6 million. --Net Assets With Donor Restrictions – Category decreases by $300,000. The school used money that had been purpose-restricted by a donor as stipulated. Thus, a reclassification of this amount into Net Assets Without Donor Restrictions is appropriate.

Chapter 17 – Accounting for State and Local Governments (Part Two) – Hoyle, Schaefer, Doupnik, Advanced Accounting, 15e

44. (65 Minutes) (Prepare financial statements for a private not-for-profit entity.) a. Entries for this not-for-profit entity are presented below. The numbers in parenthesis indicate updated account totals at that point in time. This method provides as an easy way to monitor account balances in anticipation of the creation of financial statements. (1) - Contributions receivable Contribution revenue—interest—net assets without donor restrictions

20,000

(2) – Cash

100,000 4,000

Allowance for uncollectible pledges Contributions receivable

(220,000) 20,000

(20,000) (200,000)

104,000 (net of 120,000)

(3) – Cash 180,000 Contribution revenue—donations – net assets without donor restrictions 180,000

(380,000)

(4) – Cash

23,000

(403,000) (23,000)

90,000

(90,000) (313,000)

15,000

(15,000) (15,000)

23,000

(223,000) (290,000)

23,000

Liability for conditional gift

(5) - Salary expense—healthcare Cash

90,000

Reclassification – net assets with donor restrictions Reclassification – net assets without donor restrictions

15,000

(6) – Land, buildings, and equipment Cash

23,000

Liability for conditional gift Contribution revenue—donations – net assets without donor restrictions

23,000

(180,000)

-023,000

(203,000)

44. (continued) (7) – Cash 12,000 Contribution revenue—donations – net assets with donor restrictions (Entity records this contribution because it holds variance powers.) (8) - Land, buildings, and equipment Note payable Cash

(302,000) 12,000

(12,000)

450,000 50,000

(723,000) (450,000) (252,000)

50,000

(65,000) (65,000)

500,000

Reclassification – net assets with donor restrictions 50,000 Reclassification – net assets without donor restrictions (To record reclassification of restricted amount properly spent.) (9) – Cash

30,000

(282,000)

Chapter 01 - The Equity Method of Accounting for Investments – Hoyle, Schaefer, Doupnik, Advanced Accounting, 15e

Exchange revenues—memberships – net assets without donor restrictions Deferred revenues (Membership dues are revenues and not contributions because members receive substantial benefits. Of the total, 2/3 have been earned.) (10) – Cash 40,000 Investment income – net assets without donor restrictions (Income is earned on permanently restricted net assets but use of the subsequent income is unrestricted.) (11) – Investments—internally restricted for emergencies Investments

20,000 10,000

(20,000) (10,000)

40,000

(322,000) (40,000)

9,000

(9,000) (291,000)

43,000

(12,000) (15,000) (16,000) (279,000)

9,000

(12) - Rent expense 12,000 Advertising expense 15,000 Utilities expense 16,000 Cash (Expenses are one-half for healthcare, one-fourth for fundraising, and one-fourth for administrative.)

(13) - Contributions receivable 149,000 (net of 269,000) Contribution revenue—donations – net assets with donor restrictions 149,000 (161,000) (Although this pledge is unrestricted, it will not be collected for five years and, therefore, the proceeds are viewed as time restricted.) Contributions receivable Contribution revenue—interest – net assets with donor restrictions

6,000

(net of 275,000) 6,000

(6,000)

40,000

(40,000) (683,000)

15,000

(15,000) (264,000)

44. (continued) (14) - Depreciation expense Land, buildings, and equipment (Depreciation is 60 percent for healthcare, 30 percent for administration, and 10 percent for fundraising.)

40,000

(15) - Interest expense Cash (This cost is entirely related to healthcare.)

15,000

Based on the final balances computed above, the following statements can be prepared. WATSON FOUNDATION STATEMENT OF ACTIVITIES For Year Ending December 31, 2024 Net Assets Without Donor

Net Assets With Donor

Chapter 17 – Accounting for State and Local Governments (Part Two) – Hoyle, Schaefer, Doupnik, Advanced Accounting, 15e

Restrictions

Contribution revenue: --Donations --Interest Total

$ 203,000 20,000 223,000

$ 161,000 6,000 167,000

Investment income Exchange revenues--memberships Total contributions and revenues

40,000 20,000 $ 283,000

$ 167,000

Net assets released from restrictions

65,000

(65,000)

$ 348,000

$ 102,000

Total contributions, revenues, and net assets released from restrictions Expenses: Program services--healthcare --Salary --Rent --Advertising --Utilities --Depreciation --Interest Supporting services--fundraising --Rent --Advertising --Utilities --Depreciation Supporting services—administrative --Rent --Advertising --Utilities --Depreciation

($90,000) (6,000) (7,500) (8,000) (24,000) (15,000) (150,500) (3,000) (3,750) ( 4,000) (4,000)

(4,750)

(3,000) (3,750) (4,000) (12,000)

Total expenses

(22,750) $(188,000)

-0-

Excess of total contributions, revenues, and net assets released from restriction over expenses

160,000

102,000

Net assets at beginning of year

400,000

Net assets at end of year

$560,000

$502,000

Chapter 01 - The Equity Method of Accounting for Investments – Hoyle, Schaefer, Doupnik, Advanced Accounting, 15e

b. WATSON FOUNDATION STATEMENT OF FINANCIAL POSITION December 31, 2024 ASSETS Cash Contributions receivable (net) Investments Investments—internally restricted Land, buildings, and equipment (net) Total assets

$ 264,000 275,000 291,000 9,000 683,000 $1,522,000

LIABILITIES Deferred revenues Notes payable Total liabilities

$ 10,000 450,000 $ 460,000

NET ASSETS Without donor restrictions Unrestricted Board designated for emergency purposes With donor restrictions Total net assets Total liabilities and net assets

$551,000 9,000

$ 560,000 502,000 1,062,000 $1,522,000

45. (40 minutes) (Determining amounts to be reported by various not-for-profit entities)

PART ONE a. The college reports the tuition properly as exchange revenue. However, the financial aid figure should be a direct reduction to the tuition revenue rather than a separate expense. In either case, the financial aid reduces net assets without donor restrictions so the $400,000 total computed at the end of the year is correct. b. As indicated in (a), the financial aid should not have been an expense but, rather, a reduction in tuition revenue. Removing the $140,000 from the reported amount of expenses reduces that total from $500,000 to $360,000. PART TWO a. Because the donor specified the use of the income, the NFP should record both income balances initially as increases within net assets with donor restrictions. When properly spent, the NFP reclassifies the amount into net assets without donor restrictions. Instead, this entity recorded the amounts immediately in net assets without donor restrictions. Because the entity spent the amounts properly, they both wound up in the correct category. The entity also reported the expenses correctly. Thus, no changes are necessary. The $400,000 shown as net assets without donor restrictions is correct. b. The NFP recognized each expenditure as an expense under net assets without donor restrictions. That handling is correct. This reporting is correct so that the $500,000 reported 1-55 © McGraw Hill LLC. All rights reserved. No reproduction or distribution without the prior written consent of McGraw Hill LLC.

Chapter 17 – Accounting for State and Local Governments (Part Two) – Hoyle, Schaefer, Doupnik, Advanced Accounting, 15e

expense balance is appropriate. c. As indicated in (a), the $5,000 and the $7,000 should have initially increased net assets with donor restrictions and then removed through a reclassification when spent (leaving no net change). Because the entity recorded neither amount in net assets with donor restrictions, the total of $400,000 is correct. The effect is the same either way.

PART THREE a. The entity reported a $50,000 contributed revenue at the time of the gift under net assets with donor restrictions. However, the gift was conditional. The entity should report the balance as a liability. Removing the revenue reduces the net assets with donor restrictions from $300,000 to $250,000. b. After the appropriate expenditure, the revenue is reclassified into net assets without donor restrictions. Although the first recording was incorrect, the ultimate reporting within net assets without donor restrictions is correct. The entity recorded the depreciation correctly. The net assets without donor restrictions is correct at $400,000. The balance requires no changes. c. The depreciation was recorded appropriately. No changes are necessary. The expense total of $500,000 is correct. d. In buying the bus, the entity met the stipulations on the gift. Thus, it should no longer report the $50,000 within net assets with donor restrictions. That is the way the balance was reported, so the ending balance of $400,000 does not need correction.

PART FOUR a. In this case, because the entity received nothing in exchange for the membership dues, these collections should have been recorded as contribution revenue, an increase in net assets without donor restrictions. Instead, the entity recorded the dues as membership revenue. Although that recording was incorrect, it still increases net assets without donor restrictions by the correct amount. The specific source of the net assets is wrong, but the total of the net assets without donor restrictions is correct at $300,000 as of the end of Year One. b. The explanation is the same as in a. above. In addition, the investments held for emergencies do not change the overall totals. The entity just labels the internally restricted assets. The correct balance of net assets without donor restrictions is correct at $400,000 at the end of Year Two. c. None of the net assets are subject to donor restrictions. The entity did not record any changes for net assets with donor restrictions. The $400,000 balance at the end of Year Two is correct.

PART FIVE a. The problem here is that an expense of $70,000 was reported although the donation was a garage that should be capitalized as an asset. Subsequently, the entity should record depreciation expense on this asset at the rate of $7,000 per year. For this reason, at the end of Year Two expenses are overstated by $63,000 ($70,000 minus $7,000). Net assets without donor restrictions is too low by $63,000. Instead of a balance of $400,000, the entity should report $463,000 as its net assets without donor restrictions.

Chapter 01 - The Equity Method of Accounting for Investments – Hoyle, Schaefer, Doupnik, Advanced Accounting, 15e

b. The entity reports no increase in assets as a result of the contributed garage. The entity should report the $70,000 garage less $7,000 in accumulated depreciation. Adding the net balance of $63,000 to the reported total for assets of $900,000 gives a corrected figure of $963,000. c. As indicated in (a) above, expenses are overstated by $63,000. Removing this $63,000 reduces the expense total from $500,000 to $437,000.

PART SIX a. The NFP reports net revenues of $1.8 million ($3.0 million revenue less $1.2 provision for bad debts) but wants to use the most likely amount. For the first portfolio, the most likely amount is $1.5 million. For the second portfolio, the most likely amount is $300,000 for a total revenue of $1.8 million. Bad debt expense is 5 percent of that figure or $90,000 for a net of $1,710,000. Reducing the previous reporting of $1.8 million to $1,710,000 is a $90,000 reduction. That reduces the net assets without donor restrictions by $90,000 from $400,000 to $310,000 as of the end of Year Two. b. As shown in a., the $3.0 million revenue should be reduced to $1.8 million or a reduction of $1.2 million. 46. (40 minutes) (Accounting for mergers and acquisitions) a. In an acquisition, the assets and liabilities of the acquired entity are included at fair value. The buildings and equipment reported by Swim For Safety must be increased by $140,000 from $590,000 to $730,000. Because the acquisition value ($1 million) exceeds the total fair value recognized for the individual assets and liabilities ($1,470,000 plus $140,000 less $690,000 or $920,000), the consolidated balances report the excess ($80,000 in this case) as goodwill. Goodwill is reported because Swim For Safety is not primarily supported by contributions and investment income. Cash held by Help & Save decreases because of the $1 million payment. The same reduction occurs in the charity‘s total for net assets without donor restrictions.\

46. (continued) The increases in the buildings & equipment ($140,000) as well as the increase in goodwill ($80,000) create increases in net assets without donor restrictions because no external restriction is in place for these assets. Consolidated balances: --Cash * $1,100,000 ($1,600,000 less $1,000,000 plus $500,000) --Contributions receivable (net) - $280,000 ($70,000 plus $210,000) --Investments - $470,000 ($300,000 plus $170,000) --Buildings & equipment - $1,430,000 ($700,000 plus $730,000) --Goodwill - $80,000 (above) --Total assets - $3,360,000 (summation) --Accounts payable and accrued liabilities - $180,000 ($110,000 plus $70,000) --Notes payable - $1,720,000 ($1,100,000 plus $620,000) --Total liabilities - $1,900,000 (summation) 1-57 © McGraw Hill LLC. All rights reserved. No reproduction or distribution without the prior written consent of McGraw Hill LLC.

Chapter 17 – Accounting for State and Local Governments (Part Two) – Hoyle, Schaefer, Doupnik, Advanced Accounting, 15e

--Net assets without donor restrictions - $740,000 ($1,100,000 less $1,000,000 payment plus $140,000 increase in buildings and equipment plus $80,000 in goodwill plus $420,000 from Swim For Safety) --Net assets with donor restrictions - $720,000 ($360,000 plus $360,000) --Total net assets - $1,460,000 (summation) --Total liabilities and net assets - $3,360,000 ($1,900,000 plus $1,460,000) b. In an acquisition, the assets and liabilities of the acquired entity are included at fair value. Thus, the buildings and equipment reported by Swim For Safety must be increased by $140,000 from $590,000 to $730,000. Because the acquisition value ($990,000) exceeds the total fair value recognized for the individual assets and liabilities ($1,470,000 plus $140,000 less $690,000 or $920,000), the combined balances normally show the excess ($70,000 in this case) as goodwill. However, one possible exception exists to that handling. If contributions and investment income are the predominant means of support (as is the case here), the $70,000 excess is not recognized as an asset. Instead, the $70,000 (within the $990,000 payment) is an immediate reduction in net assets without donor restrictions. Cash held by Help & Save must be reduced by the payment of $990,000 as is the balance shown for net assets without donor restrictions. The increase in the buildings & equipment ($140,000) creates an increase in net assets without donor restrictions since no external restriction is in place for these assets. The resulting NFP does not recognize goodwill Consolidated balances: --Cash - $1,110,000 ($1,600,000 less $990,000 plus $500,000) --Contributions receivable (net) - $280,000 ($70,000 plus $210,000) --Investments - $470,000 ($300,000 plus $170,000) --Buildings & equipment - $1,430,000 ($700,000 plus $730,000) --Total assets - $3,290,000 (summation)

46. (continued) --Accounts payable and accrued liabilities - $180,000 ($110,000 plus $70,000) --Notes payable - $1,720,000 ($1,100,000 plus $620,000) --Total liabilities - $1,900,000 (summation) --Net assets without donor restrictions- $670,000 ($1,100,000 less $990,000 payment plus $140,000 addition to buildings and equipment plus $420,000 balance for Swim for Safety) --Net assets with donor restrictions - $720,000 ($360,000 plus $360,000) --Total net assets - $1,390,000 (summation) --Total liabilities and net assets - $3,290,000 ($1,900,000 plus $1,390,000) c. This transaction is a merger. Two not-for-profit entities are brought together to form a new notfor-profit entity that operates under a newly formed governing body. As a merger, the carryover method is used. Book values are simply added together to get new reported balances. The companies spent no cash. Without an acquisition value, the consolidation requires no adjustments to fair value.

Chapter 01 - The Equity Method of Accounting for Investments – Hoyle, Schaefer, Doupnik, Advanced Accounting, 15e

Consolidated balances: --Cash - $2,100,000 ($1,600,000 plus $500,000) --Contributions receivable (net) - $280,000 ($70,000 plus $210,000) --Investments - $470,000 ($300,000 plus $170,000) --Buildings & equipment - $1,290,000 ($700,000 plus $590,000) --Total assets - $4,140,000 (summation) --Accounts payable and accrued liabilities - $180,000 ($110,000 plus $70,000) --Notes payable - $1,720,000 ($1,100,000 plus $620,000) --Total liabilities - $1,900,000 (summation) --Net assets without donor restrictions - $1,520,000 ($1,100,000 plus $420,000) --Net assets with donor restrictions - $720,000 ($360,000 plus $360,000) --Total net assets - $2,240,000 (summation) --Total liabilities and net assets - $4,140,000 ($1,900,000 plus $2,240,000) 47. (15 minutes) (Handling of various events by two different charities) a. Charity A debits repair expense and credits contribution revenue. These two changes offset so the reporting has no effect on the total reported for net assets. Charity B makes no entry at all. The entity reports no change in its total net assets. After this accounting, the two charities report the same amount of net assets although Charity A will have a larger revenue balance and a larger expense balance. b. Charity A will report the investment income as an increase in net assets without donor restrictions and then report salary expense for the same amount. These two changes offset so that the total of the net assets without donor restrictions is not affected. Charity B initially increases net assets with donor restrictions to reflect the income. It reclassifies the amount to net assets without donor restrictions when spent. It also records the salary expense. These two changes cancel out so that the total of the net assets without donor restrictions remains unchanged. After this reporting, the two charities report the same amount of net assets without donor restrictions. c. The only difference here between Charity A and Charity B is in the handling of the excess $20,000 acquisition value ($800,000 less $780,000). Charity A records this amount as goodwill because the acquired charity gains a significant amount of its support from exchange transactions. Charity B records this excess as a reduction in net assets because the acquired charity gets most of its resources from donations. Because of this reduction, net assets without donor restrictions will be $20,000 lower for Charity B. d. Charity A reports revenue of $30,000 after the implicit price concessions but then has to report bad debt expense of $30,000. Charity B views this as charity care and reports nothing. Charity A reports higher revenue by $30,000 and a higher expense total by the same amount. e. Volunteers do the work so the cakes are a donation. NFPs record donated gifts at fair value. Charity A views the fair value as $50 per cake or $50,000. That is a contribution revenue. When sold, no additional increase in net assets occurs. Charity A receives the recorded balance for the cakes. The increase in net asset without donor restrictions is the initial donation of $50,000. Charity B views the fair value as $30 per cake or $30,000. That is a contribution revenue. 1-59 © McGraw Hill LLC. All rights reserved. No reproduction or distribution without the prior written consent of McGraw Hill LLC.

Chapter 17 – Accounting for State and Local Governments (Part Two) – Hoyle, Schaefer, Doupnik, Advanced Accounting, 15e

However, when sold, the donors pay $20 per cake more than fair value ($20,000). If the charity views the $50 as a reasonable price, it reports an exchange revenue of the additional $20,000. If the charity views the $30 as a reasonable price, it reports the extra $20,000 as an additional contribution revenue. Either way, the increase in net assets without donor restrictions is $50,000. 48. (15 Minutes) (Series of questions about the reporting of health care entities) a. A third party payor is an outside entity (such as Medicare or an insurance company) that pays a portion, or all, of a patient's medical expenses. They are common due to the extremely high cost of medical care. Because of their need for accurate financial information, such third party payors have exerted pressure on health care entities over the decades to develop adequate accounting principles and reliable accounting systems. They are also able to negotiate significant explicit price concessions from the health care entities. Often the charged balance for patient care is considerably different from the amount that a third-party payor will pay. b. To be in conformity with U.S. GAAP, the for-profit hospital must follow the applicable rules provided in the Accounting Standards Codification except for rules specifically designated for notfor-profit entities. The not-for-profit hospital must follow all of the rules of the Accounting Standards Codification including those designed for not-for-profit entities. If the rules are not consistent, the not-for-profit hospital follows the not-for-profit rules. c. Because of the explicit price concessions, the health care entity has the problem of variable consideration. It does not know the exact amount that it will receive. The health care entity can choose to recognize the most likely amount, which is $5 million, based on the 40 percent likelihood. The health care entity can also use the expected average using a weighted average approach. This process includes all possibilities. 40 percent of $5.0 million is $2.0 million. 30 percent of $4.0 million is $1.2 million. 30 percent of $3.0 million is $0.9 million. The total amount is $4.1 million. Whether the health care entity reports $5 million or $4.1 million, recognition of bad debts might prove necessary because of the uncertainty of the reported amounts. d. Because of the implicit price concessions, the health care entity has the problem of variable consideration. The exact amount that it will receive is unknown. The health care entity can choose to recognize the most likely amount, which is $1 million, based on the 50 percent likelihood. The health care entity can also use the expected average using a weighted average approach. This process includes all possibilities. 50 percent of $1.0 million is $500,000. 30 percent of $700,000 is $210,000. 20 percent of $400,000 is $80,000. The total amount is $790,000. Whether the health care entity reports $1 million or $790,000, recognition of bad debts might prove necessary because of the uncertainty of the reported amounts. e. Charity care occurs when a private not-for-profit health care entity provides services without any expectation of collection. The NFP might have a policy against seeking money in certain cases or the likelihood of collection might be so small as to not be worth the effort. A private notfor-profit health care entity does not report charity care on its financial statements because it makes no attempt at collection. The NFP does disclose the financial effect of charity care to provide information about the direct and indirect costs of this policy. 49. (12 Minutes) (Reporting the various transactions of a not-for-profit health care entity) The hospital does not report the charity care of $1.5 million because it does not expect to make

Chapter 01 - The Equity Method of Accounting for Investments – Hoyle, Schaefer, Doupnik, Advanced Accounting, 15e

any attempt at collection. Of the remaining $7.5 million, 90 percent or $6.75 million is in a portfolio of patients with insurance. The other $750,000 is comprised of patients without insurance. For the patients with insurance, the hospital believes it has a 40 percent chance of collecting $5.3 million after explicit price concessions of $2.2 million and a 60 percent of collecting $5.1 million. Using a weighted average approach, the hospital reports the variable consideration as revenue of $5.18 million ($5.3 million times 40 percent [$2.12 million] plus $5.1 million times 60 percent [$3.06 million]). For the patients without insurance, the hospital believes it has a 10 percent chance of collecting $450,000 after implicit price concessions of $300,000 and a 90 percent of collecting $350,000. Using a weighted average approach, the hospital reports the variable consideration as revenue of $360,000 ($450,000 times 10 percent [$45,000] plus $350,000 times 90 percent [$315,000]). Lennon Hospital records the supplies at their $4,000 value and makes an offsetting increase in net assets without donor restrictions because of the contribution revenue. As the supplies are used, the hospital reclassifies the $4,000 asset as an expense. The $400,000 pledge is conditional so the hospital does not report it. A barrier must be overcome (acquisition of the MRI machine) or the donor will not convey the money. 50. (45 Minutes) (Journal entries and financial reporting for private not-for-profit health care entity) a. Investments - internally restricted Cash b.

160,000 160,000

Cash Contribution revenue – net assets with donor restrictions Investments – permanently restricted Cash

80,000 80,000

Medical supplies Cash

25,000

Reclassified – net assets with donor restrictions Reclassified – net assets without donor restrictions

25,000

25,000 25,000

d. Accounts receivable—covered patients Patient service revenues

1,500,000

Accounts receivable—uninsured patients Patient service revenues

250,000

1,500,000

e. 250,000

Chapter 17 – Accounting for State and Local Governments (Part Two) – Hoyle, Schaefer, Doupnik, Advanced Accounting, 15e

Charity care is not reported g.

Depreciation expense—healthcare Depreciation expense—administrative Depreciation expense—fundraising Accumulated depreciation

77,000 22,000 11,000

Cash Interest income---net assets with donor restrictions

15,000

Bad debt expense—healthcare Allowance for doubtful accounts—covered patients Allowance for doubtful accounts—uninsured patients

70,000

Pharmaceutical expense—healthcare Medical supplies

25,000

110,000

h. 15,000

i. 50,000 20,000

j. 25,000

k.Cash 172,000 Investments—internally restricted Gain on sale of investments—assets without donor restrictions Equipment Cash

160,000 12,000 212,000 212,000

Reclassified – net assets with donor restrictions Reclassified – net assets without donor restrictions

25,000 25,000

50. (continued) l. Accounts receivable—unconditional pledges Contribution revenue—net assets with donor restrictions

131,000 131,000 Assets Without Donor Restrictions

Contribution revenue Patient service revenues Interest income Gain on sale of investments

Assets With Donor Restrictions $ 211,000

$1,750,000 15,000 12,000

Reclassified from net assets with donor restrictions to net assets without donor restrictions

50,000

(50,000)

Chapter 01 - The Equity Method of Accounting for Investments – Hoyle, Schaefer, Doupnik, Advanced Accounting, 15e

1,812,000

Contributions, revenues, and reclassifications Expenses Healthcare Depreciation Bad debts Pharmaceutical Administrative Depreciation Fundraising Depreciation

$ 77,000 70,000 25,000

176,000

172,000 22,000 11,000

Total expenses Increase in net assets

205,000

-0-

$1,607,000

$ 176,000

Develop Your Skills Research Case 1

This assignment is an excellent way to demonstrate the wealth of information available on the Internet about charities and other not-for-profit entities. Many individuals want to be generous and help entities that deserve assistance. Determining whether a specific organization is worthy of support is not necessarily easy. Every charity will claim that it is helping to improve some element of society that is in need. Obviously, the information that students find at this website depends on the specific charities they choose to examine. However, some of the information that is normally available includes:  the entity‘s stated purpose,  year it was started,  website address,  the existence of any affiliated organizations,  whether this entity has met all of the standards of the group that created the website and, if not, what was the problem,  a discussion of the charity‘s programs along with the program expenses,  identification of the chief executive officer (along with compensation),  number of individuals on the board and the number of staff members working in the entity,  methods used for fundraising,  tax status,  sources of funding, including dollar amounts From this type of information, a student should be able to write a detailed overview of the not-for-profit entity and its operations and finances. 1-63 © McGraw Hill LLC. All rights reserved. No reproduction or distribution without the prior written consent of McGraw Hill LLC.

Chapter 17 – Accounting for State and Local Governments (Part Two) – Hoyle, Schaefer, Doupnik, Advanced Accounting, 15e

Research Case 2

The Charity Navigator website provides a wide array of information about its methodology that should help students understand how a potential donor can evaluate a charity. The website lists the following information on March 17, 2022. First, go ―Rating Methodology‖ and then access the link, ―How Charities Are Rated.‖ The reader can find information about the assessment of ―Financial Health.‖ It includes the following information. ―Charity Navigator‘s evaluations are based on the financial information that each charity provides in its informational tax return, the IRS Form 990. With that information, we analyze each charity‘s financial performance in seven key areas, which assess its financial efficiency and capacity, in relation to the charity‘s cause area. Their final score of ‗Financial Health‘ comes from combining a charity‘s scores on a zero to ten scale for each of the seven performance metrics.‖ These performance metrics are listed here. Additional information is available for each of these metrics on the website. Financial Efficiency Performance Metrics Performance Metric One: Program Expense Percentage  Performance Metric Two: Administrative Expense Percentage  Performance Metric Three: Fundraising Expense Percentage  Performance Metric Four: Fundraising Efficiency  Allocation Adjustments  Financial Capacity Performance Metrics  Performance Metric Five: Program Expenses Growth  Performance Metric Six: Working Capital Ratio  Performance Metric Seven: Liabilities to Assets Ratio This site provides a vast quantity of data to explain these performance metrics. For anyone who has an interest in the not-for-profit world, these metrics provide a valid way of judging efficiency and financial health. Research Case 3

This case introduces students to the information disclosed on the Form 990, a document that most tax-exempt organizations must make public. An interested party can find some of this information in the entity‘s financial statements, but much of it goes beyond what is otherwise available. The filing of Form 990 ensures that the public has information on organizations that are not required to pay income taxes (except, possibly, on unrelated business income). Because of the sheer number and visibility, most not-for-profit entities that

Chapter 01 - The Equity Method of Accounting for Investments – Hoyle, Schaefer, Doupnik, Advanced Accounting, 15e

students might choose to research are likely to qualify as Section 501(c)(3) charities. The available salary information will give students the opportunity to discuss whether officials of these entities receive too much compensation or too little. Do the amounts seem reasonable in comparison to the amount of revenues generated or the quantity of assets managed? What, for example, would the president of a comparable-sized for-profit business make in salary and other compensation? Throughout the chapter, mention was made of the disclosure of functional expenses and the amount expended by an entity for program service expenses. One possible class exercise is to list a number of well-known charities and compare their ratio of program service expenses to total expenses. Students can discuss the range of percentages. Another simple class exercise is to ask students to indicate the information that they found that was especially interesting. A charity must include an array of information on its Form 990. What data seems most important and why does the government require inclusion of each of these items? Research Case 4

Students often have trouble envisioning the amount of evolution that can take place in accounting and financial reporting. By comparing the 1987 financial statements for Georgetown University to the current statements, students should note the substantial amount of change that has taken place. Here are just a few of the more obvious examples that students might list. --The influence of government accounting in 1987 is obvious. These statements resemble fund financial statements for the Governmental Funds of a state or local government more than they resemble the current financial statements of a private not-for-profit entity. --Instead of a statement of activities, the university reports a statement of changes in fund balance. --The statements have multiple columns that include Current Funds, Loan Funds, and Plant Funds. --The statements separate the current funds into ―unrestricted‖ and ―restricted‖ but the cause of any restriction is not clear. --Expenditures are listed rather than expenses. --Scholarships and fellowships are shown as expenditures and not as reductions in tuition revenue.

Chapter 17 – Accounting for State and Local Governments (Part Two) – Hoyle, Schaefer, Doupnik, Advanced Accounting, 15e

--Transfers between funds are listed. --There is no statement of cash flows. Analysis Case 1

A potential donor should be interested in the array of information that is available from studying the actual financial statements of a not-for-profit entity. The purpose of financial statements is to provide a clear and complete picture of the financial operations and position of the entity to help outsiders make decisions. Students can observe the construction of financial statements in textbooks. However, only by making use of real statements can they come to appreciate the quantity of information openly available. One way to approach this assignment is to ask the students to list the five most interesting pieces of information that they uncover about a particular charity. An Internet search can help students access the financial statements for many private not-for-profit entities. Many well-known organizations have statements that are easily located on their websites. The exact information that is available will depend on the not-for-profit entity that is studied. As just one example, the following information comes from recent financial statements for the American Heart Association, Inc. for June 30, 2021, and the year then ended: 1--This not-for-profit entity has four program services listed in its financial statements: research, public health education, professional education and training, and community services. 2--The charity reported total expenses for the year ended June 30, 2021, in excess of $830 million. Of that total, the charity reported more than $150 million in connection with supporting services. Thus, it incurred approximately 18 percent of each dollar of expense in connection with supporting services (management and general and fundraising). 3--In the statement of activities, the American Heart Association recognized $39.4 million in contributed services and materials for the year ended June 30, 2021. Note 1, section i, spells out information about these donations as well as other donated services that were not recognized. The biggest single source of contributed materials was $14.7 million for public health education. The biggest single source of contributed services was $12.2 million for professional education. 4--A question that is raised in connection with virtually any charity has to do with the amount of financial resources that are expended to raise more resources. In the year ended June 30, 2021, the American Heart Association, incurred $78.3 million in fundraising expenses. That amount makes up 1-66 © McGraw Hill LLC. All rights reserved. No reproduction or distribution without the prior written consent of McGraw Hill LLC.

Chapter 01 - The Equity Method of Accounting for Investments – Hoyle, Schaefer, Doupnik, Advanced Accounting, 15e

approximately 9.4 percent of the total expenses for the period. 5—As of June 30, 2021, the financial statements show that the American Heart Association held $513.7 million in net assets without donor restrictions and $631.7 million in net assets with donor restrictions. 6—For the year ended June 30, 2021, $173.2 million of restricted net assets were reclassified to unrestricted net assets. Either the related purpose restriction had been satisfied ($103.5 million) or a time restriction expired ($69.7 million). Analysis Case 2

The following answers were found in the financial statements for the University of Southern California for June 30, 2021, and the year then ended. 1. The pledges receivable, net balance is $377.9 million as of June 30, 2021, and $439.9 million as of June 30, 2020. 2. As of June 30, 2021, the university reports net assets without donor restrictions of $4.6 billion and net assets with donor restrictions of $6.7 billion. 3. For the year ended June 30, 2021, the university reports student tuition and fees (net of financial aid) of $1.58 billion. For the year ended June 30, 2020, the university reports student tuition and fees (net of financial aid) of $1.62 billion. 4. According to Note 1, for the year ended June 30, 2021, the university reports financial aid of $671.5 million. For the year ended June 30, 2020, the university reports financial aid of $638.0 million. 5. For the year ended June 30, 2021, the university reports contributions without donor restrictions of $283.3 million ($278.5 million operating and $4.8 million nonoperating). During that same period, the university reports contributions with donor restrictions of $240.6 million. 6. Note 1 contains the following information about the university‘s net assets. Net Assets Without and With Donor Restrictions: Net assets without donor restrictions are the part of net assets of a not-for-profit entity that are not subject to donor-imposed restrictions. A donor-imposed restriction is a donor stipulation that specifies a use for a contributed asset that is more specific than broad limits resulting from the following: a) the nature of the not-for-profit entity, b) the environment in which it operates and c) the purposes specified in its articles of incorporation or bylaws, comparable documents, or d) time restrictions.

Chapter 17 – Accounting for State and Local Governments (Part Two) – Hoyle, Schaefer, Doupnik, Advanced Accounting, 15e

This classification includes all revenues, gains and expenses not restricted by donors. The university reports all expenses, with the exception of investment expenses, which are required to be netted against investment return, in this class of net assets, since the use of restricted contributions in accordance with donors‘ stipulations results in the release of the restriction. The part of net assets of a not-for-profit entity that is subject to donor-imposed restrictions includes contributions for which donor-imposed restrictions have not been met (primarily future capital projects), endowment appreciation, charitable remainder unitrusts, pooled income funds, gift annuities and pledges receivable. 7. Note 13 contains the following information about the university‘s functional expenses. Functional Expenses: Expenses are presented below by functional classification in accordance with the overall service mission of the university. Each functional classification displays all expenses related to the underlying operations by natural classification. Depreciation expense is allocated based on square footage occupancy. Interest expense on external debt is allocated to the functional categories which have benefited from the proceeds of the external debt. Plant operations and maintenance represents space related costs which are allocated to the functional categories directly and/or based on the square footage occupancy. For the year ended June 30, 2021, functional expense consists of the following (in thousands): Academic, Health Care and Student Services Compensation Fringe benefits Operating expenses Cost of goods sold Travel Settlement Allocations: --Depreciation --Interest --Plant operations and maintenance Total

Support Services

Fundraising Activities

Year Ended June 30, 2021

$2,221,167 535,995 1,270,776 88,204 1,944 450,000

$ 329,696 110,961 476,537 17,266 4,761 450,000

$32,784 11,205 8,264 105,470 24

$2,583,647 658,161 1,755,577

209,887 29,016 172,505

95,146 55,112 (175,107)

1,749 84,128 2,602

306,782

$4,529,494

$1,364,372

$56,628

$5,950,494

6,729

Communication Case

Under the Strong Financial Oversight section, six principles serve as practical guidance for the accountant of a private not-for-profit entity. Students will already

Chapter 01 - The Equity Method of Accounting for Investments – Hoyle, Schaefer, Doupnik, Advanced Accounting, 15e

expect some of these recommendations based on their education and experiences but others may be new to them. What students focus on will depend on their personal interests. Here is an explanation of the six principles within the Strong Financial Oversight section of the 33 Principles. Principle 21

A charitable organization must keep complete, current, and accurate financial records and ensure strong financial controls are in place. Its board should receive and review timely reports of the organization‘s financial activities and should have a qualified, independent financial expert audit or review these statements annually in a manner appropriate to the organization‘s size and scale of operations. Principle 22

The board of a charitable organization must institute policies and procedures to ensure that the organization (and, if applicable, its subsidiaries) manages and invests its funds responsibly, in accordance with all legal requirements. The full board should review and approve the organization‘s annual budget and should monitor actual performance against the budget. Principle 23

A charitable organization should not provide loans (or the equivalent, such as loan guarantees, purchasing or transferring ownership of a residence or office, or relieving a debt or lease obligation) to directors, officers, or trustees. Principle 24

A charitable organization should spend a significant amount of its annual budget on programs that pursue its mission while ensuring that the organization has sufficient administrative and fundraising capacity to deliver those programs responsibly and effectively. Principle 25

A charitable organization should establish clear, written policies for paying or reimbursing expenses incurred by anyone conducting business or traveling on behalf of the organization, including the types of expenses that can be paid for or reimbursed and the documentation required. Such policies should require that travel on behalf of the organization is to be undertaken cost-effectively. Principle 26

A charitable organization should neither pay for nor reimburse travel expenditures for spouses, dependents or others who are accompanying someone conducting business for the organization unless they, too, are conducting such business. 1-69 © McGraw Hill LLC. All rights reserved. No reproduction or distribution without the prior written consent of McGraw Hill LLC.

Chapter 17 – Accounting for State and Local Governments (Part Two) – Hoyle, Schaefer, Doupnik, Advanced Accounting, 15e

CHAPTER 19 ACCOUNTING FOR ESTATES AND TRUSTS Chapter Outline I.

Estate accounting encompasses the recording and reporting of events that occur from the time of a person's death until distribution of all property. A. An individual who dies "testate" had prepared a valid will whereas one who dies "intestate" expires without a valid will. 1. State probate laws govern wills and estates. These statutes facilitate three (3) goals. a. To gather and preserve the decedent's property. b. To ascertain the decedent's intent for his/her property. c. To settle debts and distribute the remaining assets consistent with the decedent's intentions. 2. Where no will exists, the laws of descent (for real property) and the laws of distribution (for personal property) govern the distribution of the decedent's property. B. A will should name an executor of the estate to oversee the management and conveyance of property. If an executor is not named or is not able to serve, the probate court will appoint an administrator. C. Claims against the estate must be paid in a specific order of priority. 1. Expenses of administering the estate – which include legal costs, executor fees and similar items. 2. Funeral expenses and medical expenses of last illness. 3. Taxes and debts given legal preference. 4. All other claims. D. Estate distributions. 1. Devise—a testamentary gift of real property. 2. Specific legacy (or bequest)—an item of personal property that is identified directly by the testator in his/her will. 3. Demonstrative legacy—a cash gift made from a particular identified source. 4. General legacy—a cash gift made with no source designated.

Chapter 01 - The Equity Method of Accounting for Investments – Hoyle, Schaefer, Doupnik, Advanced Accounting, 15e

5. Residual legacy—a gift of any remaining estate property. 6. If sufficient property is not available to satisfy all legacies, the process of abatement is used to reduce the various gifts. E. Estate and inheritance taxes. 1. Federal estate tax—an excise tax on the right to convey property. a. The fair market value of estate property is taxed after reduction for funeral expenses, estate administration expenses, liabilities, charitable bequests, and the value of all property conveyed to spouse. b. In 2010, the federal estate tax was repealed, except for estates electing to be covered by such. Beginning in 2011, a portable exemption from federal estate taxes in the amount of $5.0 million became available. This exemption is now indexed and was $5.12 million in 2012; $5.25 million in 2013; $5.34 million in 2014; $5.43 million in 2015; $5.45 million in 2016; $5.49 million in 2017; $11.18 million in 2018; $11.4 million in 2019, $11.58 million in 2020, $11.7 million in 2021, and $12.06 million in 2022. Estate tax law allows for portability of an unused exemption to the surviving spouse. c. An individual is allowed an annual exclusion from federal gift taxes of $16,000 per donee plus an $12.06 million lifetime exclusion for 2022 which will continue to be indexed prospectively. 2. State inheritance tax—assessed on the right to receive property. This tax varies significantly from state to state. 3. Estate income tax—tax on income earned by estate property. F. Recording the transactions of an estate. 1. Assets are recorded at fair value. 2. Debts, expenses, and distributions are only recorded when paid. 3. Income and principal have their balances and transactions separately identified because testators often transfer income and principal to different beneficiaries. 4. Charge and Discharge statements are prepared as necessary to report on the progress being made in settling the estate. II.

Trust funds are created so that a fiduciary can be put in charge of specified assets that will be distributed ultimately (the income and/or principal) to one or more designated parties. 1. Trusts ensure that the distribution of a person's assets is as intended. 2. An inter vivos trust is created by a living individual. 3. A testamentary trust is created by a will.

Chapter 17 – Accounting for State and Local Governments (Part Two) – Hoyle, Schaefer, Doupnik, Advanced Accounting, 15e

B. CPAs often utilize trusts to decrease the size of a client's estate and, thus, reduce estate taxes. C. Many types of trusts exist including: 1. Qualified Terminable Interest Property Trust—income goes to one or more parties with the principal eventually being conveyed to a different party. 2. Charitable Remainder Trust—income goes to one or more parties with the principal eventually being conveyed to a specified charity. 3. Spendthrift Trust – income is utilized for the benefit of the beneficiaries in a manner that protects the trust income and assets from the beneficiaries' creditors and also from the beneficiaries' own financial indiscretions. 4. Life Insurance Trust – assets are utilized to obtain life insurance on a party and provided that the trust is irrevocable, the proceeds of the life insurance policies are not included in the insured's taxable estate. D. Accounting for a trust. 1. In many trusts, the distinction between income and principal is essential. a. Investing costs, improvements, and the cost of preparing property in order to sell are viewed as adjustments to the trust's principal. b. Interest, insurance, and rent are typically adjustments to the trust's income. 2. Income and principal have their transactions and balances separately identified. Answer to Discussion Question Is this Really an Asset? Fulfilling the instructions found in a will is not always an easy task. In this case, the will contains a specific legacy: letters written by the decedent's grandfather were to be given to a cousin. Perhaps the decedent intended for this property to be retained by a family member. However, the cousin cannot now be located. Moreover, sufficient cash does not exist to satisfy a general cash legacy of $20,000 that remains. Normally, a sale of the letters would be ordered to help resolve this cash shortage but differing opinions exist as to the value of the property. Finding a buyer (if one can be located) may take a considerable amount of time and energy. How should the administrator report these letters and what should be done? The administrator should begin by contacting an attorney to learn of the specific probate laws of the state in which the estate is located. For reporting purposes, the letters should be listed on a charge and discharge statement but with no dollar value attached. They must, however, be identified as an asset of the estate. With any property of this type, no true worth can be determined until a legitimate offer to purchase is made. Thus, to report a value without any prospect of a buyer could be misleading and could even result in the imposition of a transfer or inheritance tax.

Chapter 01 - The Equity Method of Accounting for Investments – Hoyle, Schaefer, Doupnik, Advanced Accounting, 15e

The administrator will probably need to confer with representatives of the local church (which is entitled to the $20,000 general legacy) as well as with any parties who are to receive residual amounts from the estate. If the letters are clearly worth less than $6,000, church officials may opt to take the letters in hopes of eventually locating a future buyer. Conversely, if the letters might be worth more than $6,000 (so that a residual legacy may be left), the administrator may have to convey the letters to a dealer with the order to liquidate the property so that the distribution of the estate can be concluded. This discussion question identifies one of many situations in which an administrator should obtain the services of a qualified professional – an attorney, or other experienced estate representative. Answers to Questions 1. The term "testate" refers to a decedent who dies leaving a valid will. "Intestate" indicates an individual who has died without having written a valid will. 2. When an individual dies without having prepared a valid will, state inheritance laws become applicable. Normally, these laws are written to correspond with the most common methods used in distributing property, such as providing for spouses, children, and close relatives. Such laws are referred to as "laws of descent" when they describe the appropriate conveyance of real property. "Laws of distribution" specify the methods that are used for conveying personal property. 3. Probate laws are state statutes which govern wills and estates. Depending upon the nature and extent of a decedent's will (or lack of a will), these statutes may play a significant role in the manner of administering and distributing the decedent's estate. 4. Probate laws provide an orderly structure for the process of administering and distributing a decedent's estate. The objectives of probate laws are — To gather and preserve all of the decedent's property, — To discover the decedent's intent for the property held at death and then implement those wishes if possible, and — To carry out an orderly and fair settlement of all debts and distribution of property. 5. The executor (or administrator if an executor is not named in the will or is unable to serve) must first ensure that all applicable laws are satisfied. Second, the executor must attempt to learn the decedent's wishes and then carry them out, if possible. The executor is a fiduciary of the estate and has a high standard of care when dealing with property for the benefit of the estate's beneficiaries. The student should note that the executor may be compensated for her responsibilities and such compensation is frequently based upon a percentage (%) of the estate's value. 6. Estate assets are reported at fair market value since historical cost (if known) would not be important in paying debts, making distributions, or determining transfer tax obligations. 7. All assets of an estate should be presented on the discharge statement. If the asset has a speculative value the asset should be identified but without a dollar value. With assets of this type, it is extremely difficult to ascertain a true value unless or until a legitimate offer to purchase is made. Reporting a value without any prospect of a buyer could be misleading and

Chapter 17 – Accounting for State and Local Governments (Part Two) – Hoyle, Schaefer, Doupnik, Advanced Accounting, 15e

could even result in the imposition of a transfer or inheritance tax. 8. Since an executor must satisfy (if possible) all of the claims against an estate, an adequate search for these claims must be made. In most states, a public notice has to be placed in an appropriate newspaper at least one time per week for two or three weeks. All claims must then be received by the executor within a reasonable period of time, frequently four (4) months from the date of the first notice. 9. Because of the possibility that estate assets may be insufficient to satisfy all debts and claims, state probate laws usually specify the following order of priority. Thus, if a shortage of assets does occur, the claims at the top of this list are paid first followed by the second level and so on. — Expenses of administering the estate. — Funeral expenses and the medical expenses of any last illness. — Taxes and debts given preference under federal or state laws. — All other claims. 10. An estate that is heavily in debt could possibly leave the members of the decedent's immediate family with nothing. This potential hardship is often viewed by state probate laws as unfair. Therefore, a small homestead allowance is allowed to a surviving spouse and/or minor and dependent children prior to the payment of claims against the estate. In addition, a monthly family allowance is provided (for a specified period) while the estate is being settled. Consequently, family members are entitled to a relatively small amount of money from every estate prior to the payment of debts and expenses. 11. A devise is a gift of real property such as land or a building. In contrast, a legacy (or bequest) is the conveyance of personal property such as an automobile or cash. It would also include the conveyance of intangible personal property. 12.

— A specific legacy is the conveyance of an identified piece of personal property. The gift of a car, for example, or shares of corporate stock would be viewed as a specific legacy. — A demonstrative legacy is a cash gift that is made from a specific source. The gift of $6,000 from a savings account in a local bank would be deemed a demonstrative legacy. — A general legacy is a cash gift where the source is not identified. The gift of $6,000 in cash would be a general legacy. — A residual legacy is simply a gift of any property that remains in an estate after all other legacies have been fulfilled.

13. The process of abatement is utilized if an estate has insufficient resources to satisfy all of the legacies spelled out in a will. This guideline dictates the reductions that must be made to legacies during the distribution process. The process of abatement is also relevant if specified property or cash from a particular source was no longer available at the time of the decedent's death to fulfill specific or demonstrative legacies. 14. The federal estate tax is an excise tax on the right to convey property. Thus, the value of the decedent's property at death is the basis for this assessment. However, an alternate valuation

Chapter 01 - The Equity Method of Accounting for Investments – Hoyle, Schaefer, Doupnik, Advanced Accounting, 15e

date (six months after death or at the date of distribution, whichever comes first) can be chosen by the executor. The value of estate assets is then reduced by a series of costs, debts, and distributions including: — funeral expenses, — estate administration expenses, — liabilities, — casualties and thefts during the administration of the estate, — charitable bequests, — marital deduction for property conveyed to spouse. The federal estate tax is computed on the net value of the estate using graduated rates. The estate is then allowed to reduce the amount of net assets based on an exemption that was $5.0 million in 2011, $5.12 million in 2012, $5.25 million in 2013, $5.34 million in 2014, $5.43 million in 2015, $5.45 million in 2016, $5.49 million in 2017, $11.18 million in 2018, $11.4 million in 2019, $11.58 million in 2020, $11.7 million in 2021, and $12.06 million in 2022. This exemption is indexed for inflation in future years. 15. The TCJA significantly increases the federal tax exemption for estate, gift, and generationskipping transfers beginning January 1, 2018 and continuing until the end of 2025. Without legislative action, the exemptions will revert to the 2017 provisions on January 1, 2026. The TCJA resulted in federal estate, gift, and generation-skipping transfer tax exemptions of $11.18 million in 2018, $11.4 million in 2019, $11.58 million in 2020, $11.7 million in 2021, and $12.06 million in 2022, and will be indexed for inflation in future years. 16. Individuals are allowed to make gifts of up to $16,000 per person per year (the amount is $32,000 if given by a married couple) without incurring any gift taxes. This amount is to be indexed for inflation. Amounts beyond the $16,000 per donee exclusion are taxable. 17. Distributions to a spouse directly decrease the taxable value of an estate and, hence, reduce the amount of federal estate taxes. However, when the spouse eventually dies, a large estate may be left by the subsequently deceased spouse, thus creating a significant tax liability. Estate planners often attempt to devise methods to reduce the future value of the remaining spouse's estate. One approach that is popular is the creation of a credit shelter trust fund at the time of the first death. If an individual's unified transfer credit has not been previously decreased in order to avoid taxation of gifts, an estate of a certain size is tax free. Because of the TCJA, an estate of $12.06 million or less (2022) could be conveyed without creating a tax effect. Hence, if all other property is conveyed to the decedent's spouse or to charity, a trust fund of the appropriate amount can be created (usually with the trust income going to the spouse until death) without incurring an estate tax. Four desirable results occur: 1. No estate taxes are paid on the first decedent's estate. 2. The income of the trust fund assets can still be used for the benefit of the spouse. 3. The assets of the trust fund can be directed to a chosen recipient at the spouse's eventual death. 4. The estate of the spouse is reduced by a considerable amount of assets, creating a large

Chapter 17 – Accounting for State and Local Governments (Part Two) – Hoyle, Schaefer, Doupnik, Advanced Accounting, 15e

savings in estate taxes at the second spouse's death. 18. Several deductions are allowed in the computation of estate income taxes: —A personal exemption of $600. —Amounts of income conveyed to charities. —Amounts incurred as ordinary and necessary expenses for the production or generation of the estate's taxable income (such as accountant or attorney fees). —Amounts of income conveyed currently to the beneficiaries. 19. In addition to identifying the proper distribution of assets, a testator may identify proposed guardians for minor or incapacitated children in a will. In fact, for many individuals this concern may be more compelling than the fear of estate or transfer taxes. 20. The distinction between principal and income may be of paramount importance, especially if they are to be conveyed to different parties. Assets held at the decedent's death comprise the principal of an estate whereas any earnings thereafter are income. Unfortunately, in reality, drawing a distinction may be quite difficult for a number of unique transactions. Therefore, in the decedent's will, instructions as to the impact that transactions have on principal and on income should be specified. If the decedent has not provided guidance in this area, state laws apply. The answer to question 21 gives examples of the typical method by which this distinction is made. 21. The following are examples of the usual method by which the distinction between the principal and income of an estate is established: Adjustments to principal: gains and losses on the sale of securities, debts incurred prior to death, funeral expenses, major improvements to rental property, and dividends declared prior to death even if received after death. Adjustments to income: property taxes, repair expenses, utilities, insurance, and management expenses. Note that the decedent can vary from the above distinctions by addressing the allocation of expenses in her will. 22. For federal estate tax purposes, the value of an estate at the date of the decedent's death should be determined. An alternate valuation date may be chosen by the executor if this decision will reduce the estate taxes to be paid. The alternate date is the earlier of six months after death or the date of conveyance. 23. The executor is given the responsibility of locating, valuing, and distributing all estate assets. Therefore, the reporting process emphasizes the value of all assets being held and their ultimate disposition. Liabilities, expenses, and distributions are only recorded at the time that they reduce these estate assets. The primary reason for this approach is that the estate's liabilities are often not fully identified until a point in time well after the decedent's date of death.

Chapter 01 - The Equity Method of Accounting for Investments – Hoyle, Schaefer, Doupnik, Advanced Accounting, 15e

24. The charge and discharge statement of an estate is produced for several purposes. It lists the assets originally included in the estate. The statement also reports the assets that have been distributed to date to satisfy debts, expenses, or the stipulations of the decedent's will. Finally, the charge and discharge statement lists the value of assets still being held and indicates whether they are attributed to principal or income. This statement permits the probate court and beneficiaries to monitor the executor's progress in administering and distributing the decedent's estate. 25. A trust fund is comprised of assets that have been conveyed to a fiduciary who will manage and distribute them as specified by the party (the trustor) creating the fund. The trust fund is managed for the benefit of the trust's beneficiaries and the trustee has fiduciary obligations to the beneficiaries. 26. Trust funds have become popular as a means of reducing the size of a decedent's estate, as well as shielding assets from third parties. Thus, trusts may serve to decrease the amount that must be paid to the government in estate taxes. Furthermore, they are often created so that professional managers will oversee a decedent's assets and ensure that these assets are used as that person intended. 27. An inter vivos trust is simply one that is started by a living individual. Such a trust may be revocable or irrevocable. If the trust is revocable, the value of the assets in such a trust will be included in the trustor's taxable estate upon his/her passing. 28. A testamentary trust is simply a trust created by a will. 29. — QTIP Trust (Qualified Terminable Interest Property Trust)—The income of the trust (and possibly some of the principal) is conveyed to a party (frequently a spouse) for a period of time. After that time, the remaining principal goes to a different party. — GRATs (Grantor Retained Annuity Trusts)—The trustor continues to collect fixed payments (ie: annuities) from the trust fund assets. After a stated period, the principal is conveyed to a named beneficiary. — Charitable Remainder Trust—All income is paid to one or more beneficiaries until death or for a stated period. The principal is then given to a named charity. 30. The distinction between principal and income is especially important in accounting for a trust because in many cases they are to be given to different parties. Many trusts are created so that one group of beneficiaries is to collect income for a period of time with the principal then going to a different group of beneficiaries. Only by keeping principal and income balances separate can all parties receive the amounts that are appropriate. Answers to Problems

1. B (the laws of distribution apply to the distribution of an intestate person's personal property). 2. D (real property that is owned by joint tenants or by tenants in the entirety typically becomes the property of the surviving tenant (owner) by operation of 1-77 © McGraw Hill LLC. All rights reserved. No reproduction or distribution without the prior written consent of McGraw Hill LLC.

Chapter 17 – Accounting for State and Local Governments (Part Two) – Hoyle, Schaefer, Doupnik, Advanced Accounting, 15e

law). 3. A (the laws of distribution are state statutes that apply to the transfer of personal property when someone passes without a valid will). 4. D (effectively a modified accrual process is utilized to determine how to treat earned – ie: accrued – interest which is received after the date of death). 5. B (although it is prudent to have a will, the law does not require such). 6. A (although state probate statutes vary, most states require the publication of notice of death and then permit claims against the decedent's estate only for a statutorily shortened period of time). 7. B (many persons pass without sufficient assets to satisfy their obligations and the prioritization of the decedent's claims permits an executor/executrix to distribute assets with the confidence that she will not be personally liable for a misapplication of estate assets). 8. D (personal debts, such as unpaid rent, are typically not priority claims against an estate). 9. C (the term for the transfer of real property is 'devise'). 10. C (the homestead allowance is designed to ensure that surviving spouses and children have the financial ability to maintain a modest residence or homestead). 11. D (a specific legacy is a transfer of personal property that is actually or 'specifically' identified in the testator's will). 12. C (a demonstrative legacy is the transfer of assets, often cash, from a specified source). 13. A (if an estate is not sufficient to permit all of the transfers identified by the testator, then the executor must reduce some transfers through the process of 'abatement' which instructs the executor how to go about reducing or eliminating transfers). 14. C (estate values are typically based upon the date of death, although an alternate date is permitted if such would result in a reduction in estate taxation – the alternate date is the earlier of six months after the date of death or the actual date of asset distribution). 15. C (the TCJA of 2017 provided an $12.06 million exemption per transferor beginning in 2022, as a result of indexing). 16. B (losses are deductible for Estate income tax purposes). 1-78 © McGraw Hill LLC. All rights reserved. No reproduction or distribution without the prior written consent of McGraw Hill LLC.

Chapter 01 - The Equity Method of Accounting for Investments – Hoyle, Schaefer, Doupnik, Advanced Accounting, 15e

17. A (only Fitzgerald will have a taxable estate since for calendar year 2022, a decedent is able to transfer $12,060,000 without incurring a federal estate tax liability). 18. B (the alternate valuation date is the earlier of the date of distribution or six (6) months after the date of death). 19. B (the alternate valuation date is the earlier of the date of distribution or six (6) months after the date of death). 20. B (the TCJA of 2017 provides an $12.06 million exemption for gifts (2022), but does not eliminate the gift tax entirely). 21. A (the use of this estate / trust planning will reduce the overall size of the couple's taxable estates while still providing income for the surviving spouse). 22. B (funeral expenses are deductible from the estate for federal estate tax purposes). 23. A (the remainderman gets the 'remainder' – that is what is left after another beneficiary receives income / assets for a specified period of time). 24. C (property taxes relate to the production of income for / from rental property and are likely charged as an expense related to income). 25. D (liabilities are recorded when satisfied due in part to the fact that not all liabilities are known to the executor until after notice has been provided of the decedent's passing). 26. B (inter vivos refers to being created 'within the life'). 27. C (the charity gets the 'lead' portion of the trust). 28. B ($8,400,000 – $700,000 – $420,000 – $50,000 – $20,000 – $110,000 = $7,100,000). 29.A

A (Rental income of $5,000 less $600 exemption).

30.(30 Minutes) (Define terms used in estate accounting) a. Will—the instructions, prepared consistent with the applicable state laws, given by an individual to direct the distribution to be made of the person's property after death. b. Estate—the legal entity that holds title to all of a decedent's property until those assets are properly distributed. c. Intestate—refers to the death of an individual who passes without having prepared a valid, legal will. 1-79 © McGraw Hill LLC. All rights reserved. No reproduction or distribution without the prior written consent of McGraw Hill LLC.

Chapter 17 – Accounting for State and Local Governments (Part Two) – Hoyle, Schaefer, Doupnik, Advanced Accounting, 15e

d. Probate laws—state laws that govern and regulate wills and estates. e. Trust—a fund of assets that has been conveyed to a fiduciary who will manage and then distribute those assets according to the specifications of the individual who created the trust. f. Inter vivos trust—a trust fund created by a living person rather than as a result of the specifications of a will. g. Charitable remainder trust—a trust fund where the income is paid to one or more beneficiaries for a specified period (or until their death). After that point in time, the principal is conveyed to a named charity. h. Remainderman—a beneficiary of a trust who is entitled to receive a principal balance, but only after a specified time. Until then, the income is distributed to a different income beneficiary (often for the life of that person). i. Executor—an individual who oversees an estate in a stewardship (fiduciary) capacity. The person must follow any applicable laws, locate all assets, discover and satisfy all valid claims against the estate, and uncover and follow (if possible) the intent of the decedent for any remaining property. j. Homestead allowance—an amount that is provided to a decedent's surviving spouse and/or minor and dependent children before claims against the estate are paid. This allowance ensures that (if assets are available) some amount is given to the immediate family regardless of the amount of debt incurred by the decedent. 31.(30 Minutes) (Discussion of questions about estates) a. Probate laws are state laws that govern wills and estates. These laws provide an orderly structure for the process of administering a decedent's estate (property). The Uniform Probate Code has been adopted by many states so that laws are consistent, at least between those particular states. The general objectives of probate laws are: — To gather and preserve all of the decedent's property held at death. — To locate and provide a fair settlement for all debts. — To discover the decedent's intent for any remaining property and to follow those wishes if possible. b. The executor must locate and preserve all of the assets owned by the decedent at death, discover and satisfy (if sufficient assets are available) all valid claims against the estate, determine the wishes of the decedent as to any remaining property, comply with all laws, and distribute assets according to the intentions of the decedent. The executor is also entitled to reasonable compensation for his/her performance of these tasks. c. All property of value should be included in an inventory of estate assets. 1-80 © McGraw Hill LLC. All rights reserved. No reproduction or distribution without the prior written consent of McGraw Hill LLC.

Chapter 01 - The Equity Method of Accounting for Investments – Hoyle, Schaefer, Doupnik, Advanced Accounting, 15e

Thus, cash, investments, receivables, and other valuables should all be listed. In some states, real property (such as land) is conveyed directly to a beneficiary at death so that it is not included in the estate. However, even this real property is assumed to be part of the estate for estate tax purposes. Additionally, chooses in action (the ability or right to pursue a claim) may have value and should be considered by the executor. d. The order of priority for paying claims against an estate are as follows: (1)—expenses of administering the estate. (2)—funeral expenses and the medical expenses of any last illness. (3)—taxes and debts given preference under federal or state laws. (4)—all other claims. 32.(20 Minutes) (Identify parties in connection with will) a. Howard Amadeus has been designated to receive the principal of the trust fund after Lucy Van Jones' death and is, therefore, referred to as the remainderman. b. Josh O'Brien has established the trust fund and is known legally as the trustor and in some states is referred to as the settlor – same meaning as trustor. c. A demonstrative legacy is a cash gift from a particular source. The gift of all money from the First Savings Bank to Richard Blaine is a demonstrative legacy. d. Since the $9,000 cash gift to Nelson Tucker does not come from a designated source, it is known as a general legacy. If it were to originate from a specified source, then it would be a demonstrative legacy. e. The gift of the antique collection to Lisa Lunn is a specific legacy because it is a gift of specified personal property. f. Lucy Van Jones will receive the income from the trust fund for the remainder of her life, a position known as a life tenant. g. Josh O'Brien is the testator – the decedent passing with a valid will. 33.(30 Minutes) (Distribution to be made of an estate) a. 800 shares of Coca-Cola Co. stock are given to Cindy Cheng. Since the estate does not own more Coca-Cola stock, this is all Cindy will receive. Title to the house goes to Dennis Davis as the decedent directed. $41,000 cash in the First National Bank goes to Jack Abrams. Because this bequest was limited to $50,000 in this bank account, and the account 1-81 © McGraw Hill LLC. All rights reserved. No reproduction or distribution without the prior written consent of McGraw Hill LLC.

Chapter 17 – Accounting for State and Local Governments (Part Two) – Hoyle, Schaefer, Doupnik, Advanced Accounting, 15e

contained less than $50,000, the $41,000 is all that Jack Abrams will receive. $16,000 cash in the New Hampshire Savings and Loan still remains. However, the will specifically directs that Suzanne is to receive $18,000. Therefore, to have the $16,000 amount, more cash must be added. Either the Xerox stock or the other property (or both) must be liquidated in order to give Suzanne Benton $18,000. Any remaining property is conveyed to Wilbur N. Ed, the residuary beneficiary. b. 1,000 shares of Coca-Cola Co. stock are given to Cindy Cheng. The additional 200 shares will either be transferred to the residuary beneficiary, or liquidated if necessary to satisfy other bequests. $50,000 cash in the First National Bank goes to Jack Abrams. $5,000 cash remains in the First National Bank along with $6,000 in the New Hampshire Savings and Loan. To this total, more cash must be added in order to obtain enough cash to satisfy Suzanne's bequest. Either the Xerox stock, the remaining Coca-Cola stock, and/or the other remaining property must be liquidated in order to give Suzanne Benton a total of $18,000. Any remaining property is conveyed to Wilbur N. Ed. 34.(5 Minutes) (Compute the taxable estate value) Value of estate assets ................................................ Conveyed to spouse .................................................. Conveyed to charities ................................................ Funeral expenses ....................................................... Administrative expenses ........................................... Debts ............................................................................ Taxable estate .............................................................

$2,300,000 (1,000,000) (260,000) (23,000) (41,000) (246,000) $ 730,000

Amounts conveyed to children or to most trusts are not deductible in computing the taxable value of a decedent's estate. Thus the $500,000 transfer and the $230,000 transfers are components of the taxable estate. 35.(15 Minutes) (Determine taxable estate value) Gross Estate (fair market value) .............................. $2,381,000 Funeral Expenses ...................................................... $ 20,000 Administration Expenses .......................................... 10,000 Charity Bequests ....................................................... 60,000 Marital Deduction ....................................................... 870,000 (960,000) Taxable Estate ..................................................... $ 1,421,000

Chapter 01 - The Equity Method of Accounting for Investments – Hoyle, Schaefer, Doupnik, Advanced Accounting, 15e

36.(5 Minutes) (Computation of taxable income of an estate) Rental income ............................................................. Interest income ........................................................... Dividend income ......................................................... Total income ............................................................... Personal exemption ................................................... Gift to charity .............................................................. Distributed to beneficiary .......................................... Taxable income ....................................................

$ 9,000 6,000 5,000 $20,000 (600) (5,000) (6,000) $ 8,400

37.(60 Minutes) (Record journal entries for an estate and prepare charge and discharge statement) a.

––Cash—Principal ..................................................... 300,000 Life Insurance Receivable ........................................ 200,000 Investment in Stocks and Bonds .............................. 100,000 Rental Property .......................................................... 90,000 Personal Property ...................................................... 130,000 Estate Principal .................................................... (To record property held by Rose Shields at death.)

820,000

1. No entry. Estates do not record liabilities until assets are used in payment. 2. Cash—Principal .................................................... 5,000 Cash—Income ...................................................... 7,000 Assets Subsequently Discovered (Interest Rec.). 5,000 Estate Income ................................................. 7,000 (To record receipt of interest income. The $5,000 earned prior to the decedent's death was not included in original listing of estate assets so it is an 'asset subsequently discovered'.) 3. Expenses—Income .............................................. 6,000 Cash—Income ................................................. 6,000 (Ordinary repair expenses are made to rental property and are generally charged to income rather than principal.) 4. Debts of the Decedent ............................................... 80,000 Cash—Principal .............................................. (To pay liabilities and obligations of the decedent.)

80,000

5. Cash—Principal.......................................................... 19,000 1-83 © McGraw Hill LLC. All rights reserved. No reproduction or distribution without the prior written consent of McGraw Hill LLC.

Chapter 17 – Accounting for State and Local Governments (Part Two) – Hoyle, Schaefer, Doupnik, Advanced Accounting, 15e

Investments in Stocks and Bonds ................. 16,000 Gain on Sale of Stocks Principal ................... 3,000 (To record sale of stocks and to reflect gain on such sale with the additional proceeds becoming part of the estate's principal.) 6. Cash—Principal .................................................... 2,000 Cash—Income ............................................................ 12,000 Assets Subsequently Discovered (Rent Rec.) 2,000 Estate Income ................................................. 12,000 (To record receipt of rental income. The $2,000 earned prior to the decedent's death was not included in original listing of estate assets and is therefore an 'asset subsequently discovered'.) 7. Legacy—Jim Arness ............................................ Cash—Income ................................................. (Payment is made to income beneficiary.)

6,000

Cash—Principal .................................................... Life Insurance Receivable .............................. (Collection is made from life insurance policy.)

200,000

6,000

8. 200,000

Legacy—Amanda Blake ....................................... 200,000 Cash—Principal .............................................. (Payment is made of proceeds from life insurance policy.)

200,000

Funeral Expenses ................................................ Cash—Principal ............................................... (To record cost of decedent's funeral.)

10,000

9. 10,000

b. ESTATE OF ROSE SHIELDS Charge and Discharge Statement As to Principal I charge myself with: Assets per original inventory ............................. Assets subsequently discovered: Interest receivable .......................................... Rental income receivable ............................... Gain on sale of stocks ......................................... Total charges ........................................................

$820,000 $ 5,000 2,000

7,000 3,000 830,000

Chapter 01 - The Equity Method of Accounting for Investments – Hoyle, Schaefer, Doupnik, Advanced Accounting, 15e

Debts of decedent ................................................ 80,000 Funeral expenses ................................................. 10,000 Legacy: Amanda Blake (proceeds of life insurance) ........................................................ 200,000 Estate principal ............................................... Estate principal: Cash ...................................................................... Investments in stocks and bonds ....................... Rental property ..................................................... Personal property ................................................ Estate principal ...............................................

290,000 $540,000 $236,000 84,000 90,000 130,000 $540,000

As to Income I charge myself with: Interest income .......................................................... $ 7,000 Rental income ....................................................... 12,000

$19,000

I credit myself with: Repair expenses ........................................................ $ 6,000 Legacy: Jim Arness ............................................. 6,000 Balance as to Income .....................................

12,000 $ 7,000

Balance as to income: Cash ......................................................................

$ 7,000

38.(45 Minutes) (Prepare charge and discharge statement for an estate) ESTATE OF GINA PURCELL Charge and Discharge Statement As to Principal I charge myself with: Assets per original inventory .............................. Assets subsequently discovered: Rental income receivable ........................... Dividends receivable ........................................... Gain on sale of Polaroid stock ............................ Total charges ..................................................

$1,204,000 $ 4,000 2,000

I credit myself with: Debts of decedent ................................................ 81,000 Funeral and executor expenses .......................... 33,000 Legacy: Charitable remainder trust .................... 300,000 Transfer of Dell stock ........................... 32,000 Estate principal ...............................................

6,000 3,000 $1,213,000

446,000 $ 767,000

Chapter 17 – Accounting for State and Local Governments (Part Two) – Hoyle, Schaefer, Doupnik, Advanced Accounting, 15e

Estate principal: Cash ...................................................................... Investments .......................................................... Rental property ..................................................... Estate principal ...............................................

$ 422,000 45,000 300,000 $ 767,000

As to Income I charge myself with: Rental income............................................................ $ 7,000 Dividend income .................................................. 10,000

$ 17,000

I credit myself with: Repair expenses ................................................... Legacy: income to beneficiary ............................ Balance as to income .....................................

6,000 $ 11,000

2,000 4,000

Balance as to income: Cash .......................................................................

$ 11,000

39.(30 Minutes) (Prepare journal entries for an estate) Note: Since the income and principal of this estate are both to go to the same beneficiary, no reason exists for separately labeling the assets as being derived from principal and income. a. Cash ............................................................................ Interest receivable ..................................................... Life insurance receivable (payable to estate) ......... Residence ................................................................... Investment in Coca-Cola ........................................... Investment in Polaroid .............................................. Investment in Ford ..................................................... Estate Principal ....................................................

80,000 6,000 300,000 200,000 50,000 110,000 140,000

Cash............................................................................. Interest receivable ................................................ Estate income interest .........................................

7,000

Funeral expenses ...................................................... Cash .......................................................................

20,000

886,000

b. 6,000 1,000

c. 20,000

d. No entry. Debts are only recorded by an estate when paid. e. Cash ............................................................................

12,000

Chapter 01 - The Equity Method of Accounting for Investments – Hoyle, Schaefer, Doupnik, Advanced Accounting, 15e

Assets subsequently discovered .......................

12,000

f. Legacy—Kevin Simmons .......................................... Residence .............................................................

200,000

Cash ............................................................................ Life Insurance receivable (payable to estate) ....

300,000

Debts of the decedent ............................................... Cash ......................................................................

100,000

200,000

g. 300,000

h. 100,000

No entry for discovery of additional debts. Debts are only recorded by an estate when paid. i. Legacy—Thomas Thorne .......................................... Cash ......................................................................

150,000

Cash ............................................................................ Investment in Polaroid ......................................... Gain on sale ..........................................................

112,000

Administrative expenses .......................................... Cash .......................................................................

10,000

150,000

j. 110,000 2,000

k. 10,000

40.(60 Minutes) (Prepare journal entries for an estate and a charge and discharge statement) Note: Since the income and principal of this estate are both to go to the same beneficiary, no reason exists for separately labeling the assets as being derived from principal and income. 1.

Cash............................................................................. Certificates of deposit ............................................... Dividend receivable ................................................... Life insurance receivable — payable to estate ....... Residence and personal effects ............................... Investment in Ford Motor Co. ................................... Investment in Xerox .................................................. Estate Principal ....................................................

19,000 90,000 3,000 450,000 470,000 72,000 97,000 1,201,000

Chapter 17 – Accounting for State and Local Governments (Part Two) – Hoyle, Schaefer, Doupnik, Advanced Accounting, 15e

2. Cash ............................................................................ Life insurance receivable — payable to estate ..

450,000

Cash ............................................................................ Dividend receivable ............................................. Estate income .......................................................

4,000

450,000

3,000 1,000

No entry. Debts are only recorded by an estate when paid.

5. Legacy—Sue Pope .................................................... Residence and personal effects .........................

470,000

Land ............................................................................ Assets subsequently discovered .......................

15,000

Debts of the decedent ............................................... Cash ......................................................................

108,000

470,000

6. 15,000

7. 108,000

No entry is made for the discovery of additional debts, since debts are only recorded by an estate when paid. 8. Funeral and administrative expenses ...................... Cash ......................................................................

31,000

Legacy—Ned Pope .................................................... Cash ......................................................................

110,000

Cash ................................................................... Investment in Ford Motor Co ............................... Gain on sale ..........................................................

81,000

Funeral and administrative expenses ............. Cash ......................................................................

16,000

Legacy—Harwood Pope ................................... Cash .......................................................................

81,000

31,000

9. 110,000

10. 72,000 9,000

11. 16,000

12. 81,000

Chapter 01 - The Equity Method of Accounting for Investments – Hoyle, Schaefer, Doupnik, Advanced Accounting, 15e

Part b. ESTATE OF LENNIE POPE Charge and Discharge Statement As to principal and income I charge myself with: Assets per original inventory ....................................... $1,201,000 Assets subsequently discovered: Land ....................................................................... 15,000 Gain on sale of Ford Motor Co. stock ...................... 9,000 Dividend income ........................................................ 1,000 Total charges ........................................................ $1,226,000 I credit myself with: Debts of decedent ..................................................... Funeral and administrative expenses....................... Legacies distributed: Sue Pope ........................................ $470,000 Ned Pope ........................................ 110,000 Harwood Pope ............................... 81,000 Total credits .......................................................... Balance on hand ............................................................. As: Estate principal: Cash ............................................................................ Certificates of deposit ............................................... Land ............................................................................ Shares of Xerox ......................................................... Estate principal .................................................... Estate Income: Cash ......................................................................

$108,000 47,000

661,000 816,000 $ 410,000

$207,000 90,000 15,000 97,000 $409,000 $ 1,000

41.(30 Minutes) (Prepare journal entries for a trust) a. Cash—Principal ......................................................... Investments in Stocks ............................................... Rental Property .......................................................... Trust Principal ......................................................

300,000 200,000 150,000

Investments in Bonds ............................................... Cash—Principal ....................................................

260,000

Commission Expense—Principal ............................. Cash—Principal.....................................................

3,000

650,000

b. 260,000 3,000

Chapter 17 – Accounting for State and Local Governments (Part Two) – Hoyle, Schaefer, Doupnik, Advanced Accounting, 15e

c. Repair Expense—Principal ....................................... Cash—Principal ....................................................

7,000

Cash—Principal ......................................................... Cash—Income ............................................................ Trust Principal ...................................................... Trust Income—Dividends ....................................

1,000 3,000

Insurance Expense—Income .................................... Cash—Income ......................................................

2,000

Cash—Income ............................................................ Trust Income—Rental ..........................................

8,000

Trustee Expense—Principal ..................................... Trustee Expense—Income ........................................ Cash—Principal .................................................... Cash—Income ......................................................

3,000 1,000

Equity in Income: Beneficiary .................................. Cash—Income ......................................................

5,000

7,000

d. 1,000 3,000

e. 2,000

f. 8,000

g. 3,000 1,000

h. 5,000

42. (20 Minutes) (Prepare journal entries for a trust)

Land .................................................................................. Trust—Principal..........................................................

320,000

Cash—Income ................................................................. Trust—Income ...........................................................

60,000

Insurance Expense—Income ......................................... Cash—Income ............................................................

4,000

Property Taxes Expense—Income ................................ Cash—Income ............................................................

6,000

Land Improvements ........................................................ Cash—Income ............................................................

4,000

320,000 60,000 4,000 6,000 4,000

(This payment for paving is made from cash income because no principal cash is held. The trust agreement should indicate how such payments are to be made and recorded. The following adjustment is also likely necessary to indicate that 1-90 © McGraw Hill LLC. All rights reserved. No reproduction or distribution without the prior written consent of McGraw Hill LLC.

Chapter 01 - The Equity Method of Accounting for Investments – Hoyle, Schaefer, Doupnik, Advanced Accounting, 15e

this payment has been made from income rather than principal.) Due from Trust—Principal ............................................. Due to Trust—Income ...............................................

4,000

Maintenance Expense—Income ................................ Cash—Income ............................................................

8,000

Equity in Income: Beneficiary .................................... Cash—Income ............................................................

30,000

4,000 8,000 30,000

Develop Your Skills (60 Minutes) Research Case 1

This case is designed to help the student experience how the Internet can be used to research practical accounting issues in a quick way. Here, a client wants to know about a Minor's Section 2503(c) Trust. Perhaps no one currently with this CPA firm knows much about this type of trust. However, a significant amount of information is readily available using the Internet. The student is directed to search the Internet to find analyses of a Section 2503(c) trust. The student should find information about this specific type of trust similar to the following information. Obviously, more information may be needed to enable the CPA to work at an appropriate level with the client but this coverage provides a basic understanding. 

Gifts can be held in this type of trust until the child reaches the age of 21.



In 2008, up to $12,000 that was given by each person to the trust could be excluded from any gift tax consideration. This amount increased to $13,000 in 2009, $14,000 in 2013, $15,000 in 2018, and $16,000 in 2022.



For the exclusion to apply, the recipient must receive a present interest; in other words, the gift must be open to the recipient's immediate use.



All property and income must be expended before the recipient reaches the age of 21. Any remaining assets must be distributed to the person at the time of the 21st birthday.



The trustee can use the money in the trust to pay for the recipient's college costs (that is obviously why it is being covered on this particular website).



Some trusts of this type are set up so that the recipient can only withdraw the undistributed assets for a short period after the person's 21st birthday. If 1-91

Chapter 17 – Accounting for State and Local Governments (Part Two) – Hoyle, Schaefer, Doupnik, Advanced Accounting, 15e

not taken then, the money reverts to the trust fund. 

After the recipient's 21st birthday, gifts can still be made to the trust fund but no exclusion is allowed. However, this problem can be avoided by setting up the Minor's Section 2503(c) Trust in conjunction with another type of trust known as a Crummey Trust.



Income earned by the trust is taxed at trust income rates unless distributed directly to the recipient so that it is then taxed at the recipient's tax rates. After the recipient's 21st birthday, the income is taxable to that person whether received or not.



There are a number of specific problems associated with this type of trust including high administrative costs, high income tax rates on trust income, and the possibility of causing the recipient problems trying to qualify for other types of college financial aid.



The website suggests considering the Uniform Gift/Transfer to Minor's Act as a good alternative to the Minor's Section 2503(c) Trust.

The preceding information does not make the reader an expert in this type of trust, but it certainly does provide a wealth of information so that initial discussions can be held in a knowledgeable way with the client. Research Case 2 (60 Minutes)

Students often believe that all answers can be found in textbooks or the needed information is simply a part of every CPA's basic knowledge. However, in real life, most issues are resolved by research. Here, the CPA firm is faced with a tax question concerning the deduction allowed an estate for distributable net income. The CPA may well know the answer to that question or, if not, will have to look it up. This assignment allows, and requires, the students to find instructions provided on-line by the Internal Revenue Service. Once the instruction form for 1041 is found through a search, the student will probably go to the index of this document. The link for the 1041 instructions can be located at: http://www.irs.gov/pub/irspdf/i1041.pdf "The income distribution deduction allowable to estates and trusts for amounts paid, credited, or required to be distributed to beneficiaries is limited to distributable net income (DNI). This amount, which is figured on Schedule B, line 7, is also used to determine how much of an amount paid, credited, or required to be distributed to a beneficiary will be includible in his or her gross income." From the above quote as well as from the table of contents for these instructions, the student can determine that Schedule B is used to compute the amount of 1-92 © McGraw Hill LLC. All rights reserved. No reproduction or distribution without the prior written consent of McGraw Hill LLC.

Chapter 01 - The Equity Method of Accounting for Investments – Hoyle, Schaefer, Doupnik, Advanced Accounting, 15e

distributable net income. Therefore, the student can scroll down through these instructions (about 15-20 pages) and come upon over a page of actual guidance on how Schedule B is completed, including line-by-line instructions. This schedule provides the student (and the CPA) with the necessary information to determine DNI. Note, though, that some parts of this process are relatively easy while other steps are more complex. However, through a careful reading, the method by which this figure is determined can be ascertained. Research Case 3 (45 Minutes)

This research case requires the student to use a legal or commercial search engine to locate a specific state's probate code. Every state has a probate statutory scheme. Approximately twenty (20) states have adopted a version of the uniform probate code, in an attempt to utilize a consistent asset distribution process. Montana is one of the states that has adopted a version of the uniform probate code, although the professor may wish to permit students to work this research case based on their home state's laws. The student should ultimately arrive at the following link for the relevant statutory provisions: https://leg.mt.gov/bills/mca/title_0720/chapters_index.html Depending upon the student's familiarity, it may be prudent for the professor to provide the link for the student and evaluate the student's answer based on the student's application of the statute. This statue, which is similar to the statutes of the other states which have adopted the uniform probate code, provides the following: 72-2-113. Share of heirs other than surviving spouse. (1) Any part of the intestate estate not passing to the decedent's surviving spouse under 72-2-112, (https://leg.mt.gov/bills/mca/title_0720/chapter_0020/part_0010/section_0120/07200020-0010-0120.html) or the entire intestate estate if there is no surviving spouse, passes in the following order to the individuals designated below who survive the decedent: (a) to the decedent's descendants by representation; (b) if there is no surviving descendant, to the decedent's parents equally if both survive or to the surviving parent; (c) if there is no surviving descendant or parent, to the descendants of the decedent's parents or either of them by representation; (d) if there is no surviving descendant, parent, or descendant of a parent and the decedent is: (i) survived by one or more grandparents or descendants of grandparents: (A) one-half to: (I) the decedent's paternal grandparents equally if both survive; (II) the surviving paternal grandparent; or (III) the descendants of the decedent's paternal grandparents or either of them if both are deceased, the descendants taking by representation; and 1-93 © McGraw Hill LLC. All rights reserved. No reproduction or distribution without the prior written consent of McGraw Hill LLC.

Chapter 17 – Accounting for State and Local Governments (Part Two) – Hoyle, Schaefer, Doupnik, Advanced Accounting, 15e

(B) the other one-half to the decedent's maternal relatives in the same manner; or (ii) not survived by a grandparent or descendant of a grandparent on either the paternal or the maternal side, the entire estate to the decedent's relatives on the other side in the same manner as the half; (e) if there is no surviving descendant, grandparent, or descendant of a grandparent, to the person of the closest degree of kinship with the decedent. Except as provided in subsection (2), if more than one person is of that closest degree, those persons share equally. (2) If more than one person is of the closest degree as provided in subsection (1)(e) but they claim through different ancestors, those who claim through the nearer ancestor must receive to the exclusion of those claiming through a more remote ancestor. Section 72-2-113-1(c) will provide that Ms. Voga's cousins could inherit from her grandmother through Ms. Voga's great grandparents, if in fact Ms. Voga's grandmother had no decendants. Clearly the grandmother has at least one decendant – Ms. Voga. However, the prudent professional should explain this process to the client as there is no guarantee that Ms. Voga will outlive her grandmother. Analysis Case 1 (45 Minutes)

Many resources exist on the Internet to explain different legal and tax benefits of various estate planning techniques. Dozens of links that are located by searching for "Grantor Retained Annuity Trust". The student should have little difficulty in locating relevant resources. Included in the information about GRATs at this suggested link and at many other links is the following: 

It can be used to transfer profitable and quickly appreciating property to a donee, such as the donor's child(ren), in such a way as to minimize gift and estate taxes.



Property is transferred into an irrevocable trust, but the income is retained for a period of time (or for the shorter of a period of time or the person's remaining life).



At the end of the specified period, the property goes to the named beneficiary.



The person creating the trust is allowed to get a stream of cash from the income of the asset over the period specified.



Hopefully, the value of the property placed in the estate will grow so that the beneficiary receives a particularly high amount in comparison to what was 1-94

Chapter 01 - The Equity Method of Accounting for Investments – Hoyle, Schaefer, Doupnik, Advanced Accounting, 15e

initially placed in the trust. 

For gift tax purposes, the conveyed value is the value when the trust was created less the value of the annuity interest that the original owner retains.



The reduced value limits or eliminates any potential gift tax effects.



Consequently, income is retained by the original owner while conveying the property to the eventual recipient at a lower set value as a way to reduce the amount taken by the government in taxes.

This trust is, thus, advantageous when an individual wishes to transfer wealth to subsequent generations while also minimizing the transfer taxes. It is particularly useful if the transferor can identify and transfer rapidly appreciating assets. Analysis Case 2 (45 Minutes)

In setting the value of an estate, the executor has the option to choose an alternate date for valuation purposes if that decision will reduce the taxes to be paid. This case was created to help the student obtain additional information about this decision if ever encountered in the real world. Because this is a tax issue, the student is being directed to make use of the Internal Revenue Service website as well as the instructions printed for each taxation area. For many areas of accounting, the more the student knows about the IRS website the better prepared the student will be. By doing a search of the IRS site, the instructions for the Form 706 can be located. That is the form used for federal estate tax filing purposes. By going directly to the index at the back of these instructions, the student can locate information on the topic of "alternate valuation." The information provided in the instructions discusses the basic issues concerning valuation at death versus the option of either six-months after death or the date of transfer whichever comes first. Within that coverage, special issues such as interest, rents, and dividends are explained in detail. Basically, this information is provided here by the IRS so that the average person can perform the duties of an executor or, at least, understand the impact of the decisions made by the executor, such as the decision as to the proper valuation date.