Solutions Manual for Advanced Accounting 4e Hamlen, Huefner, Larga Test Bank by QuentinAxel

b Reported net income; 35% x $7,000,000 = Less unconfirmed profit on ending inventory 35% x [$6,000,000 – ($6,000,000/1.25)] = Equity in net income for 2020 Less dividends; 35% x $2,000,000 Plus beginning investment balance Ending investment balance

$ 2,450,000 (420,000) $ 2,030,000 (700,000) 50,000,000 $51,330,000

d Fizzy’s entry to record the acquisition is: Current assets Property Goodwill Liabilities Cash

10.

25,000 2,500,000 25,475,000 3,000,000 25,000,000

EXERCISES E1.1

Investment in Trading Securities (in millions) a. $384 – 39 = $345 b. Unrealized gains and losses on trading securities are reported in income. c. Investment in trading securities Cash

345

Investment in trading securities Gain on trading securities (income)

Cash Loss on trading securities (income) Investment in trading securities

370 14

345

E1.2

384

Investment in Trading and Available-for-Sale Securities a. 2019 entries Investment in trading securities Cash Investment in trading securities Gains on trading securities (income) 2020 entries Cash Investment in trading securities Gains on trading securities (income)

500,000 500,000 20,000 20,000

525,000 520,000 5,000

Investment in trading securities Cash

700,000

Losses on trading securities (income) Investment in trading securities

100,000

700,000

100,000

b. (1) 2019 entries Investment in AFS securities Cash Investment in AFS securities Gains on AFS securities (OCI) 2020 entries Cash Reclassification of gains on AFS securities (OCI) Investment in AFS securities Gains on AFS securities (income)

500,000 500,000 20,000 20,000

525,000 20,000 520,000 25,000

Investment in AFS securities Cash

700,000

Losses on AFS securities (income) Investment in AFS securities

100,000

700,000

100,000

(2) 2019 entries are the same as in (1). 2020 entries Cash Reclassification of gains on AFS securities (OCI) Investment in AFS securities Gains on AFS securities (income)

525,000 20,000 520,000 25,000

Investment in AFS securities Cash

700,000

Losses on AFS securities (income) Allowance for credit losses on AFS securities (contra to investment account)

100,000

700,000

100,000

(3) 2019 entries are the same as in (1). 2020 entries Cash Reclassification of gains on AFS securities (OCI) Investment in AFS securities Gains on AFS securities (income)

E1.3

525,000 20,000 520,000 25,000

Investment in AFS securities Cash

700,000

Losses on AFS securities (OCI) Investment in AFS securities

100,000

700,000

100,000

Held-to-Maturity Investments Amortization schedule (supports numbers in entries below) Interest Income Amortization (4% x Beginning ($250,000 – Interest investment balance) income) 1/1/2019 12/31/2019 $208,904 $41,096 12/31/2020 207,260 42,740 12/31/2021 205,550 44,450 12/31/2022 203,772 46,228 12/31/2023 201,923 48,077 January 1, 2019 Investment in HTM securities Cash December 31, 2019 Cash Interest income Investment in HTM securities December 31, 2020 Cash Interest income Investment in HTM securities December 31, 2021 Cash Interest income Investment in HTM securities

Investment Balance (Beginning balance – amortization) $5,222,591 5,181,495 5,138,755 5,094,305 5,048,077 5,000,000

5,222,591 5,222,591

250,000 208,904 41,096

250,000 207,260 42,740

250,000 205,550 44,450

December 31, 2022 Cash Interest income Investment in HTM securities

250,000 203,772 46,228

December 31, 2023 Cash Interest income Investment in HTM securities

250,000 201,923 48,077

Cash

5,000,000 Investment in HTM securities

E1.4

5,000,000

Investment in Equity Securities with No Significant Influence a. December 31, 2018 Investment in Becker Corporation Investment in Corey Corporation Total

$ 380,000 640,000 $1,020,000

December 31, 2019 Investment in Corey Corporation

$ 510,000

b. 2018 Gain on investment in Allen Corporation= $210,000 - $200,000 = Loss on investment in Becker Corporation = $380,000 - $400,000 = Gain on investment in Corey Corporation = $640,000 - $600,000 = Net gain

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

2019 Gain on investment in Becker Corporation = $405,000 - $380,000 = Loss on investment in Corey Corporation = $510,000 - $640,000 = Net loss

$ 25,000 (130,000) $(105,000)

2020 Loss on investment in Corey Corporation = $500,000 - $510,000 = $ (10,000)

E1.5

Financial Statement Display of AFS Debt Securities a. The loss is a direct reduction in the investment balance, and is reported in income. Investment in AFS securities………………………………………….. b. (1)

The loss is reported in an allowance account, and is reported in income.

Investment in AFS securities Less: Allowance for expected credit losses Net investment in AFS securities……………………… (2)

$200,000 ( 40,000) $160,000

The credit-related loss is reported in an allowance account, and is reported in income. The market-related loss is a direct reduction in the investment balance, and is reported in OCI.

Investment in AFS securities ($200,000 - $5,000) Less: Allowance for expected credit losses Net investment in AFS securities………………………

E1.6

$160,000

$195,000 ( 35,000) $160,000

Investment in AFS Securities a. $460,000 - $65,000 = $395,000. Historical cost = fair value less unrealized gains. b. Cash received = $85,000, derived by reconstructing the summary entry to record sales of AFS securities: Cash Reclassification of unrealized gains on AFS securities (OCI) Gain on sale of AFS securities (income) Investment in AFS securities

85,000 10,000 20,000 75,000

The credit to investment in AFS securities is $75,000, because the investment balance declined by $60,000 in 2020, but $15,000 in unrealized gains was recorded in OCI. $520,000 + $15,000 – X = $460,000; X = $75,000. The amount of cash received is the number that balances the entry. The other numbers are given in the exercise.

E1.7

Equity Method Investment with Intercompany Sales Calculation of 2019 equity in Coca-Cola FEMSA’s net income: Coca-Cola’s share of Coca-Cola FEMSA’s reported income (28% x $5 million) + Realized profit on intercompany sales [28% x ($1,350,000 – ($1,350,000/1.35))] - Unrealized profit on intercompany sales [28% x ($1,215,000 – ($1,215,000/1.35))] Equity in net income of Coca-Cola FEMSA Entry to record equity in Coca-Cola FEMSA’s net income: Investment in Coca-Cola FEMSA Equity in net income of Coca-Cola FEMSA (income)

E1.8

$ 1,400,000 98,000 (88,200) $ 1,409,800

1,409,800 1,409,800

Equity Method Investment with Cost in Excess of Book Value Analysis of acquisition cost (not required): Acquisition cost 40% x book value (40% x $6,000,000) Excess of fair value over book value: Patents (40% x $1,000,000) Technology (40% x $2,000,000) Goodwill

$ 15,000,000 $ 2,400,000 400,000 800,000

3,600,000 $ 11,400,000

Calculation of 2019 equity in Ronco’s net income: Revco’s share of Ronco’s reported income (40% x $900,000) - Amortization of patent undervaluation ($400,000/10) - Amortization of unreported technology ($800,000/5) Equity in net income of Ronco

$ 360,000 (40,000) (160,000) $ 160,000

Revco’s entries for 2019: January 1, 2019 Investment in Ronco Cash During 2019 Cash Investment in Ronco $250,000 x 40% = $100,000 December 31, 2019

15,000,000 15,000,000

100,000 100,000

Investment in Ronco Equity in net income of Ronco (income)

160,000 160,000

December 31, 2019 investment balance: $15,000,000 – $100,000 + $160,000 = $15,060,000

E1.9

Equity Method and Other Comprehensive Income Journal entries for 2020: Investment in Turner Cash To record investment in 30% of Turner’s stock.

10,000,000 10,000,000

Investment in Turner 300,000 Equity in net income of Turner (income) 300,000 To record Mitchell’s share of Turner’s net income for 2020; 30% x $1,000,000 = $300,000. Cash

75,000

Investment in Turner To record receipt of dividends from Turner; $75,000 = $250,000 x 30%.

75,000

Losses on AFS investments (OCI) 24,000 Investment in Turner 24,000 To record Mitchell’s share of Turner’s OCI for 2020; $80,000 x 30% = $24,000.

E1.10 Equity Method Investment Cost Computation Changes in the investment balance in 2018, 2019, and 2020: 2018 $ 480,000

2019 $ 600,000

2020 $ 560,000

40% reported net income Amortization of unreported intangibles (40% x $4,000,000/5) (320,000) (320,000) (320,000) Equity in net income $ 160,000 $ 280,000 $ 240,000 Less 40% dividends (80,000) (100,000) (92,000) Change in investment balance $ 80,000 $ 180,000 $ 148,000 *Total increase in investment balance = $80,000 + $180,000 + $148,000 = $408,000 Investment balance December 31, 2020 Less: 2018 - 2020 increase in investment balance January 2, 2018 investment cost =

E1.11 Change in Reporting for Equity Investment

$14,608,000 – $ 408,000* $14,200,000

Entries made by Stream (not required): January 1, 2020 Investment in Topsia

2,000,000

Cash To record investment in 10% of Topsia’s stock.

2,000,000

December 31, 2020 Cash

20,000

Dividend income (income) To record receipt of cash dividends; $20,000 = 10% x $200,000.

20,000

Investment in Topsia

100,000 Gain on investment (income) 100,000 To record unrealized gain on Topsia investment; $100,000 = $2,100,000 - $2,000,000. January 1, 2021 Investment in Topsia

8,000,000 Cash 8,000,000 To record additional investment in 30% of Topsia’s stock. Going forward, the investment is reported prospectively using the equity method. December 31, 2021 Cash

120,000

Investment in Topsia To record receipt of cash dividends; $120,000 = 40% x $300,000. Investment in Topsia

120,000

160,000 Equity in net income of Topsia (income) 160,000 To record equity in Topsia’s net income; $160,000 = 40% x $400,000 Account balances are as follows: a. Investment in Topsia, December 31, 2020: $ 2,100,000 = ($2,000,000 + $100,000) Investment in Topsia, December 31, 2021: $10,140,000 = ($2,100,000 + $8,000,000 - $120,000 + $160,000) b. Dividend income, 2020 Dividend income, 2021

20,000 --

c. Unrealized gain on investment, 2020 Unrealized gain on investment, 2021

100,000 --

d. Equity in net income of Topsia, 2020

Equity in net income of Topsia, 2021

160,000

E1.12 Joint Venture (in millions) Each investor reports the investment on its December 31, 2020 balance sheet at $2,800,000 [= $2,500,000 + (50% x $600,000)] Each investor reports equity in the joint venture’s net income at $300,000 on its 2020 income statement. The individual assets and liabilities of the joint venture are not reported separately by the investors.

E1.13 Equity Method Investment with Basis Differences Several Years Later Calculation of 2019 equity in Taylor’s net income: Saxton’s share of Taylor’s reported income (30% x $325,000) + Correction of depreciation of plant and equipment (30% x $2,000,000/10) Equity in net income of Taylor

$ 97,500 60,000 $ 157,500

Note: There is no amortization of the customer database because its life is over. Saxton’s entries for 2019: During 2019 Cash 45,000 Investment in Taylor To record receipt of dividends from Taylor; $45,000 = 30% x $150,000. December 31, 2019 Investment in Taylor Equity in net income of Taylor (income) To record equity in net income of Taylor.

45,000

157,500 157,500

E1.14 Merger and Stock Investment (see related E1.13) a. Current assets Plant and equipment Customer database Goodwill Current liabilities Long-term debt Cash

10,000,000 68,000,000 700,000 10,300,000

Investment in Taylor Cash

15,000,000

16,000,000 58,000,000 15,000,000

b. 15,000,000

E1.15 Merger (in millions) Current assets Plant and equipment Intangible assets Goodwill Current liabilities Long-term debt Cash To record the merger.

10 20 15 105 12 38 100

Note that the amount of recorded goodwill exceeds the acquisition cost. This is a common occurrence in practice, as the fair value of the acquired company’s identifiable net assets is often less than zero.

E1.16 Change from Significant Influence to Control (see related E1.15) (in millions) Investment in Healthy Snax Gain on equity method investment (income) To revalue the equity method investment to fair value

15 15

Current assets Plant and equipment Intangible assets Goodwill Current liabilities Long-term debt Cash Investment in Healthy Snax To record acquisition of the remaining shares of Healthy Snax.

10 20 15 105 12 38 60 40

E1.17 Consequences of Investment Reporting Choices (amounts in millions) a. Investment in Bubbly Cash

950

Tangible assets Goodwill Liabilities Cash

1,000 850

950

900 950

c. Significant influence investment: $20,000/$80,000 = 25% Merger: ($20,000 + $900)/($80,000 + $1,000 + $850 - $950) = 25.8% d. Use of the equity method prevents Bubbly’s high leverage from affecting CocaCola’s balance sheet. Evaluation is based on whether or not the investor actually controls the investee. An auditor should review factors that determine the extent of control, such as government regulations, agreements between the investor and investee regarding shareholder rights, and inability to obtain representation on the investee’s board. Because in many cases the company benefits from classifying its investment as a significant influence investment instead of a controlling investment, the auditor should investigate questionable choices carefully.

PROBLEMS P1.1

Investments in Trading and AFS Securities a. 3/5/19 Investment in trading security A Cash

350,000 350,000

6/3/19 Cash Loss on trading securities (income) Investment in trading security A

325,000 25,000

7/14/19 Investment in trading security B Cash

225,000

8/2/19 Investment in AFS security D Cash

175,000

11/20/19 Investment in AFS security E Cash

300,000

12/31/19 Investment in trading security B Gain on trading securities (income) $27,000 = $252,000 - $225,000.

350,000

225,000

175,000

300,000

27,000 27,000

Investment in AFS security D Gain on AFS securities (OCI) $15,000 = $190,000 - $175,000.

15,000

Loss on AFS security E (income) Allowance for credit losses $50,000 = $250,000 - $300,000.

50,000

1/15/20 Cash Loss on trading securities (income) Investment in trading security B

15,000

50,000

235,000 17,000 252,000

4/2/20 Cash Reclassification of gain on AFS securities (OCI) Investment in AFS security D Gain on AFS securities (income)

213,000 15,000 190,000 38,000

4/6/20 Investment in AFS security F Cash

710,000

9/1/20 Investment in trading security C Cash

400,000

12/31/20 Investment in trading security C Gain on trading securities (income) $10,000 = $410,000 - $400,000.

710,000

400,000

10,000 10,000

Loss on AFS security E (income) Allowance for credit losses $35,000 = $215,000 - $250,000.

35,000

Investment in AFS security F Gain on AFS securities (OCI) $25,000 = $735,000 - $710,000.

25,000

b. 2019 Financial Statements Balance Sheet, 12/31/19 Assets: Investment in trading securities Investment in AFS securities ($190,000 + $300,000) Less: Allowance for credit losses

35,000

25,000

$ 252,000 $490,000 (50,000)

Equity: AOCI gains Income Statement, 2019 Gains (losses) on trading securities (-$25,000 + $27,000) Credit losses on AFS securities Statement of Comprehensive Income, 2019 Gains on AFS securities

440,000 15,000

$ 2,000 50,000

15,000

2020 Financial Statements Balance Sheet, 12/31/20 Assets: Investment in trading securities Investment in AFS securities ($300,000 + $735,000)$1,035,000 Less: Allowance for credit losses (85,000)

P1.2

$ 410,000 950,000

Equity: AOCI gains ($15,000 – $15,000 + $25,000)

25,000

Income Statement, 2020 Gains (losses) on trading securities (-$17,000 + $10,000) Realized gains on AFS securities Credit loss on AFS securities

(7,000) 38,000 (35,000)

Statement of Comprehensive Income, 2020 Gains on AFS securities Reclassifications of (gains) on AFS securities

25,000 (15,000)

Available-for-Sale Debt Investment Impairment The securities are impaired in both years because their fair value is less than cost. The credit loss is reported in income, as the difference between cost and the present value of expected cash flows. The remaining market-related loss is reported in OCI. December 31, 2020 Credit losses on AFS securities (income) Loss on AFS securities (OCI)

15,000 5,000

Allowance for credit losses 15,000 Investment in AFS securities 5,000 To record credit-related and noncredit-related losses on AFS debt securities. $15,000 = $85,000 - $100,000 and $5,000 = $80,000 - $85,000. December 31, 2021 Allowance for credit losses Loss on AFS securities (OCI)

4,000 1,000

Credit losses on AFS securities (income) 4,000 Investment in AFS securities 1,000 To record credit-related and noncredit-related losses on AFS debt securities. $4,000 = $89,000 - $85,000; the total increase in value is ($83,000 - $80,000) = $3,000 and the credit-related gain is $4,000, so the market-related loss is $1,000.

P1.3

Held-to-Maturity Intercorporate Debt Investments a. Bond #1 pays $60,000 annually in interest and $1,000,000 at maturity. Cash flow $60,000 $60,000 $60,000 $60,000 $1,060,000 Total price

Present value calculation $60,000/1.05 $60,000/(1.05)2 $60,000/(1.05)3 $60,000/(1.05)4 $1,060,000/(1.05)5

Present value $ 57,143 54,422 51,830 49,362 830,538 $1,043,295

Bond #2 pays $20,000 annually in interest and $500,000 at maturity. Cash flow $20,000 $20,000 $20,000 $520,000 Total price

Present value calculation $20,000/1.05 $20,000/(1.05)2 $20,000/(1.05)3 $520,000/(1.05)4

Present value $ 19,048 18,141 17,277 427,805 $ 482,271

Amortization tables to support answers to requirements b, c and d: Bond #1 Interest Income (5% x Beginning investment balance) 1/1/2019 12/31/2019 12/31/2020 12/31/2021 12/31/2022 12/31/2023

$52,165 51,773 51,362 50,930 50,476

Amortization ($60,000 – Interest income) $7,835 8,227 8,638 9,070 9,525*

Investment Balance (Beginning balance – amortization) $1,043,295 1,035,460 1,027,233 1,018,595 1,009,525 1,000,000

*Includes a rounding adjustment of $1

Bond #2 Interest Income (5% x Beginning investment balance) 1/1/2019 12/31/2019 12/31/2020

$24,114 24,319

Amortization (Interest income – $20,000) $4,114 4,319

Investment Balance (Beginning balance + amortization) $482,271 $486,385 490,704

12/31/2021 12/31/2022

24,535 24,762

4,535 4,761*

495,239 500,000

*Includes a rounding adjustment of - $1

b. Bond #1 Bond #2 Total interest income

2019

2020

$ 52,165 24,114 $ 76,279

$ 51,773 24,319 $ 76,092

c. $1,018,595 + $495,239 = $1,513,834 d. Expected credit losses occur because it is improbable that the bond issuer will be able to make the remaining interest and principal payments per the bond agreement. Factors indicating impairment loss relate to the financial health of the bond issuer, such as failure to make payments on other debts and a significant decline in credit rating. Estimates are made using the CECL model, which forecasts payments over the life of the bond. Changes in expected credit losses are reported in income. In this case, a credit loss of $500,000 is reported in income, and an allowance is set up to reduce the investment account by the amount of the expected credit loss.

P1.4

Trading and AFS Securities in Financial Statements a.

Given information: Change in trading investments account: $8,500 - $11,000 = $(2,500) Cash received from sales of trading investments: $4,000 Purchases of trading investments: $1,000 Therefore journal entries were:

Investment in trading securities

1,000

Cash To record purchases of trading securities. Cash

4,000

Investment in trading securities Net gains on trading securities To record net change in value of trading securities held and sold. Net gains on trading securities reported in 2019 income = $500

1,000

Given information: Change in AFS investments account: $1,000 Cash received from sales of AFS investments: $6,000 Purchases of AFS investments: $3,600

3,500 500

Net change in unrealized gains on AFS securities held at year-end: $2,000 Reclassification of net unrealized gains included in net income on AFS securities sold: $2,100

Therefore journal entries were: Investment in AFS securities

3,600

Cash To record purchase of AFS securities.

3,600

Investment in AFS securities

2,000

Unrealized gains on AFS securities (OCI) To record unrealized gains on AFS securities held at year-end.

2,000

Cash Reclassification of net gains on AFS securities

6,000 2,100 Investment in AFS securities Gain on sale of AFS securities (income)

4,600 3,500

To record sale of AFS securities. Gain on sale of AFS investments, included in income = $3,500

c. Reported value of AFS securities sold Less previously reported gains Original cost of AFS securities sold

P1.5

$4,600 (2,100) $2,500

Trading, AFS, and Equity Investments Cash

43,000

Investment in trading securities Gain on sale of trading securities (income) To record sale of trading securities. Cash

40,000 3,000

20,000

Investment in trading securities Gain on sale of trading securities (income) To record sale of trading securities; $16,000 = $56,000 - $40,000. Investment in trading securities Cash To record investment in trading securities.

16,000 4,000

60,000 60,000

Loss on trading securities (income) 8,000 Investment in trading securities To record unrealized loss on trading securities; $8,000 = $52,000 - $60,000. Cash Reclassification of gains on AFS securities (OCI) Investment in AFS securities Gain on sale of AFS securities (income) To record sale of AFS securities.

55,000 5,000

Investment in AFS securities Cash To record purchase of AFS securities.

40,000

8,000

50,000 10,000

40,000

Impairment loss on AFS securities (income) 6,000 Allowance for credit losses on AFS securities 6,000 To record credit loss on AFS securities held at year-end; $6,000 = $34,000 - $40,000. Cash Investment in equity securities Gain on equity securities (income) To record purchase of equity securities.

50,000 45,000 5,000

Investment in equity securities 8,000 Gains on equity securities (income) 8,000 To record increase in value of equity securities held at year-end; $8,000 = $63,000 – ($100,000 - $45,000). Balance Sheet, December 31, 2020 Investment in trading securities ($56,000 - $40,000 - $16,000+$60,000 - $8,000) Investment in AFS securities ($50,000 - $50,000 + $40,000) $40,000 Less allowance for credit losses (6,000) Net investment in AFS securities……….…………………………. 34,000 Investment in equity securities ($100,000 - $45,000 + $8,000)……….. 63,000 AOCI (unrealized gains (losses) on AFS securities………………………… 0

$52,000

Income Statement for 2020 Net losses on trading securities ($3,000 + $4,000 - $8,000)………………. $ (1,000) Net gains on AFS securities ($10,000 - $6,000)…………………………… 4,000 Net gains on equity securities ($5,000 + $8,000)………………………….. 13,000 Net gains on trading, AFS, and equity securities…………………………... $ 16,000 Statement of Comprehensive Income for 2020

Reclassification of gains on AFS securities sold……………………………. (5,000)

P1.6

Investment in AFS Securities (in millions) a. Cash 11,540 Losses on AFS securities (income) 51 Reclassification of gains on AFS securities (OCI) 100 Gains on AFS securities (income) Investment in AFS securities Note: The credit to investment in AFS securities is a plug number. The other amounts are given.

152 11,539

b. Losses on AFS securities (OCI) 282 Investment in AFS securities 282 The net change in OCI from AFS investments is a loss of $382. Entry a. reduces OCI by $100. Therefore unrealized losses for AFS securities on hand at year-end must be $282. c. Investment in AFS securities Cash $8,606 + X - $11,539 - $282 = $6,413; X = $9,628.

P1.7

9,628 9,628

Equity Method Investment Several Years After Acquisition Note to instructor: This problem provides an introduction to calculating a parent’s investment balance in years subsequent to acquisition, covered in Chapter 4. a. Calculation of 2020 equity in net income Better Bottlers’ net income (45% x $2,500,000) – Amortization of patents and trademarks revaluation [45% x (($160,000,000 - $150,000)/10)] – Amortization of brand names [45% x ($9,000,000/15)] Equity in net income of Better Bottlers

$ 1,125,000 (450,000) (270,000) $ 405,000

Best Beverages’ journal entries for 2020: Investment in Better Bottlers Equity in net income of Better Bottlers (income)

405,000

Cash (45% x $650,000 dividends)

292,500

405,000

Investment in Better Bottlers

292,500

b. Investment balance, January 2, 2017 + 45% x 2017 to 2020 change in Retained Earnings (reported income less dividends): [45% x ($25,000,000 – $13,000,000)] – 4 years of revaluation write-offs: $450,000 x 4 $270,000 x 4 Investment balance, December 31, 2020

P1.8

$ 30,000,000

5,400,000 (1,800,000) (1,080,000) $ 32,520,000

Equity Method Investment Several Years After Acquisition Note to instructor: This problem can be used to prepare students for equity method calculations of investment balance in Chapters 4 and 6. a. (Calculation of equity in net income for 2018-2019 provided in addition to 2020’s calculation, for use in requirement c.) Equity in net income calculation 2018-2019 30% x Seaway’s net income: 2018-2019: (30% x $14,000,000); 2020: (30% x $4,000,000) Write-off of P&E revaluation (30% x $4,000,000/10 each year) Amortization of undervalued intangibles (30% x $6,000,000/2 for 2018 and 2019 only) 2019 ending inventory profit, upstream [30% x ($925,000 – $925,000/1.25)] 2019 ending inventory profit, downstream [30% x ($420,000 – $420,000/1.2)] 2020 ending inventory profit, upstream [30% x ($625,000 – $625,000/1.25)] 2020 ending inventory profit, downstream [30% x ($696,000 – $696,000/1.2)] Equity in net income

2020

$ 4,200,000

$ 1,200,000

240,000

120,000

(1,800,000)

(55,500)

55,500

(21,000)

21,000

(37,500)

-$ 2,563,500

(34,800) $ 1,324,200

b. Investment in Seaway Equity in net income of Seaway

1,324,200 1,324,200

Losses on AFS securities (OCI) Investment in Seaway

240,000

Cash

450,000 Investment in Seaway

240,000

450,000

c. Investment, January 2, 2018 + Equity in net income, 2018-2019 + Unrealized gains on AFS securities, 2018-2019 (30% x $1 million) – Dividends, 2018-2019 (30% x $5 million) + Equity in net income, 2020 – Unrealized losses on AFS securities, 2020 (30% x $800,000) – Dividends, 2020 (30% x $1.5 million) Investment, December 31, 2020

P1.9

$ 10,000,000 2,563,500 300,000 (1,500,000) 1,324,200 (240,000) (450,000) $ 11,997,700

Equity Method Investment with Basis Differences a. Manchester has $600,000/$2 = 300,000 shares outstanding 30% x 300,000 = 90,000 shares acquired b. Calculation of 2019 equity in net income (in thousands) Manchester’s net income (30% x $1,500) Adjusted for Bristol’s share of revaluation write-offs: + Reduction in cost of goods sold (30% x $500) (note 1) + Depreciation on revaluation of P&E (30% x $1,800/20) (note 2) – Amortization of franchises (30% x ($1,000/5)) Equity in Manchester net income

$ 450 150 27 (60) $ 567

Note 1: Because Manchester uses FIFO, the beginning inventory is completely sold during the year. Note 2: Revaluation of P&E = $1,800 decline [= ($4,000 – $1,500) – $700]

P1.10 Equity Method Investment, Intercompany Sales Note to instructor: This problem provides an introduction to elimination of unconfirmed intercompany profits in consolidation, covered in Chapter 6. (in thousands) a.

Jackson’s reported net income must be adjusted for unconfirmed profits in ending inventory. Calculation of 2020 equity in net income: Jackson’s net income (40% x $10,000) – Unconfirmed profit on downstream ending inventory [$26,000 – ($26,000/1.3)] x 40% – Unconfirmed profit on upstream ending inventory [$12,000 – ($12,000/1.2)] x 40% Equity in Jackson’s net income

$40,000 + $800 – (40% x $1,000) = $40,400

$ 4,000 (2,400)

(800) 800

P1.11 Equity Investments, Various Reporting Methods (in thousands) a. Balance Sheet, December 31, 2019 Current assets $ 38,5001 Property, net 450,000 Investment in equity securities 1,200 Identifiable intangibles 5,000 Total assets $ 494,700

Current liabilities Long-term liabilities Capital stock Retained earnings Total liabilities and equity

20,000 200,000 90,000 184,700 $ 494,700

2019 Income Statement Sales revenue Cost of sales Operating expenses Loss on equity investment Net income 1

$ 900,000 (750,000) (140,000) (300) $ 9,700

$38,500 = $40,000 balance without investment – $1,500 original investment

b. Balance Sheet, December 31, 2019 Current assets $ 34,0001 Property, net 450,000 Investment in Quarry 7,2002 Identifiable intangibles 5,000 Total assets $ 496,200

Current liabilities Long-term liabilities Capital stock Retained earnings Total liabilities and equity

2019 Income Statement Sales revenue Equity in income of Quarry Cost of sales Operating expenses Net income 1 2

20,000 200,000 90,000 186,200 $ 496,200

$ 900,000 1,200 (750,000) (140,000) $ 11,200

$34,000 = $40,000 balance without investment – $6,000 original investment $7,200 = $6,000 original investment + (40% x $3,000) equity in net income

c. Balance Sheet, December 31, 2019 Current assets $ 30,0001 Property, net 535,000 Identifiable intangibles 5,000 Goodwill 11,0002 Total assets $ 581,000

Current liabilities Long-term liabilities Capital stock Retained earnings Total liabilities and equity

22,000 281,000 90,000 188,0003 $ 581,000

2019 Income Statement Sales revenue Cost of sales Operating expenses Net income

$ 960,000 (770,000) (177,000) $ 13,000

$30,000 = $40,000 balance without investment – $15,000 investment + $5,000 Quarry’s current assets $11,000 = $15,000 investment – $4,000 Quarry’s book value at date of acquisition 3 $188,000 = $185,000 Parker’s retained earnings + $3,000 Quarry’s net income 1 2

P1.12 Joint Venture (all amounts in millions) a. Allen Corp. adjusting entry: Equity in net loss of Albar 1 Investment in Albar 1 To record equity in Albar’s net loss for 2019. Albar’s net loss = $2.0, since its change in retained earnings is $(2.4) and it distributed $0.4 in dividends. Barkely Corp. adjusting entries: Equity in net loss of Albar Investment in Albar

1 1

Impairment loss 3.3 Investment in Albar 3.3 After equity in Albar’s net loss is recorded, the investment balance is $3.8. Therefore the impairment loss is $3.3 (= $3.8 – $0.5). b. Current assets Plant and equipment, net Investment in Albar Enterprises Intangibles Total assets Current liabilities Noncurrent liabilities Capital stock Retained earnings Total liabilities and equity $3.8 = $4.8 – $1 $66.0 = $67.0 – $1 3 $0.5 = $4.8 – $1 – $3.3 4 $13.4 = $17.7 – $1 – $3.3 1 2

Allen Corp. $ 1.2 150.0 3.81 200.0 $ 355.0 $

14.0 265.0 10.0 66.02 $ 355.0

Barkely Corp. $ 0.6 65.0 0.53 3.5 $ 69.6 $

0.2 55.0 1.0 13.44 $ 69.6

c. Although Allen and Barkely probably use similar techniques to compute the value of their investment, considerable judgment is involved in estimating future expected cash flows, risk, and investment holding period. Strategy and expectations concerning the investment may differ between the two corporations. An impairment loss is only reported if the loss is considered to be other than temporary. Allen and Barkely may therefore come to different conclusions regarding the value of their investment in Albar Enterprises.

P1.13 Change in Reporting for Equity Investment January 1, 2020 Investment in Moxie

6,000,000

Cash To record investment in 15% of Moxie’s stock. December 31, 2020 Cash

6,000,000

7,500

Dividend income (income) To record receipt of cash dividends; $7,500 = 15% x $50,000.

7,500

Investment in Moxie

200,000 Gain on investment (income) 200,000 To record unrealized gain on Moxie investment; $200,000 = $6,200,000 - $6,000,000. December 31, 2021 Cash

12,000

Dividend income (income) To record receipt of cash dividends; $12,000 = 15% x $80,000. Investment in Moxie

12,000

250,000

Gain on investment (income) To record unrealized gain on Moxie investment; $250,000 = $6,450,000 - $6,200,000. January 1, 2022 Investment in Moxie Cash To record additional investment in 25% of Moxie’s stock. December 31, 2022 Cash Investment in Moxie To record receipt of cash dividends; $40,000 = 40% x $100,000.

250,000

15,000,000 15,000,000

40,000 40,000

Investment in Moxie

100,000

Equity in net income of Moxie (income) To record equity in Moxie’s net income; $100,000 = 40% x $250,000.

100,000

Calculation of Investment balance, December 31, 2022: Fair value of 15% investment, January 1, 2022 Additional investment, January 1, 2022 Equity in net income, 2022 Cash dividends, 2022 Investment balance, December 31, 2022

$ 6,450,000 15,000,000 100,000 (40,000) $21,510,000

P1.14 Balance Sheet After Business Acquisition

Assets Current assets Property and equipment Intangibles Goodwill

Total assets 1

Wilson Corporation Balance Sheet (in millions) Liabilities $ 15 Current liabilities 560 Long-term debt 50 Total liabilities 221 Equity Capital stock Retained earnings AOCI ___ Total equity $ 647 Total liabilities and equity

27 465 $ 492 $

50 120 (15) $ 155 $ 647

$22 = $50 – ($5 + $60 + $23 + $7 – $2 – $65)

P1.15 Merger ( in millions of euros) Property, plant and equipment, net of liabilities Intangible assets Goodwill Consideration paid (cash, etc.)

16 70 274 360

Note: the amount recorded for goodwill is the difference between total consideration paid and the fair value of identifiable net assets acquired; €274 = €360 - €16 - €70.

P1.16 Change from Significant Influence to Control (all amounts in millions) a. Using the equity method, the investment balance reflects the original cost of the investment, plus (minus) the investor’s share of changes in the investee’s retained earnings and AOCI. Equity method investments are not carried at fair value. Although the investment’s reported value usually significantly understates fair value, in this case the investment is carried at an amount that is above fair value. The investment is written down and a loss is reported in income if the impairment is judged to be other than temporary. In this case, there are two possibilities as to why no impairment had been recorded: the impairment did not occur until the time of the merger, or the impairment was not considered to be other than temporary. b. Fair value = $50 - $19 = $31. c. The equity method investment is revalued to fair value, with the loss reported in income. Acquisition cost is $300 + $31 = $331, while the fair value of identifiable net assets acquired is $2,000 – $1,900 = $100. Therefore acquired goodwill is $331 – $100 = $231. The journal entries are as follows: Loss on equity method investment (income Equity method investment Identifiable assets Goodwill Liabilities Equity method investment Cash

19 19 2,000 231 1,900 31 300

P1.17 Merger with Associate (all amounts in millions) a. Acquisition cost Fair value of identifiable net assets Goodwill

$20,103 + $12,946 $9,779 + $8,231 – $1,975 – $2,578

$33,049 (13,457) $19,592

b. Using the equity method, OCI of associates is reported by the investor. When the investment is converted or sold, this OCI is reclassified out of AOCI and reported in income. c. Investment in associates 6,211 Reclassification of OCI gains of associates (OCI) 199 Gain on conversion of investment in associate (income) 6,410 The debit to investment in associates is a plug number. Current assets Noncurrent assets Goodwill Current liabilities Noncurrent liabilities Cash Investment in associates d. $12,946 – $6,211 (adjustment in c. above) = $6,735 million

8,231 9,779 19,592 2,578 1,975 20,103 12,946

CHAPTER 2 SOLUTIONS TO MULTIPLE CHOICE QUESTIONS, EXERCISES AND PROBLEMS

MULTIPLE CHOICE QUESTIONS 1.

b Only the advanced production technology and customer lists intangibles meet the contractual or separability criteria.

c $40,000 – $400 = $39,600

b Outside consultants costs are expensed.

a This is a post-acquisition event, and does not adjust the date-of-acquisition value of the equipment. The reduction in value is a loss, reported on the income statement.

c This change in value occurs in the measurement period, and corrects the original acquisition entry. The correction is: Goodwill Identifiable intangible assets

2,000 2,000

c $60,000 – ($4,200 + $6,000 + $14,000 + $4,000 + $1,000 – $2,000 – $11,600) = $44,400

b $8,000 – ($4,200 + $6,000 + $14,000 + $500 – $2,000 – $11,600) = $(3,100)

d Favorable location does not meet the contractual or separable criteria.

d The Codification requires capitalization of acquired in-process R&D regardless of its alternative future use or probability of success.

10.

a Warranty liabilities are known liabilities, and are likely to be estimable within the measurement period. The others are “other contingencies” and less likely to have measurable fair values at the date of acquisition.

EXERCISES E2.1

Recording a Merger and a Stock Acquisition a. Cash and receivables Equity method investments Inventory Plant assets Goodwill Merger expenses (income) Current liabilities Long-term debt Cash

50,000 400,000 300,000 1,200,000 6,100,000 200,000

Investment in Slys Merger expenses (income) Cash

6,000,000 200,000

350,000 1,700,000 6,200,000

E2.2

6,200,000

Recording a merger Current assets Plant and equipment Patents and trademarks Identifiable intangible: developed technology Goodwill Merger expenses (income) Current liabilities Long-term debt Cash Earnout liability

350,000 1,600,000 1,500,000 2,000,000 8,650,000 400,000 600,000 3,000,000 10,400,000 500,000

E2.3

Post-Combination Balance Sheet: Merger and Stock Acquisition a. Allen makes the entries shown below in alternatives (1) and (2), respectively: (1) Cash Other current assets Property, plant and equipment Identifiable intangibles Goodwill Current liabilities Long-term liabilities Cash

50,000 150,000 400,000 200,000 350,000

Investment in Benson Cash

800,000

100,000 250,000 800,000

(2) 800,000

Allen’s post-acquisition balance sheet for each alternative is as follows: Allen Corp. Post-combination Balance Sheet Cash Other current assets Property plant and equipment Investment in Benson Identifiable intangibles Goodwill Current liabilities Long-term liabilities Common stock Additional paid-in capital Retained earnings

(1) $ 250,000 750,000 1,600,000 -200,000 350,000 $3,150,000 $ 400,000 850,000 200,000 900,000 800,000 $3,150,000

(2) $ 200,000 600,000 1,200,000 800,000 --$2,800,000 $ 300,000 600,000 200,000 900,000 800,000 $2,800,000

b. In the stock acquisition, total assets are unchanged from Allen's pre-combination balance sheet, reflecting the payment of $800,000 cash for the acquisition of a $800,000 stock investment. In the merger, total assets increase by $350,000. Cash of $800,000 was paid to acquire assets recorded at $1,150,000 (including $200,000 of previously unrecorded identifiable intangibles and $350,000 of goodwill). Note that $350,000 in liabilities was also recorded, so that there was no change in Allen's net assets. Total assets are higher in the merger because Benson’s assets are included with Allen’s assets on a line-by-line basis. In comparing the balance sheet in (1) with the balance sheet in (2), note that if the investment balance in (2) is replaced with the individual assets and liabilities acquired, the two balance sheets are identical.

E2.4

Recording an Acquisition (in millions) Identifiable intangible assets Other assets Goodwill Merger expenses (income) Liabilities Cash (1)

2,504 1,551 1,938 200 1,852 4,341

(1) $4,141 + $200 = $4,341

E2.5

Bargain Purchase a. Price paid Fair value of identifiable net assets: Current assets Land Buildings and equipment Identifiable intangibles Loans payable Gain on acquisition

$ 3,000,000 $ 250,000 800,000 1,000,000 1,500,000 (300,000)

3,250,000 $ 250,000

b. Current assets Land Buildings and equipment Identifiable intangibles Loans payable Cash Gain on acquisition (income)

250,000 800,000 1,000,000 1,500,000 300,000 3,000,000 250,000

c. The addition of $75,000 in contingent liabilities reduces the fair value of identifiable net assets acquired to $3,175,000 (= $3,250,000 – $75,000). Therefore the gain on acquisition is $175,000 (= $3,000,000 – $3,175,000).

E2.6

Goodwill and Bargain Purchase (in thousands)

Current assets Plant assets Identifiable intangibles Goodwill Liabilities Cash Gain on acquisition (income)

Case 1 400 750 900 750 800 2,000 --

Case 2 100 300 200 2,300

Case 3 300 2,000 800 -900 1,000 2,000 2,000 -100

Note to instructor: This exercise opens discussion of how valuations, which are often Level 3 estimates, impact the balance sheet and income.

E2.7

Changes in Acquisition Values a. The value changes occurred during the measurement period. We know this because goodwill is adjusted, implying that the initial acquisition entry has been corrected. b. Goodwill Inventories Identifiable intangible assets Earnout liability

There is no adjustment to expenses or losses, because the remeasured assets have not been written off during the measurement period.

5 24 5

E2.8

Measurement Period Adjustment with Income Effects

Equipment Depreciation expense

8,062,500 937,500

Goodwill To correct the valuation of acquired equipment and related depreciation.

9,000,000

The adjustment, net of depreciation, to the equipment account = ($36,000,000 $27,000,000) x (43/48) = $8,062,500. Alternatively, the correction to depreciation expense = [(36,000,000 - $27,000,000)/4] x (5/12) = $937,500. Although two months of the depreciation expense adjustment is related to 2019, it is recognized as part of 2020 depreciation.

E2.9

Acquisition Cost Tangible assets Intangible assets Goodwill Merger expenses (income) Liabilities Cash Common stock Additional paid-in capital

25,000,000 90,000,000 100,000,000 900,000 55,000,000 101,650,000 1,500,000 57,750,000

E2.10 Identifiable Intangibles (all amounts in thousands) a. Identifiable intangibles reported in an acquisition are those arising from contractual and other legal rights and/or those which are separable. Of the eight previously unreported intangibles listed, five appear to meet the criteria: Customer contracts Brand names Favorable leases Developed technology In-process R&D

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

b. Price paid Fair value of identifiable net assets: Current assets Plant and equipment Licenses and trademarks Customer contracts Brand names Favorable leases Developed technology In-process R&D Current liabilities Long term liabilities Goodwill

$ 80,000 $

250 5,000 8,000 2,000 3,000 500 200 1,000 (800) (9,500)

9,650 $ 70,350

c. Current assets Plant and equipment Licenses and trademarks Customer contracts Brand names Favorable leases Developed technology In-process R&D Goodwill Current liabilities Long term liabilities Cash

250 5,000 8,000 2,000 3,000 500 200 1,000 70,350 800 9,500 80,000

E2.11 Preacquisition Contingency Original acquisition entry: Current assets Plant and equipment Goodwill Estimated liability-lawsuits Other liabilities Cash

900,000 5,000,000 7,600,000 500,000 3,000,000 10,000,000

The increase in the estimated liability from $500,000 to $650,000 is the result of new information on liability value as of the acquisition date, so the adjustment is treated as a correction of the original acquisition entry, within the measurement period.

Change in preacquisition contingency within measurement period: Goodwill Estimated liability-lawsuits

150,000 150,000

Changes in the estimated liability due to events occurring after the acquisition date are reported in income, following normal GAAP. Change in preacquisition contingency not in measurement period: Estimated liability-lawsuits Gain on estimated liability-lawsuits (income)

350,000 350,000

E2.12 Contingent Consideration (all amounts in millions) a. Agreement (1) is reported at the present value of the expected payment, calculated as follows: ($120 – $100) x 25% x 55% = ($150 – $100) x 25% x 15% = Total expected value

$ 2.750 1.875 $ 4.625

Present value at 20% = $4.625/(1.20)4 = $2.23 Agreement (2)’s $1 million payment is reported as part of Aircastle’s acquisition cost. The payment related to services to be provided subsequent to the acquisition is expensed as incurred. The present value of the $1 million payment is calculated as follows: $1/(1.05) = $0.95 The total amount Aircastle reports at the date of acquisition as a liability and as part of total acquisition cost is $2.23 + $0.95 = $3.18 million, or $3 million, rounded to the nearest million. b. (1) The value change is a correction of the original acquisition entry. Earnout liability Goodwill

0.5 0.5

(2) The value change is not a correction of the acquisition entry. GAAP requires that the earnouts be marked to market through income. Earnout liability Gain on earnout (income)

0.5 0.5

E2.13 In-Process R&D, Other Previously Unreported Intangibles, Goodwill The in-process R&D and patent rights meet Codification requirements for capitalization. The contracts under negotiation with potential customers and the skilled workforce do not meet the contractual or separability criteria, so these assets are reported as part of goodwill. The acquisition entry is as follows: Current assets Plant assets In-process R&D Patent rights Goodwill Liabilities Common stock (par $0.50) Additional paid-in capital

500,000 700,000 2,500,000 3,000,000 23,750,000 450,000 1,000,000 29,000,000

E2.14 Recording Asset Acquisition a. Flowers acquired only a subset of Hostess’ net assets, in particular its bread brands, including Wonder and Butternut, and related facilities. ASC Topic 805 standards apply to business combinations, where the acquirer obtains control over a business (Section 805-10-25). Hostess’ bread brands are a business as defined in ASC Topic 805, with inputs, processes, and outputs. Flowers must use acquisition accounting to record its acquisition of Hostess’ bread brands and related facilities. b. Flowers likely reports a receivable for the amount of the gain. Based on the information provided, a logical conclusion is that the receivable is included in “financial assets” acquired. The entry is (in thousands): Financial assets Gain on legal settlement (income)

1,400 1,400

c. (in thousands) Property, plant and equipment Trademarks Financial assets Goodwill Selling, distribution and administrative expense (income) Gain on legal settlement (income) Cash (1)

160,673 189,000 1,650 5,419 16,000 1,400 371,342

(1) $355,342 + $16,000 = $371,342

E2.15 Changes in Acquisition Values (all amounts in thousands) a. Goodwill Plant and equipment Depreciation expense

6,000 5,600 400

The new information adjusts the acquisition entry because it is within one year of the acquisition and reflects new information on date-of-acquisition value. The adjustment to depreciation expense, already recorded on the original value, is $400 = ($6,000/5) x 4/12. b. Goodwill Cost of goods sold

400 400

The new information adjusts the acquisition entry because it is within one year of the acquisition and reflects new information on date-of-acquisition value. The correction is to cost of goods sold since the inventory has been sold. c. Loss on equipment (income) Plant and equipment

3,000 3,000

The new information reflects changes in value occurring subsequent to the acquisition date, and therefore normal accounting standards apply. There is no adjustment to previously recorded depreciation, but future depreciation will be based on the revised value. d. The new information on the brand names reflects changes in value occurring subsequent to the acquisition date, and therefore normal accounting standards apply. GAAP prohibits the recognition of unrealized gains on intangible assets, so no entry is made.

The new information on the earnout also reflects changes in value occurring subsequent to the acquisition date. Here, GAAP requires the earnout to be marked to market through income. The entry is: Earnout liability Gain on earnout (income)

1,000 1,000

E2.16 Valuing Identifiable Intangibles Net cash flow projections, by year, are as follows: Fiscal year

2019

2020

2021

2022

2023

Projected revenue

$25,000,000

$31,250,000

$39,062,500

$48,828,125

$61,035,156

Less cost of sales and operating expenses

(21,250,000)

(26,562,500)

(33,203,125)

(41,503,906)

(51,879,883)

Projected operating income

3,750,000

4,687,500

5,859,375

7,324,219

9,155,273

Less income tax expense

(1,125,000)

(1,406,250)

(1,757,813)

(2,197,266)

(2,746,582)

After-tax operating income

2,625,000

3,281,250

4,101,562

5,126,953

6,408,691

Plus depreciation expense

800,000

825,000

900,000

850,000

900,000

Less capital expenditures

(1,000,000)

(700,000)

(200,000)

(500,000)

(400,000)

Less contributory assets capital charge

(200,000)

(220,000)

(230,000)

(250,000)

$ 2,225,000

$ 3,186,250

$ 4,571,562

$ 5,226,953

$ 6,658,691

Net cash flow

Present value of net cash flow = $2,225,000/1.2 + $3,186,250/(1.2)2 + $4,571,562/(1.2)3 + $5,226,953/(1.2)4 + $6,658,691/(1.2)5 = $11,909,113, or approximately $12 million. E2.17 Step Acquisition (in thousands) Noncontrolling interest (equity) Contributed capital/APIC (equity) Cash Common stock (equity) Contributed capital/APIC (equity) Notes payable

3,500 3,200 4,500 50 1,750 400

PROBLEMS P2.1

Acquisition Entries, Various Types of Combinations, Acquisition Costs a. Cash and receivables Inventory Equity method investments Land Buildings and equipment Patents Goodwill Merger expenses (income) Liabilities Cash

35,000 45,000 20,000 11,000 14,000 10,000 137,000 20,000

Cash and receivables Inventory Equity method investments Land Buildings and equipment Patents Merger expenses (income) Liabilities Cash Gain on acquisition (income)

35,000 45,000 20,000 11,000 14,000 10,000 5,000

22,000 270,000

22,000 115,000 3,000

c. Investment in Steel Acquisition expenses Cash

275,000 15,000 290,000

P2.2

Identification of Acquirer and Balance Sheet Valuation a. (1)

Current assets Property, plant and equipment Identifiable intangibles Goodwill

Axtel Inc. Balance Sheet October 4, 2019 $ 65,000 Current liabilities

$100,000

375,000 20,000 60,000 $520,000

250,000 80,000 90,000 $520,000

Long-term debt Common stock Retained earnings

(2)

Current assets Property, plant and equipment Identifiable intangibles Goodwill

Barcel Inc. Balance Sheet October 4, 2019 $150,000 Current liabilities

$100,000

550,000 25,000 50,000 $775,000

505,000 60,000 110,000 $775,000

Long-term debt Common stock Retained earnings

b. Fair values are recorded only for the acquired company; net assets of the acquiring company remain at book value. The fair value of total assets is higher than book value for both companies, but the difference is greater for Axtel’s assets. Therefore when Barcel is the acquirer, there is a greater revaluation to fair value. A reconciliation is provided below. Book value of Axtel’s assets Book value of Barcel’s assets Fair value adjustments recorded for: Axtel’s assets (1) Barcel’s assets (2) Post-combination recorded assets (1) (2)

Case (1) $240,000 200,000

Case (2) $240,000 200,000

– 80,000 $520,000

335,000 – $775,000

($100,000 - $40,000) + ($400,000 - $200,000) + $25,000 + $50,000 = $335,000 ($25,000 - $50,000) + ($175,000 - $150,000) + $20,000 + $60,000 = $80,000

P2.3

Acquisition with Stock Options a. Cash paid to Mandiant shareholders Fair value of stock issued to Mandiant shareholders Fair value of vested equity awards assumed Total acquisition cost

$106,538,000 704,414,000 86,703,000 $897,655,000

The unvested equity awards will be expensed over the future service period to which they apply, since they are compensation for future services. The out of pocket acquisition costs are expensed as incurred, per ASC Topic 805. b. Intangible assets are separately capitalized if they are contractual or separable. Based on the information provided in FireEye’s annual report, it is not clear that the content intangibles and customer relationships meet the criteria. As an auditor, given that the content intangibles comprise a large part of the assets acquired and are to be amortized over a longer period of time, more attention might be appropriate to be sure the facts are accurately reported. c. Acquisition cost Less fair value of identifiable net assets acquired Goodwill

$897,655,000 (195,024,000) $702,631,000

d. Net tangible assets Developed technology In-process research and development Content intangibles Customer relationships Contract backlog Trade names Goodwill Merger expenses (income) Deferred tax liability Cash (1) Common stock (2) Paid-in capital (3) (1) $106,538,000 + $8,500,000 = $115,038,000 (2) (16,921,000 + 6,680,000) x $0.0001 = $2,360, or $2,000 rounded. (3) $704,414,000 + $86,703,000 – $2,000 = $791,115,000

9,629,000 54,600,000 1,400,000 128,500,000 66,000,000 12,600,000 12,400,000 702,631,000 8,500,000 90,105,000 115,038,000 2,000 791,115,000

P2.4

Acquisition with Earnout

(all amounts in thousands) a. Cash paid to iSIGHT shareholders Fair value of stock issued to iSIGHT shareholders Fair value of earnout Total acquisition cost

$192,800,000 28,200,000 35,600,000 $256,600,000

b. Issues might include: • • •

•

Identifiable intangibles: Do they meet criteria for capitalization? How are estimated amortization periods for limited life intangibles determined? Level 3 estimation techniques are used to determine the values of the identifiable intangibles. Many judgments are made in applying the excess earnings method and relief-from-royalty method. How are these judgments made? Are the methods used reasonable? What is the documentation regarding estimates used? The value of the earnout depends on estimates of expected bookings. What are the estimates used, and are they supportable?

c. Acquisition cost Less fair value of identifiable net assets acquired Goodwill

$256,600,000 (54,106,000) $202,494,000

d. Identifiable intangible: Customer relationships Identifiable intangible: Content Identifiable intangible: Developed technology Identifiable intangible: Trade name Identifiable intangible: Non-competition agreements Goodwill Merger expenses (income) Net tangible liabilities Deferred tax liability Cash (1) Common stock (2) Paid-in capital (3) Earnout liability (1) $192,800,000 + $1,900,000 = $194,700,000 (2) 1,793,305 x $0.0001 = $179 (3) $28,200,000 – $179 = $28,199,821

32,600,000 28,900,000 17,100,000 3,100,000 1,100,000 202,494,000 1,900,000 18,366,000 10,328,000 194,700,000 179 28,199,821 35,600,000

P2.5

Valuation of Identifiable Intangible Assets a. Present value of cash flows for IPR&D: 2019 2020 2021 Terminal value Total value

€400/1.15 €450/(1.15)2 €350/(1.15)3 [(€350/(0.15-0.10))]/(1.15)3

€

348 340 230 4,603 € 5,521

Present value of cash flows for developed technology: 2019 2020 2021 Terminal value Total value

€1,500/1.12 €2,000/(1.12)2 €2,100/(1.12)3 [(€2,100/(0.12-0.10))]/(1.12)3

€ 1,339 1,594 1,495 74,737 € 79,165

b. Acquisition cost Fair value of identifiable net assets acquired: Book value IPR&D Developed technology Goodwill

P2.6

€ 200,000 € 5,000 5,521 79,165

89,686 € 110,314

Identifiable Intangibles and Goodwill a. Acquisition cost (1,000,000 shares @ $35) Identifiable net assets acquired: Cash Accounts receivable Parts inventory Equipment Intangible: Lease Intangible: Service contracts Intangible: Trade name Current liabilities Long-term liabilities Goodwill

$35,000,000 $ 300,000 2,600,000 6,000,000 19,500,000 1,250,000 2,000,000 200,000 (3,100,000) (8,000,000)

20,750,000 $14,250,000

Note: The lease, service contracts, and trade name qualify as identifiable intangibles, as they are based on legal or contractual rights. The work force does not qualify as an identifiable intangible, as it is neither separable nor based on legal/contractual rights. Thus the work force value is included as part of goodwill.

b. Prince’s journal entry to record the merger is as follows: Cash Accounts receivable Parts inventory Equipment Intangible: Lease Intangible: Service contracts Intangible: Trade name Goodwill Merger expenses (income) Cash (1) Current liabilities Long-term liabilities Capital stock (2)

300,000 2,600,000 6,000,000 19,500,000 1,250,000 2,000,000 200,000 14,250,000 1,200,000 1,800,000 3,100,000 8,000,000 34,400,000

Notes: (1) Cash paid for professional fees ($1,200,000) and registration and issue costs ($600,000). (2) Proceeds from stock issue ($35,000,000) less registration and issue costs ($600,000). No par value is specified, so it is not possible to distinguish common stock at par value from additional paid-in capital.

P2.7

Goodwill a. The following business factors or conditions might give rise to goodwill: • • • • •

Well-trained, motivated, and cooperative employees, and superior management. Product-related factors such as reputed high quality. Exclusive processes or formulas. Loyal customer base. Favorable or unusual location, and good distribution channels.

b. Cost of acquiring Toga Corporation Fair market value of the identifiable net assets: Accounts receivable Inventories Equity method investments Property, plant and equipment Current liabilities Total fair market value of identifiable net assets Goodwill

$ 1,000,000 $ 40,000 70,000 150,000 100,000 (80,000) $

280,000 720,000

c. Goodwill is recorded as an asset only when acquired from another enterprise, i.e., Lisa Corporation's purchase of Toga Corporation. The goodwill was not included on Toga Corporation's balance sheet since the internally generated costs of developing a well-trained workforce, loyal customer base, and business reputation are typically expensed as incurred.

P2.8

Bargain Purchase and Preacquisition Contingency a. Cash and receivables Inventory Plant assets Other assets Current liabilities Estimated lawsuit liability Long-term debt Capital stock Gain on acquisition (income)

6,400,000 5,800,000 6,500,000 3,000,000 5,000,000 800,000 1,800,000 10,000,000 4,100,000

b. The $500,000 decline in the value of the lawsuit is a clarification of value as of the date of acquisition and is within one year of the acquisition date. Therefore the value change occurs within the measurement period, and the original acquisition entry is adjusted, as follows: Estimated lawsuit liability Gain on acquisition (income)

500,000 500,000

c. The $100,000 increase in the value of the lawsuit is reported as a loss, and is not a correction in the original acquisition entry. The entry to record settlement of the lawsuit is as follows: Estimated lawsuit liability Loss on lawsuit (income) Cash

300,000 100,000 400,000

P2.9

Post-Combination Balance Sheet, Goodwill (all amounts in thousands) Softdata makes the following entry to record the acquisition: Current assets Property, plant and equipment Patents and trademarks Identifiable intangible: Customer relationships Identifiable intangible: Developed technology Goodwill Merger expenses (income) Current liabilities Long-term liabilities Common stock Additional paid-in capital (1) Current assets (cash) (2)

15 300 900 200 250 715 10 15 965 3 591 816

(1) $600 - $6 registration fees – $3 par value = $591 (2) $800 + $6 + $10 = $816

Softdata’s post-acquisition balance sheet is as follows: Current assets ($1,000 – $816 + $15) Property, plant and equipment Patents and trademarks Customer relationships Developed technology Goodwill Total assets

199 5,300 1,400 200 250 715 _____ $ 8,064

Current liabilities Long-term liabilities Common stock Additional paid-in capital Retained earnings ($270 – $10) Accumulated OCI Treasury stock Total liabilities and equity

215 6,365 13 1,241 260 (25) ___(5) $ 8,064

P2.10 Valuation Adjustments (in thousands) Current assets Limited life intangible assets Long-term debt Goodwill Property, plant and equipment Indefinite life intangible assets Current liabilities Paid-in capital

5 400 100 1,245 500 1,000 50 200

P2.11 Earnings Contingency, In-Process R&D, Bargain Purchase (all dollar amounts in thousands) a. ($60,000 – $50,000) x $2 = ($80,000 – $50,000) x $2 =

$20,000 x .08 = $60,000 x .02 =

$2,800/(1.15)2 =

$1,600 1,200 $2,800 $2,117

b. Price paid:

Cash Earnout Total price Fair value of reported assets: Fair value of reported liabilities: Fair value of unreported IPR&D Gain on acquisition

$1,250,000 2,117 $1,252,117 $8,200,000 (7,850,000)

(350,000) (1,000,000) $ 97,883

c. Current assets Property, plant and equipment Patents In-process R&D Liabilities (1) Cash Gain on acquisition (income)

200,000 5,000,000 3,000,000 1,000,000 7,852,117 1,250,000 97,883

(1) Includes contingent consideration liability of $2,117.

d. Current assets Property, plant and equipment Patents In-process research & development Total assets

$ 3,950,000 65,000,000 13,000,000

Liabilities Capital stock Retained earnings (2)

1,000,000 $82,950,000

_________ Total liabilities and equity $82,950,000

(2) $15,000,000 + $97,883 gain = $15,097,883

$42,852,117 25,000,000 15,097,883

P2.12 Recording Acquisitions, Bargain Gain and Goodwill a. The information provided in Avnet’s annual report summarizes multiple acquisitions. Each is recorded separately. For most of these acquisitions, acquisition cost exceeded the fair value of identifiable net assets acquired, and goodwill was reported. Avnet’s acquisition of Internix, Inc., also discussed in the chapter, resulted in a bargain gain because the fair value of identifiable net assets acquired exceeded acquisition cost by $32,679,000. b. Cash Accounts receivable, net Inventory Other current assets Property, plant and equipment Identifiable intangible: customer relationships Other assets Goodwill Merger expenses (income) Current liabilities Long term debt Gain on acquisition (income) Cash (1)

29,276,000 226,743,000 91,791,000 33,689,000 25,311,000 35,248,000 12,044,000 157,521,000 116,382 157,986,000 112,007,000 32,679,000 309,067,382

(1) $308,951,000 + $116,382 = $309,067,382

P2.13 Valuation Issues and Goodwill Remeasurement a. Salesforce.com’s footnotes disclose that it uses the Black-Scholes option pricing model to value the stock options. This model uses the current stock price, the option price, the time to expiration, the market rate of interest and estimates of market volatility to estimate the current fair value of unexercised options at the grant date. The model is also typically used to value the compensation expense related to stock options granted as incentive compensation, per ASC Topic 718. b. Salesforce.com determined that only $17,428,000 of the total $102.2 million in equity awards should be included in acquisition cost. The remainder relates to future services to be performed by ExactTarget employees. Acquisition cost adds to goodwill. Awards related to future services are expensed over the related future service period. c. According to the footnotes, the deferred tax liability relates primarily to the difference between the book and tax basis of identifiable intangibles. This liability is paid in the future as the intangibles are written off. The basis in identifiable intangibles is likely either zero or below fair value. As the intangibles are written off, the write-off on the books will be higher than the allowed deduction for tax purposes. Therefore tax expense will be less than taxes owing, causing a payoff of the deferred tax liability.

d. The adjustment is a correction of the original acquisition entry, and therefore must be a clarification of values as of the acquisition date. If goodwill is reduced, then identifiable assets must have increased or liabilities decreased. The most likely scenario is remeasurement of the identifiable intangible assets. Salesforce.com may have information that expected revenues from developed technologies or customer relationships at the date of acquisition are more robust than previously estimated. Or the estimated customer liability, presumably for services to be rendered in the future, was overstated.

P2.14 Valuation of Goodwill and Consideration Paid (all dollar amounts in thousands) a. Cash paid to KAYAK’s former shareholders Fair value of priceline.com shares issued to KAYAK’s former shareholders Fair value of assumed vested KAYAK stock options Total acquisition cost

$ 521,443 1,282,334 264,423 $2,068,200

The professional consulting fees of $8,500 are expensed at the acquisition date. b. The net credit to additional paid-in capital is calculated as follows: Fair value of priceline.com shares issued to KAYAK’s former shareholders Fair value of assumed vested KAYAK stock options Less: par value of priceline.com shares issued (1,522,000 x $0.008) Less: stock issuance costs Net credit to additional paid-in capital

$1,282,334 264,423 (12) (1,200) $1,545,545

c. Acquisition cost Fair value of identifiable net assets acquired: Current assets Trade names Supply and distribution agreements Technology Other long-term assets Deferred tax liabilities Other liabilities Goodwill

$2,068,200 $ 322,000 496,000 302,000 73,000 11,700 (326,000) (42,800)

835,900 $1,232,300

P2.15 Step Acquisition (in millions) a. Noncontrolling interest Contributed capital

55,960 74,430

Cash 58,890 Common stock (par) 127 Contributed capital 61,173 Notes payable 5,000 Preferred stock 1,700 Equity investment (asset) 3,500 To record acquisition of Vodafone’s 45% interest in Verizon Wireless. All amounts are given except the debit to contributed capital, which is a plug number. b.

The debit to contributed capital represents the difference between the fair value of consideration paid and the book value of the noncontrolling interest, and equals $74,430.

P2.16 Step Acquisition (in millions of CHF) a.

Fair value of investment in L’Oréal Less gain on sale Less loss reclassified from AOCI to income Book value of investment in L’Oréal

CHF7,342 (4,569) (188) CHF2,585

Fair value of investment in Galderma Less gain on revaluation Book value of investment in Galderma

CHF3,923 (2,817) CHF1,106

For clarity, the sale of the L’Oréal investment and acquisition of the remainder of Galderma’s shares are treated as two different transactions.

(1) Cash Investment in L’Oréal Other comprehensive income Gain on sale (income) To record the sale of L’Oréal investment.

7,342 2,585 188 4,569

(2) Investment in Galderma

2,817 Gain on investment (income)

2,817

To revalue the investment to fair value. Property, plant and equipment Intangible assets Inventories and other assets Goodwill

401 5,401 1,171 2,576

Financial debt 179 Employee benefits, deferred taxes and provisions 1,015 Other liabilities 525 Investment in Galderma 3,923 Cash 3,907 To record acquisition of the remaining shares in Galderma. Goodwill = the total purchase price (= CHF3,923 + CHF3,907) less the fair value of identifiable net assets acquired (CHF5,254).

P2.17 Step Acquisition (numbers in millions of CHF) a.

The cash paid consists of two parts: settling up of recorded liabilities, and the cost of acquiring the noncontrolling interests. Cost of acquiring noncontrolling interests: CHF1,208 – CHF311 = CHF897 The book value of noncontrolling interests = CHF267 CHF897 – CHF267 = CHF630 The difference between the book value of noncontrolling interests and the amount paid to them is an adjustment to the acquirer’s equity, typically in contributed capital.

b. Noncontrolling interests (equity) Liabilities Contributed capital (equity) Cash To record increase in ownership interests with no change in control.

267 311 630 1,208

CHAPTER 3 SOLUTIONS TO MULTIPLE CHOICE QUESTIONS, EXERCISES AND PROBLEMS

MULTIPLE CHOICE QUESTIONS 1.

d The major motivation for off-balance-sheet financing is to avoid the impact on leverage.

b The fair values of the entity’s individual assets and liabilities are included with those of the U.S. company on the consolidated balance sheet. The fair value of the entity’s net assets is owned completely by outside parties, and is labeled noncontrolling interest.

d Cash Flow $156,000 46,800 31,200 Total

Present Value $150,000 45,000 30,000

Prob 0.65 0.20 0.15

Expected PV $ 97,500 9,000 4,500 $111,000

Investment $111,000 111,000 111,000

Residual Returns $39,000 (66,000) (81,000)

Expected Gains $25,350 _____ $25,350

Expected Losses $(13,200) (12,150) $ 25,350

The entry on PR’s books is: Investment in SX Merger expenses Cash Capital stock 6.

50,000 200 10,600 39,600

a Elimination (E) is: Capital stock Retained earnings Accumulated OCI Treasury stock Investment in SX

5,000 8,000 1,000 9,600 2,400

c Elimination (R) is: Current assets Identifiable intangible assets (1) Long-term debt Goodwill (2) PP&E Current liabilities Investment in SX (1) (2)

$(14,000 – $4,000) + $4,000 + $1,000 = $15,000 $50,000 – ($4,200 + $6,000 + $14,000 + $4,000 + $1,000 – $2,000 – $11,600) = $34,400

d See elimination R above.

10.

2,200 15,000 400 34,400 4,000 400 47,600

EXERCISES E3.1

Eliminating Entries, Goodwill (amounts in millions) (E) Capital stock 2 Retained earnings 9 Treasury stock 1 Investment in SSC 10 To eliminate SSC’s shareholders’ equity accounts and the book value portion of the investment account. (R) Goodwill 50 Investment in SSC 50 To revalue SSC’s net assets to fair value and eliminate the difference between book value and fair value of SSC’s net assets from the investment account. Goodwill = $60 – ($2 + $9 - $1) = $50.

E3.2

Eliminating Entries, Previously Unreported Intangibles, Goodwill (amounts in millions) a. Acquisition cost Skoda’s book value Excess of acquisition cost over book value Excess of fair value over book value: Order backlogs Developed technology Goodwill b.

$ 40.0 (2.1) 37.9 $ 1.5 6.0

(7.5) $ 30.4

(E) Capital stock 0.8 Retained earnings 1.6 AOCI 0.3 Investment in Skoda 2.1 To eliminate Skoda’s shareholders’ equity accounts and the book value portion of the investment account.

(R) Order backlogs 1.5 Developed technology 6.0 Goodwill 30.4 Investment in Skoda 37.9 To revalue Skoda’s assets and liabilities to fair value and eliminate the difference between book value and fair value of Skoda’s net assets from the investment account.

E3.3

Eliminating Entries, Revaluation of Reported Net Assets, Goodwill (amounts in thousands) a. Acquisition cost Samson’s book value Excess of acquisition cost over book value Excess of fair value over book value: Accounts receivable Inventories Land, buildings and equipment, net Trademarks Developed technology Noncurrent liabilities Goodwill

$ 30,000 (72,000) (42,000) $

(500) (15,000) (220,000) 140,000 6,000 5,000

84,500 $ 42,500

Note that even though Petrel pays less than book value for Samson’s stock, Petrel still pays more than the fair value of Samson’s identifiable net assets, and therefore goodwill is recognized. b.

(E) Common stock 1,000 Additional paid-in capital 80,000 AOCI 500 Retained earnings 5,500 Treasury stock 4,000 Investment in Samson 72,000 To eliminate Samson’s shareholders’ equity accounts and the book value portion of the investment account.

(R) Trademarks 140,000 Developed technology 6,000 Noncurrent liabilities 5,000 Goodwill 42,500 Investment in Samson 42,000 Accounts receivable 500 Inventories 15,000 Land, buildings and equipment, net 220,000 To revalue Samson’s assets and liabilities to fair value and eliminate the difference between book value and fair value of Samson’s net assets from the investment account. Note that because the acquisition cost is less than book value, eliminating entry (R) requires a debit to the investment account to eliminate it.

E3.4

Eliminating Entries, Bargain Gain (amounts in millions) a. Acquisition cost Skelton book value Excess of acquisition cost over book value Excess of fair value over book value: Current assets Noncurrent assets Identifiable intangibles Bargain gain

$ 8 (20) (12) $ (2) (25) 17

10 $ (2)

The fair value of Skelton’s identifiable net assets is $10 (= $3 + $20 + $17 – $30). Phelps paid only $8, and records a gain of $2 on acquisition Investment in Skelton Cash Gain on acquisition To record the bargain gain investment on Phelps’ books.

10 8 2

b. (E) Capital stock 25 Retained earnings 5 Investment in Skelton 20 To eliminate Skelton’s shareholders’ equity accounts and the book value portion of the investment account. (R) Identifiable intangibles 17 Investment in Skelton 10 Current assets 2 Noncurrent assets 25 To revalue Skelton’s assets and liabilities to fair value and eliminate the difference between book value and fair value of Samson’s net assets from the investment account.

E3.5

Eliminating Entries with Previously Unreported Intangibles (E) Capital stock 7,000,000 AOCI 1,800,000 Retained deficit 500,000 Treasury stock 300,000 Investment in Senyo 8,000,000 To eliminate Senyo’s equity and the book value portion of the investment account. (R) In-process R&D 1,500,000 Goodwill 6,000,000 Land 500,000 Investment in Senyo 7,000,000 To revalue Senyo’s identifiable net assets to fair value, recognize goodwill, and eliminate the remainder of the investment account.

E3.6

Acquisition and Eliminating Entries, Acquisition Expenses a. Investment in Stengl Merger expenses Common stock Additional paid-in capital Cash

10,000,000 300,000 250,000 9,750,000 300,000

b. (E) Capital stock 200,000 Retained earnings 1,800,000 Investment in Stengl 2,000,000 To eliminate Stengl’s equity and the book value portion of the investment account. (R) Long-term debt 25,000 Identifiable intangible assets 500,000 Goodwill 8,275,000 Plant assets, net 600,000 Inventories 200,000 Investment in Stengl 8,000,000 To revalue Stengl’s identifiable net assets to fair value, recognize goodwill, and eliminate the remainder of the investment account. Note: Acquisition costs are expensed separately on Pinnacle’s books and do not affect consolidation eliminating entries.

E3.7

Acquisition and Eliminating Entries, Bargain Purchase a. Publix acquisition entry: Investment in Sherman Merger expenses Cash Gain on acquisition

25,480,000 2,000,000 27,200,000 280,000

Calculation of gain on acquisition: Fair value of Sherman = $25,000,000 + $100,000 + $100,000 + $250,000 + $30,000 = $25,480,000 $25,480,000 – $25,200,000 = $280,000 gain b. Consolidation working paper elimination entries: (E) Capital stock 20,000,000 Retained earnings 5,000,000 Investment in Sherman 25,000,000 To eliminate Sherman’s equity and the book value portion of the investment account.

(R) Inventories 100,000 Land 100,000 Other plant assets, net 250,000 Long-term debt 30,000 Investment in Sherman 480,000 To revalue Sherman’s identifiable net assets to fair value and eliminate the remainder of the investment account. Note: Acquisition costs and the gain on acquisition are recorded separately as expenses and gains, respectively, on Publix’ books, and do not affect consolidation eliminating entries.

E3.8

Interpreting Eliminating Entries a. The shareholders’ equity (book value) of Seaboard is $48,000,000, based on the first eliminating entry. b. The acquisition cost is $88,000,000, so the excess paid over book value is $40,000,000. c. Acquisition cost Book value Excess of acquisition cost over book value Fair value less book value: Noncurrent assets (overvalued) Goodwill

E3.9

$88,000,000 48,000,000 40,000,000 2,000,000 $42,000,000

Acquisition Entry and Consolidation Working Paper a. Phoenix makes the following entry to record the acquisition (amounts in millions): Investment in Spark Merger expenses Cash Common stock Additional paid-in capital (1) (1) [($25 – $1) x 30] – $5 = $715

1,700 8 963 30 715

This entry is reflected in Phoenix’s account balances in the consolidation working paper below.

b. Consolidation Working Paper (in millions) Accounts Taken From Books Phoenix Dr(Cr)

Spark Dr(Cr)

Current assets Plant and equipment, net Investment in Spark

1,037 11,900 1,700

$ 200 700 --

Brand names and trademarks Goodwill Current liabilities Long-term liabilities Common stock, $1par Additional paid-in capital Retained earnings Total

--(500) (8,000) (330) (4,715) (1,092) $ 0

--(150) (300) (100) (50) (300) $ 0

Eliminations Dr

Consolidated Balances Dr(Cr)

Cr 40 (R) 250 (R) 450 (E) 1,250 (R)

(R) 200 (R) 1,340

(E) 100 (E) 50 (E) 300 $ 1,990

$ 1,197 12,350 -200 1,340 (650) (8,300) (330) (4,715) (1,092) $ 0

_______ $ 1,990

Goodwill may be separately calculated as follows: Acquisition cost Spark’s book value Excess of acquisition cost over book value Excess of fair value over book value: Current assets Plant and equipment, net Brand names and trademarks Goodwill

$1,700 (450) $1,250 $ (40) (250) 200

90 $1,340

E3.10 Consolidation Working Paper, Simple Example (in millions) a. Investment in Sylvan Cash

40 40

b. Consolidation Working Paper (in millions) Accounts Taken From Books Princecraft Dr(Cr) Cash Other current assets Property and equipment, net Investment in Sylvan

20 20 70 40

Goodwill Liabilities Common stock Additional paid-in capital Retained earnings Total

-(30) (15) (45) (60) $ 0

Eliminations

Sylvan Dr(Cr) $

2 8 15 --

-(8) (5) (10) (2) $ 0

17 (E) 23 (R) (R) 23 (E) 5 (E) 10 (E) 2 $ 40

____ $ 40

Consolidated Balances Dr(Cr) $ 22 28 85 -23 (38) (15) (45) (60) $ 0

Note for eliminating entry (R): Because there are no revaluations of Sylvan’s identifiable assets and liabilities, the excess of acquisition cost over the book value of the acquired company is attributed entirely to goodwill. Goodwill = acquisition cost of $40 minus book value of $17 = $23. Eliminating entry (R) eliminates the remainder of the investment account and recognizes the acquired goodwill. c. Princecraft Company and Subsidiary Consolidated Balance Sheet (in millions) Date of Acquisition Assets Liabilities Cash $ 22 Total liabilities Other current assets 28 Property and equipment, net 85 Shareholders’ equity Goodwill 23 Common stock Additional paid-in capital Retained earnings _____ Total equity Total assets $ 158 Total liabilities and equity

$ 38

15 45 60 120 $ 158

E3.11 Consolidation with Revaluations of Recorded Net Assets (amounts in millions) a. Acquisition cost Shelby book value Excess of acquisition cost over book value Excess of fair value over book value: Cash and receivables Inventory Property and equipment, net Long term liabilities Goodwill

$ 50 (15) 35 $

1 (3) (10) 2

10 $ 45

b. Consolidation Working Paper (in millions) Accounts Taken From Books

Cash and receivables

Eliminations

Panoz Dr(Cr)

Shelby Dr(Cr)

(R) 1

Consolidated Balances Dr(Cr) $

Inventory

3 (R)

Property and equipment, net

350

100

10 (R)

440

Investment in Shelby

15 (E)

35 (R) Goodwill

Current liabilities

(60)

(20)

Long term liabilities

(200)

(80)

(R) 2

(278)

Capital stock

(120)

(10)

(E) 10

(120)

Retained earnings

(100)

(6)

(E) 6

(100)

AOCI

(1)

(E) 1

Treasury stock

____

$ 65

Total

(R) 45

45 (80)

2 (E) $ 65

20 $

(in millions)

Panoz Corporation and Subsidiary Consolidated Balance Sheet Date of Acquisition

Assets Cash and receivables Inventory Property and equipment, net Goodwill

Total assets

$ 16 47 440 45

____ $ 548

Liabilities Current liabilities Long-term liabilities Total liabilities

$ 80 278 358

Shareholders’ equity Capital stock Retained earnings Accumulated other comprehensive income Treasury stock Total equity Total liabilities and equity

120 100 (10) (20) 190 $ 548

E3.12 Consolidation with Previously Unrecorded Intangibles and Goodwill (see related E2.10) (all amounts in thousands) a. Acquisition cost Ciber book value Excess of acquisition cost over book value Excess of fair value over book value: Current assets Plant and equipment, net Licenses and trademarks Long term liabilities Customer contracts Brand names Favorable leases Developed technology In-process R&D Goodwill

$80,000 (6,600) $73,400 $ (150) (7,000) 3,000 500 2,000 3,000 500 200 1,000

(3,050) $70,350

b. Consolidation Working Paper (in thousands) Accounts Taken From Books Brightcove Dr(Cr)

Ciber Dr(Cr)

Current assets Plant and equipment, net Licenses and trademarks Investment in Ciber

$ 40,000 200,000 -80,000

Customer contracts Brand names Favorable leases Developed technology In-process R&D Goodwill Current liabilities Long-term liabilities Capital stock Retained earnings Total

------(80,000) (150,000) (35,000) (55,000) $ 0

------(800) (10,000) (8,000) 1,400 $ 0

400 12,000 5,000 --

Eliminations Dr

Cr 150 (R) 7,000 (R)

(R) 3,000 6,600 (E) 73,400 (R) (R) 2,000 (R) 3,000 (R) 500 (R) 200 (R) 1,000 (R) 70,350 (R) 500 (E) 8,000 _______ $ 88,550

1,400 (E) $ 88,550

Consolidated Balances Dr(Cr) $ 40,250 205,000 8,000 -2,000 3,000 500 200 1,000 70,350 (80,800) (159,500) (35,000) (55,000) $ 0

c. Brightcove, Inc. and Subsidiary Consolidated Balance Sheet (in thousands) Date of Acquisition Assets Liabilities Current assets $ 40,250 Current liabilities Plant and equipment, net 205,000 Long-term liabilities Licenses and trademarks 8,000 Total liabilities Other identifiable intangible assets 6,700 Goodwill 70,350 Shareholders’ equity Capital stock Retained earnings ________ Total equity Total assets $ 330,300 Total liabilities and equity

$ 80,800 159,500 240,300

35,000 55,000 90,000 $ 330,300

E3.13 Pushdown Accounting (see related E3.12) (amounts in thousands) a. Licenses and trademarks 3,000 Long term liabilities 500 Customer contracts 2,000 Brand names 3,000 Favorable leases 500 Developed technology 200 In-process R&D 1,000 Goodwill 70,350 Current assets 150 Plant and equipment, net 7,000 Retained earnings 1,400 Pushdown capital 72,000 To revalue Ciber’s net assets to fair value and reset retained earnings to zero. b. Consolidation Working Paper (in thousands) Accounts Taken From Books Brightcove Dr(Cr)

Ciber Dr(Cr)

Current assets Plant and equipment, net Licenses and trademarks Investment in Ciber

$ 40,000 200,000 -80,000

Customer contracts Brand names Favorable leases Developed technology In-process R&D Goodwill Current liabilities Long-term liabilities Capital stock Pushdown capital Retained earnings Total

------(80,000) (150,000) (35,000) -(55,000) $ 0

2,000 3,000 500 200 1,000 70,350 (800) (9,500) (8,000) (72,000) -$ 0

250 5,000 8,000 --

Eliminations Dr

Consolidated Balances Dr(Cr)

80,000 (E)

$ 40,250 205,000 8,000 --

(E) 8,000 (E) 72,000 _______ ________ $ 80,000 $ 80,000

2,000 3,000 500 200 1,000 70,350 (80,800) (159,500) (35,000)

(55,000) 0

$ 80,800 159,500 240,300

35,000 55,000 90,000 $ 330,300

The consolidated balance sheet is the same regardless of whether Ciber uses pushdown accounting. Only the eliminating entries change.

E3.14 Reconstructing Eliminating Entries and Book Value (all numbers in millions) a. Consolidated total assets Less: Cove’s current assets ($75 – $65) Less: Cove’s noncurrent assets Fair value of Bay’s total assets Less: Goodwill Fair value of Bay’s identifiable assets

$ 186 (10) (100) $ 76 (37) $ 39

b. Acquisition cost Less: Goodwill Fair value of Bay’s identifiable net assets Fair value of Bay’s identifiable assets (from a. above) Less: Fair value of Bay’s identifiable net assets Fair value of Bay’s liabilities

$ 65 (37) $ 28 $ 39 (28) $ 11

c. Fair value of Bay’s identifiable net assets (from b. above) Less: Fair value of previously unreported intangibles Book value of Bay’s net assets

$ 28 (16) $ 12

d. (E) Shareholders’ equity–Bay Investment in Bay

(R) Identifiable intangibles Goodwill Investment in Bay

16 37

E3.15 Pushdown Accounting (in millions) a. Identifiable intangibles 25 Goodwill 53 Current assets 2 Plant and equipment 30 Retained earnings 1 Pushdown capital 45 To revalue Sofia’s net assets to fair value and reset retained earnings to zero. b.

(E) Capital stock Pushdown capital Investment in Sofia

5 45 50

E3.16 Identifying and Analyzing Variable Interest Entities a. Minority shareholder C guarantees 92% of A’s debt, which is most of A’s capital, providing evidence that A cannot obtain financing on its own, and indicating that A’s owners lack the usual characteristics of equity. Therefore A is likely to be classified as a VIE. C has decision-making power through its majority representation on the board. C has the obligation to absorb A’s significant losses and benefits through its equity interest and guarantee of A’s bank loans, and will likely be designated as A’s primary beneficiary. Therefore C will consolidate A. b. B is not a VIE because it can obtain financing on its own. D is the sole owner of B through its 100% equity ownership, and should consolidate B under the voting interest model. A small proportion of equity does not automatically lead to the conclusion that the equity holders are not exposed to the usual risks and rewards of stock ownership.

c. The 15% equity could be enough to avoid identifying A as a VIE, if there is evidence that A can obtain financing on its own, has a level of equity comparable to other entities who can obtain financing on their own, or that its equity is deemed adequate to absorb A’s expected losses. In that case, E is the controlling investor and C does not consolidate A. If A cannot obtain financing on its own, or its equity is not sufficient to absorb expected losses, A is a VIE. C has the decision making power, and by agreeing to compensate E for any of A’s losses, C absorbs significant losses. Therefore C is likely to be A’s primary beneficiary and should consolidate A. d. B’s shareholders are insulated from losses by the guarantees provided by C and D. Moreover, D’s unsecured loan to B provides additional subordinated financial support. These factors indicate that B is a VIE. D has decision making power through its control of B’s board. Losses in guaranteed residual values on D’s specialized property, and its unsecured loan to B, require D to absorb a potentially significant amount of B’s losses. Therefore it is likely that D is B’s primary beneficiary and must consolidate B.

E3.17 Identification of Variable Interest Entity and Primary Beneficiary a. If qualitative factors are inconclusive, the answer to this question depends on a quantitative analysis of the ability of the equity interest to absorb Startek’s potential losses. Using the quantitative analysis presented in the chapter (and illustrated in ASC para. 810-10-55-53), expected gains and losses are computed as follows (in millions): Expected Cash Flow $ 11 33 55

Present Value $ 10 30 50

Prob. 0.40 0.20 0.40

Expected PV $ 4 6 20 $ 30

Investment Fair Value $ 30 30 30

Residual Returns $ (20) -20

Expected Gains

$ $

8 8

Expected Losses $ (8) _____ $ (8)

Because the $4,000,000 equity interest is insufficient to absorb the expected losses of $8,000,000 computed above, the quantitative analysis indicates that Startek is a VIE. b. Softek must have (1) the power to direct Startek’s activities that most significantly affect its economic performance, and (2) be exposed to the losses and benefits that are potentially significant to Startek. Because Softek guarantees Startek’s debt, it probably meets requirement (2). However, we don’t have enough information to assess Softek’s decision making power over Startek.

PROBLEMS P3.1

Eliminating Entries, Goodwill (amounts in millions) a. Acquisition cost Book value (deficit) Excess of acquisition cost over book value Fair value less book value: Fixed assets, net Customer lists Brand names Goodwill

$ 500 28 $ 528 $ (35) 70 150

(185) $ 343

b. (E) Common stock 2 Additional paid-in capital 25 Investment in Sherwood 28 Retained earnings Accumulated other comprehensive loss Treasury stock To eliminate Sherwood’s equity accounts and the book value portion of the investment account.

50 3 2

(R) Customer lists 70 Brand names 150 Goodwill 343 Fixed assets, net 35 Investment in Sherwood 528 To revalue Sherwood’s assets and liabilities to fair value and eliminate the remainder of the investment account.

P3.2

Consolidation Working Paper, Identifiable Intangibles, Goodwill a. (in millions) Investment in GOC Merger expenses Common stock Additional paid-in capital (1) Contingent consideration liability Cash

112 5 2 55 2 58

(1) APIC = fair value of shares issued – par value of shares issued – registration fees: $55 = $60 – $2 – $3

b. Consolidation Working Paper (in millions)

Current assets Property, plant and equipment, net Investment in GOC

Accounts Taken From Books ITI GOC Dr (Cr) Dr (Cr) $ 142 $ 10

Identifiable intangible assets

Goodwill Current liabilities Long-term liabilities Common stock, par Additional paid-in capital Retained earnings Accumulated other comprehensive income Treasury stock Total

500 112

130

1,300

(150) (1,202) (22) (605) (95)

(20) (100) (4) (60) 25

15 5 0

(3) 2 0

Eliminations Dr (R) 5

Consolidated Balances Dr (Cr) $ 157

60 (R) 40 (E) 72 (R) (R) 10 (R) 5 (R) 25 (R) 90

1,360

25 (E)

90 (170) (1,305) (22) (605) (95)

2 (E) $ 202

15 5 0

3 (R) (E) 4 (E) 60

(E) 3 _____ $ 202

570 --

P3.3

Stock Acquisition and Consolidation Working Paper Eliminating Entries (amounts in millions) a. Investment in Hospira Merger expenses Cash

16,087 877 16,964

b. Acquisition cost Hospira book value Excess of acquisition cost over book value Excess of fair value over book value: Inventories Property, plant and equipment In-process R&D Developed technology rights Other noncurrent assets Long-term debt Deferred tax liabilities Other noncurrent liabilities Goodwill c. (E) Shareholders’ equity—Hospira Investment in Hospira (R) In-process R&D Developed technology rights Other noncurrent liabilities Goodwill Inventories Property, plant and equipment Other noncurrent assets Long-term debt Deferred tax liabilities Investment in Hospira

$16,087 (7,928) $ 8,159 $ (1,313) (3,620) 1,030 8,290 (138) (28) (3,380) 22

(863) $ 7,296

7,928 7,928

1,030 8,290 22 7,296 1,313 3,620 138 28 3,380 8,159

P3.4

Consolidated Balance Sheet Working Paper, Bargain Purchase (amounts in millions) a. Calculation of gain on acquisition: Acquisition cost Book value Excess of acquisition cost over book value Excess of fair value over book value: Inventory Equity method investments Land Buildings and equipment Identifiable intangibles Gain on acquisition

$ 1,700 (1,295) $ 405 $ (100) (50) 245 300 110 $

(505) 100

b. Consolidation Working Paper

(in millions)

Accounts Taken From Books Paxon Saxon Dr (Cr) Dr (Cr)

Cash and receivables Inventory Equity method investments Investment in Saxon

$ 1,160 1,700 -1,800

Land Buildings and equipment, net Identifiable intangibles Current liabilities Long-term debt Common stock, par value Additional paid-in capital Retained earnings Total

650 2,400 -(1,500) (2,000) (500) (1,200) (2,510) $ 0

175 600 -(1,000) (400) (100) (350) (845) $ 0

Eliminations Dr

720 900 300

Cr 100 (R) 50 (R) 1,295 (E) 505 (R)

(R) 245 (R) 300 (R) 110

(E) 100 (E) 350 (E) 845 $ 1,950

______ $ 1,950

Consolidated Balances Dr (Cr) $ 1,880 2,500 250 -1,070 3,300 110 (2,500) (2,400) (500) (1,200) (2,510) $ 0

c. Paxon Corporation and Subsidiary Consolidated Balance Sheet (in millions) January 1, 2019 Assets Liabilities Cash and receivables $ 1,880 Current liabilities Inventory 2,500 Long-term debt Equity method investments 250 Total liabilities Land 1,070 Buildings and equipment, net 3,300 Shareholders’ equity Identifiable intangibles 110 Common stock, par value Additional paid-in capital Retained earnings _______ Total equity Total assets $ 9,110 Total liabilities and equity

P3.5

$ 2,500 2,400 4,900

500 1,200 2,510 4,210 $ 9,110

Pushdown Accounting with Bargain Gain (see related P3.4) (amounts in millions) a. Land Buildings and equipment Identifiable intangibles Retained earnings Equity method investments Inventory Pushdown capital

245 300 110 845 50 100 1,350

b. Consolidation Working Paper

P3.6

(in millions)

Accounts Taken From Books Paxon Saxon Dr (Cr) Dr (Cr)

Cash and receivables Inventory Equity method investments Investment in Saxon Land Buildings and equipment, net Identifiable intangibles Current liabilities Long-term debt Common stock, par value Additional paid-in capital Pushdown capital Retained earnings Total

$ 1,160 1,700 -1,800 650 2,400 -(1,500) (2,000) (500) (1,200) -(2,510) $ 0

Eliminations Dr

Consolidated Balances Dr (Cr)

720 800 250 1,800 (E)

420 900 110 (1,000) (400) (100) (350) (1,350) -$ 0

(E) 100 (E) 350 (E)1,350 ______ $ 1,800

______ $ 1,800

$ 1,880 2,500 250 -1,070 3,300 110 (2,500) (2,400) (500) (1,200)

(2,510) 0

Acquisition and Eliminating Entries

(amounts in millions) a.

Based on the information provided, it appears that Cruise had zero or negligible equity when GM acquired it. We know this because previously unreported net assets equal the acquisition cost. In-process R&D $130 Deferred tax liability (39) Goodwill 490 Total $581

b. Investment in Cruise Cash Additional paid-in capital To record GM’s investment in Cruise stock.

581 291 290

The other arrangements appear to be contingent on the future performance of employees, and therefore are not costs of acquiring the company as it exists at the date of acquisition. c.

Only eliminating entry R is required.

(R) In-process R&D 130 Goodwill 490 Deferred tax liability 39 Investment in Cruise 581 To revalue Cruise’ assets and liabilities to fair value and eliminate the investment account.

P3.7

Consolidated Balance Sheet Working Paper, Previously Reported Goodwill (amounts in thousands) a. Investment in Static Merger expenses Common stock Additional paid-in capital Cash

16,000 100 200 15,300 600

b. Acquisition cost Static’s book value Excess of acquisition cost over book value Excess of fair value over book value: Cash and receivables Inventory Equity method investments Plant assets, net Copyrights Goodwill (1) Noncurrent liabilities Goodwill

$ 16,000 (4,000) $ 12,000 $ (500) (300) 3,400 (2,600) 3,300 (500) (100)

(2,700) $ 9,300

(1) All pre-existing goodwill is eliminated, even though it may be deemed to have a non-zero fair value.

c. Consolidation Working Paper (in thousands) Accounts Taken From Books Progressive Static Dr (Cr) Dr (Cr) Cash and receivables Inventory Equity method investments Investment in Static

$ 7,400 7,000 -16,000

$ 2,000 2,400 600 --

Plant assets, net Copyrights Goodwill Current liabilities Noncurrent liabilities Common stock, par Additional paid-in capital Retained earnings Total

10,000 1,000 -(6,000) (4,000) (300) (16,200) (14,900) $ 0

3,600 200 500 (2,000) (3,300) (100) (400) (3,500) $ 0

Eliminations Dr

Cr 500 (R) 300 (R)

(R) 3,400 4,000 (E) 12,000(R) 2,600 (R) (R) 3,300 (R) 9,300

500 (R) 100 (R)

(E) 100 (E) 400 (E) 3,500 $ 20,000

_____ $ 20,000

Consolidated Balances Dr (Cr) $

8,900 9,100 4,000 --

11,000 4,500 9,300 (8,000) (7,400) (300) (16,200) (14,900) $ 0

(in thousands)

Progressive Corporation and Subsidiary Consolidated Balance Sheet June 30, 2019

Assets Cash and receivables Inventory Equity method investments Plant assets, net Copyrights Goodwill

$ 8,900 9,100 4,000 11,000 4,500 9,300

Total assets

_______ $ 46,800

Liabilities Current liabilities Long-term debt Total liabilities

$ 8,000 7,400 15,400

Shareholders’ equity Common stock, par Additional paid-in capital Retained earnings Total equity Total liabilities and equity

300 16,200 14,900 31,400 $ 46,800

P3.8

Consolidated Balances, Different Acquirers a. Consolidation Working Paper (in millions) Accounts Taken From Books Eliminations Webnet Microtech Solutions Dr (Cr) Dr (Cr) Dr Cr Current assets Property, plant and equipment, net

200

5 -(4) (20) (3) (224) (14) $ 0

5 -(4) (20) (2) (25) (14) $ 0

Investment in Webnet

Consol. Balances Dr (Cr) $

20 100

41 (E)

159 (R) Patents Goodwill Current liabilities Long-term debt Common stock, par Additional paid-in capital Retained earnings Total

(R) 159

(E) 2 (E) 25 (E) 14 $ 200

_____ $ 200

10 159 (8) (40) (3) (224) (14) $ 0

b. Consolidation Working Paper (in millions) Accounts Taken From Books Eliminations Webnet Solutions Microtech Dr (Cr) Dr (Cr) Dr Cr Current assets Property, plant and equipment, net

Investment in Microtech

200

Patents Developed technology Client relationships Goodwill Current liabilities Long-term debt Common stock, par Additional paid-in capital Retained earnings Total

5 ---(4) (20) (3) (224) (14) $ 0

5 ---(4) (20) (2) (25) (14) $ 0

Consol. Balances Dr (Cr) $

(R) 20

20 120

41 (E) 159 (R) (R) 10 (R) 100 (R) 29

(E) 2 (E) 25 (E) 14 _____ $ 200 $ 200

-20 100 29 -(8) (40) (3) (224) (14) $ 0

c. The consolidated balance sheets are compared below. Consolidated Balance Sheet (in millions) Microtech acquires Webnet Assets Current assets Property, plant and equipment, net Identifiable intangibles Goodwill Total assets Liabilities Current liabilities Long-term debt Total liabilities Shareholders’ equity Common stock, par Additional paid-in capital Retained earnings Total equity Total liabilities and equity

Webnet acquires Microtech

20 100 10 159 $ 289

8 40 48

3 224 14 241 $ 289

20 120 149 -$ 289

8 40 48

3 224 14 241 $ 289

Both sets of consolidated balances report the same total assets and the same individual liabilities and equities. However, the individual asset accounts differ. The acquirer’s assets are not revalued to fair value, nor are previously unreported assets recognized. Microtech has understated property, plant and equipment and patents, as well as unreported identifiable intangible assets. Webnet Solutions’ assets and liabilities are reported at amounts approximating fair value, and there are no identifiable intangibles. When Microtech is the acquirer, the difference between Webnet Solutions’ acquisition price and reported book value is reported as goodwill, and the difference between book and fair value of Microtech’s assets is not recognized. When Webnet Solutions is the acquirer, its goodwill is not recognized, but Microtech’s property and patents are reported at fair value, and its identifiable intangibles are recognized.

Does management want the $159 million excess of acquisition cost over book value to be reported as the unspecified asset goodwill, or distributed among several identifiable assets (property, plant and equipment, patents, client relationships)? If Webnet Solutions is the acquirer, Microtech’s previously unreported identifiable assets will come to light. To the extent that the existence of identifiable intangibles such as developed technology and client relationships indicate favorable future earnings potential, investors may view the new disclosures as a positive signal, increasing stock price. If Microtech is the acquirer, no identifiable intangibles are recognized, and investors may wonder if Webnet Solutions will sustain its value in the future, as these assets would seem to be the lifeblood of a technology company. Management will also consider the implications for future income. Identifiable assets usually have limited lives and are depreciated or amortized over time, reducing earnings on a regular basis. Goodwill is tested for impairment loss, and may never be written off. If Microtech is the acquirer, future reported income may be higher because there are no identifiable intangibles to be amortized. Note to instructor: This problem illustrates the games companies can play to choose between different financial statement displays of the same transaction economics.

P3.9

Tangible and Intangible Asset Revaluations (in thousands) a. Consideration paid Previously unrecorded intangibles acquired: Customer contracts and related relationships Developed technology Trade name, trademark, and domain name Goodwill Fair value of tangible net assets acquired

Polyvore $ 160,582

225 17,550 1,150 131,084

BrightRoll $ 581,165

$85,600 19,400

(150,009) $ 10,573

8,100 416,580

(529,680) $

51,485

b. Goodwill is that part of the acquisition cost that is not explained by acquisition of tangible net assets or identifiable intangible assets. Possible reasons for large goodwill values: •

The fair value of tangible net assets tends to be small, especially for technology companies where value is derived mostly from intangible assets.

•

GAAP limits the recognition of identifiable intangible assets to those that are contractual or separable, and valuation of identifiable intangibles is a complex process involving many estimates.

•

It is also possible that the purchase price was inflated.

Note: In 2015 Yahoo! reported goodwill impairment charges of about $4.5 billion, representing over 85% of its total recorded goodwill. This is an indication that recorded goodwill was overstated due to inflated acquisition cost. c. Polyvore eliminations: (E) Shareholders’ equity—Polyvore Investment in Polyvore

10,000

(R) Tangible net assets (1) Customer contracts and related relationships Developed technology Trade name, trademark, and domain name Goodwill Investment in Polyvore

573 225 17,550 1,150 131,084

10,000

150,582

(1) $10,573 – $10,000 = $573.

BrightRoll eliminations: (E) Shareholders’ equity—BrightRoll Investment in BrightRoll

50,000

(R) Tangible net assets (2) Customer contracts and related relationships Developed technology Trade name, trademark, and domain name Goodwill Investment in BrightRoll

1,485 85,600 19,400 8,100 416,580

(2) $51,485 - $50,000 = $1,485.

50,000

531,165

P3.10 Stock Acquisition, Previous Equity Interest and Goodwill, Merger-Related Costs, Deferred Taxes (amounts in millions) a. Investment in Grupo Modelo Merger expenses Cash (1) Investment in associates

34,008 100 20,203 13,905

(1) $20,103 + $100 = $20,203

b. Goodwill reported on an acquired company’s books is not an identifiable asset and is not separately reported. The difference between acquisition cost and the fair value of net identifiable assets acquired is reported as goodwill on the consolidated balance sheet. c. This acquisition must be nontaxable; the acquiree does not pay taxes on any gain. Therefore the tax basis of the acquired net assets remains at Grupo Modelo’s tax basis, which is typically lower than fair value at the date of acquisition. AB InBev reports net assets acquired at fair value on its books, and writes them off over time. Therefore the book write-offs are higher than the tax deductions, causing cash paid for taxes to be greater than tax expense. The discrepancy is payment of deferred tax liabilities, created at the date of acquisition. The acquiring company reports a deferred tax liability for the additional taxes it will pay in excess of the tax expense it reports on its books, as these intangible assets are written off. d. Acquisition cost (see a. above) Grupo Modelo’s book value Excess of acquisition cost over book value Excess of fair value over book value: Property, plant and equipment Goodwill Intangible assets Investment in associates Investment securities Current assets Employee benefits Trade and other payables Deferred tax liabilities Current liabilities Goodwill

$ 34,008 (9,203) $ 24,805 $

99 (796) 4,454 (4) -4,333 -(509) (714) (1,650)

(5,213) $ 19,592

e. (E) Shareholders’ equity–Grupo Modelo Investment in Grupo Modelo (R) Property, plant and equipment Intangible assets Current assets Goodwill (new) Goodwill (old) Investment in associates Trade and other payables Deferred tax liabilities Current liabilities Investment in Grupo Modelo

9,203 9,203

99 4,454 4,333 19,592 796 4 509 714 1,650 24,805

P3.11 Consolidation of Variable Interest Entities (dollar amounts in millions) a. U.S. GAAP requires a 2-step process to determine if SPEs should be consolidated. First, determine if the SPE is a variable interest entity. The SPE is a VIE if its equity does not have the usual equity characteristics, in terms of risk and return. These factors must be considered: (1) Does the equity interest have the power to make decisions? (2) Is the equity interest exposed to the risks and rewards connected with the SPE? (3) Is the equity interest sufficient to allow the SPE to obtain financing on its own? Limitations on the voting power of the equity interest, and caps on the amount of losses the equity interest may incur, are indicators of VIE status. If the SPE’s business activities are predominantly conducted on behalf of an entity that has few voting rights, the SPE’s equity interest may not be exposed to the normal risks and returns of stock ownership. To determine the sufficiency of the SPE’s equity, qualitative factors include whether the SPE is in fact able to obtain financing on its own, or has equity equivalent to other entities who are able to obtain financing on their own. If qualitative factors are not conclusive, a quantitative analysis may be done to determine if the SPE’s equity level is sufficient to absorb expected future losses. Once the SPE is classified as a VIE, GM consolidates it if it is the VIE’s primary beneficiary. GM determines if it has the power to direct the decisions that significantly affect the VIE’s performance, and is exposed to the risks and returns connected with that performance.

GM likely classified the SPEs as VIEs because GM Financial provides the assets that are used to repay the debt. It seems unlikely that the SPEs could obtain financing on their own, since they exist to securitize these assets. GM Financial is the primary beneficiary of the VIEs because it services the securitized assets, and therefore has the power to direct the VIEs’ major decisions. GM Financial also apparently has exposure to the VIEs’ risks and returns. b. Consolidation of the VIEs adds $50,779 (= $2,067 + $29,371 + $19,341) to consolidated assets, and $38,244 to consolidated liabilities. The remainder of $12,535 (= $50,779 – $38,244) is the VIEs’ equity interest, which is included as “noncontrolling interest” in the equity section of GM’s consolidated balance sheet. P3.12 Identifiable Intangibles and Goodwill (see related P2.6) a. Prince makes the following entry to record the acquisition on its own books (in thousands): Investment in Squire Merger expenses Capital stock Cash

35,000 1,200 34,400 1,800

The account balances for Prince, shown in the working paper below, reflect the above entry. Merger expenses reduce retained earnings, a component of shareholders’ equity. Consolidation Working Paper (in thousands) Accounts Taken From Books

Cash Accounts receivable Parts inventory Vehicle inventory Equipment, net Investment in Squire Intangible: Lease Intangible: Service contracts Intangible: Trade name Goodwill Current liabilities Long-term liabilities Shareholders’ equity Total

Eliminations

Prince Dr (Cr) $ 1,000 6,000 -15,000 40,000 35,000

Squire Dr (Cr) $ 300 2,700 5,200 -17,600 --

(R) 1,250

---(5,000) (25,000) (67,000) $ 0

---(3,100) (8,600) (14,100) $ 0

(R) 2,000 (R) 200 (R)14,250

(R)

Consolidated Balances Dr (Cr) $ 1,300 100 (R) 8,600 6,000 15,000 59,500 14,100 (E) -20,900(R) 1,250 Cr

800

(R) 1,900

(R) 600 (E)14,100 $ 35,100

_______ $ 35,100

2,000 200 14,250 (8,100) (33,000) (67,000) $ 0

b. If Prince records the acquisition as a statutory merger, Prince makes the following entry (in thousands): Cash Accounts receivable Parts inventory Equipment, net Intangible: Lease Intangible: Service contracts Intangible: Trade name Goodwill Merger expenses Cash Current liabilities Long-term liabilities Capital stock

300 2,600 6,000 19,500 1,250 2,000 200 14,250 1,200 1,800 3,100 8,000 34,400

When the above entry is reflected in Prince’s account balances, Prince’s balance sheet account balances are identical to those shown in the consolidated column of the working paper for a stock acquisition.

P3.13 Working Backwards—Reconstruct Balance Sheet and Eliminating Entries (in thousands) a. Piedmont’s entry to record the acquisition was as follows: Investment in Stearns Merger expenses Capital stock (1) Cash (2) Earnings contingency liability

220,000 500 119,300 96,200 5,000

(1) $120,000 – $700 = $119,300 (2) $95,000 + $500 + $700 = $96,200

Reversing this entry out of Piedmont’s balance sheet produces its balance sheet just prior to the acquisition:

Piedmont Corporation Balance Sheet, Immediately Prior to Date of Acquisition (in thousands) Current assets (3) $ 136,200 Liabilities (4) Plant assets, net 360,000 Capital stock (5) ________ Retained earnings (6) Total assets $ 496,200 Total liabilities and equity

$ 215,000 180,700 100,500 $ 496,200

(3) $40,000 + $96,200 = $136,200 (4) $220,000 - $5,000 = $215,000 (5) $300,000 - $119,300 = $180,700 (6) $100,000 + $500 = $100,500

b. (E) Capital stock Retained earnings Investment in Stearns (R) Identifiable intangibles Goodwill Plant assets, net (7) Investment in Stearns

40,000 25,000 15,000

100,000 135,000 30,000 205,000

(7) $470,000 – $360,000 – $140,000 = $(30,000)

c. Acquisition cost Stearns’ book value Excess of acquisition cost over book value Excess of fair value over book value: Plant assets, net Identifiable intangibles Goodwill

$ 220,000 (15,000) $ 205,000 $ (30,000) 100,000

(70,000) $ 135,000

P3.14 Consolidated Balance Sheet Working Paper, Identifiable Intangibles (amounts in thousands) a. Acquisition cost (1) GP’s book value (2) Excess of acquisition cost over book value Excess of fair value over book value: Current assets Fixed assets, net Trademarks Licensing agreements Order backlogs Long-term liabilities Goodwill

$ 41,250 (5,000) 36,250 $ 200 (7,000) 2,600 2,400 5,000 1,000

(4,200) $ 32,050

(1) $5,000 + $36,000 + $250 = $41,250 (2) $500 + $8,500 – $2,000 – $1,400 – $600 = $5,000

Note: The skilled workforce and future synergies are not capitalized separately but are included in goodwill. b. Consolidation Working Paper (in thousands) Accounts Taken From Books

Current assets Fixed assets, net Investment in GP Trademarks Other identifiable intangibles Goodwill Current liabilities Long-term liabilities Common stock, par Additional paid-in capital Retained earnings AOCI Treasury stock Total

International Auto Dr (Cr) $ 22,900 420,000 41,250

Eliminations

Genuine Parts Dr (Cr) $ 1,000 27,000 --

Dr (R) 200

89,000

3,400

(R) 2,600

-(25,000) (350,250) (10,000) (143,100) (43,800) (4,000) 3,000 $ 0

-(400) (26,000) (500) (8,500) 2,000 1,400 600 $ 0

(R) 2,400 (R) 5,000 (R)32,050

Consolidated Balances Cr Dr (Cr) $ 24,100 7,000 (R) 440,000 5,000 (E) -36,250 (R) 95,000 7,400

(R) 1,000 (E) 500 (E) 8,500

_______ $ 52,250

2,000 (E) 1,400 (E) 600 (E) $ 52,250

32,050 (25,400) (375,250) (10,000) (143,100) (43,800) (4,000) 3,000 $ 0

Note: International Auto’s trial balance at the date of acquisition is determined by combining its trial balance just prior to the acquisition with this acquisition journal entry: Investment in GP Merger expenses Common stock, par Additional paid-in capital Cash Earnings contingency liability

41,250 1,200 2,000 33,100 7,100 250

c. International Auto and Subsidiary Consolidated Balance Sheet, Date of Acquisition (in thousands) Assets Current assets Fixed assets, net Trademarks Other identifiable intangibles Goodwill

Total assets

$ 24,100 440,000 95,000 7,400 32,050

________ $ 598,550

Liabilities Current liabilities Long-term liabilities Total liabilities Shareholders’ equity Common stock, par Additional paid-in capital Retained earnings Accumulated other comprehensive income Treasury stock Total shareholders’ equity Total liabilities and equity

25,400 375,250 400,650

10,000 143,100 43,800 4,000 (3,000) 197,900 $ 598,550

P3.15 Pushdown Accounting (see related P3.14) a. Current assets Trademarks Other identifiable intangibles Goodwill Long-term liabilities Fixed assets Retained earnings AOCI Pushdown capital

200 2,600 7,400 32,050 1,000 7,000 2,000 1,400 32,850

b. Consolidation Working Paper (in thousands) Accounts Taken From Books

International Auto Dr (Cr) $ 22,900 420,000 41,250 89,000

Genuine Parts Dr (Cr) $ 1,200 20,000 -6,000

--(25,000) (350,250) (10,000) (143,100) -(43,800) (4,000) 3,000 $ 0

7,400 32,050 (400) (25,000) (500) (8,500) (32,850) --600 $ 0

Eliminations

Consolidated Balances Cr Dr (Cr) $ 24,100 440,000 41,250 (E) -95,000 7,400 32,050 (25,400) (375,250) (10,000) (143,100)

(E) 500 (E) 8,500 (E) 32,850

_______ $ 41,850

600 (E) $ 41,850

(43,800) (4,000) 3,000 $ 0

P3.16 Consolidated Balance Sheet Working Paper, Bargain Gain, Special Issues (in thousands) a. Acquisition cost Steamobile’s book value Excess of book value over acquisition cost Excess of fair value over book value: Current assets Fixed assets, net (1) Identifiable intangibles Goodwill (old) Liabilities Bargain gain (1) $140,000 – ($150,000 – $40,000) = $30,000

$ 20,000 (30,000) (10,000) $ (2,000) 30,000 6,000 (35,000) (1,000)

2,000 $ 8,000

b. Consolidation Working Paper (in thousands) Accounts Taken From Books Packard Dr (Cr) $ 15,000 500,000 (160,000) 28,000 --(215,000) (90,000) (78,500) 500 $ 0

Current assets Fixed assets Accumulated depreciation Investment in Steamobile Identifiable intangibles Goodwill Liabilities Capital stock Retained earnings AOCI Total

Eliminations

Steamobile Dr (Cr) $ 5,000 150,000 (40,000) -35,000 (120,000) (35,000) 5,800 (800) $ 0

Dr (R) 30,000 (R) 40,000 (R) 2,000 (R) 6,000

Cr 2,000(R) 40,000(R) 30,000(E) 35,000(R) 1,000(R)

(E )35,000 5,800(E) (E) 800 _______ $ 113,800 $ 113,800

Consolidated Balances Dr (Cr) $ 18,000 640,000 (160,000) -6,000 -(336,000) (90,000) (78,500) 500 $ 0

Note 1: Packard’s trial balance at the date of acquisition is determined by combining its trial balance just prior to the acquisition with this acquisition journal entry: Investment in Steamobile Cash Bargain gain

28,000 20,000 8,000

Note 2: An additional eliminating entry removes Steamobile’s accumulated depreciation account and nets it against the fixed assets account. c. Packard and Subsidiary Consolidated Balance Sheet, Date of Acquisition (in thousands) Assets Current assets Fixed assets, net of $160,000 accumulated depreciation Identifiable intangibles

Total assets

18,000 480,000 6,000

________ $ 504,000

Liabilities Liabilities Shareholders’ equity Capital stock Retained earnings Accumulated other comprehensive income Total shareholders’ equity Total liabilities and equity

$ 336,000

90,000 78,500 (500) 168,000 $ 504,000

P3.17 Acquisition with Bargain Gain (all dollar amounts in thousands, except per share price) a. Investment in SolarCity Merger expenses Capital stock (1) Capital stock – stock options Bargain gain (2) Cash (1) (2)

2,234,704 21,700 2,058,477 87,500 88,727 21,700

11,124,497 x $185.04 = $2,058,477 Fair value of SolarCity net assets acquired = $480,020 + $5,781,496 + $1,056,312 + $356,510 + $838,772 - $468,668 - $3,403,840 - $2,405,898 = $2,234,704; acquisition cost = $2,058,477 + $87,500 = $2,145,977; $2,234,704 - $2,145,977 = $88,727

Note: unvested awards are not included in the acquisition cost, as they require future service. b.

Tesla’s entry in a. is reflected in its working paper trial balance. Consolidation Working Paper (in thousands) Accounts Taken From Books

Current assets Solar energy systems Operating lease vehicles Property, plant and equipment Investment in SolarCity Identifiable intangibles Other assets Accounts payable and accrued liabilities Debt and capital leases Deferred revenue and other liabilities Capital stock Retained deficit AOCI Total

Eliminations

Tesla Dr (Cr) $ 5,778,300 -3,134,000

SolarCity Dr (Cr) $ 400,000 4,800,000 --

5,781,000 2,234,704

800,000 --

(R) 256,312

-526,000

-904,196

(R) 356,510

(4,300,000) (2,456,000)

(475,000) (3,400,000)

(5,966,704) (7,774,000) 3,018,700 24,000 $ 0

(2,391,290) (1,300,000) 662,094 -$ 0

Dr (R) 80,020 (R) 981,496

637,906 (E) 1,596,798 (R) 65,424 (R) (R)

6,332

Consolidated Balances Dr (Cr) $ 6,258,320 5,781,496 3,134,000 6,837,312 -356,510 1,364,772

(4,768,668) 3,840 (R) (5,859,840)

14,608 (R) (8,372,602) (7,774,000) 662,094 (E) 3,018,700 _______ _______ 24,000 $ 2,980,670 $2,980,670 $ 0 (E )1,300,000

c. Tesla, Inc. Consolidated Balance Sheet, Date of Acquisition (in thousands) Assets Current assets Solar energy systems Operating lease vehicles Property, plant and equipment Identifiable intangibles Other assets

Total assets

$ 6,258,320 5,781,496 3,134,000 6,837,312 356,510 1,364,772

________ $23,732,410

Liabilities Accounts payable and accrued liabilities Debt and capital leases Deferred revenue and other liabilities Total liabilities Shareholders’ equity Capital stock Retained deficit Accumulated other comprehensive loss Total equity Total liabilities and equity

$ 4,768,668 5,859,840 8,372,602 19,001,110 7,774,000 (3,018,700) (24,000) 4,731,300 $ 23,732,410

CHAPTER 4 SOLUTIONS TO MULTIPLE CHOICE QUESTIONS, EXERCISES AND PROBLEMS MULTIPLE CHOICE QUESTIONS 1.

b Goodwill at the date of acquisition is $10,000,000 (= $16,000,000 – 4,000,000 + 8,000,000 – 10,000,000). Goodwill at 1/1/20 is $10,000,000 – 2,000,000 = $8,000,000. Buildings and equipment revaluation at 1/1/20 is a credit of $8,000,000 – [3 x (8,000,000/20)] = $6,800,000. Intangibles revaluation at 1/1/20 = $10,000,000 – [3 x ($10,000,000/5)] = $4,000,000. Eliminating entry (R) is as follows: Goodwill Identifiable intangibles Buildings and equipment Investment in Salem

6,800,000 5,200,000

b Eliminating entry (O) is as follows: Operating expenses Buildings and equipment Goodwill Identifiable intangibles

8,000,000 4,000,000

2,100,000 400,000 500,000 2,000,000

a Calculation of equity in net income: Salem’s reported net income $14,000,000 – $8,000,000 – $3,500,000 = Revaluation write-offs: Buildings and equipment depreciation Identifiable intangibles amortization Goodwill impairment loss Equity in income of Salem

$ 2,500,000 400,000 (2,000,000) (500,000) $ 400,000

c Original cost Change in Salem’s retained earnings to 1/1/20 3 years buildings and equipment depreciation 3 years identifiable intangibles amortization Goodwill impairment loss to 1/1/20 Investment balance, 1/1/20 Equity in net income, 2020 Investment balance, 12/31/20

c Customer lists No

Book value > undiscounted cash flows? Fair value Book value Impairment loss 6.

$ 16,000,000 14,000,000 1,200,000 (6,000,000) (2,000,000) 23,200,000 400,000 $ 23,600,000

Fair value Book value Possible impairment loss Actual impairment loss (limited to book value) 7.

Division 1 $ 14,000,000 16,000,000 $ 2,000,000 $ 1,600,000

Division 2 $ 20,000,000 19,500,000 $ 0 $ 0

Fair value of CGU Book value of CGU Potential goodwill impairment Actual impairment loss (limited to book value) 8.

Brand names N/A $ 3,400,000 5,200,000 $ 1,800,000

CGU 1 $ 14,000,000 15,000,000 1,000,000

CGU 2 $ 7,000,000 10,000,000 3,000,000

1,000,000

CGU 3 $13,000,000 10,500,000 NA

3,000,000

Fair value Book value Impairment loss

Customer Lists $ 1,200,000 1,500,000 $ 300,000

Brand Names $ 3,400,000 5,200,000 $ 1,800,000

10.

a $500,000 – 100,000 = $400,000.

EXERCISES E4.1

Equity Method Accounting, First Year a.

Calculation of equity in net income:

Johnson’s reported net income Revaluation write-offs: Developed technology $50,000,000/5 Goodwill impairment loss Equity in net income of Johnson b. Entries made by George during 2019: Investment in Johnson Capital stock

$ 85,000,000 (10,000,000) (5,000,000) $ 70,000,000

800,000,000 800,000,000

Investment in Johnson Equity in net income of Johnson

70,000,000

Cash

20,000,000

70,000,000

Investment in Johnson

20,000,000

The December 31, 2019, investment balance is $800,000,000 + $70,000,000 $20,000,000 = $850,000,000.

E4.2

Equity Method Accounting, Subsequent Years (in thousands) a. SJ Telecom reported net income – Identifiable intangibles amortization Equity in net income of SJ Telecom

$20,000/5

$ 6,500 (4,000) $ 2,500

b. Acquisition cost + Increase in SJ retained earnings, 2019-2020 – Identifiable intangibles amortization, 2019-2020 – Goodwill impairment losses, 2019-2020 Investment balance, January 1, 2021 + Equity in net income, 2021 – Dividends, 2021 Investment in SJ Telecom, December 31, 2021

($20,000/5) x 2

$400,000 12,000 (8,000) (1,000) 403,000 2,500 (1,500) $404,000

E4.3

Equity Method and Eliminating Entries, First Year (in thousands) a. Acquisition cost Book value Excess of acquisition cost over book value Identifiable intangibles Goodwill

b. Reported net income Impairment loss Equity in net income c. (C) Equity in net income of San Jose Investment in San Jose (E) Common stock, $1 par Additional paid-in capital Retained deficit, January 1 Treasury stock Investment in San Jose

$ 250,000 (28,200) $221,800 (50,000) $ 171,800

$ 4,000 (1,000) $ 3,000

3,000 3,000

5,000 25,000 1,000 800 28,200

(R) Identifiable intangibles Goodwill Investment in San Jose

50,000 171,800

(O) Impairment losses Identifiable intangibles

1,000

221,800

1,000

E4.4

Equity Method and Eliminating Entries, First Year (in thousands) a. Southern Light reported net income + Adjustment to cost of goods sold on inventory revaluation + Depreciation on plant asset revaluation – Brand name impairment loss – Goodwill impairment loss Equity in net income of Southern Light

$ 20,000

$10,000/10 =

2,000 1,000 (3,000) (5,000) $ 15,000

b. Investment in Southern Light Cash

300,000

Investment in Southern Light Equity in net income of Southern Light Equity in OCI of Southern Light

15,500

Cash

2,500

300,000

15,000 500

Investment in Southern Light

2,500

c. (C) Equity in net income of Southern Light Equity in OCI of Southern Light Dividends Investment in Southern Light (E) Capital stock Retained earnings, 7/1 AOCI, 7/1 Treasury stock Investment in Southern Light (R) Brand names Goodwill (1) Inventories Plant and equipment, net Investment in Southern Light

15,000 500 2,500 13,000

26,000 142,000 5,000 1,000 172,000

60,000 80,000 2,000 10,000 128,000

(1) Acquisition date goodwill = $300,000 – $172,000 + $2,000 + $10,000 – $60,000 = $80,000

(O) Impairment losses Inventories Plant and equipment, net Cost of goods sold Depreciation expense Brand names Goodwill

E4.5

8,000 2,000 1,000 2,000 1,000 3,000 5,000

Acquisition Cost, Equity Method, Eliminating Entries, Second Year a. The acquisition entry is as follows: Investment in Saddlestone Merger expenses Capital stock Contingent consideration liability Cash

20,300,000 250,000 20,000,000 300,000 250,000

Calculation of equity in net income for 2020 and 2021: Saddlestone’s reported net income Revaluation write-off: Identifiable intangibles $2,000,000/5 Goodwill impairment loss Equity in net income of Saddlestone

2020 $ 3,000,000

2021 $ 3,500,000

(400,000) -$ 2,600,000

(400,000) (200,000) $2,900,000

Peak’s equity method entries for 2020 and 2021: 2020: Investment in Saddlestone Equity in net income of Saddlestone Equity in OCI of Saddlestone Cash

2,700,000 2,600,000 100,000 1,000,000

Investment in Saddlestone

1,000,000

2021: Investment in Saddlestone Equity in OCL of Saddlestone Equity in net income of Saddlestone

2,875,000 25,000

Cash

1,000,000 Investment in Saddlestone

2,900,000

1,000,000

b. Consolidation working paper eliminating entries for 2021: (C) Equity in net income of Saddlestone Equity in OCL of Saddlestone Dividends – Saddlestone Investment in Saddlestone

2,900,000 25,000 1,000,000 1,875,000

(E) Capital stock, 1/1 2,000,000 Retained earnings, 1/1 (1) 7,000,000 Accumulated OCI, 1/1 (2) 300,000 Investment in Saddlestone (1) $5,000,000 + $3,000,000 - $1,000,000 = $7,000,000. (2) $200,000 + $100,000 = $300,000. (R) Identifiable intangibles (3) 1,600,000 Goodwill (4) 11,100,000 Investment in Saddlestone (3) $2,000,000 - $400,000 = $1,600,000. (4) $20,300,000 - $7,200,000 - $2,000,000 = $11,100,000. (O) Amortization expense Goodwill impairment loss Identifiable intangibles Goodwill

E4.6

12,700,000

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

Eliminating Entries After First and Second Years a. Calculation of equity in net income for 2020: Safeco’s reported net income Revaluation write-offs: Equipment $500,000/5 Inventory Goodwill impairment loss Equity in net income of Safeco

9,300,000

$ 1,600,000 (100,000) (200,000) (50,000) $ 1,250,000

Peerless’ entries for 2020: Investment in Safeco Cash

8,000,000

Investment in Safeco Equity in net income of Safeco

1,250,000

8,000,000

1,250,000

Cash

600,000 Investment in Safeco

600,000

Calculation of goodwill is as follows: Acquisition cost Book value of Safeco Excess of acquisition cost over book value Fair value less book value: Equipment Inventory Goodwill

$ 8,000,000 (7,000,000) 1,000,000 $ 500,000 200,000 $

(700,000) 300,000

Consolidation working paper eliminating entries for 2020: (C) Equity in net income of Safeco Dividends – Safeco Investment in Safeco

1,250,000 600,000 650,000

(E) Stockholders’ equity—Safeco, 1/1 Investment in Safeco

7,000,000

(R) Equipment, net Inventory Goodwill Investment in Safeco

500,000 200,000 300,000

(O) Depreciation expense Cost of goods sold Goodwill impairment loss Equipment, net Inventory Goodwill b. Calculation of equity in net income for 2021:

7,000,000

1,000,000

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

Safeco’s reported net income Revaluation write-off: Equipment $500,000/5 Equity in net income of Safeco

$ 2,000,000 (100,000) $ 1,900,000

Peerless’s equity method entries for 2021: Investment in Safeco Equity in net income of Safeco

1,900,000

Cash

800,000

1,900,000

Investment in Safeco

800,000

The Investment in Safeco balance at December 31, 2021 is $8,000,000 + $1,250,000 – $600,000 + $1,900,000 – $800,000 = $9,750,000. Consolidation working paper eliminating entries for 2021: (C) Equity in net income of Safeco Dividends – Safeco Investment in Safeco

1,900,000 800,000 1,100,000

(E) Stockholders’ equity—Safeco, 1/1 8,000,000 Investment in Safeco 8,000,000 Stockholders’ equity—Safeco at 1/1/2021 = $7,000,000 + $1,600,000 – $600,000 = $8,000,000 (R) Equipment, net Goodwill Investment in Safeco

400,000 250,000

(O) Depreciation expense Equipment, net

100,000

650,000

100,000

E4.7

Equity Method, Eliminating Entries, Several Years After Acquisition (in thousands) a. Calculation of total goodwill is as follows: Acquisition cost Book value of Stage 4 Excess of acquisition cost over book value Revaluations: Land Buildings Identifiable intangibles Long-term debt Goodwill

$ 25,000 (5,000) 20,000 $ (400) (1,000) 4,000 200

b. Calculation of equity in net income for 2021: Stage 4’s reported net income Revaluation write-offs: Buildings $(1,000)/20 Long-term debt $200/10 Goodwill impairment loss Equity in net income of Stage 4

$ 600 50 (20) (60) $ 570

c. Calculation of Investment in Stage 4, 12/31/21 Investment in Stage 4, 1/1/13 Stage 4’s reported income, 2013-2020 Stage 4’s reported dividends, 2013-2020 Revaluation write-offs, 2013-2020: Buildings $[(1,000)/20] x 8 Identifiable intangibles (full balance) Long-term debt $[200/10] x 8 Goodwill impairment loss Investment in Stage 4, 1/1/21 Equity in net income, 2021 Stage 4’s dividends, 2021 Investment in Stage 4, 12/31/17

25,000 10,000 (3,000) 400 (4,000) (160) (300) 27,940 570 (100) $ 28,410

(2,800) $ 17,200

d. Consolidation working paper eliminating entries for 2021: (C) Equity in net income of Stage 4 Dividends – Stage 4 Investment in Stage 4 (E) Shareholders’ equity—Stage 4, 1/1 Investment in Stage 4

570 100 470

12,000 12,000

Shareholders’ equity, January 1, 2021 = $5,000 + $10,000 – $3,000 = $12,000.

(R) Long-term debt 40 Goodwill 16,900 Land 400 Buildings, net 600 Investment in Stage 4 15,940 Revaluations at January 1, 2021 = original revaluations less write-offs for 2013-2020 (8 years). (O) Interest expense Buildings, net Goodwill impairment loss Long-term debt Depreciation expense Goodwill

E4.8

20 50 60 20 50 60

Consolidation After Several Years Calculation of original goodwill is as follows: Acquisition cost Book value of Baker Excess of acquisition cost over book value Revaluation: Buildings Goodwill

$ 37,500,000 (5,000,000) 32,500,000 1,000,000 $ 33,500,000

Calculation of equity in net income for 2019: Baker’s reported net income Revaluation write-offs: Buildings $1,000,000/25 Goodwill impairment loss Equity in net income of Baker

300,000

40,000 (100,000) $ 240,000

Calculation of investment balance at December 31, 2019: Investment in Baker, 12/31/13 Baker reported income, 2013-2018 Revaluation write-offs, 2013-2018: Buildings ($1,000,000/25) x 6 Investment in Baker, 1/1/19 Equity in net income, 2019 Investment in Baker, 12/31/19

$37,500,000 1,300,000 240,000 39,040,000 240,000 $39,280,000

Consolidation working paper eliminating entries for 2019: (C) Equity in net income of Baker Investment in Baker

240,000 240,000

(E) Shareholders’ equity—Baker, 1/1 6,300,000 Investment in Baker 6,300,000 Shareholders’ equity, January 1, 2019 = $5,000,000 + $1,300,000 = $6,300,000. (R) Goodwill 33,500,000 Buildings, net 760,000 Investment in Baker 32,740,000 Revaluations at January 1, 2019 = original revaluations less write-offs for 2013-2018. (O) Buildings, net Goodwill impairment loss Depreciation expense Goodwill

40,000 100,000 40,000 100,000

E4.9

Projecting Consolidation Eliminating Entries a. Consolidation eliminating entries in 2020, three years after acquisition. (R) Identifiable intangibles 1,800,000 Land 2,000,000 Goodwill 14,800,000 Property and equipment, net 8,000,000 Investment in Samson 10,600,000 The inventories are sold. Identifiable intangibles as of the start of 2020 = $3,000,000 – (2 x $600,000) = $1,800,000. Goodwill at the start of 2020 = $15,000,000 - $200,000 = $14,800,000. Property and equipment revaluation at the start of 2020 = $10,000,000 – (2 x $1,000,000) = $8,000,000. (O) Amortization expense 600,000 Property and equipment, net 1,000,000 Identifiable intangibles 600,000 Depreciation expense 1,000,000 There is no goodwill impairment in 2020, the inventories have been sold, and land is not written off. Identifiable intangibles and property and equipment are the only revaluations available for write-off. b. Consolidation eliminating entries in 2023, six years after acquisition. (R) Land 2,000,000 Goodwill 14,400,000 Property and equipment, net 5,000,000 Investment in Samson 11,400,000 The inventories are sold, and the identifiable intangibles have been completely written off. Goodwill at the start of 2023 = $15,000,000 - $200,000 - $400,000 = $14,400,000. Property and equipment revaluation at the start of 2023 = $10,000,000 – (5 x $1,000,000) = $5,000,000. (O) Property and equipment, net 1,000,000 Depreciation expense 1,000,000 Land is not written off, there is no goodwill impairment in 2023, and inventories and identifiable intangibles have already been completely written off.

c. Consolidation eliminating entries in 2028, eleven years after acquisition. (R) Land 2,000,000 Goodwill 14,400,000 Investment in Samson 16,400,000 The inventories are sold, and the identifiable intangibles and property and equipment have been completely written off. There have been no goodwill impairment losses since 2021. No entry (O) is required since the land and goodwill are not written off in 2028.

E4.10 Identifiable Intangibles and Goodwill, U.S. GAAP Amortization expense for 2020: Customer relationships Favorable leaseholds Total

$4,000,000/4 $8,000,000/5

$ 1,000,000 1,600,000 $ 2,600,000

Impairment testing – identifiable intangibles: Customer relationships Book value = $4,000,000 – 2 x ($4,000,000/4) = $2,000,000 Book value > Sum of undiscounted cash flows? $2,000,000 > $1,200,000: Yes Impairment loss = $2,000,000 - $900,000 = $1,100,000 Favorable leaseholds Book value = $8,000,000 – 1.5 x ($8,000,000/5) = $5,600,000 Book value > Sum of undiscounted cash flows? $5,600,000 < $6,000,000: No Brand names Book value = $18,000,000 Book value > Sum of discounted cash flows? $18,000,000 > $7,000,000: Yes Impairment loss = $18,000,000 - $7,000,000 = $11,000,000

Impairment testing – Goodwill: Reporting Unit

Unit FV < BV?

Possible Impairment Loss

Actual Impairment Loss

Asia

$400,000,000 > $300,000,000: No

N/A

South America

$350,000,000> $200,000,000: No

N/A

Europe

$500,000,000< $600,000,000: Yes

$600,000,000 – 500,000,000 = 100,000,000

$100,000,000

Summary: Amortization expense – identifiable intangibles Impairment losses – identifiable intangibles Goodwill impairment loss Total

2,600,000 12,100,000 100,000,000 $114,700,000

E4.11 Identifiable Intangibles and Goodwill, IFRS (see related E4.10) Amortization expense for 2020: Customer relationships Favorable leaseholds Total

$4,000,000/4 $8,000,000/5

$ 1,000,000 1,600,000 $ 2,600,000

Impairment testing – identifiable intangibles: Customer relationships Book value = $4,000,000 – 2 x ($4,000,000/4) = $2,000,000 Book value > Sum of discounted cash flows? $2,000,000 > $900,000: Yes Impairment loss = $2,000,000 - $900,000 = $1,100,000 Favorable leaseholds Book value = $8,000,000 – 1.5 x ($8,000,000/5) = $5,600,000 Book value > Sum of discounted cash flows? $5,600,000 > $4,400,000: Yes Impairment loss = $5,600,000 – $4,400,000 = $1,200,000 Brand names Book value = $18,000,000 Book value > Sum of discounted cash flows? $18,000,000 > $7,000,000: Yes Impairment loss = $18,000,000 - $7,000,000 = $11,000,000

Impairment testing – Goodwill: Actual impairment loss

Reporting Unit

Unit FV < BV?

Possible impairment loss

E. Asia

$300,000,000 < $350,000,000: Yes

$350,000,000 – 300,000,000 = $50,000,000

$40,000,000

Indonesia

$120,000,000 > $100,000,000: No

Brazil

$410,000,000 >$130,000,000: No

Mediterranean

$190,000,000 < $220,000,000: Yes

$220,000,000 – 190,000,000 = $30,000,000

$30,000,000

Scandinavia

$230,000,000 < $300,000,000: Yes

$300,000,000 – 230,000,000 = $70,000,000

$70,000,000

Summary: Amortization expense – identifiable intangibles Impairment losses – identifiable intangibles Goodwill impairment loss Total

2,600,000 13,300,000 140,000,000 $ 155,900,000

E4.12 Consolidated Income Statement a. (in millions) Sales $5,000 + $2,000 Cost of goods sold $3,000 + $800 + $160 Gross margin Depreciation expense $500 + $140 – ($200/10) Interest expense $100 + $60 + ($100/5) Other expenses $600 + $700 Total operating expenses Net income

$ 7,000 3,960 3,040 620 180 1,300 2,100 $ 940

b. Parson reports its own income of $800 million plus its equity in the income of Soaper of $140 million. Equity in the income of Soaper is Soaper’s reported income adjusted for write-offs of Soaper’s net asset revaluations. Consolidated income is Parson’s and Soaper’s reported revenues and expenses, with Soaper’s expenses adjusted for the revaluation write-offs. Parson’s separately reported income and consolidated income therefore report the same items, packaged differently.

E4.13 Amortization and Impairment Testing of Identifiable Intangible Assets (in thousands) a. Technology Lancope, Inc. Jasper Technologies, Inc.

($79,000/5) x 7/12 = ($240,000/6) x 4/12 =

$ 9,217 13,333

Customer Relationships Lancope, Inc. Jasper Technologies, Inc.

($29,000/6) x 7/12 = ($75,000/7) x 4/12 =

2,819 3,571

Total amortization expense

$ 28,940

b. Technology

Book Value > End-of-Year Book Value Undiscounted Cash Flows?

Impairment Loss

Lancope, Inc.

$ 69,783

$69,783 > $70,000? No

Jasper Technologies, Inc.

226,667

$226,667 > $200,000? Yes

$226,667 – 150,000 =

$ 76,667

Lancope, Inc.

26,181

$26,181 > $25,000? Yes

$26,181 – 20,000 =

6,181

Jasper Technologies, Inc.

71,429

$71,429 > $80,000?

IPR&D Lancope, Inc. Jasper Technologies, Inc.

121,000 23,000

Customer Relationships

N/A N/A

$121,000 – 105,000 = --

Total impairment loss

$98,848

Lancope, Inc. Jasper Technologies, Inc. End of fiscal 2016 book value

16,000 --

Technology $ 69,783 150,000 $ 219,783

Customer Relationships $ 20,000 71,429 $ 91,429

IPR&D $105,000 23,000 $128,000

E4.14 Equity Method Income and Working Paper Eliminations (in millions) a. Investment balance, 1/1/20 Investment balance, 1/1/19 = $2,000 + $200 2019 equity in net income Write-off of identifiable intangibles = Saber’s 2019 net income

$ 2,286 2,200 86 8 $ 94

($40/5)

b. Saber’s shareholders’ equity, 1/1/19 2019 net income Saber’s shareholders’ equity, 1/1/20

$ 2,000 94 $ 2,094

Saber’s 2020 net income Write-off of identifiable intangibles = Equity in net income of Saber

c. ($40/5) $

d. (C) Equity in net income of Saber Investment in Saber

142

(E) Shareholders’ equity – Saber Investment in Saber

2,094

150 (8) 142

142

2,094

(R) Identifiable intangibles 32 Goodwill 160 Investment in Saber 192 Beginning-of-year identifiable intangibles balance is $40 - $8 = $32. Total goodwill is $200 total excess of acquisition cost over book value less $40 fair value of identifiable intangibles = $160. (O) Amortization expense Identifiable intangibles

8 8

e. At the beginning of 2024, the identifiable intangibles are fully amortized and the remaining balance for goodwill is $160 - $100 = $60. (R) Goodwill Investment in Saber

There are no revaluation write-offs in 2024, so eliminating entry O is not required. E4.15 Goodwill Impairment, IFRS

A CGU is the smallest group of assets with independent cash inflows, while a reporting unit is an operating segment that is regularly evaluated by top management. Operating segments are likely to be larger than CGUs.

Recoverable amount is defined as the greater of fair value less costs to sell, and value-inuse, which is the present value of the CGU’s future expected cash flows. U.S. GAAP specifies that the reporting unit’s book value be compared with its “fair value.” In practice, however, “recoverable amount” and “fair value” are likely to be similar.

£700 million + £450 million = £1,150 million

Recoverable amount is estimated as value-in-use, which is the present value of future estimated cash flows. Causes of a decline in value-in-use include higher risk (higher risk-adjusted discount rate), lower growth in EBITDA, and higher capital expenditures.

£100/(0.087 - 0.01) = £1,299 million £100/(0.097 - 0.01) = 1,149 million Decline in value = £ 150 million

E4.16 Consolidation in First Year Using Cost Method (see related E4.4) (in thousands) a. Investment in Southern Light Cash Cash

300,000 300,000 2,500

Dividend income

2,500

b. (C) Dividend income Dividends – Southern Light (E) Capital stock Retained earnings, 7/1 AOCI, 7/1 Treasury stock Investment in Southern Light

2,500 2,500

26,000 142,000 5,000 1,000 172,000

(R) Brand names Goodwill (1) Inventories Plant and equipment, net Investment in Southern Light

60,000 80,000 2,000 10,000 128,000

(1) Acquisition date goodwill = $300,000 - $172,000 + $2,000 + $10,000 - $60,000 = $80,000

(O) Impairment losses Inventories Plant and equipment, net Cost of goods sold Depreciation expense Brand names Goodwill

8,000 2,000 1,000 2,000 1,000 3,000 5,000

Note: Eliminating entries (E), (R), and (O) are the same as in E4.4. Eliminating entry (A) is not required since it is the first year and no adjustment to beginning retained earnings or AOCI is necessary.

E4.17 Consolidation After Several Years Using Cost Method (see related E4.8) Calculation of total goodwill is as follows: Acquisition cost Book value of Baker Excess of acquisition cost over book value Revaluation: Buildings Goodwill

$ 37,500,000 (5,000,000) 32,500,000 1,000,000 $ 33,500,000

Calculation of adjustment to investment balance to convert it to complete equity method at January 1, 2019: Baker reported income, 2013-2018 Revaluation write-offs, 2013-2018: Buildings ($1,000,000/25) x 6 Adjustment to Investment in Baker, 1/1/19

$ 1,300,000 240,000 $ 1,540,000

Consolidation working paper eliminating entries for 2019: (A) Investment in Baker Shareholders’ equity –Adams (E)

1,540,000 1,540,000

Shareholders’ equity—Baker, 1/1 6,300,000 Investment in Baker 6,300,000 Shareholders’ equity, January 1, 2019 = $5,000,000 + 1,300,000 = $6,300,000. (R) Goodwill 33,500,000 Buildings, net 760,000 Investment in Baker 32,740,000 Revaluations at January 1, 2019 = original revaluations less write-offs for 2013-2018. (O) Buildings, net Goodwill impairment loss Depreciation expense Goodwill

40,000 100,000

Note: Eliminating entries (E), (R) and (O) are the same as in E4.8.

40,000 100,000

PROBLEMS P4.1

Simple Trial Balance Consolidation Working Paper, First and Second Years a. Consolidation Working Paper, December 31, 2019 Trial Balances Taken From Books Dr (Cr)

Eliminations Dr

Consolidated Balances Dr (Cr)

Pacnet

SecureWorks

Current assets

$ 3,000,000

$ 2,000,000

Plant assets, net

58,000,000

42,000,000

(O)

500,000

5,000,000

(R)

95,500,000

Identifiable intangibles

1,000,000

(R)

2,000,000

400,000

(O)

2,600,000

Investment in SecureWorks

42,100,000

2,100,000

(C)

(E) (R)

1,000,000

(O)

Goodwill

Liabilities

(80,000,000)

(35,000,000)

Capital stock

(5,000,000)

(1,000,000)

(E)

1,000,000

(5,000,000)

Retained earnings, beginning

(12,000,000)

(5,000,000)

(E)

5,000,000

(12,000,000)

Sales revenue

(100,000,000)

(60,000,000)

Equity in net income

(2,100,000)

Cost of sales

80,000,000

45,000,000

Operating expenses

15,000,000

12,000,000

(R) 37,000,000

6,000,000 34,000,000

5,000,000

(115,000,000)

(160,000,000) (C)

2,100,000

-125,000,000

(O)

900,000

________

$ 48,500,000

Consolidated Income Statement Year Ended December 31, 2019 Sales revenue Cost of sales Gross margin Operating expenses Net income

36,000,000

$ 160,000,000 (125,000,000) 35,000,000 (27,900,000) $ 7,100,000

27,900,000 $

Consolidated Balance Sheet, December 31, 2019 Assets Current assets Plant assets, net Intangibles Goodwill Total assets Liabilities and shareholders’ equity Liabilities Capital stock Retained earnings (1) Total liabilities and shareholders’ equity (1)

5,000,000 95,500,000 2,600,000 36,000,000 $139,100,000 $115,000,000 5,000,000 19,100,000 $139,100,000

$12,000,000 + $7,100,000 = $19,100,000.

b. Consolidation Working Paper, December 31, 2020 Trial Balances Taken From Books Dr (Cr)

Eliminations

SecureWorks

Current assets

$ 4,000,000

$ 3,500,000

Plant assets, net

66,200,000

45,000,000

(O)

500,000

4,500,000

(R)

107,200,000

800,000

(R)

1,600,000

400,000

(O)

2,000,000

43,200,000

1,100,000

(C)

9,000,000

(E)

33,100,000

(R)

1,500,000

(O)

Identifiable intangibles Investment in SecureWorks

Consolidated Balances Dr (Cr)

Pacnet

Goodwill

Liabilities

(85,000,000)

(37,000,000)

Capital stock

(5,000,000)

(1,000,000)

(E)

1,000,000

(5,000,000)

Retained earnings, beginning

(19,100,000)

(8,000,000)

(E)

8,000,000

(19,100,000)

Sales revenue

(110,000,000)

(65,000,000)

Equity in net income

(1,100,000)

Cost of sales

82,000,000

46,000,000

Operating expenses

24,000,000

16,500,000

(R) 36,000,000

7,500,000

34,500,000 (122,000,000)

(175,000,000) (C)

1,100,000

-128,000,000

(O)

1,400,000

________

$ 49,600,000

41,900,000 $

Consolidated Income Statement Year Ended December 31, 2020 Sales revenue Cost of sales Gross margin Operating expenses Net income

$ 175,000,000 (128,000,000) 47,000,000 (41,900,000) $ 5,100,000

Consolidated Balance Sheet, December 31, 2020 Assets Current assets Plant assets, net Intangibles Goodwill Total assets Liabilities and shareholders’ equity Liabilities Capital stock Retained earnings (1) Total liabilities and shareholders’ equity (1)

P4.2

7,500,000 107,200,000 2,000,000 34,500,000 $151,200,000 $122,000,000 5,000,000 24,200,000 $151,200,000

$19,100,000 + $5,100,000 = $24,200,000.

Consolidated Financial Statements One Year After Acquisition a. Calculation of equity in net income for 2020: Santo’s reported net income Revaluation write-offs: Inventory (1) Plant assets $8,000,000/8 Patents $2,000,000/4 Long-term debt $500,000/10 Goodwill impairment loss Equity in net income of Santo

$ 5,000,000 (1,500,000) 1,000,000 (500,000) 50,000 (400,000) $ 3,650,000

(1) Since the revalued inventory was sold in 2020, cost of goods sold is adjusted for the revaluation.

b. Consolidation Working Paper, December 31, 2020 Trial Balances Taken From Books Dr (Cr) Ponon Cash and receivables

Eliminations

Santo

4,500,000

Consolidated Balances Dr (Cr)

3,100,000

Inventory

5,000,000

5,200,000

(R)

Plant assets, net

8,000,000

12,000,000

(O-2) 1,000,000

Investment in Santo

28,690,000

Patents

(R)

Goodwill

(R)

Current liabilities

(5,100,000)

(2,000,000)

Long-term debt

(20,000,000)

(3,260,000)

(O-4)

50,000

Capital stock

(8,000,000)

(6,000,000)

(E)

6,000,000

(8,000,000)

Retained earnings, Jan. 1

(4,300,000)

(3,840,000)

(E)

3,840,000

(4,300,000)

(400,000)

(160,000)

(E)

160,000

(400,000)

Sales

(30,000,000)

(13,200,000)

Equity in income of Santos

(3,650,000)

(C)

3,650,000

Equity in OCI of Santos

(40,000)

(C)

40,000

Cost of goods sold

18,000,000

4,000,000

(O-1) 1,500,000

23,500,000

Depreciation and amortization expense

2,000,000

3,200,000

Interest and other expenses

5,400,000

1,000,000

(100,000)

(40,000)

___________

$ 40,640,000

AOCI, Jan. 1

1,500,000

7,600,000

OCI $

10,200,000

8,000,000

(R)

13,000,000

3,690,000 10,000,000 15,000,000

2,000,000

500,000 (O-3)

1,500,000

20,000,000

400,000 (O-5)

19,600,000 (7,100,000)

500,000

(R)

(23,710,000)

(43,200,000)

(O-3)

GW impairment loss

1,500,000 (O-1)

(O-5)

1,000,000 (O-2)

4,700,000

50,000 (O-4)

6,350,000

500,000

400,000

400,000 (140,000) $

c. Consolidated Statement of Comprehensive Income For the Year 2020 Sales Costs of goods sold Gross margin Operating expenses: Depreciation and amortization expense Interest and other expenses Goodwill impairment loss Net income Other comprehensive income Comprehensive income

$ 43,200,000 (23,500,000) 19,700,000 $ 4,700,000 6,350,000 400,000

(11,450,000) 8,250,000 140,000 $ 8,390,000

Consolidated Balance Sheet, December 31, 2020 Assets Cash and receivables Inventory Plant assets, net Patents Goodwill Total assets Liabilities and shareholders’ equity Current liabilities Long-term debt Capital stock Retained earnings (2) Accumulated other comprehensive income (3) Total liabilities and shareholders’ equity

7,600,000 10,200,000 13,000,000 1,500,000 19,600,000 $ 51,900,000 $

7,100,000 23,710,000 8,000,000 12,550,000 540,000 $ 51,900,000

(2) $4,300,000 + $8,250,000 = $12,550,000 (3) $400,000 + $140,000 = $540,000

P4.3

Equity Method and Eliminating Entries Three Years after Acquisition a. Calculation of equity in net income for 2020: Sunset Coast’s reported net income for 2020 Revaluation write-offs: Plant assets ($500,000)/10 Identifiable intangibles $1,000,000/5 Equity in net income of Sunset Coast

$ 400,000 50,000 (200,000) $ 250,000

b. Calculation of investment balance at December 31, 2020: Investment in Sunset Coast, January 1, 2018 Sunset Coast’s reported income, 2018-2019 Sunset Coast’s reported dividends, 2018-2019 (50% of reported income) Revaluation write-offs, 2018-2019: Plant assets [($500,000)/10] x 2 Identifiable intangibles ($1,000,000/5) x 2 Goodwill impairment, 2019 Investment in Sunset Coast, December 31, 2019 Equity in net income, 2020 (see requirement a.) Sunset Coast’s reported dividends, 2020 (50% x $400,000) Investment in Sunset Coast, December 31, 2020

$ 5,000,000 850,000 (425,000) 100,000 (400,000) (100,000) 5,025,000 250,000 (200,000) $ 5,075,000

Under LIFO and increasing inventory, the acquisition date revalued inventory is assumed to still be on hand. c. Consolidation working paper eliminating entries for 2020: (C) Equity in net income of Sunset Coast Dividends – Sunset Coast (0.5 x $400,000) Investment in Sunset Coast

250,000 200,000 50,000

(E) Shareholders’ equity—Sunset Coast, 1/1 1,825,000 Investment in Sunset Coast 1,825,000 Sunset Coast’s shareholders’ equity, January 1, 2018 = $1,400,000 (acquisition cost $5,000,000 less excess over book value $3,600,000). Sunset Coast’s shareholders’ equity, January 1, 2020 = acquisition-date equity + net income less dividends for 2018 and 2019 = $1,400,000 + (1 – 0.5) ($850,000) = $1,825,000. (R) Identifiable intangibles 600,000 Goodwill 3,400,000 Inventory 400,000 Plant assets, net 400,000 Investment in Sunset Coast 3,200,000 Revaluations at January 1, 2020 = original revaluations less write-offs for 2018 and 2019. Goodwill at January 1, 2020 = $3,600,000 + $400,000 + $500,000 $1,000,000) = $3,500,000 original value, less $100,000 in impairment = $3,400,000.

(O) Plant assets, net Amortization expense Depreciation expense Identifiable intangibles

50,000 200,000 50,000 200,000

d. Puffin’s income from its own operations plus equity in net income of Sunset Coast = consolidated net income: $1,500,000 + $250,000 = $1,750,000.

P4.4

Consolidation at End of First Year, Preacquisition Contingency a. Calculation of equity in net income for 2020: Sanders’ reported net income for 2020 Revaluation write-offs: Inventory (FIFO) Equipment $400,000/10 IPR&D impairment Equity in net income of Sanders

$ 600,000 (100,000) (40,000) (25,000) $ 435,000

Perkins’ entries for 2020: Investment in Sanders Merger expenses Restructuring expenses Cash

20,000,000 80,000 250,000 20,330,000

Investment in Sanders Equity in net income of Sanders

435,000

Cash

150,000

435,000

Investment in Sanders

150,000

b. Acquisition cost Book value of Sanders Revaluations: Revaluations: Inventory Equipment Unrecorded lawsuit liability (1) Unrecorded IPR&D Goodwill

$ 100,000 400,000 (85,000) 500,000

20,000,000 (4,000,000) 16,000,000

(915,000) $ 15,085,000

(1) The estimated liability increases from $50,000 to $85,000 within the measurement period.

c. Consolidation working paper eliminating entries for 2020:

(C) Equity in net income of Sanders Dividends – Sanders Investment in Sanders (E) Shareholders’ equity—Sanders, 1/1 Investment in Sanders (R) Inventory Equipment, net IPR&D Goodwill Lawsuit liability Investment in Sanders (O) Cost of goods sold Depreciation expense Impairment loss Inventory Equipment, net IPR&D

P4.5

435,000 150,000 285,000

4,000,000 4,000,000

100,000 400,000 500,000 15,085,000 85,000 16,000,000

100,000 40,000 25,000 100,000 40,000 25,000

Consolidated Balance Sheet Working Paper, Bargain Purchase (see related P3.4)

(in millions) a. Calculation of equity in net income for 2019: Saxon’s reported net income for 2019 ($10,000 + $10 – $8,000 – $40 – $25 – $1,600) Revaluation write-offs: Inventory Equity method investments (adjusts gain/loss on sale) Buildings and equipment $300/20 Identifiable intangibles $110/5 Equity in net income of Saxon

$ 345 100 50 (15) (22) $ 458

Calculation of Investment balance, December 31, 2019: Investment balance, January 1, 2019 (1) Equity in net income for 2019 Dividends for 2019 Investment balance, December 31, 2019

$ 1,800 458 (100) $ 2,158

(1) Paxon acquired Saxon for $1,700, but there is a bargain gain that increases the investment balance by $100, as follows:

Calculation of gain on acquisition: Acquisition cost Book value ($100 + $350 + $845) Excess of acquisition cost over book value Excess of fair value over book value: Inventory Equity method investments Land Buildings and equipment Identifiable intangibles Gain on acquisition

$ 1,700 (1,295) 405 $ (100) (50) 245 300 110

(505) $ 100

Therefore Paxon’s entry to record the acquisition was: Investment in Saxon Cash Gain on acquisition

1,800 1,700 100

Revised 01.30.17

b. Consolidation Working Paper, December 31, 2019 Trial Balances Taken From Books Dr (Cr) (in millions)

Paxon

Saxon

Cash and receivables

$ 3,200

Inventory Equity method investments Investment in Saxon

Land

Eliminations Dr

Consolidated Balances Dr (Cr)

800

$ 4,000

2,260

940

(O-1)

100

(R)

3,200

(O-2)

(R)

2,158

358

(C)

1,295

(E)

505

(R)

650

300

(R)

245

3,600

1,150

(R)

300

15 (O-3)

5,035

(R)

110

22 (O-4)

Current liabilities

(2,020)

(1,200)

(3,220)

Long-term debt

(5,000)

(450)

(5,450)

Common stock

(500)

(100)

(E)

100

(500)

Additional paid-in capital

(1,200)

(350)

(E)

350

(1,200)

Retained earnings, Jan. 1

(2,410)

(845)

(E)

845

(2,410)

500

100

(30,000)

(10,000)

(458)

(10)

Buildings and equipment, net Identifiable intangibles

Dividends Sales revenue Equity in net income of Saxon Gain on sale of securities Gain on acquisition

(100)

Cost of goods sold

26,000

8,000

Depreciation and amortization expense

300

Interest expense

250

2,770

1,600

Other operating expenses $

1,195

100

(C)

500 (40,000)

(C)

458

-50 (O-2)

(60) (100)

100 (O-1) (O-3)

(O-4)

33,900 377

275 ________ $

2,595

_______ $

2,595

4,370 $

Revised 01.30.17

c. Consolidated Income Statement Year Ended December 31, 2019 (in millions) Sales Costs of goods sold Gross margin Operating expenses: Depreciation and amortization expense Interest expense Other operating expenses Income before other gains Gain on sale of securities Gain on acquisition Net income

$ 40,000 (33,900) 6,100 $

377 275 4,370

Consolidated Balance Sheet, December 31, 2019 (in millions) Assets Cash and receivables Inventory Land Buildings and equipment, net Identifiable intangibles Total assets Liabilities and shareholders’ equity Current liabilities Long-term debt Common stock Additional paid-in capital Retained earnings (1) Total liabilities and shareholders’ equity

(5,022) 1,078 60 100 $ 1,238

4,000 3,200 1,195 5,035 88 $ 13,518 $

3,220 5,450 500 1,200 3,148 $ 13,518

(1) $2,410 + $1,238 - $500 = $3,148

P4.6

Goodwill Allocation and Impairment Testing (in millions) a. Identifiable assets acquired $50 + $250 + $125 = Liabilities assumed $35 + $190 + $100 = Net identifiable assets acquired Total acquisition cost Total goodwill

$ 425 (325) 100 180 $ 80

Allocation to business units: Networks

Global Services

Mobile Broadband

U.S. Cellular

$ 50

$ 250

$ 125

$ --

Liabilities assumed

(35)

(190)

(100)

Net assets assigned

$ 15

Identifiable assets acquired

Fair value of reporting unit

Less: Net assets assigned

(15)

(60)

(25)

Increase in fair value

N/A

__N/A

Allocation of goodwill

$ 40

$ 25

$ 10

The total tentative allocation equals the total goodwill to be allocated. b. Compare the fair value of each reporting unit at December 31, 2020 with its book value at that date.

Fair value

Networks $50

Global Services $90

Mobile Broadband $25

U.S. Cellular $ 95

Book value

100

Difference

$ 2

$(2)

$(8)

$ (5)

Preliminary loss

Actual loss

Goodwill is impaired for Global Services, Mobile Broadband, and U.S. Cellular. A $12 million goodwill impairment loss (= $2 million + $5 million + $5 million) is recorded for 2020.

P4.7

Intangible Assets and Goodwill: Amortization and Impairment 2020 amortization expense: Customer lists $500,000/5 Developed technology $800,000/10 Total

$ 100,000 80,000 $ 180,000

2020 impairment test for identifiable intangibles Customer Lists Original book value $ 500,000 Less: amortization 2018 (100,000) 2019 (100,000) 2020 (100,000) Book value, December 31, 2020 $ 200,000

Developed Technology $ 800,000

Internet Domain Name $ 1,300,000

(80,000) (80,000) (80,000) 560,000

– – ___–_____ $ 1,300,000

Step 1 of impairment test for customer lists and developed technology: To determine whether impairment has occurred for limited-life identifiable intangibles, compare the undiscounted future cash flows from the asset to its book value.

Future undiscounted cash flows Book value Difference Conclusion

Customer Lists $ 250,000 200,000 $ 50,000 Not impaired

Developed Technology $ 500,000 560,000 $ (60,000) Impaired

Step 2 of impairment test for customer lists and developed technology: For limited-life identifiable intangibles that are deemed impaired in Step 1, calculate amount of impairment as the difference between discounted cash flows and book value.

Future discounted cash flows Book value Impairment

Customer Lists ----

Developed Technology $ 420,000 560,000 $ 140,000

Impairment test for indefinite-life identifiable intangibles, impairment loss = book value in excess of discounted cash flows, if any. Internet domain name impairment loss = $1,300,000 - $750,000 = $550,000. 2020 goodwill impairment test The company bypasses the qualitative test. Quantitative test: compare fair value of reporting unit at December 31, 2020 to the book value of the unit at that date. Fair value of reporting unit Book value Difference

$ 17,000,000 18,500,000 $ (1,500,000)

Goodwill impairment is tentatively $1,500,000. Since the tentative loss is less than the total goodwill balance, the actual goodwill impairment loss is $1,500,000.

Summary: Amortization expense for 2020: Customer lists Developed technology Impairment write-offs for 2020: Developed technology Internet domain name Goodwill Total

P4.8

100,000 80,000

140,000 550,000 1,500,000

180,000

2,190,000 $ 2,370,000

Consolidation After Four Years a. Consolidation Working Paper, December 31, 2020 Trial Balances Taken From Books Dr (Cr)

Eliminations

Perth

Sharbot

Current assets

$ 5,000

Plant assets, net

34,800

28,000

(O)

400

6,800

(R)

56,400

(R)

4,000

2,000

(O)

2,000

23,600

400

(C)

18,000

(E)

5,200

(R)

500

(O)

Intangibles Investment in Sharbot

Goodwill (1)

Consolidated Balances Dr (Cr)

(in thousands)

2,500

Liabilities

(22,000)

(10,000)

Capital stock

(15,000)

(2,000)

(E)

2,000

(15,000)

Retained earnings, Jan. 1

(25,000)

(16,000)

(E)

16,000

(25,000)

Sales revenue

(25,000)

(14,000)

(400)

Cost of sales

20,000

8,000

Operating expenses

4,000

3,500

Equity in net income

(R)

8,000

7,500

(32,000)

(39,000) (C)

400

-28,000

(O)

2,100 $

32,900

______ $

32,900

(1) Original goodwill = $16,000 - $4,000 + $8,000 - $10,000 = $10,000; cumulative impairment to the beginning of 2020 is $2,000.

Consolidated Income Statement Year Ended December 31, 2020 (in thousands) Sales revenue

7,500

$ 39,000

9,600 $

Cost of sales Gross margin Operating expenses Net income

(28,000) 11,000 (9,600) $ 1,400

Consolidated Balance Sheet, December 31, 2020 (in thousands) Assets Current assets $ 7,500 Plant assets, net 56,400 Intangibles 2,000 Goodwill 7,500 Total assets $ 73,400 Liabilities and shareholders’ equity Liabilities $ 32,000 Capital stock 15,000 Retained earnings (1) 26,400 Total liabilities and shareholders’ equity $ 73,400 (1) $25,000 + $1,400 = $26,400

P4.9

Consolidation Working Paper, Three Years After Acquisition (see related P3.2) (in millions) a. Calculation of equity in net income for fiscal 2019, 2020, and 2021:

GOC’s reported net income (loss) Revaluation write-offs: Property, plant and equipment $(60)/20 Patents and trademarks $10/5 Long-term debt $(3)/3 Advanced technology $5/5 Customer lists impairment loss Goodwill impairment loss Equity in net income of GOC (i) $12 = $900 – $800 – $88

2019 $ 15

2020 $ (2)

2021 $ 12 (i)

3 (2) 1 (1)

3 (2) 1 (1) (2) _ (3) $ (6)

3 (2) 1 (1) (4) _(2) $ 7

_ (2) $ 14

Calculation of Investment balance, June 30, 2021: Investment balance, June 30, 2018 (adjusted to remove earnings contingency) Equity in net income for fiscal 2019 Equity in net income for fiscal 2020 Equity in net income for fiscal 2021 Equity in OCI for fiscal 2019 and 2020 ($4 - $3) Equity in OCI for fiscal 2021 Investment balance, June 30, 2021

$ 110 14 (6) 7 1 1 $ 127

b. Consolidation Working Paper, June 30, 2021 Trial Balances Taken From Books Dr (Cr) (in millions) Current assets

ITI $

Eliminations

GOC (R)

600

140

(O-1)

(R)

689

1,100

(R) (R) (R)

6 3 23

2 (O-2) 1 (O-4) 4 (O-5)

1,155

127

Current liabilities

(175)

(10)

Long-term liabilities

(1,125)

(105)

(O-3)

Common stock

(22)

(4)

(E)

(22)

Additional paid-in capital

(580)

(60)

(E)

(580)

Retained earnings, July 1

(118)

Accumulated other comprehensive income, July 1

(16)

(4)

Treasury stock

Sales revenue

(2,000)

(900)

Equity in income of GOC

(7)

(C)

Equity in OCI of GOC

(1)

(C)

1,400

800

Goodwill impairment loss

(O-6)

Other operating expenses

580

(O-2) (O-4) (O-5)

2 1 4

Other comprehensive income

(3)

(1)

Identifiable intangible assets

Investment in GOC

Goodwill (1)

Cost of goods sold

Consolidated Balances Dr (Cr)

Property, plant and equipment, net

232

8 54 65 (R)

249

2 (O-6)

81 (185)

12 (E)

(R)

(1,230)

(E)

(118)

(16) 2

(E)

8 (2,900)

2,200

_____ $

209

2 3 (O-1) 1 (O-3)

671

_____ $

209

(4) $

(1) Acquisition-date goodwill is calculated as follows: Acquisition cost (adjusted) GOC’s book value Excess of acquisition cost over book value Excess of fair value over book value: Inventory Property, plant and equipment Patents and trademarks Advanced technology Customer lists Long-term debt Goodwill

$ 110 (40) 70 $

5 (60) 10 5 25 (3) $

(18) 88

c. Consolidated Statement of Comprehensive Income for Fiscal 2021 (in millions) Sales revenue $ 2,900 Costs of goods sold (2,200) Gross margin 700 Operating expenses: Goodwill impairment loss $ 2 Other operating expenses _ 671 __ 673 Net income 27 Other comprehensive income 4 Comprehensive income $ 31 Consolidated Balance Sheet, June 30, 2021 (in millions) Assets Current assets Property, plant and equipment, net Identifiable intangible assets Goodwill Total assets Liabilities and shareholders’ equity Current liabilities Long-term liabilities Common stock Additional paid-in capital Retained earnings (1) Accumulated other comprehensive income (2) Treasury stock Total liabilities and shareholders’ equity (1) $118 + $27 = $145. (2) $16 + $4 = $20

249 689 1,155 _ _81 $ 2,174 $

185 1,230 22 580 145 20 _ _(8) $ 2,174

P4.10 Working Paper Eliminating Entries, Partial Year Consolidation (see related P3.3) (in millions) a. Calculation of equity in net income for 2015: Hospira’s reported net loss Revaluation write-offs: Inventory Property, plant and equipment [$3,620/20] x [4/12] In-process research and development Developed technology rights [$8,290/16] x [4/12] Long-term debt Deferred tax liabilities Equity in net income of Hospira

$ (575) 1,313 60 (200) (173) 5 600 $ 1,030

b. Consolidation working paper eliminating entries for 2015: (C) Equity in net income of Hospira Investment in Hospira

1,030

(E) Shareholders’ equity—Hospira, 9/3/15 Investment in Hospira

7,928

(R) In-process R&D Developed technology rights Other noncurrent liabilities Goodwill Inventories Property, plant and equipment Other noncurrent assets Long-term debt Deferred tax liabilities Investment in Hospira

1,030

7,928

1,030 8,290 22 7,296 1,313 3,620 138 28 3,380 8,159

(O) Inventories Property, plant and equipment Impairment loss Amortization expense Long-term debt Deferred tax liabilities Cost of goods sold Depreciation expense In-process research and development Developed technology rights Interest expense Tax expense

1,313 60 200 173 5 600 1,313 60 200 173 5 600

P4.11 Goodwill Impairment Testing, IFRS and U.S. GAAP a. For IFRS goodwill impairment testing purposes, the recoverable amount of a CGU is the higher of its “value-in-use,” typically calculated as the discounted present value of future expected cash flows, and “net market value,” defined as fair value less selling costs. Nokia follows IFRS by valuing its continuing CGUs using discounted cash flows. b. Discount rates are adjusted for specific risks associated with the cash flows, thereby taking into consideration differences in the uncertainty of the business environment. The cash flows of the Withings CGU are significantly more uncertain than those of the other CGUs. Fixed Networks’ cash flows are the least uncertain. c. Only the Withings CGU has a book value in excess of fair value, so the tentative goodwill impairment loss is €5,000 million - €4,900 million = €100 million. Withings is allocated €141 million total goodwill, so the loss recognized is the full amount, €100 million. d. The fair values of both reporting units are greater than book values, so there is no impairment loss. Here, the assumed reporting units are larger than CGUs. The underperforming Withings CGU is combined with the better-performing Applications & Analytics CGU, and the resulting reporting unit’s fair value exceeds its book value.

P4.12 Complete Equity Method and Eliminating Entries, Four Years After Acquisition (in thousands) a. (1) Sound Telecom reported net income + Depreciation on plant asset revaluation - Amortization of identifiable intangibles - Goodwill impairment loss Equity in net income of Sound Telecom

$40,000/10 = $10,000/5 =

$ 5,000 4,000 (2,000) (1,000) $ 6,000

(2) Sound Telecom’s retained earnings, January 1, 2018 + Net income, 2018-2020 Retained earnings, January 1, 2021

$50,000 12,000 $62,000

Sound Telecom’s AOCI, January 1, 2018 + OCI, 2018-2020 AOCI, January 1, 2021

$ 2,000 1,000 $ 3,000

(3) Investment balance, January 1, 2018 + Sound Telecom net income, 2018-2020 + Depreciation on plant asset revaluation, 20182020 - Amortization of identifiable intangibles, 20182020 - Goodwill impairment loss, 2018-2020 + Equity in Sound Telecom’s OCI, 2018-2020 Investment balance, December 31, 2020 + Equity in net income of Sound Telecom, 2021 - Equity in Sound Telecom’s other comprehensive loss, 2021 Investment balance, December 31, 2021

$400,000 12,000 $40,000/10 x 3 =

12,000

$10,000/5 x 3 =

(6,000) (5,000) 1,000 414,000 6,000 (200) $419,800

b. Consolidation Working Paper, December 31, 2021 Trial Balances Taken From Books Dr (Cr)

Eliminations

(in thousands)

Peerless Network

Sound Telecom

Current assets

$ 175,000

$ 50,000

Plant assets, net

860,000

410,000

(O-3)

4,000

28,000

(R)

1,246,000

Identifiable intangibles

40,000

10,000

(R)

4,000

2,000 (O-1)

52,000

Investment in Sound Telecom

419,800

Liabilities

(898,500)

(390,200)

Capital stock

(50,000)

(10,000)

(E)

10,000

(50,000)

Retained earnings, Jan. 1

(490,000)

(62,000)

(E)

62,000

(490,000)

AOCI, Jan. 1

(25,000)

(3,000)

(E)

3,000

(25,000)

Sales revenue

(1,200,000)

(650,000)

(6,000)

Equity in OCI

200

Cost of sales

800,000

450,000

Operating expenses

375,000

195,000

(500)

200

________

$ 455,000

$455,000

Goodwill (1)

Equity in net income

Other comprehensive income $

Consolidated Balances Dr (Cr)

5,800 75,000 339,000 (R)

363,000

225,000

1,000 (O-2)

362,000 (1,288,700)

(1,850,000) (C)

6,000

-200

(C)

-1,250,000

(O-1) (O-2)

2,000 1,000

4,000 (O-3)

569,000 (300) $

(1) Original goodwill = $400,000 - $62,000 + $40,000 - $10,000 = $368,000; $368,000 - $5,000 = goodwill as of January 1, 2021, shown in eliminating entry (R).

c. Consolidated Statement of Comprehensive Income Year Ended December 31, 2021 (in thousands) Sales revenue $ 1,850,000 Cost of sales (1,250,000) Gross margin 600,000 Operating expenses (569,000) Net income 31,000 Other comprehensive income 300 Comprehensive income $ 31,300

Consolidated Balance Sheet, December 31, 2021 (in thousands) Assets

Current assets Plant assets, net Identifiable intangible assets Goodwill Total assets Liabilities and shareholders’ equity Liabilities Capital stock Retained earnings (1) Accumulated other comprehensive income (2) Total liabilities and shareholders’ equity

225,000 1,246,000 52,000 362,000 $ 1,885,000 $ 1,288,700 50,000 521,000 25,300 $ 1,885,000

(1) $490,000 + $31,000 = $521,000 (2) $25,000 + $300 = $25,300

P4.13 Intangibles Under IFRS a. Customer relationships and brands are the most likely to have been acquired in a business combination, as internally generated costs for these items are unlikely to be capitalized per IFRS. Internally developed software definitely was not acquired in a business combination, and probably represents development costs capitalized per IFRS. Purchased software and telecoms licenses may be acquired in a business combination. b. U.S. GAAP would likely not allow as much capitalization of internally generated costs, such as software. Whereas IFRS allows capitalization of development costs, U.S. GAAP does not. In addition, U.S. GAAP requires the book value of limited life intangibles to be greater than the sum of undiscounted future cash flows before impairment can be recognized. IFRS does not have this requirement. c. (1) At 31 March 2018, the book value is £36 million after 2018 amortization of £4 million, and the market value is £45 million. 31 March 2018 entries are (all amounts in £ millions): Amortization expense Intangible assets

Intangible assets Revaluation surplus (OCI) £45 million - £36 million = £9 million

31 March 2019 entries are: Amortization expense Intangible assets £45 million/9 = £5 million Revaluation surplus (OCI) Loss (income) Intangible assets

5 5

9 2 11

At this point the ending book value is £29 million (= £40 – £4 + £9 – £5 – £11], equal to the market value on that date. (2) IFRS impairment loss = book value – greater of (value-in-use, £1,800 million; market value, £1,500 million) = £2,000 – £1,800 = £200 million. U.S. GAAP impairment loss = 0 (sum of undiscounted cash flows £2,500 million > book value, £2,000 million, indicating “no impairment”). The U.S. GAAP two-step test for limited life intangibles removes some potential impairments from consideration because of the book value: undiscounted cash flows screen. IFRS directly compares recoverable amount (market value or value-in-use, whichever is higher) with book value. Since recoverable amount is lower than the sum of the undiscounted cash flows, IFRS will likely recognize more impairment losses over time than U.S. GAAP.

P4.14 Consolidation After Acquisition, Revaluation Write-Off Issues (see related P3.10) (in millions) a. Grupo Modelo reported net income - Depreciation on property revaluation - Amortization of intangibles + Deferred tax liability reversal Equity in net income of Grupo Modelo

$4,000 + $5 – $1,500 – $2,000 + $1,000 – $200 - $300 = $99/10 = (50% x $4,454)/5 =

1,005 (9.9) (445.4) 20 $ 569.7

b. Investment balance, January 1, 2013 + Grupo Modelo change in retained earnings, 2013-2017 + Grupo Modelo change in AOCI, 2013-2015 - Depreciation on property revaluation, 2013-2015 - Amortization of intangibles revaluation, 2013-2015 - Increase in cost of goods sold, 2013 + Accrued trade and other payables, 2013-2014 + Reversal of deferred tax liabilities through 2015 + Accrued current liabilities Investment balance, December 31, 2015 + Equity in net income of Grupo Modelo, 2016 + Equity in Grupo Modelo’s OCI, 2016 Investment balance, December 31, 2016

$34,008 $16,503 - $7,003 = $1,200 - $700 = $99/10 x 3 (50% x $4,454)/5 x 3

9,500 500 (29.7) (1,336.2) (4,333) 509 100 1,650 40,568.1 569.7 100 $41,237.8

c. Consolidation Working Paper, December 31, 2016 Trial Balances Taken From Books Dr (Cr) (in millions)

InBev

Current assets

$ 15,000

Eliminations

Grupo Modelo $

Consolidated Balances Dr (Cr)

8,000

23,000

Investment securities

300

Investment in associates

200

(R)

229

41,237.8

669.7

(C)

Investment in Grupo Modelo

310

19,203

(E)

21,365.1

(R)

Property, plant and equipment, net

18,000

15,000

(R)

69.3

9.9

(O)

33,059.4

Intangible assets

25,000

10,000

(R)

3,117.8

445.4

(O)

37,672.4

Goodwill

50,000

796

(R)

69,592

Current liabilities

(20,000)

(4,000)

(24,000)

Trade and other payables

(2,000)

(1,200)

(3,200)

Deferred tax liabilities

(9,800)

(2,200)

Employee benefits liability

(1,600)

(400)

(2,000)

Loans and borrowings

(52,568.1)

(5,731)

(58,299.1)

Issued capital

(1,700)

(200)

(E)

200

(1,700)

Share premium

(17,000)

(1,300)

(E)

1,300

(17,000)

Retained earnings, Jan. 1

(29,000)

(16,503)

(E) 16,503

(29,000)

AOCI, Jan. 1

(2,000)

(1,200)

(E)

(2,000)

Dividends

2,100

Revenue

(40,000)

(4,000)

(44,000)

(R) 19,592

(O)

614

(R)

(12,594)

1,200

Equity in income of Grupo Modelo

(569.7)

(C)

569.7

Equity in OCI of Grupo Modelo

(100)

(C)

100

Equity in income of associates

(50)

(5)

(55)

Cost of sales

16,000

1,500

17,500

Operating expenses

10,000

2,000

Nonrecurring income

(5,000)

(1,000)

(6,000)

Finance expenses

2,000

200

2,200

Income tax expense

1,700

300

Other comprehensive income

(150)

(100)

________

____ __

$ 43,127.1

(O)

455.3

12,455.3

(O)

1,980 (250) $

d. Consolidated Statement of Comprehensive Income, 2016 (in millions) Revenue $ 44,000 Cost of sales (17,500) Gross margin 26,500 Operating expenses (12,455.3) Operating income 14,044.7 Nonrecurring income 6,000 Equity in income of associates 55 Finance expenses (2,200) Income before tax 17,899.7 Tax expense (1,980) Net income 15,919.7 Other comprehensive income 250 Comprehensive income $ 16,169.7 Consolidated Balance Sheet, December 31, 2016 (in millions) Assets Current assets Investment securities Investment in associates Property, plant and equipment, net Intangible assets Goodwill Total assets Liabilities and shareholders’ equity Liabilities: Current liabilities Trade and other payables Deferred tax liabilities Employee benefit liability Loans and borrowings Total liabilities Shareholders’ equity: Issued capital Share premium Retained earnings (1) Accumulated other comprehensive income (2) Total shareholders’ equity Total liabilities and shareholders’ equity (1) $29,000 + $15,919.7 - $2,100 = $42,819.7 (2) $2,000 + $250 = $2,250

23,000 310 229 33,059.4 37,672.4 69,592 $ 163,862.8

24,000 3,200 12,594 2,000 58,299.1 100,093.1

1,700 17,000 42,819.7 2,250 63,769.7 $ 163,862.8

P4.15 Cost Method and Eliminating Entries Three Years After Acquisition (see related P4.3) Calculation of Investment balance at January 1, 2020 following the complete equity method: Investment in Sunset Coast, January 1, 2018 Sunset Coast’s reported income, 2018-2019 Sunset Coast’s reported dividends, 2018-2019 (50% of reported income) Revaluation write-offs, 2018-2019: Plant assets [($500,000)/10] x 2 Identifiable intangibles ($1,000,000/5) x 2 Goodwill impairment, 2019 Investment in Sunset Coast, January 1, 2020

$ 5,000,000 850,000 (425,000) 100,000 (400,000) (100,000) $ 5,025,000

Under LIFO and increasing inventory, the acquisition date revalued inventory is assumed to still be on hand. Consolidation working paper eliminating entries for 2020: (C) Dividend income Dividends – Sunset Coast (0.5 x $400,000)

200,000 200,000

(A) Investment in Sunset Coast 25,000 Shareholders’ equity—Puffin, 1/1 25,000 Using the cost method, the investment balance on Puffin’s books is $5,000,000. This entry adjusts the investment to the complete equity method. (E) Shareholders’ equity—Sunset Coast, 1/1 1,825,000 Investment in Sunset Coast 1,825,000 Sunset Coast’s shareholders’ equity, January 1, 2018 = $1,400,000 (acquisition cost $5,000,000 less excess over book value $3,600,000). Sunset Coast’s shareholders’ equity, January 1, 2020 = acquisition-date equity + net income less dividends for 2018 and 2019 = $1,400,000 + (1 – 0.5) ($850,000) = $1,825,000. (R) Identifiable intangibles Goodwill Inventory Plant assets, net Investment in Sunset Coast

600,000 3,400,000 400,000 400,000 3,200,000

Revaluations at January 1, 2020 = original revaluations less write-offs for 2018 and 2019. Goodwill at January 1, 2020 = $3,600,000 + $400,000 + $500,000 $1,000,000) = $3,500,000 original value, less $100,000 in impairment = $3,400,000. (O) Plant assets, net Amortization expense Depreciation expense Identifiable intangibles

50,000 200,000 50,000 200,000

Note: Eliminating entries (E), (R) and (O) are the same as in P4.3, when Puffin uses the complete equity method on its own books.

P4.16 Cost Method and Eliminating Entries, Four Years After Acquisition (see related P4.12) (in thousands) Peerless’ trial balance from P4.12 is adjusted to amounts appearing when Peerless uses the cost method. Balances for the investment, retained earnings, Jan. 1 and AOCI, Jan. 1 accounts are affected. There are no accounts for equity in net income or equity in OCI. There is no dividend income since Sound Telecom does not declare dividends during 2018-2021. Consolidation Working Paper, December 31, 2021 Trial Balances Taken From Books Dr (Cr)

Eliminations

(in thousands)

Peerless Network

Sound Telecom

Current assets

$ 175,000

Plant assets, net

860,000

410,000

(O-3)

4,000

28,000 (R)

1,246,000

Identifiable intangibles

40,000

10,000

(R)

4,000

2,000 (O-1)

52,000

Investment in Sound Telecom

400,000

-14,000

75,000 (E) 339,000 (R)

(A) (R)

363,000

1,000 (O-2)

50,000

Consolidated Balances Dr (Cr) $

225,000

Goodwill

Liabilities

(898,500)

(390,200)

Capital stock

(50,000)

(10,000)

(E)

10,000

Retained earnings, Jan. 1 (1)

(477,000)

(62,000)

(E)

62,000

13,000 (A)

(490,000)

AOCI, Jan. 1 (2)

(24,000)

(3,000)

(E)

3,000

1,000 (A)

(25,000)

Sales revenue

(1,200,000)

(650,000)

(1,850,000)

Cost of sales

800,000

450,000

1,250,000

Operating expenses

375,000

195,000

(500)

200

________

$ 463,000

Other comprehensive income $

362,000 (1,288,700)

(O-1) (O-2)

2,000 1,000

(50,000)

4,000 (O-3)

569,000 (300) $

(1) Peerless’ retained earnings, Jan. 1 = $490,000 - $13,000 = $477,000; $13,000 = total equity in net income recognized 20182020, using the complete equity method. (2) Peerless’ AOCI, Jan. 1 = $25,000 - $1,000 = $24,000; $1,000 = total equity in OCI recognized 2018-2020, using the complete equity method.

No eliminating entry (C) is required since Sound Telecom did not declare dividends in 2021. Eliminating entry (A) adjusts Peerless’ investment account to its correct balance at January 1, 2021, following the complete equity method. The entry is shown in journal entry format below. The credits to retained earnings and AOCI are total equity in net income 2018-2020 and total equity in OCI 2018-2020, respectively. (A) Investment in Sound Telecom Retained earnings, Jan. 1 AOCI, Jan. 1

14,000 13,000 1,000

P4.17 Consolidation After Four Years, Cost Method (see related P4.8) (in thousands) Eliminating entry (A) adjusts Perth’s beginning investment and retained earnings accounts to the values it would report if it used the complete equity method. The change in both accounts to the beginning of 2020 is calculated as follows: Change in Sharbot’s retained earnings, 2017-2019 ($2,000 + $16,000 $4,000) Revaluation write-offs for 2017-2019: Plant assets ($8,000/20) x 3 Identifiable intangibles ($10,000/5) x 3 Goodwill impairment Adjustment

$ 14,000 1,200 (6,000) (2,000) $ 7,200

Eliminating entry (C) is not required because Sharbot does not declare and pay dividends in 2020. Eliminating entries (E), (R), and (O) are the same as when Perth uses the complete equity method; see the solution to P4.8.

Consolidation Working Paper, December 31, 2020 Trial Balances Taken From Books Dr (Cr)

Eliminations

Perth

Sharbot

Current assets

$ 5,000

Plant assets, net

34,800

28,000

(O)

400

6,800

(R)

56,400

(R)

4,000

2,000

(O)

2,000

16,000

(A)

7,200

18,000

(E)

5,200

(R)

500

(O)

Intangibles Investment in Sharbot

Goodwill (1)

Consolidated Balances Dr (Cr)

(in thousands)

2,500

Liabilities

(22,000)

(10,000)

Capital stock

(15,000)

(2,000)

Retained earnings, Jan. 1

(17,800)

(16,000)

(R)

8,000

7,500

7,500 (32,000)

(E)

2,000

(15,000) 7,200

(E)

(A)

(25,000)

16,000

Sales revenue

(25,000)

(14,000)

(39,000)

Cost of sales

20,000

8,000

28,000

Operating expenses

4,000

3,500

(O)

2,100 $

39,700

______ $

39,700

(1) Original goodwill = $16,000 - $4,000 + $8,000 - $10,000 = $10,000; cumulative impairment to the beginning of 2020 is $2,000.

9,600 $

CHAPTER 5 SOLUTIONS TO MULTIPLE CHOICE QUESTIONS, EXERCISES AND PROBLEMS MULTIPLE CHOICE QUESTIONS 1.

b Calculation of goodwill: Acquisition cost Fair value of noncontrolling interest Total fair value Book value Plant and equipment revaluation Identifiable intangibles Fair value of identifiable net assets Goodwill

$ 91,700,000 6,300,000 98,000,000 $ 13,000,000 (25,000,000) 40,000,000 28,000,000 $ 70,000,000

Allocation of goodwill between controlling and noncontrolling interest: Total goodwill Pomegranate’s goodwill: $91,700,000 – (90% x $28,000,000) Goodwill to noncontrolling interest

$ 70,000,000 66,500,000 $ 3,500,000

Goodwill is allocated 95% to the controlling interest and 5% to the noncontrolling interest. (R) Identifiable intangibles Goodwill Plant and equipment Investment in Starfruit (1) Noncontrolling interest in Starfruit (2)

40,000,000 70,000,000 25,000,000 80,000,000 5,000,000

(1) [90% x ($40,000,000 - $25,000,000)] + $66,500,000 (2) [10% x ($40,000,000 - $25,000,000)] + $3,500,000

c (R) Identifiable intangibles Goodwill Plant and equipment Investment in Starfruit (1) Noncontrolling interest in Starfruit (2) (1) [90% x ($24,000,000 - $20,000,000)] + (95% x $68,000,000) (2) [10% x ($24,000,000 - $20,000,000)] + (5% x $68,000,000)

24,000,000 68,000,000 20,000,000 68,200,000 3,800,000

Starfruit net income Revaluation write-offs: Plant and equipment depreciation Identifiable intangibles amortization Goodwill impairment loss

Equity in Net Income $ 6,750,000

NCI in Net Income $ 750,000

2,250,000 (7,200,000) (475,000) $ 1,325,000

250,000 (800,000) (25,000) $ 175,000

c 10% x ($13,000,000 + $40,000,000 – $25,000,000) = $2,800,000

c Noncontrolling interest in net income = $750,000 + $250,000 – $800,000 = Noncontrolling interest in OCI = 10% x $100,000 = Noncontrolling interest in comprehensive income

$ 200,000 10,000 $ 210,000

d (E) Shareholders’ equity Investment in Starfruit Noncontrolling interest in Starfruit (R) Identifiable intangibles Plant and equipment Investment in Starfruit (1) Noncontrolling interest in Starfruit (2)

13,000,000 11,700,000 1,300,000

40,000,000 25,000,000 14,300,000 700,000

(1) Investment in Starfruit balance on Pomegranate’s books is $26,000,000 (= $20,000,000 cost + $6,000,000 gain on acquisition). Elimination of the investment in (R) is the remainder of the investment balance, after elimination (E). (2) The credit to noncontrolling interest in (R) brings the noncontrolling interest to fair value, after elimination (E).

a There is no goodwill when the acquisition is a bargain purchase.

10.

EXERCISES E5.1

Date of Acquisition Consolidation Eliminating Entries a. Calculation of goodwill: Acquisition cost Fair value of noncontrolling interest Total fair value Book value of Saylor Revaluations: Land Developed technology Goodwill

$ 20,000,000 4,000,000 24,000,000 $ 5,000,000 (200,000) 2,000,000

6,800,000 $ 17,200,000

Allocation of goodwill between controlling and noncontrolling interest: Total goodwill Pennant’s goodwill: $20,000,000 – (80% x $6,800,000) Goodwill to noncontrolling interest

$ $

17,200,000 14,560,000 2,640,000

b. Working paper eliminating entries, date of acquisition: (E) Shareholders’ equity – Saylor Investment in Saylor (80%) Noncontrolling interest in Saylor (20%) (R) Developed technology Goodwill Land Investment in Saylor (1) Noncontrolling interest in Saylor (2) (1) [80% x ($2,000,000 - $200,000)] + $14,560,000 = $16,000,000 (2) [20% x ($2,000,000 - $200,000)] + $2,640,000 = $3,000,000

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

2,000,000 17,200,000 200,000 16,000,000 3,000,000

E5.2

Equity in Net Income and Noncontrolling Interest in Net Income a. Acquisition cost Fair value of noncontrolling interest Total fair value Book value of Sun City Revaluation: Identifiable intangibles Goodwill

$ 41,750,000 14,750,000 56,500,000 $ 5,000,000 7,500,000

12,500,000 $ 44,000,000

Allocation of goodwill between controlling and noncontrolling interest: Total goodwill Palm’s goodwill: $41,750,000 – (70% x $12,500,000) Goodwill to noncontrolling interest

$ 44,000,000 33,000,000 $ 11,000,000

Goodwill is allocated in a 75:25 ratio. b.

2020 equity in net income and noncontrolling interest in net income:

Sun City’s reported net income Revaluation write-offs: Identifiable intangibles $7,500,000/5 Goodwill impairment loss

Total $ 10,000,000

Equity in NI $ 7,000,000

Noncontrolling Interest in NI $ 3,000,000

(1,500,000) (2,000,000) $ 6,500,000

(1,050,000) (1,500,000) $ 4,450,000

(450,000) (500,000) $ 2,050,000

E5.3

Consolidation Eliminating Entries, Date of Acquisition and Two Years Later a. Calculation of goodwill: Acquisition cost Fair value of noncontrolling interest Total fair value Book value of Stardust Revaluations: Plant and equipment Identifiable intangibles Goodwill

$ 51,100,000 2,900,000 54,000,000 $ 2,000,000 (6,000,000) 8,000,000

4,000,000 $ 50,000,000

Allocation of goodwill between controlling and noncontrolling interest: Total goodwill Plaza’s goodwill: $51,100,000 – (90% x $4,000,000) Goodwill to noncontrolling interest

$ 50,000,000 47,500,000 $ 2,500,000

Goodwill is allocated in a 95:5 ratio. b. Working paper eliminating entries, date of acquisition: (E) Capital stock Retained earnings Accumulated OCI Investment in Stardust (90%) Noncontrolling interest in Stardust (10%) (R) Identifiable intangibles Goodwill Plant and equipment Investment in Stardust (1) Noncontrolling interest in Stardust (2) (1) [90% x ($8,000,000 - $6,000,000)] + $47,500,000 = $49,300,000 (2) [10% x ($8,000,000 - $6,000,000)] + $2,500,000 = $2,700,000

300,000 1,650,000 50,000 1,800,000 200,000

8,000,000 50,000,000 6,000,000 49,300,000 2,700,000

c. 2021 equity in net income and noncontrolling interest in net income:

Stardust’s reported net income Revaluation write-offs: Plant and equipment $6,000,000/10 Identifiable intangibles $8,000,000/4 Goodwill impairment loss 95:5

Equity in NI $ 3,600,000

Noncontrolling Interest in NI $ 400,000

600,000 540,000 (2,000,000) (1,800,000) (200,000) (190,000) $ 2,400,000 $ 2,150,000

60,000 (200,000) (10,000) $ 250,000

Total $ 4,000,000

Working paper eliminating entries, two years later: (C) Equity in NI Equity in OCL Investment in Stardust (E) Capital stock Retained earnings, beg. (1) Accumulated OCI, beg. (2) Investment in Stardust (90%) Noncontrolling interest in Stardust (10%)

2,150,000 9,000 2,141,000

300,000 4,450,000 75,000 4,342,500 482,500

(1) $1,650,000 + $2,800,000 = $4,450,000 (2) $50,000 + $25,000 = $75,000

(R) Identifiable intangibles Goodwill Plant and equipment Investment in Stardust (3) Noncontrolling interest in Stardust (4)

6,000,000 50,000,000 5,400,000 48,040,000 2,560,000

(3) [90% x ($6,000,000 - $5,400,000)] + $47,500,000 = $48,040,000 (4) [10% x ($6,000,000 - $5,400,000)] + $2,500,000 = $2,560,000

(O) Operating expenses Plant and equipment Identifiable intangibles Goodwill (N) Noncontrolling interest in NI Noncontrolling interest in OCL Noncontrolling interest

1,600,000 600,000 2,000,000 200,000

250,000 1,000 249,000

E5.4

Consolidating a VIE at the Date of Acquisition a. (E) Equity

250,000 Noncontrolling interest

b. (E) Equity

250,000

250,000 Noncontrolling interest

(R) Other assets Identifiable intangibles Goodwill

250,000

65,000 1,000,000 185,000

Noncontrolling interest Goodwill = $1,500,000 - $250,000 - $65,000 - $1,000,000 = $185,000.

E5.5

1,250,000

Consolidating a VIE in a Subsequent Year (E) Equity, beginning

250,000 Noncontrolling interest

(R) Other assets Identifiable intangibles Goodwill

250,000

65,000 1,000,000 185,000 Noncontrolling interest

(O) Depreciation expense Impairment loss

1,250,000

13,000 100,000 Other assets Identifiable intangibles

(N) NCI in income Noncontrolling interest $12,000 = $125,000 - $13,000 - $100,000.

13,000 100,000

12,000 12,000

E5.6

Date of Acquisition Consolidation Eliminating Entries, Bargain Purchase a. Acquisition cost Fair value of noncontrolling interest Total Book value of Sparrow Revaluations: Land Other plant assets, net Identifiable intangible assets Fair value of identifiable net assets Gain on acquisition

$ 20,000,000 4,000,000 24,000,000 $ 26,000,000 (700,000) (2,000,000) 3,000,000 26,300,000 $ (2,300,000)

Peregrine’s acquisition entry: Investment in Sparrow Merger expenses Cash Gain on acquisition

22,300,000 2,500,000 22,500,000 2,300,000

b. Working paper eliminating entries, date of acquisition: (E) Capital stock Retained earnings Accumulated other comprehensive loss Treasury stock Investment in Sparrow (80%) Noncontrolling interest in Sparrow (20%) (R) Identifiable intangible assets Noncontrolling interest in Sparrow (1) Other plant assets, net Land Investment in Sparrow (2)

3,000,000 25,000,000 1,500,000 500,000 20,800,000 5,200,000

3,000,000 1,200,000 2,000,000 700,000 1,500,000

(1) $5,200,000 – $4,000,000 = $1,200,000 adjustment needed to bring the NCI balance to its fair value at the date of acquisition. (2) $22,300,000 – $20,800,000 = $1,500,000 to eliminate the remainder of the investment balance.

E5.7

Goodwill, Equity Method, Eliminating Entries, First Year (see related E4.3) (in thousands) a. Calculation of goodwill is as follows: Acquisition cost Fair value of noncontrolling interest Total Book value of San Jose Cable Revaluation: Identifiable intangibles Goodwill

$ 200,000 50,000 250,000 $ 28,200 50,000

78,200 $ 171,800

Allocation of goodwill between controlling and noncontrolling interest: Total goodwill Playtel’s goodwill: $200,000 – (75% x $78,200) Goodwill to noncontrolling interest

$ 171,800 141,350 $ 30,450

b. 2020 equity in net income and noncontrolling interest in net income:

San Jose’s reported net income Revaluation write-off: Identifiable intangibles impairment

Total $ 4,000

Equity in NI $ 3,000

(1,000) $ 3,000

(750) $ 2,250

Noncontrolling interest in NI $ 1,000

(250) 750

c. Consolidation working paper eliminating entries for 2020: (C) Equity in net income of San Jose Investment in San Jose (E) Common stock, $1 par Additional paid-in capital Retained deficit, January 1 Treasury stock Investment in San Jose Noncontrolling interest in San Jose

2,250 2,250

5,000 25,000 1,000 800 21,150 7,050

(R) Identifiable intangibles Goodwill Investment in San Jose (1) Noncontrolling interest in San Jose (2)

50,000 171,800 178,850 42,950

(1) (75% x $50,000) + $141,350 (2) (25% x $50,000) + $30,450

(O) Impairment losses Identifiable intangibles

1,000 1,000

(N) Noncontrolling interest in net income Noncontrolling interest in San Jose

E5.8

750 750

Consolidation Eliminations Several Years After Acquisition a. Paramount’s acquisition cost Fair value of noncontrolling interest Total Book value, date of acquisition Revaluations: Accounts receivable Inventory Equipment Patents Deferred tax liabilities Goodwill

$ 2,910,000 790,000 3,700,000 $1,500,000 (100,000) (125,000) (400,000) 200,000 (75,000)

1,000,000 $ 2,700,000

Paramount’s share of goodwill = $2,910,000 – (75% x $1,000,000) = $2,160,000 Noncontrolling interest’s share of goodwill = $540,000 (20%)

(80%)

January 2015 balance Change in Sun’s retained earnings, 2015-2020: ($1,800,000 – $800,000), divided 75:25 Write-off of Sun’s identifiable net asset revaluations, 2015-2020: ($100,000 + $125,000 + $240,000 – $200,000 + $60,000), divided 75:25 Goodwill impairment, 2015-2020: ($2,700,000 – $2,000,000), divided 80:20 Balance, end of 2020 (E)

Investment $ 2,910,000

Noncontrolling interest $ 790,000

750,000

250,000

243,750

81,250

(560,000) $ 3,343,750

(140,000) 981,250

Shareholders’ equity-Sun Investment in Sun Noncontrolling interest in Sun

2,500,000 1,875,000 625,000

(R) Goodwill Equipment, net (1) Deferred tax liabilities Investment in Sun (2) Noncontrolling interest in Sun (3)

2,000,000 160,000 15,000 1,468,750 356,250

(1) $400,000 – [(6/10) x $400,000] (2) (80% x $2,000,000) – (75% x $175,000) (3) (20% x $2,000,000) – (25% x $175,000)

E5.9

Consolidation Eliminating Entries Several Years After Acquisition (in thousands) a. Acquisition cost Fair value of noncontrolling interest Total Book value, date of acquisition Revaluations: Plant and equipment Favorable lease agreements Gaming licenses Deferred tax liabilities Goodwill

$ 41,450 13,550 55,000 $

4,000 (15,000) 5,000 7,000 (3,000)

Palomar’s share of goodwill = $41,450 – (65% x -$2,000) = $42,750 Noncontrolling interest’s share of goodwill = $14,250 (25%)

2,000 $ 57,000 (75%)

b. Investment $ 41,450 6,825

Date of acquisition cost Change in Sahara’s retained earnings, 2016-2019: ($12,000 – $1,500) x 65% Revaluation write-offs, identifiable net assets, 2016-2019: + Plant and equipment [4 x ($15,000/20)] x 65% - Favorable leases $5,000 x 65% - Gaming licenses [4 x ($7,000/7)] x 65% + Deferred tax reversals $2,200 x 65% Goodwill impairment losses, 2016-2019 $3,600 x 75% Balance, January 1, 2020 + Equity in NI for 2020 [($2,550 + $15,000/20 - $7,000/7 + $300) x 65%] – ($1,000 x 75%) - Dividends (65% x $200) Investment balance, December 31, 2020

c. (C) Equity in NI

1,950 (3,250) (2,600) 1,430 (2,700) 43,105 940 (130) $ 43,915

940

Dividends Investment in Sahara (E) Capital stock RE, January 1 Investment in Sahara Noncontrolling interest (R) Gaming licenses Goodwill Plant and equipment Deferred tax liabilities Investment in Sahara (1) Noncontrolling interest (2)

130 810

2,500 12,000 9,425 5,075

3,000 53,400 12,000 800 33,680 9,920

(1) [65% x ($3,000 - $12,000 - $800)] + (75% x $53,400) = $33,680 (2) [35% x ($3,000 - $12,000 - $800)] + (25% x $53,400) = $9,920

(O) Plant and equipment Deferred tax liabilities Goodwill impairment loss Amortization expense Depreciation expense Tax expense Goodwill Gaming licenses

750 300 1,000 1,000

(N) Noncontrolling interest in NI (3) Dividends Noncontrolling interest (3) [($2,550 + $15,000/20 - $7,000/7 + $300) x 35%] – ($1,000 x 25%) = $660

750 300 1,000 1,000

660 70 590

E5.10 Consolidation Working Paper, Date of Acquisition (see related E3.10) a. Calculation of goodwill: Acquisition cost Fair value of noncontrolling interest Total fair value Book value of Sylvan Goodwill

$ 43,000,000 4,250,000 47,250,000 17,000,000 $ 30,250,000

Allocation of goodwill between controlling and noncontrolling interest: Total goodwill Princecraft’s goodwill: $43,000,000 – (90% x $17,000,000) Goodwill to noncontrolling interest

$ 30,250,000 27,700,000 $ 2,550,000

b. Consolidation Working Paper Accounts Taken From Books

(in thousands)

Princecraft Dr (Cr)

Sylvan Dr (Cr)

Cash

17,000

Eliminations

2,000

Consolidated Balances Dr (Cr) $

19,000

Other current assets

20,000

8,000

28,000

Property and equipment, net

70,000

15,000

85,000

Investment in Sylvan

43,000

15,300 (E) 27,700 (R)

Goodwill

(R)

30,250

Total liabilities

(30,000)

(8,000)

Common stock

(15,000)

(5,000)

(E)

5,000

(15,000)

Additional paid-in capital

(45,000)

(10,000)

(E)

10,000

(45,000)

Retained earnings

(60,000)

(2,000)

(E)

2,000

(60,000)

(38,000)

Noncontrolling interest

1,700 (E) ______

Total

30,250

______

$ 47,250

2,550 (R) $47,250

(4,250) $

Note: Princecraft’s balance sheet above reflects the following acquisition entry (in thousands): Investment in Sylvan Cash

43,000 43,000

c. Consolidated Balance Sheet, Date of Acquisition (in thousands) Assets Cash Other current assets Property and equipment, net Goodwill Total assets Liabilities and shareholders’ equity Total liabilities Shareholders’ equity Princecraft’s shareholders’ equity: Common stock Additional paid-in capital Retained earnings Total Princecraft’s shareholders’ equity Noncontrolling interest Total shareholders’ equity Total liabilities and shareholders’ equity

19,000 28,000 85,000 30,250 $ 162,250 $

38,000

15,000 45,000 60,000 120,000 4,250 124,250 $ 162,250

E5.11 Consolidation Eliminating Entries, Date of Acquisition: U.S. GAAP and IFRS (in thousands) a. Plummer’s acquisition entry: Investment in Softek Merger expenses Cash Common stock, par value Additional paid-in capital

100,000 2,000 2,000 200 99,800

Calculation of goodwill: Acquisition cost Fair value of noncontrolling interest Total fair value Book value of Softek Revaluations: Plant assets Trademarks Customer lists Goodwill

$ 100,000 9,000 109,000 $ 8,900 (6,000) 2,000 3,000

7,900 $ 101,100

Allocation of goodwill between controlling and noncontrolling interest: Total goodwill Plummer’s goodwill: $100,000 – (90% x $7,900) Goodwill to noncontrolling interest

$ 101,100 92,890 $ 8,210

Consolidation eliminating entries: (E) Common stock Additional paid-in capital Retained deficit Accumulated OCL Treasury stock Investment in Softek Noncontrolling interest in Softek (R) Trademarks Customer lists Goodwill Plant assets, net Investment in Softek (1) Noncontrolling interest in Softek (2)

400 20,000 10,000 1,000 500 8,010 890

2,000 3,000 101,100 6,000 91,990 8,110

(1) [90% x ($2,000 + $3,000 – $6,000)] + $92,890 = $91,990 (2) [10% x ($2,000 + $3,000 – $6,000)] + $8,210 = $8,110

b. Consolidation eliminating entries: (E) Common stock Additional paid-in capital Retained deficit Accumulated OCL Treasury stock Investment in Softek Noncontrolling interest in Softek

400 20,000 10,000 1,000 500 8,010 890

(R) Trademarks Customer lists Goodwill Noncontrolling interest in Softek (3) Plant assets, net Investment in Softek

2,000 3,000 92,890 100 6,000 91,990

(3) 10% x ($2,000 + $3,000 – $6,000) = $(100)

Note: The IFRS alternative valuation method attributes no goodwill to the noncontrolling interest. The noncontrolling interest balance at the date of acquisition is 10% x the fair value of Softek’s identifiable net assets, or 10% x $7,900 = $790.

E5.12 Consolidation at Date of Acquisition, IFRS and U.S. GAAP (in millions) a. Calculation of goodwill: Acquisition cost Less 49% fair value of identifiable net assets Goodwill

€ 39.00 (2.45) € 36.55

49% x €5

Noncontrolling interest = 51% x €5 = €2.55 b. (E) Shareholders’ equity Investment in Compador Noncontrolling interest (R) Current assets Current liabilities and provisions Goodwill Noncurrent assets Investment in Compador

5.00 2.45 2.55

0.10 0.10 36.55 0.20 36.55

Note: There is no revaluation adjustment to the noncontrolling interest in (R) because the total fair value of the identifiable net assets equals book value.

c. Calculation of goodwill: Acquisition cost Fair value of noncontrolling interest Total fair value Book value Net revaluations of identifiable net assets Fair value of identifiable net assets Goodwill

€ 39.00 38.00 77.00 € 5.00 -5.00 € 72.00

Goodwill to the controlling interest = €39.00 – (49% x €5.00) = €36.55 (equal to the amount reported using the IFRS alternative). Noncontrolling interests = fair value at date of acquisition = €38. d. (E) Shareholders’ equity Investment in Compador Noncontrolling interest (R) Current assets Current liabilities and provisions Goodwill Noncurrent assets Investment in Compador Noncontrolling interest

5.00 2.45 2.55

0.10 0.10 72.00 0.20 36.55 35.45

E5.13 Consolidation Eliminating Entries, One Year After Acquisition, IFRS a. Calculation of goodwill: Acquisition cost Share of fair value of identifiable net assets: ( €5,000,000 x 40%) Goodwill Noncontrolling interests = 60% x €5,000,000 = €3,000,000.

€ 70,000,000 2,000,000 € 68,000,000

b. (C) Equity in NI of E-Minus Investment in E-Minus

2,400,000 2,400,000

40% x €6,000,000 = €2,400,000.

(E) Shareholders’ equity Investment in E-Minus Noncontrolling interest (R) Goodwill Investment in E-Minus

5,000,000 2,000,000 3,000,000

68,000,000 68,000,000

Eliminating entry (O) is not required since goodwill is not impaired. (N) Noncontrolling interest in NI Noncontrolling interest

3,600,000 3,600,000

€6,000,000 x 60% = €3,600,000.

E5.14 Consolidated Balance Sheet, Date of Acquisition: U.S. GAAP and IFRS a. Calculation of goodwill: Acquisition cost $3,000,000 + (200,000 x $80) Fair value of noncontrolling interest Total fair value Book value of Powerline Revaluations: Current assets Plant and equipment Brand names Goodwill

$ 19,000,000 1,800,000 20,800,000 $ 4,500,000 (500,000) (6,000,000) 3,000,000

1,000,000 $ 19,800,000

Allocation of goodwill between controlling and noncontrolling interest: Total goodwill Microsoft’s goodwill: $19,000,000 – (90% x $1,000,000) Goodwill to noncontrolling interest

$ 19,800,000 18,100,000 $ 1,700,000

b. Consolidation Working Paper Accounts Taken From Books

(in thousands)

Microsoft Dr (Cr)

Current assets

7,000

Plant and equipment, net

35,000

Investment in Powerline

19,000

Eliminations

Powerline Dr (Cr) $

Consolidated Balances Dr (Cr)

2,000

500 (R)

7,000

6,000 (R)

8,500 36,000

4,050 (E) 14,950 (R)

Brand names

(R) 3,000

3,000

Goodwill

(R) 19,800

19,800

Current liabilities

(5,000)

(1,500)

(6,500)

Long-term liabilities

(20,000)

(3,000)

(23,000)

Common stock, par value

(5,000)

(100)

Additional paid-in capital

(19,600)

Retained earnings Accumulated other comprehensive (income) loss Noncontrolling interest

Total

100

(5,000)

(1,450)

(E) 1,450

(19,600)

(11,000)

(3,000)

(E) 3,000

(11,000)

(400)

________

_______

(E)

50 (E)

(400)

450 (E) ______ $ 27,350

1,350 (R) $ 27,350

(1,800) $

Note 1: Microsoft’s balance sheet above reflects the following acquisition entry (in thousands): Investment in Powerline 19,000 Cash 3,000 Common stock 2,000 Additional paid-in capital 14,000 Note 2: The $14,950,000 credit to investment in entry (R) = [90% (-$500,000 $6,000,000 + $3,000,000)] + $18,100,000 (goodwill). The $1,350,000 credit to noncontrolling interest in entry (R) = [10% ($500,000 - $6,000,000 + $3,000,000)] + $1,700,000 (goodwill).

c. Calculation of goodwill: Acquisition cost 90% x fair value of identifiable net assets Goodwill

$ 19,000,000 900,000 $ 18,100,000

90% x $1,000,000

Consolidation Working Paper Accounts Taken From Books

(in thousands)

Microsoft Dr (Cr)

Current assets

7,000

Plant and equipment, net

35,000

Investment in Powerline

19,000

Eliminations

Powerline Dr (Cr) $

Consolidated Balances Dr (Cr)

2,000

500 (R)

7,000

6,000 (R)

8,500 36,000

4,050 (E) 14,950 (R)

Brand names

(R) 3,000

3,000

Goodwill

(R) 18,100

18,100

Current liabilities

(5,000)

(1,500)

(6,500)

Long-term liabilities

(20,000)

(3,000)

(23,000)

Common stock, par value

(5,000)

(100)

Additional paid-in capital

(19,600)

Retained earnings Accumulated other comprehensive (income) loss Noncontrolling interest Total

100

(5,000)

(1,450)

(E) 1,450

(19,600)

(11,000)

(3,000)

(E) 3,000

(11,000)

(400)

(R)

$ 26,000

(E)

350

50 (E)

(400)

450 (E)

(100)

$ 26,000

Note: The IFRS alternative valuation method attributes no goodwill to the noncontrolling interest. At the date of acquisition, the noncontrolling interest is valued at 10% of the fair value of Powerline’s identifiable net assets, or 10% x $1,000,000 = $100,000.

E5.15 Consolidated Cash Flow from Operations Consolidated net income + Depreciation expense + Amortization expense + Loss on sale of plant assets - Undistributed equity method income ($200,000 - $80,000) - Increase in receivables + Decrease in inventory - Decrease in current operating liabilities Cash flow from operating activities

$ 25,000,000 8,000,000 2,000,000 500,000 (120,000) (600,000) 900,000 (100,000) $ 35,580,000

E5.16 Consolidated Cash from Operations a. Parent’s reported income Subsidiary’s reported income Less revaluation write-offs: Depreciation Amortization Goodwill impairment loss Consolidated net income

$ 1,000,000 240,000

Consolidated net income + Consolidated depreciation expense (1) + Consolidated amortization expense (2) + Goodwill impairment loss - Undistributed equity investment income (3) Cash from operating activities

$ 1,182,000 216,000 65,000 40,000 (25,000) $ 1,478,000

(3,000) (15,000) (40,000) $ 1,182,000

(1) $175,000 + $38,000 + $3,000 (2) $50,000 + $15,000 (3) $60,000 - $35,000

E5.17 Consolidated Statement of Cash Flows Post Ranch Resort and Subsidiary Consolidated Statement of Cash Flows For the year 2020 Cash from operating activities Consolidated net income Add (subtract) items not affecting cash: Depreciation expense Goodwill impairment loss Undistributed equity method income (1) Gain on sale of property, plant and equipment Changes in current assets and liabilities: Increase in receivables Decrease in inventories Increase in current liabilities Net cash from operating activities Cash from investing activities Acquisition of property, plant and equipment Sale of property, plant and equipment (2) Net cash used for investing activities Cash from financing activities Increase in long-term liabilities Dividends paid to controlling shareholders Dividends paid to noncontrolling shareholders (3) Net cash from financing activities Net increase in cash Plus cash balance, January 1 Cash balance, December 31

$200,000 $ 250,000 80,000 (8,000) (50,000) (15,000) 50,000 25,000

272,000

60,000 532,000

(1,000,000) 500,000 (500,000)

80,000 (60,000) (15,000) 5,000 37,000 113,000 $ 150,000

(1) $10,000 - $2,000 = $8,000. (2) $1,100,000 + $250,000 – $1,200,000 = $150,000 accumulated depreciation on property sold; $5,800,000 + $1,000,000 - $6,200,000 = $600,000 original cost of property sold; $600,000 - $150,000 = $450,000 book value of property sold; $450,000 + $50,000 = $500,000 cash received on property sold. (3) $50,000 x 30% = $15,000.

PROBLEMS P5.1

Consolidation Working Paper, Date of Acquisition (in millions) a. Calculation of goodwill: Acquisition cost Fair value of noncontrolling interest Total fair value Book value of Schmidt Revaluations: Property, plant and equipment Patents and trademarks Customer-related intangibles Long-term liabilities Goodwill

$ 1,200 _375 1,575 $ 500 (200) 45 30 25

_ 400 $ 1,175

Allocation of goodwill between controlling and noncontrolling interest: Total goodwill Petra’s goodwill: $1,200 – (75% x $400) Goodwill to noncontrolling interest

$ 1,175 900 $ 275

b. Consolidation Working Paper Accounts Taken From Books

(in millions) Current assets PP&E, net Investment in Schmidt Patents and trademarks Customer-related intangibles Goodwill Current liabilities Long-term liabilities Common stock, par value Additional paid-in capital Retained earnings Treasury stock Accumulated OCL Noncontrolling interest Total liabilities and equity

Eliminations

Petra Dr (Cr) $ 1,500 1,600 1,200

Schmidt Dr (Cr) $ 325 600 --

1,300 --

(1,600) (1,900) (300) (1,950) (3,900) 4,000 50

(100) (400) (10) (200) (300) -10

______ $ 0

Cr 200 (R) 375 (E) 825 (R)

(R) 45 (R) 30 (R) 1,175 (R) (E) (E) (E)

25 10 200 300

______ $ 1,785

10 (E) 125 (E) 250 (R) $ 1,785

Consolidated Balances Dr (Cr) $ 1,825 2,000 -1,420 30 1,175 (1,700) (2,275) (300) (1,950) (3,900) 4,000 50

(375) 0

c. Consolidated Balance Sheet, July 1, 2020 (in millions) Assets Current assets Property, plant and equipment, net Goodwill Identifiable intangibles Total assets Liabilities and shareholders’ equity Current liabilities Long-term liabilities Total liabilities Shareholders’ equity Petra’s shareholders’ equity: Common stock Additional paid-in capital Retained earnings Treasury stock Accumulated other comprehensive loss Total Petra shareholders’ equity Noncontrolling interest Total shareholders’ equity Total liabilities and shareholders’ equity

P5.2

$ $

1,825 2,000 1,175 1,450 6,450 1,700 2,275 3,975

300 1,950 3,900 (4,000) (50) 2,100 375 2,475 $ 6,450

Consolidated Balance Sheet Working Paper, Date of Acquisition, Bargain Purchase (see related P3.4) (in millions) a. Acquisition cost Fair value of noncontrolling interest Total Book value of Saxon Revaluations: Inventory Equity method investments Land Buildings and equipment, net Identifiable intangibles Fair value of identifiable net assets Gain on acquisition

$ 1,400 200 $ 1,600 $ 1,295 (100) (50) 245 300 110 (1,800) $ (200)

Paxon’s acquisition entry: Investment in Saxon Cash Gain on acquisition

1,600 1,400 200

b. Consolidation Working Paper Accounts Taken From Books

Eliminations

(in millions)

Paxon Dr (Cr)

Saxon Dr (Cr)

Cash and receivables

$ 1,460

$ 720

Inventory

Consolidated Balances Dr (Cr) $ 2,180

1,700

900

100 (R)

2,500

Equity investments

300

50 (R)

250

Identifiable intangible assets

Investment in Saxon

(R)

110

1,600

110 1,036 (E) 564 (R)

Land

650

175

(R)

245

1,070

Buildings and equipment, net

2,400

600

(R)

300

3,300

Current liabilities

(1,500)

(1,000)

(2,500)

Long-term debt

(2,000)

(400)

(2,400)

Common stock, par value

(500)

(100)

(E)

100

(500)

Additional paid-in capital

(1,200)

(350)

(E)

350

(1,200)

Retained earnings

(2,610)

(845)

(E)

845

(2,610)

(R)

Noncontrolling interest Total

Note:

$ 2,009

259 (E) $ 2,009

(200) $

In journal entry form, the eliminating entries are:

(E) Common stock, par value Additional paid-in capital Retained earnings Investment in Saxon Noncontrolling interest

100 350 845 1,036 259

(R) Land Buildings and equipment Identifiable intangible assets Noncontrolling interest Inventory Equity method investments Investment in Saxon

245 300 110 59 100 50 564

The adjustment to noncontrolling interest brings its balance to fair value at the acquisition date. The adjustment to the investment eliminates the remaining balance. c. Consolidated Balance Sheet, January 1, 2019 (in millions) Assets Cash and receivables Inventory Current assets Equity method investments Land Buildings and equipment, net Identifiable intangible assets Total assets Liabilities and shareholders’ equity Current liabilities Long-term debt Total liabilities Shareholders’ equity Paxon shareholders’ equity: Common stock Additional paid-in capital Retained earnings Total Paxon shareholders’ equity Noncontrolling interest Total shareholders’ equity Total liabilities and shareholders’ equity

$ $

2,180 2,500 4,680 250 1,070 3,300 110 9,410 2,500 2,400 4,900

500 1,200 2,610 4,310 200 4,510 9,410

P5.3

Consolidation Eliminating Entries, Date of Acquisition (in thousands) a. Investment in Summer Merger expenses Cash Earnings contingency liability

11,000 400 10,400 1,000

b. Consolidation working paper eliminating entries: (E) Common stock Retained earnings Investment in Summer Noncontrolling interest

500 3,000 2,625 875

(R) In-process research and development Patents Goodwill (1) Cash and receivables Inventories Plant assets, net Lawsuit liability Investment in Summer (2) Noncontrolling interest (3) (1) Calculation of goodwill: Acquisition cost Fair value of noncontrolling interest Total fair value Book value of Summer Revaluations: Cash and receivables Inventories Plant assets, net Patents IPR&D Lawsuit liability Goodwill

2,000 1,000 10,600 400 800 2,000 500 8,375 1,525 $ 11,000 2,400 13,400 $ 3,500 (400) (800) (2,000) 1,000 2,000 (500)

(2,800) $ 10,600

Allocation of goodwill between controlling and noncontrolling interest: Total goodwill $ 10,600 Placer’s goodwill: $11,000 – (75% x $2,800) 8,900 Goodwill to noncontrolling interest $ 1,700 (2) [75% x ($1,000 + $2,000 – $400 – $800 – $2,000 – $500] + $8,900 = $8,375 (3) [25% x ($1,000 + $2,000 – $400 – $800 – $2,000 – $500)] + $1,700 = $1,525

P5.4

Consolidated Working Paper One Year After Acquisition, Bargain Purchase (see related P4.5) (in millions) a. Calculation of gain on acquisition: Acquisition cost Fair value of noncontrolling interest

$ 1,520 180 1,700

Book value ($100 + $350 + $845) Revaluations: Inventory Equity method investments Land Buildings and equipment Identifiable intangibles Gain on acquisition

$ 1,295 (100) (50) 245 300 110

(1,800) $ (100)

Saxon’s reported net income for 2019 ($10,000 + $10 – $8,000 – $40 – $25 – $1,600 = $345) Revaluation write-offs: Inventory Equity method investments (adjustment to gain on sale) Buildings and equipment ($300/20) Identifiable intangibles ($110/5)

Total

Equity in NI

Noncontrolling interest in NI

$ 345

$ 310.5

$ 34.5

100

50 (15) (22) $ 458

45 (13.5) (19.8) $ 412.2

5 (1.5) (2.2) $ 45.8

c. Consolidation Working Paper, December 31, 2019 Trial Balances Taken From Books Paxon Dr (Cr)

(in millions) Cash and receivables

Saxon Dr (Cr)

3,370

Inventory

Eliminations

Consolidated Balances Dr (Cr)

800

4,170

2,260

940

(O-1)

100

(R)

3,200

Equity method investments

(O-2)

(R)

Identifiable intangible assets

(R)

110

22 (O-4)

1,942.2

Investment in Saxon

322.2 (C) 1,165.5 (E) 454.5 (R)

Land

650

300

(R)

245

Buildings and equipment, net

3,600

1,150

(R)

300

Current liabilities

(2,020)

(1,200)

(3,220)

Long-term debt

(5,000)

(450)

(5,450)

Common stock

(500)

(100)

(E)

100

(500)

Additional paid-in capital

(1,200)

(350)

(E)

350

(1,200)

Retained earnings, Jan. 1

(2,410)

(845)

(E)

845

(2,410)

Noncontrolling interest

1,195 15 (O-3)

5,035

129.5 (E) 50.5 (R) 35.8 (N)

Dividends

Sales revenue

500

(30,000)

Equity in net income of Saxon

100

(C)

(N)

(10,000)

(215.8)

500 (40,000)

(412.2)

(10)

Gain on acquisition

(100)

Cost of goods sold

26,000

8,000

Depreciation and amortization expense

300

Interest expense

250

275

2,770

1,600

4,370

Gain on sale of securities

Other operating expenses Noncontrolling interest in NI $

(C)

412.2

-50 (O-2)

(60) (100)

100 (O-1) (O-3)

(O-4)

(N)

33,900 377

45.8

______

$ 2,595

45.8 $

P5.5

Consolidated Working Paper Two Years After Acquisition, Bargain Purchase (see related P5.4) (all amounts in millions) a. Saxon’s reported net income for 2020 ($12,000 – $9,500 – $60 – $40 – $2,200 = $200) Revaluation write-offs: Buildings and equipment ($300/20) Identifiable intangibles ($110/5)

Total

Equity in NI

Noncontrolling interest in NI

$ 200

$ 180

$ 20

(15) (22) $ 163

(13.5) (19.8) $ 146.7

(1.5) (2.2) $ 16.3

Note: Inventory (FIFO) and long-term investment revaluations were realized through sale in 2019. b. Consolidation Working Paper, December 31, 2020 Trial Balances Taken From Books

Eliminations

(in millions)

Paxon Dr (Cr)

Saxon Dr (Cr)

Cash and receivables

$ 3,100

Consolidated Balances Dr (Cr)

850

Inventory

2,500

950

Investment in Saxon

2,043.9

$ 101.7 (C) 1,386

(E)

556.2 (R) Land

3,950 3,450

650

250

(R)

245

Buildings and equipment, net

5,905

1,440

(R)

285

15 (O-1)

7,615

Identifiable intangible assets

(R)

22 (O-2)

Current liabilities

(2,500)

(1,000)

(3,500)

Long-term debt

(6,000)

(800)

(6,800)

Common stock

1,145

(500)

(100)

(E)

100

(500)

Additional paid-in capital

(1,200)

(350)

(E)

350

(1,200)

Retained earnings, Jan. 1

(3,102.2)

(1,090)

(E)

1,090

(3,102.2)

Noncontrolling interest

154

(E)

61.8 (R) 11.3 (N) continued

(227.1)

b. Consolidation Working Paper continued Consolidation Working Paper, December 31, 2020 Trial Balances Taken From Books

(in millions)

Paxon Dr (Cr)

Saxon Dr (Cr)

500

(35,000)

(12,000)

Dividends Sales revenue Equity in net income of Saxon

(146.7)

Cost of goods sold Depreciation and amortization expense Interest expense Other operating expenses Noncontrolling interest in NI

30,000

9,500

450

Consolidated Balances Dr (Cr)

Cr 45

(C)

(N)

500 (47,000)

(C)

146.7

-39,500

(O-1)

(O-2)

547

300

340

3,000

2,200

5,200

P5.6

Eliminations

(N)

16.3 $ 2,358

______

16.3

$ 2,358

Consolidation Working Paper, Second Year Following Acquisition (in millions) a. Calculation of 2020 equity in net loss and noncontrolling interest in net loss:

Silverstem reported loss ($2,200 + $300 + $200 – $1,800 – $1,000) = $(100)

Total

Equity in NL

Noncontrolling interest in NL

$ (100)

$ (70)

$ (30)

( 10)

(7)

(3)

$ (110)

$ (77)

$ (33)

Revaluation write-offs: Identifiable intangibles

b. Consolidation Working Paper, December 31, 2020 Trial Balances Taken From Books Dr (Cr)

Eliminations

(in millions)

Prim Valley Resorts

Silverstem Casinos

Current assets

1,400

Consolidated Balances Dr (Cr)

200

Land, buildings, riverboats and equipment, net

17,844.7

2,419

Intangible assets

2,500

800

(R)

(C)

80.5

436.8 (E)

Investment in Silverstem

398.3

1,600 20,263.7

(O)

3,350

(R)

Current liabilities

(1,500)

(300)

(1,800)

Long-term liabilities

(14,000)

(2,600)

(16,600)

Capital stock

(5,520)

(324)

(E)

324

(5,520)

Retained earnings, Jan. 1

(900)

(300)

(E)

300

(900)

Noncontrolling interest

(N)

34.5

187.2 (E) 18

Dividends

100

(R)

(170.7)

3.5 (C) 1.5 (N)

100

Casino revenues

(6,600)

(2,200)

(8,800)

Food and beverage revenues

(1,400)

(300)

(1,700)

Rooms revenues

(1,000)

(200)

(1,200)

Equity in net loss of Silverstem

Direct casino, food and beverage, rooms expenses

7,200

1,800

9,000

General and administrative expenses

1,400

1,000

2,400

Impairment losses

Noncontrolling interest in net loss

_____

$ 809

(O)

(C)

10 (N)

(33) $

P5.7

Equity Method and Eliminating Entries Three Years After Acquisition (see related P4.3) a. Calculation of equity in net income and noncontrolling interest in net income for 2020:

Sunset Coast’s reported net income for 2020 Revaluation write-offs: Plant assets ($500,000)/10 Identifiable intangibles $1,000,000/20

Total

Equity in NI

Noncontrolling interest in NI

$ 400,000

$ 360,000

$ 40,000

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

45,000 (180,000) $ 225,000

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

b. Calculation of investment balance at December 31, 2020: Investment in Sunset Coast, January 1, 2018 90% x Sunset Coast’s reported income, 2018-2019 90% x Sunset Coast’s reported dividends, 2018-2019 (50% of reported income) Revaluation write-offs, 2018-2019: Plant assets [($500,000)/10] x 2 x 90% Identifiable intangibles ($1,000,000/5) x 2 x 90% Goodwill impairment, 2019 ($100,000 x 90%) Investment in Sunset Coast, December 31, 2019 Equity in net income, 2020 (see requirement a.) 90% x Sunset Coast’s reported dividends, 2020 (90% x $200,000) Investment in Sunset Coast, December 31, 2020

$4,500,000 765,000 (382,500) 90,000 (360,000) (90,000) $4,522,500 225,000 (180,000) $4,567,500

Note: Under LIFO and increasing inventory, the revalued inventory is assumed to still be on hand. The noncontrolling interest is initially valued with no discount, so goodwill impairment is shared in a 90-10 ratio.

c. Calculation of noncontrolling interest balance at December 31, 2020: Fair value of noncontrolling interest, January 1, 2018 10% x Sunset Coast’s reported income, 2018-2019 10% x Sunset Coast’s reported dividends, 2018-2019 (50% of reported income) Revaluation write-offs, 2018-2019: Plant assets ($500,000/10) x 2 x 10% Identifiable intangibles ($1,000,000/5) x 2 x 10% Goodwill impairment, 2019 ($100,000 x 10%) Noncontrolling interest in Sunset Coast, December 31, 2019 Noncontrolling interest in net income, 2020 (see req. a.) Noncontrolling interest in dividends, 2020 Noncontrolling interest, December 31, 2020

$ 500,000 85,000 (42,500) 10,000 (40,000) (10,000) $ 502,500 25,000 (20,000) $507,500

d. Consolidation working paper eliminating entries for 2020: (C) Equity in net income of Sunset Coast Dividends–Sunset Coast Investment in Sunset Coast (E) Shareholders’ equity—Sunset Coast, 1/1 Investment in Sunset Coast Noncontrolling interest in Sunset Coast

225,000 180,000 45,000

1,825,000 1,642,500 182,500

Sunset Coast’s shareholders’ equity, January 1, 2020 = $1,400,000 + (1 - 0.5)($850,000) = $1,825,000.

(R) Identifiable intangibles 600,000 Goodwill 3,400,000 Inventory 400,000 Plant assets, net 400,000 Investment in Sunset Coast 2,880,000 Noncontrolling interest in Sunset Coast 320,000 Revaluations at January 1, 2020 = original revaluations less write-offs for 2018 and 2019. Original goodwill = $4,500,000 + $500,000 – ($1,400,000 - $400,000 $500,000 + $1,000,000) = $3,500,000, less $100,000 impairment in 2019 = $3,400,000. (O) Plant assets, net Amortization expense Depreciation expense Identifiable intangibles

50,000 200,000 50,000 200,000

(N) Noncontrolling interest in NI of Sunset Coast Dividends – Sunset Coast Noncontrolling interest in Sunset Coast

P5.8

25,000 20,000 5,000

Consolidation Working Paper After Several Years (in thousands) a. Calculation of goodwill: Acquisition cost Fair value of noncontrolling interest Total fair value Book value of Regional Bottling Previously unreported franchise rights Goodwill

$ 79,000 16,000 95,000 $ 25,000 10,000

35,000 $ 60,000

Allocation of goodwill between controlling and noncontrolling interest: Total goodwill Consolidated Bottling’s goodwill: $79,000 – (80% x $35,000) (85%) Goodwill to noncontrolling interest (15%)

$ 60,000 51,000 $ 9,000

b. Calculation of equity in net loss and noncontrolling interest in net loss for 2020: Equity in NL

Total Regional Bottling’s reported net income for 2020 (1) Revaluation write-offs: Franchise rights impairment Goodwill impairment (85:15 ratio)

$ 9,000

(3,000) (5,000) $ 1,000

(2,400) (4,250) $ 550

(1) $9,000 = $300,000 – ($175,000 + $108,000 + $8,000)

7,200

Noncontrolling interest in NL $

1,800

(600) __(750) $ 450

c. Calculation of investment balance at December 31, 2020: Investment in Regional Bottling, January 1, 2011 80% x Regional’s reported comprehensive income less dividends, 2011-2019 (2) 80% x franchise rights write-offs, 2011-2019 Investment in Regional Bottling, January 1, 2020 Equity in net income, 2020 Equity in OCL, 2020 Investment in Regional Bottling, December 31, 2020

$ 79,000 4,640 (1,600) 82,040 550 (16) $ 82,574

(2) Change in book value 2011-2019 of $5,800 (= $30,800 – $25,000) is attributed to accumulated comprehensive income less dividends, since the stock accounts did not change; $30,800 = $1,000 + $12,000 + $18,100 – $100 – $200.

d. Consolidation Working Paper, December 31, 2020 Trial Balances Taken From Books

Eliminations

(in thousands)

Consolidated Bottling Dr (Cr)

Regional Bottling Dr (Cr)

Current assets

$ 160,000

$ 30,000

Property, plant & equipment, net

248,000

233,780

Franchise rights, net

466,400

Investment in Regional Bottling

82,574

Consolidated Balances Dr (Cr) $

190,000 481,780

(R)

8,000

3,000 (O)

471,400

534 (C) 24,640 (E)

Goodwill

(R) 60,000

57,400 (R)

5,000 (O)

55,000

Current liabilities

(120,000)

(20,000)

(140,000)

Long-term debt

(700,000)

(204,000)

(904,000)

Common stock

(12,000)

(1,000)

(E)

1,000

(12,000)

Additional paid-in capital

(100,000)

(12,000)

(E) 12,000

(100,000)

Retained earnings, Jan. 1

(56,940)

(18,100)

(E) 18,100

(56,940)

Accumulated other comprehensive loss, Jan. 1

13,000

100

100 (E)

13,000

Treasury stock

30,000

200

200 (E)

30,000

Noncontrolling interest

6,160 (E) 10,600 (R) 446 (N)

(17,206)

Dividends

2,000

Net sales

(1,200,000)

(300,000)

(1,500,000)

(550)

Equity in net income of Regional Bottling Equity in OCL of Regional Bottling

(C)

550

-16 (C)

Cost of sales

760,000

175,000

935,000

Selling, delivery and administrative expenses

400,000

108,000

508,000

Impairment losses

500

Interest expense

28,000

8,000

Other comprehensive (income) loss

(O)

8,000

(1,000)

Noncontrolling interest in NI

Noncontrolling interest in OCL

_____

$108,100

8,500 36,000 (980)

(N)

450

450 4 (N) $108,100

(4) $

Note: Elimination (R): credit to Investment = (80% x $8,000) + $51,000; credit to NCI = (20% x $8,000) + $9,000.

e. Consolidated Statement of Income and Comprehensive Income Year Ended December 31, 2020 (in thousands)

Net sales Cost of sales Gross profit Selling, delivery and administrative expenses Impairment losses Interest expense Consolidated net income Less: Net income attributable to noncontrolling interest Net income attributable to Consolidated Bottling

$ 1,500,000 (935,000) 565,000 (508,000) (8,500) (36,000) 12,500 (450) $ 12,050

Consolidated net income Plus: Other comprehensive income Comprehensive income Less: Comprehensive income attributable to noncontrolling interest (1) Comprehensive income attributable to Consolidated Bottling

12,500 980 13,480 (446) 13,034

(1) $450 - $4 = $446

Consolidated Balance Sheet, December 31, 2020 (in thousands)

Assets Current assets Property, plant and equipment, net Franchise rights, net Goodwill Total assets Liabilities and shareholders’ equity Current liabilities Long-term liabilities Total liabilities Shareholders’ equity Consolidated Bottling shareholders’ equity: Common stock Additional paid-in capital Retained earnings (2) Treasury stock Accumulated other comprehensive loss (3) Total Consolidated Bottling shareholders’ equity Noncontrolling interest Total shareholders’ equity Total liabilities and shareholders’ equity (2) $56,940 + $12,050 - $2,000 = $66,990 (3) $13,000 - $980 - $4 = $12,016

190,000 481,780 471,400 55,000 $ 1,198,180 $

140,000 904,000 1,044,000

12,000 100,000 66,990 (30,000) (12,016) 136,974 17,206 154,180 $ 1,198,180

P5.9

Consolidated Statement of Cash Flows

Sunny Valley Resort and Subsidiary Consolidated Statement of Cash Flows For the year 2020 (in thousands)

Cash from operating activities Consolidated net income ($350,000 + $30,000) (1) Add (subtract) items not affecting cash: Depreciation expense Goodwill impairment loss Loss on retirement of plant assets Changes in current assets and liabilities: Decrease in other current assets Increase in current liabilities Net cash from operating activities Cash from investing activities Acquisition of plant assets (2) Cash from financing activities Decrease in noncurrent liabilities Dividends paid to controlling shareholders Dividends paid to noncontrolling shareholders Net increase in cash Plus cash balance, January 1 Cash balance, December 31

$ 380,000 $ 600,000 20,000 200,000 50,000 16,000

820,000

66,000 1,266,000 (400,000)

(700,000) (50,000) (16,000)

(766,000) 100,000 500,000 $ 600,000

(1) Noncontrolling interest in net income = $150,000 x 20% (2) X = cost of plant assets acquired; $2,900,000 + X – $600,000 – $200,000 = $2,500,000; X = $400,000.

P5.10 Consolidated Statement of Cash Flows

Prime Casinos and Saratoga International Hotels Consolidated Statement of Cash Flows For the Year ended December 31, 2020 (in millions)

Cash from operating activities: Consolidated net income Add (subtract) items not affecting cash from operations: Depreciation expense Goodwill impairment loss Loss on sale of plant assets Changes in current assets and liabilities: Increase in other current assets Increase in current liabilities Net cash from operating activities Cash from investing activities: Sale of property, plant and equipment (1) Acquisition of property, plant and equipment Cash from financing activities: Increase in long-term liabilities Issuance of capital stock Dividends paid to Prime Casino shareholders Dividends paid to noncontrolling interest (2) Net increase in cash Plus cash balance, January 1, 2020 Cash balance, December 31, 2020 (1) Cost of property sold = $2,500 + $675 - $3,100 = $75 Accumulated depreciation on property sold = $800 + $250 - $1,000 = $50 Cash received from sale of property = $75 - $50 - $10 = $15 (2) $150 + $12 – $160 = $2

$ 612 $ 250 25 10 (100) 250

15 (675)

150 200 (435) (2)

285

150 1,047

(660)

(87) 300 200 $ 500

P5.11 Consolidation Two Years After Acquisition, IFRS (in millions) a. Calculation of goodwill is as follows: Acquisition cost Book value of Monaco Revaluations: Inventory Property, plant and equipment Identifiable intangibles Fair value of identifiable net assets

€ 4,000 € 1,000 (100) 400 300 1,600 x 80%

Goodwill

1,280 € 2,720

b. Calculation of equity in net income and noncontrolling interest in net income for 2020:

Monaco’s reported net income for 2020 (1) Revaluation write-offs: Property, plant and equipment €400/10 Identifiable intangibles €300/3 Goodwill

(1) €600 = €3,500 – (€2,500 + €400)

Total € 600

Equity in NI € 480

(40) (100) (200) € 260

(32) (80) (200) € 168

Noncontrolling interest in NI € 120

_ €

(8) (20) _-92

c. Consolidation Working Paper, December 31, 2020 Trial Balances Taken From Books

(in millions)

Rendezvous Dr (Cr)

Current assets

€

500

Eliminations

Monaco Dr (Cr) €

€

900

Property, plant and equipment, net

3,000

2,000

Investment in Monaco

4,316

Consolidated Balances Dr (Cr)

(R)

360

40 (O)

1,400 5,320

128 (C) 1,120 (E) 3,068 (R)

200

100 (O)

300

(R) 2,620

200 (O)

2,420

Identifiable intangibles

200

Goodwill

Liabilities

(4,648)

(1,150)

Capital stock

(1,500)

(800)

(E)

800

(1,500)

Retained earnings, Jan. 1

(1,000)

(600)

(E)

600

(1,000)

Noncontrolling interest

(R)

(5,798)

280 (E) 112 (R) 82 (N)

Dividends

(474)

40 (C) 10 (N)

Sales revenue

(5,000)

(3,500)

Equity in NI of Monaco

(168)

Cost of sales

4,200

2,500

(O)

200

300

400

(O)

840

(O)

100

(N)

____

€ 5,180

Goodwill impairment loss Administrative and other operating expenses

Noncontrolling interest in NI

-€

(8,500) (C)

168

-6,700

92 €

P5.12 Consolidation Several Years After Acquisition, IFRS (in thousands) a. Calculation of goodwill is as follows: Acquisition cost Book value of Hearty Revaluations: Plant and equipment Identifiable intangibles Long-term debt Fair value of identifiable net assets

€ 150,000 € 70,000 (50,000) 40,000 2,000 62,000 x 75%

Goodwill

46,500 € 103,500

b. Calculation of equity in net income and noncontrolling interest in net income for 2020:

Total € 15,000

Equity in NI € 11,250

Property, plant and equipment (€50,000/10)

5,000

3,750

1,250

Identifiable intangibles (€40,000/10)

(4,000)

(3,000)

(1,000)

(750)

€ 15,250

€ 11,250

€ 4,000

Hearty’s reported net income for 2020 (1)

Noncontrolling interest in NI € 3,750

Revaluation write-offs:

Goodwill

(1) €15,000 = €140,000 – (€80,000 + €45,000)

c. Consolidation Working Paper, December 31, 2020 Trial Balances Taken From Books

Eliminations

(in thousands)

Lily Dr (Cr)

Hearty Dr (Cr)

Current assets

€ 35,000

€ 20,000

Property, plant and equipment, net

226,500

202,000

Investment in Hearty

176,750

Consolidated Balances Dr (Cr) €

(O)

5,000

30,000 (R)

55,000 403,500

11,250 (C) 69,000 (E)

Identifiable intangibles

96,500 (R)

24,000

4,000 (O)

130,000

(R) 101,000

750 (O)

100,250

100,000

10,000

Current liabilities

(30,000)

(25,000)

(55,000)

Long-term debt

(350,000)

(100,000)

(450,000)

Capital stock

(80,000)

(54,000)

(E)

54,000

(80,000)

Retained earnings, Jan. 1

(60,000)

(38,000)

(E)

38,000

(60,000)

(R)

1,500

Goodwill

Noncontrolling interest

(R)

23,000 (E) 4,000 (N)

Sales revenue

(400,000)

(140,000)

Equity in net income of Hearty

(11,250)

Cost of goods sold

250,000

80,000

Goodwill impairment loss

(O)

750

Other operating expenses

143,000

45,000

(O)

4,000

(N)

4,000

______

€243,500

Noncontrolling interest in NI €

€

(25,500) (540,000)

(C)

11,250

-330,000 750 5,000 (O)

187,000 4,000 €

P5.13 Consolidation Two Years After Acquisition (in thousands) a. Calculation of 2020 equity in net income and noncontrolling interest in net income:

Silver Nugget’s reported NI for 2020 ($100,000 – $80,000 – $14,000 = $6,000) Revaluation write-off: Identifiable intangibles ($20,000/5)

Total

Equity in NI

Noncontrolling interest in NI

$ 6,000

$ 4,800

$ 1,200

(4,000) $ 2,000

(3,200) $ 1,600

(800) $ 400

b. Consolidation Working Paper, December 31, 2020 Trial Balances Taken From Books

(in thousands)

Mirror Resorts Dr (Cr)

Current assets

35,000

Eliminations

Silver Nugget Dr (Cr) $

5,000

Plant and equipment, net

216,600

140,000

Intangibles

350,000

51,050

Investment in Silver Nugget

86,440

Consolidated Balances Dr (Cr) $

40,000 356,600

(R) 16,000

4,000 (O)

413,050

440 (C) 17,200 (E) 68,800 (R)

Goodwill (1)

(R) 68,000

-68,000

Current liabilities

(50,000)

(20,000)

(70,000)

Long-term debt

(600,000)

(150,000)

(750,000)

Common stock

(500)

(100)

(E)

100

(500)

Additional paid-in capital

(6,000)

(5,500)

(E)

5,500

(6,000)

Retained earnings, Jan. 1

(25,000)

(17,700)

(E) 17,700

(25,000)

AOCI, Jan. 1

(1,000)

200

200 (E)

(1,000)

Treasury stock

4,000

1,600

1,600 (E)

4,000

Noncontrolling interest

4,300 (E) 15,200 (R) 110 (N)

continued

(19,610)

b. Consolidation Working Paper continued Consolidation Working Paper, December 31, 2020 Trial Balances Taken From Books

(in thousands)

Mirror Resorts Dr (Cr)

Dividends

Eliminations

Silver Nugget Dr (Cr)

2,000

1,500

Consolidated Balances Dr (Cr)

1,200 (C) 300 (N)

Sales revenue

(800,000)

(100,000)

Equity in net income of Silver Nugget

(1,600)

Equity in OCI of Silver Nugget

(40)

(900,000) (C)

1,600

(C)

Cost of goods sold

650,000

80,000

Operating expenses

140,000

14,000

Other comprehensive income

100

(50)

Noncontrolling interest in NI

(N)

400

Noncontrolling interest in OCI

(N)

________

$ 113,350

730,000 (O)

4,000

158,000 50

400

(1) Original goodwill = $80,000 + $18,000 - $10,000 - $20,000 = $68,000 Goodwill allocated to Mirror Resorts = $80,000 – [80% x ($10,000 + $20,000)] = $56,000

P5.14 Consolidation Working Paper One Year After Acquisition (in thousands) a. Calculation of goodwill: Acquisition cost Fair value of noncontrolling interest Total fair value Book value of Shawnee Revaluations: Plant and equipment Licenses and certificates Goodwill

2,000

$ 25,400 11,600 37,000 $ 2,000 (5,000) 8,000

5,000 $ 32,000

10 $

Allocation of goodwill between controlling and noncontrolling interest: Total goodwill Pine Mountain’s goodwill: $25,400 – (60% x $5,000) = Goodwill to noncontrolling interest

32,000 22,400 9,600

Goodwill is allocated in a 70:30 ratio. b. Calculation of 2019 equity in net income and noncontrolling interest in net income:

Shawnee’s reported NI for 2019 ($4,000 – $2,100 = $1,900) Revaluation write-offs: Plant and equipment ($5,000/10) Licenses and certificates ($8,000/4) Goodwill impairment loss (70:30 ratio)

Total

Equity in NI

Noncontrolling interest in NI

$ 1,900

$ 1,140

$ 760

500 (2,000) (150) $ 250

300 (1,200) (105) $ 135

200 (800) (45) $ 115

c. Consolidation Working Paper Accounts Taken From Books

Eliminations

(in thousands)

Pine Mountain Dr (Cr)

Shawnee Peak Dr (Cr)

Current assets

5,000

1,000

Plant and equipment, net

70,000

12,000

AFS investments

2,000

800

Investment in Shawnee

25,538

Consolidated Balances Dr (Cr) $

(O)

500

5,000 (R)

6,000 77,500 2,800

138 (C) 1,200 (E) 24,200 (R)

Licenses and certificates

(R)

8,000

2,000 (O)

6,000

Goodwill

(R)

32,000

150 (O)

31,850

Liabilities

(82,577)

(9,895)

Capital stock

(100)

(9)

(E)

(100)

(13,700)

(1,985)

(E)

1,985

(13,700)

(15)

(6)

(E)

(15)

Retained earnings, Jan. 1 AOCI, January 1

continued

(92,472)

c. Consolidation Working Paper continued Consolidation Working Paper Accounts Taken From Books

(in thousands)

Pine Mountain Dr (Cr)

Eliminations

Shawnee Peak Dr (Cr)

Consolidated Balances Dr (Cr)

Noncontrolling interest

800 (E) 10,800 (R) 117 (N)

Revenues

(11,717)

(28,000)

(4,000)

(135)

(C)

135

(3)

(C)

22,000

2,100

(O)

1,650

25,750

Unrealized gains (OCI)

(8)

(5)

Noncontrolling interest in income

(N)

115

Noncontrolling interest in OCI

(N)

______

$ 44,405

Equity in net income Equity in OCI Operating expenses

Total

(32,000)

(13) 115 2 $

d. Consolidated Statement of Income and Comprehensive Income Year Ended December 31, 2019 (in thousands)

Revenues Operating expenses Consolidated net income Net income attributable to noncontrolling interest Net income attributable to Pine Mountain Consolidated net income Other comprehensive income: Unrealized gains on AFS securities Comprehensive income Comprehensive income attributable to noncontrolling interest (1) Comprehensive income attributable to Pine Mountain (1) $115 + $2 = $117

$ 32,000 (25,750) 6,250 (115) 6,135 6,250

13 6,263 (117) 6,146

Consolidated Balance Sheet, December 31, 2019 (in thousands)

Assets Current assets Plant and equipment, net AFS investments Licenses and certificates Goodwill Total assets Liabilities and shareholders’ equity Liabilities Shareholders’ equity Pine Mountain shareholders’ equity: Capital stock Retained earnings (2) Accumulated other comprehensive income (3) Pine Mountain shareholders’ equity Noncontrolling interest Total shareholders’ equity Total liabilities and shareholders’ equity

6,000 77,500 2,800 6,000 31,850 $ 124,150 $

92,472

100 19,835 26 19,961 11,717 31,678 $ 124,150

(2) $13,700 + $6,135 = $19,835 (3) $15 + $13 - $2 = $26

P5.15 Interpreting Financial Statements (numbers in thousands) a. Noncontrolling interest in net income is $135,438 and noncontrolling interest in comprehensive income is $134,680. Therefore, noncontrolling interest in other comprehensive loss is $135,438 - $134,680 = $758. b.

(N) Noncontrolling interest in net income Noncontrolling interest in OCL Dividends Noncontrolling interest

135,438 758 103,457 31,223

c. Revenues Income from unconsolidated affiliates Expenses Nonoperating expenses Tax expense Noncontrolling interest in net income Retained earnings

9,455,123 527,616 7,902,952 820,610 22,299 135,438 1,101,440

Accumulated OCI Noncontrolling interest in OCL OCL

43 758 801

P5.16 Consolidation of VIE in Subsequent Year Consolidation Working Paper, December 31, 2019 Trial Balances Taken From Books Pontus Dr (Cr) Current assets

Eliminations

Vantage Dr (Cr)

4,000,000

1,600,000

Consolidated Balances Dr (Cr) $

5,600,000

Investments

6,000,000

33,000,000

Plant assets, net

58,900,000

900,000

Intangible assets

(R) 1,500,000

Goodwill

(R) 2,900,000

Current liabilities

(5,000,000)

(2,000,000)

(7,000,000)

Long-term liabilities

(30,000,000)

(28,000,000)

(58,000,000)

Capital stock

(10,000,000)

(4,300,000)

(E) 4,300,000

(10,000,000)

Retained earnings, Jan. 1

(22,000,000)

(1,000,000)

(E) 1,000,000

(22,000,000)

Noncontrolling interest

39,000,000 59,800,000 125,000 (O)

1,375,000 2,900,000

5,300,000 (E) 4,400,000 (R) 75,000 (N)

Dividends

600,000

100,000

Revenues

(150,000,000)

(25,000,000)

Expenses

147,500,000

24,700,000

(O) 125,000

(N) 175,000

$10,000,000 $10,000,000

Noncontrolling interest in NI $

(9,775,000)

100,000 (N)

600,000 (175,000,000) 172,325,000

____

175,000 $

Note 1: Original goodwill = $10,000,000 - $4,700,000 - $2,000,000 = $3,300,000; goodwill at 1/1/19 = $3,300,000 $400,000 = $2,900,000. Note 2: NCI in NI = $25,000,000 - $24,700,000 - $125,000 = $175,000.

P5.17 Consolidated Statement of Cash Flows

Park Plaza Resort and Superior Hotels Consolidated Statement of Cash Flows For the Year ended December 31, 2020 Cash from operating activities: Consolidated net income Add (subtract) items not affecting cash from operations: Depreciation expense Amortization expense Goodwill impairment loss Undistributed equity method income (1) Loss on sale of plant assets Changes in current assets and liabilities: Decrease in receivables Increase in inventory Increase in accounts payable Net cash from operating activities Cash from investing activities: Sale of property (2) Acquisition of property Cash from financing activities: Payment of long-term liabilities (3) Dividends paid to Park Plaza shareholders Dividends paid to noncontrolling interest (4) Net increase in cash Plus cash balance, January 1, 2020 Cash balance, December 31, 2020

$ 400,000 $ 750,000 100,000 200,000 (7,000) 150,000 220,000 (320,000) 250,000

100,000 (1,500,000)

(115,000) (176,000) (12,000)

1,193,000

150,000 1,743,000

(1,400,000)

(303,000) 40,000 600,000 $ 640,000

(1) $100,000 - $93,000 = $7,000. (2) Book value of property sold = $3,250,000 + $1,500,000 - 750,000 - $3,750,000 = $250,000. Cash received from sale of property = $250,000 - $150,000 = $100,000. (3) $9,120,000 - $5,000 - $9,000,000 = $115,000. (4) $30,000 x 40% = $12,000.

CHAPTER 6 SOLUTIONS TO MULTIPLE CHOICE QUESTIONS, EXERCISES AND PROBLEMS

MULTIPLE CHOICE QUESTIONS 1.

c Only the expenses related to provision of services are transactions with outside parties. The $3,000,000 revenue reported by Suzlon and the $3,000,000 expense reported by Patni are eliminated.

d Eliminating entries remove the intercompany asset (loan receivable) and liability (loan payable) and the interest revenue and interest expense. There is no effect on timing of income recognition, and therefore no adjustment is made to the investment account or beginning retained earnings.

a Downstream sales only affect equity in net income. The effect is to add the confirmed profit on beginning inventory of $90,000 (= $540,000 – $540,000/1.2) and subtract the unconfirmed profit on ending inventory of $80,000 (= $480,000 – $480,000/1.2), an increase of $10,000.

d Only the adjustment to 2020 depreciation affects equity in net income and noncontrolling interest in net income. It is an upstream sale, so the increase of $2,000,000/10 = $200,000 is shared 90% – 10%.

b From the consolidated company’s perspective, it paid $35,000 for the land and sold it for $85,000. Therefore the consolidated gain is $50,000.

a The intercompany gain, recognized by the subsidiary in 2017, is $400,000. In 2020, the parent sells the land to an outside party for $550,000, reporting a loss of $850,000 (= $1,400,000 – $550,000). The consolidated loss is $450,000 (= $1,000,000 – $550,000).

The 2020 eliminating entry adjusts the reported $850,000 loss to $450,000, and reclassifies it from the subsidiary’s beginning retained earnings. 7.

a The consolidation working paper for 2020 is:

Inventory

Parent Subsidiary $100,000 $ --

Cr Consolidated 20,000 (I-2) $ 80,000

Sales

450,000

500,000

(I-1) 500,000

450,000

CGS

400,000

(I-2) 20,000 500,000 (I-1)

320,000

d Eliminating entries are: Sales

30,000,000 CGS

30,000,000

Investment in subsidiary CGS

200,000

CGS

225,000

200,000

Inventory 9.

225,000

b Eliminating entries are: Patent

600,000

Investment in subsidiary 600,000 Unconfirmed downstream loss at the beginning of 2020 is [($1,000,000/5) x 3)] = $600,000. Amortization expense Patent To correct the amortization expense for 2020.

200,000 200,000

10.

c Eliminating entries are: Retained earnings, subsidiary 1,700,000 Equipment, net 1,700,000 Unconfirmed upstream gain at the beginning of 2019 is [($2,000,000/20) x 17)] = $1,700,000. Equipment, net Depreciation expense To correct the depreciation expense for 2019.

100,000 100,000

EXERCISES E6.1

Downstream Intercompany Land Transactions a. Eliminating entries: 2019 Gain on sale of land 3,000,000 Land 3,000,000 To eliminate the unconfirmed gain on the intercompany sale of land and reduce the land account to original acquisition cost. 2020 Investment in Saucony 3,000,000 Land 3,000,000 To add the prior year unconfirmed gain to the investment account to maintain equivalence with the retained earnings of Saucony and reduce the land account to original acquisition cost. b. 2021 Investment in Saucony 3,000,000 Gain on sale of land 3,000,000 To include the prior year intercompany gain, now confirmed, in current year income and restate the investment account by offsetting the previous reduction while the gain was unconfirmed.

E6.2

Upstream Intercompany Land Transactions a. Eliminating entries: 2019 Land

2,500,000

Loss on sale of land 2,500,000 To eliminate the unconfirmed loss on the intercompany sale of land and increase the land account to original acquisition cost. 2020 Land

2,500,000 Retained earnings, beginning - Source 2,500,000 To remove the unconfirmed loss from Source’s retained earnings and increase the land account to original acquisition cost.

b. Eliminating entry: 2023 Loss on sale of land 2,500,000 Retained earnings, beginning - Source 2,500,000 To remove the intercompany loss from beginning retained earnings and adjust the reported gain on the sale of land ($1,000,000) to the correct consolidated amount. Pony reports a gain of $1,000,000 (= $11,000,000 – $10,000,000) on the sale. The eliminating entry adjusts this gain with a loss of $2,500,000. The consolidated entity reports a 2023 loss on the sale of land of $1,500,000 (= $11,000,000 – $12,500,000).

E6.3

Downstream Intercompany Merchandise Transactions (in thousands) a. Eliminating entries: Investment in Sketchy 1,250 Cost of goods sold To eliminate the intercompany profit on downstream intercompany sales from Sketchy’s beginning inventory; $1,250 = $6,250 – $6,250/1.25. Sales revenue Cost of goods sold To eliminate intercompany sales and purchases.

1,250

250,000 250,000

Cost of goods sold 1,325 Inventories 1,325 To eliminate the intercompany profit from Sketchy’s ending inventory; $1,325 = $6,625 – $6,625/1.25. b. Excerpts from the consolidation working paper are as follows: Pacific Brands Dr (Cr)

Sketchy Shoes Dr (Cr)

Sales revenue

$250,000

$300,000

$250,000

Cost of goods sold

200,000

249,625

1,325 $250,000 1,250

Consolidated Balances Dr (Cr) $300,000 199,700

Pacific sales revenue is $250,000, and at a 25% markup, its cost of goods sold is $250,000/1.25 = $200,000. Sketchy’s cost of goods sold is: Beginning inventory…………………… Plus purchases…………………………. Less ending inventory…………………. Cost of goods sold……………………..

6,250 250,000 (6,625) $249,625

Consolidated sales revenue should be only the outside sales made by Sketchy, $300,000. Consolidated cost of goods sold should be the amount recorded by Sketchy, with the markup removed: $249,625/1.25 = $199,700. The eliminating entries above adjust the amounts reported on the separate books to the correct consolidated amounts.

E6.4

Upstream Intercompany Merchandise Transactions a. Eliminating entries: Retained earnings, beginning - Krocker 2,250 Cost of goods sold 2,250 To eliminate the intercompany profit on upstream intercompany sales from Krocker’s beginning inventory; $11,250 – $11,250/1.25 = $2,250. Sales revenue Cost of goods sold To eliminate intercompany sales and purchases.

1,500,000 1,500,000

Cost of goods sold 2,050 Inventories 2,050 To eliminate the intercompany profit from Krocker’s ending inventory; $10,250 – $10,250/1.25 = $2,050.

b. Krocker’s cost of shoe accessories sold = $11,250 + $1,500,000 – $10,250 = $1,501,000. The amount that should appear is the amount charged by Jimmitz, less the markup, or $1,501,000/1.25 = $1,200,800. In addition, Jimmitz recorded cost of goods sold of $1,500,000/1.25 = $1,200,000, when it sold the shoe accessories to Krocker. The eliminating entries transform the balances reported by Krocker and Jimmitz into the correct consolidated balance: $1,501,000 + $1,200,000 – $2,250 - $1,500,000 + $2,050 = $1,200,800. An excerpt from the consolidated working paper illustrates how the eliminating entries transform the balances reported on the books into the correct consolidated balances.

E6.5

Krocker Dr (Cr)

Jimmitz Dr (Cr)

Sales revenue

N/A

$1,500,000

Cost of goods sold

$1,501,000

1,200,000

Consolidated Balances Dr (Cr) --

2,050 $ 1,500,000 2,250

$1,200,800

Downstream Intercompany Equipment Transactions a. December 31, 2020 eliminating entries: Equipment, net Investment in Shiek To eliminate the beginning-of-year unconfirmed loss. $200,000 – [($200,000/5) x 1.5] = $140,000.

140,000 140,000

Depreciation expense 40,000 Equipment, net 40,000 To correct the depreciation expense recorded by Shiek in 2020 ($200,000/5).

b. December 31, 2021 eliminating entries: Equipment, net Investment in Shiek To eliminate the beginning-of-year unconfirmed loss. $200,000 – [($200,000/5) x 2.5] = $100,000.

100,000

Depreciation expense 40,000 Equipment, net To correct depreciation expense recorded by Shiek in 2021 ($200,000/5).

100,000

40,000

c. The consolidated gain on the sale of equipment is calculated as follows: Book value = $1,000,000 – (($1,000,000/5) x 3.5) = $300,000 Gain = $400,000 - $300,000 = $100,000 Shiek reports a gain on the sale of equipment as follows: Book value = $800,000 – (($800,000/5) x 3.5) = $240,000 Gain = $400,000 - $240,000 = $160,000 December 31, 2022 eliminating entry: Gain on sale of equipment 60,000 Investment in Shiek To adjust the recorded gain to the correct consolidated amount; $200,000 – (($200,000/5) x 3.5) = $60,000.

E6.6

60,000

Upstream Intercompany Building Transactions The gain reported by Shiek Shoes was $8,000,000 – ($10,000,000 – $8,500,000) = $6,500,000. a. December 31, 2020 eliminating entries: Retained earnings, beginning - Shiek 5,850,000 Accumulated depreciation 650,000 Building 6,500,000 To eliminate the beginning-of-year unconfirmed gain. $6,500,000 – [($6,500,000/20) x 2] = $5,850,000, and remove the confirmed gain (= $6,500,000/20 x 2) from the beginning balance of accumulated depreciation.

Accumulated depreciation 325,000 Depreciation expense 325,000 To eliminate the excess depreciation recorded by Pearl in 2020 (= $6,500,000/20). Building 8,500,000 Accumulated depreciation 8,500,000 To restate the building and accumulated depreciation accounts to their original acquisition cost basis. b. In Pearl’s December 31, 2020, trial balance, these balances appear: Building…………………………………………………. Accumulated depreciation (1)…………………………… Depreciation expense (2)…………………………………

$ 8,000,000 (1,200,000) 400,000

(1) $8,000,000/20 x 3 = $1,200,000. (2) $8,000,000/20 = $400,000.

The consolidated balances should be: Building…………………………………………………… $10,000,000 Accumulated depreciation (3)……………………………… 8,725,000 Depreciation expense (4)…………………………………… 75,000 (3) $8,500,000 + [($10,000,000 - $8,500,000)/20 x 3] = $8,725,000. (4) ($10,000,000 - $8,500,000)/20 = $75,000.

Using the eliminating entries above, the balances are adjusted as follows: Building: $8,000,000 – $6,500,000 + $8,500,000 = $10,000,000. Accumulated depreciation: $1,200,000 – $650,000 – $325,000 + $8,500,000 = $8,725,000. Depreciation expense: $400,000 – $325,000 = $75,000.

E6.7

Intercompany Financing Transactions a. and b. PF Consolidated Inc. Dr (Cr) Loan receivable

Sessions Athletic Gear Dr (Cr)

Consolidated Balances Dr (Cr)

$5,000,000

62,500

Interest receivable

0 0

Interest payable

(62,500)

$ 62,500

Loan payable

(5,000,000)

5,000,000

250,000

Interest revenue

(250,000)

Interest expense

250,000

Accrued interest at December 31, 2020, is $5,000,000 x 5% x 3/12 = $62,500. Interest revenue/expense for 2020 = $5,000,000 x 5% = $250,000. No balances should appear on the consolidated financial statements. Eliminating entries, in journal entry form, are: Loan payable Loan receivable

5,000,000

Interest payable Interest receivable

62,500

Interest revenue Interest expense

250,000

5,000,000

62,500

250,000

E6.8

Intercompany Service Transactions a. and b. PF Consolidated Inc. Dr (Cr) Accounts receivable

Sessions Athletic Gear Dr (Cr)

$100,000

Accounts payable

$ 100,000

Consolidated Balances Dr (Cr) $

$(100,000)

$ 100,000

8,000,000

Consulting revenue

(8,000,000)

Administrative expenses

5,000,000

8,000,000

5,000,000

The only transactions with outside parties are PF’s costs associated with providing the consulting services to Session. Therefore the consolidated statements should only show administrative expenses of $5,000,000. Eliminating entries, in journal entry form, are: Accounts payable Accounts receivable Consulting revenue Administrative expenses

E6.9

100,000 100,000 8,000,000 8,000,000

Various Intercompany Transactions a. Consolidation eliminating entries, upstream transactions: Retained earnings – Sand Hill Land

4,000,000

Retained Earnings – Sand Hill Cost of goods sold

2,400,000

Sales revenue Cost of goods sold

40,000,000

Cost of goods sold Inventory

2,200,000

4,000,000

2,400,000

40,000,000

2,200,000

Retained earnings – Sand Hill Accumulated depreciation Equipment

1,200,000 300,000

Accumulated depreciation Depreciation expense

150,000

Equipment Accumulated depreciation

1,500,000

150,000 1,000,000 1,000,000

b. Consolidation eliminating entries, downstream transactions: Investment in Sand Hill Land

4,000,000

Investment in Sand Hill Cost of goods sold

2,400,000

Sales revenue Cost of goods sold

40,000,000

Cost of goods sold Inventory

2,200,000

Investment in Sand Hill Accumulated depreciation Equipment

1,200,000 300,000

Accumulated depreciation Depreciation expense

150,000

Equipment Accumulated depreciation

4,000,000

2,400,000

40,000,000

2,200,000

1,500,000

150,000 1,000,000 1,000,000

E6.10 Intercompany Transactions, Equity Method Income and Noncontrolling Interest a.

Swaraj reported net income Amortization of identifiable intangibles Upstream loss on land Unconfirmed profit in end. inventory - upstream Confirmed profit in beg. inventory - upstream Confirmed profit on downstream equipment sale (= $1,000,000/10)

Total

Equity in NI

$7,000,000 (1,750,000) 300,000 (600,000) 350,000

$5,600,000 (1,400,000) 240,000 (480,000) 280,000

$1,400,000 (350,000) 60,000 (120,000) 70,000

100,000 $5,400,000

100,000 $4,340,000

_________ $1,060,000

Noncontrolling Interest in NI

b. Consolidation eliminating entries: Land Loss on sale of land To eliminate the unconfirmed loss on upstream land sale.

300,000 300,000

Cost of goods sold 600,000 Inventory 600,000 To eliminate the unconfirmed profit in ending inventory due to upstream sales. Retained earnings—Swaraj, beg. 350,000 Cost of goods sold 350,000 To recognize the confirmed profit in beginning inventory due to upstream sales. Investment in Swaraj 700,000 Equipment, net 700,000 To eliminate the unconfirmed profit as of the beginning of the year on downstream equipment sales (= 7/10 x $1,000,000). Equipment, net 100,000 Depreciation expense 100,000 To eliminate intercompany profit from depreciation expense (= $1,000,000/10).

E6.11 Consolidated Income Statement, Intercompany Transactions a. Star’s reported net income Amortization of identifiable intangibles Goodwill impairment loss (90:10) Confirmed profit in BI - upstream Confirmed profit in BI - downstream Unconfirmed profit in EI - upstream Unconfirmed profit in EI - downstream

Total

Equity in NI

Noncontrolling Interest in NI

$ 900,000 (100,000) (250,000) 100,000 90,000 (120,000) (50,000) $ 570,000

$ 720,000 (80,000) (225,000) 80,000 90,000 (96,000) (50,000) $ 439,000

$ 180,000 (20,000) (25,000) 20,000 -(24,000) -$ 131,000

b. Pon and Star Consolidated Income Statement Sales ($9,000,000 + $4,000,000 – $1,500,000) Cost of goods sold ($6,000,000 + $2,500,000 – $1,500,000 – $100,000 - $90,000 + $120,000 + $50,000) Other expenses ($2,000,000 + $600,000 + $100,000 + $250,000) Consolidated net income Less consolidated net income attributed to noncontrolling interest Consolidated net income attributed to controlling interest

$ 11,500,000 ( 6,980,000) ( 2,950,000) 1,570,000 ( 131,000) $ 1,439,000

E6.12 Consolidated Net Income (in thousands) a. B&H reported net income Revaluation write-off: cost of goods sold Revaluation write-off: depreciation expense Revaluation write-off: interest expense Revaluation write-off: IPR&D impairment Intercompany profits: downstream beginning inventory Intercompany profits: downstream ending inventory Intercompany profits: downstream loss on patent sale Intercompany profits: confirmed downstream patent loss ($500/5)

Total

Equity in NI

Noncontrolling Interest in NI

$ 20,000 900 300 (100) (600)

$ 10,200 459 153 (51) (306)

700 (400) 500

----

(100) $ 21,200

(100) $ 11,155

-$ 10,045

9,800 441 147 (49) (294)

b. Caleres’ net income from its own operations B&H’s net income from its own operations Revaluation write-off: cost of goods sold Revaluation write-off: depreciation expense Revaluation write-off: interest expense Revaluation write-off: IPR&D impairment loss Intercompany profits: confirmed profit on beginning inventory Intercompany profits: unconfirmed profit on ending inventory Intercompany profits: loss on sale of patent Intercompany profits: confirmed loss on sale of patent ($500/5) Consolidated net income Less consolidated net income attributed to noncontrolling interest Consolidated net income attributed to controlling interest

$ 50,000 20,000 900 300 (100) (600) 700 (400) 500 (100) 71,200 (10,045) $ 61,155

Note: Consolidated net income to the controlling interest ($61,155) equals the parent’s separate net income ($50,000) plus its equity in net income of the subsidiary ($11,155).

E6.13 Consolidation Working Paper Eliminations, Intercompany Merchandise Sales

a. (in thousands) Stallion’s reported income (1) Confirmed profit in beginning inventory (2) Unconfirmed profit in ending inventory (3) Equity in net income

$1,000 700 (450) $1,250

Acquisition cost (4) Change in book value to the beginning of the year (5) Goodwill write-off to the beginning of the year Unconfirmed profit in last year’s ending inventory (2) Investment balance, beginning of year Equity in net income, current year Investment balance, end of year

$10,000 2,000 (500) (700) 10,800 1,250 $12,050

(1) (2) (3) (4) (5)

$150,000 - $90,000 - $59,000 = $1,000 $300 + $400 = $700 $200 + $250 = $450 $3,000 + $7,000 = $10,000 ($1,000 + $4,000) - $3,000 = $2,000

b. Consolidation Working Paper Trial Balances Taken From Books

Eliminations

(in thousands)

Prance Dr (Cr)

Current assets

Plant and equipment, net

350,000

250,000

Investment in Stallion

12,050

2,500

Stallion Dr (Cr) $

1,500

Consolidated Balances Dr (Cr)

450 (I-3)

3,550 600,000

(I-2)

400

1,250 (C) 4,700 (E) 6,500 (R)

Goodwill

Liabilities

(353,300)

(245,500)

Capital stock

(2,000)

(1,000)

(E)

1,000

Retained earnings, beg.

(6,000)

(4,000)

(I-1)

300

(E)

3,700

(6,000)

(I-4) 12,000

(413,000)

Sales revenue

(R)

6,500

6,500 (598,800)

(275,000)

(150,000)

Equity in net income of Stallion

(1,250)

(C)

1,250

Cost of sales

200,000

90,000

(I-3)

450

(2,000)

-300 (I-1) 400 (I-2)

Operating expenses

73,000 $

12,000 (I-4)

277,750 132,000

59,000

_____

______

$ 25,600

E6.14 Consolidation Working Paper Eliminations, Intercompany Merchandise Sales, Noncontrolling Interest (in thousands) a. Calculation of goodwill: Acquisition cost Fair value of noncontrolling interest Total fair value Book value of Spire Revaluations: Identifiable intangibles Goodwill

$ 21,000 3,000 24,000 $ 4,000 5,000

9,000 $ 15,000

Allocation of goodwill between controlling and noncontrolling interest: Total goodwill Paymore’s goodwill: $21,000 – (80% x $9,000) Goodwill to noncontrolling interest

$ 15,000 13,800 $ 1,200

b. Calculation of fiscal 2021 equity in net income and noncontrolling interest in net income:

(in thousands)

Total

Spire’s reported net income Revaluation write-off: Identifiable intangibles $5,000/5 Intercompany transactions: Confirmed profit on upstream beginning inventory ($1,000 - $1,000/1.25) Unconfirmed profit on upstream ending inventory ($750 - $750/1.25)

$ 1,500

Equity in NI $

1,200

Noncontrolling interest in NI $

300

(1,000)

(800)

(200)

200

160

(150) $ 550

(120) 440

(30) 110

c. Consolidation Working Paper Trial Balances Taken From Books

Eliminations

(in thousands)

Paymore Dr (Cr)

Spire Dr (Cr)

Current assets

Plant and equipment, net

1,200,000

750,000

Intangibles

101,360

Investment in Spire

22,080

10,000

4,500

Consolidated Balances Dr (Cr)

150 (I-2)

14,350 1,950,000

(R)

2,000

1,000 (O)

102,360

440 (C) 6,240 (E) 15,400 (R)

Goodwill

Liabilities

(945,000)

(745,000)

Capital stock

(28,000)

(3,000)

(E)

3,000

(28,000)

Retained earnings, beg.

(340,000)

(5,000)

(I-1)

200

(340,000)

(E)

4,800

Noncontrolling interest

(R)

15,000

15,000 (1,690,000)

1,560 (E) 1,600 (R) 110 (N)

Sales revenue

(1,200,000)

(300,000)

(440)

(C)

440

980,000

200,000

(I-2)

150

Equity in net income of Spire Cost of sales

(I-3) 25,000

(3,270) (1,475,000) --

200 (I-1) 25,000 (I-3)

Operating expenses Noncontrolling interest in NI $

200,000

98,500

(O)

1,000

(N)

110

_______

$ 51,700

1,154,950 299,500 110 $

E6.15 Consolidation Working Paper Eliminations, Variety of Intercompany Transactions Consolidation Working Paper Trial Balances Taken From Books

(in thousands)

Pacific Athletic Dr (Cr)

Current assets

Eliminations

Solovair Apparel Dr (Cr)

10,000

4,000

Consolidated Balances Dr (Cr)

120 (I-3)

Plant and equipment, net

150,000

92,000

(I-6)

500

1,500 (I-5)

Investment in Solovair

15,305

(I-1)

300

2,205 (C)

13,880 241,000

7,400 (E)

6,000

200 (O)

5,800

Goodwill

Liabilities

(145,860)

(85,375)

Capital stock

(1,000)

(500)

(E)

500

Retained earnings, beg.

(20,000)

(8,400)

(I-2)

100

(I-5)

1,500

(E)

6,800

(20,000) (200)

AOCI, beg.

(R)

6,000 (R)

(231,235)

(200)

(100)

(E)

100

(200,000)

(50,000)

(I-4)

5,000

Equity in net income of Solovair

(2,180)

(C)

2,180

Cost of sales

120,000

38,000

(I-3)

120

Sales revenue and gains

Operating expenses

100 (I-2) 5,000 (I-4)

153,020

500 (I-6)

84,100

Other comprehensive income

(40)

(25)

Equity in OCI of Solovair

(25)

(C)

______

23,325

$ 23,325

(245,300) --

10,400

200

300 (I-1)

74,000

(O)

(1,000)

(65) -$

E6.16 Intercompany Inventory Transactions, Multiple Subsidiaries a.

(1)

Sales revenue (Crocs) = $34,500,000 + $28,750,000 = $63,250,000 Cost of goods sold (Crocs) = $63,250,000/1.15 = $55,000,000

(2)

Cost of goods sold (Ocean Minded) = $920,000 + $34,500,000 $1,035,000 = $34,385,000 Cost of goods sold (Bite) = $575,000 + $28,750,000 - $805,000 = $28,520,000

Consolidated inventory = ($1,035,000 + $805,000)/1.15 = $1,600,000 Consolidated cost of goods sold = ($34,385,000 + $28,520,000) /1.15 = $54,700,000

c. (I-1) Investment in Ocean Minded 120,000 Investment in Bite 75,000 Cost of goods sold 195,000 To recognize confirmed downstream profit in beginning inventories; $120,000 = $920,000 – ($920,000/1.15); $75,000 = $575,000 – ($575,000/1.15). (I-2) Sales revenue Cost of goods sold To eliminate gross intercompany sales and purchases.

63,250,000 63,250,000

(I-3) Cost of goods sold 240,000 Inventory 240,000 To eliminate unconfirmed profit in ending inventories; $240,000 = ($1,035,000 + $805,000) – (($1,035,000,000 + $805,000)/1.15). d.

Reported net income Confirmed BI profit Unconfirmed EI profit

Equity in NI Equity in NI of Ocean Minded of Bite $2,000,000 $2,500,000 120,000 75,000 (135,000) (105,000) $1,985,000 $2,470,000

E6.17 Various Intercompany Transactions, Noncontrolling Interest, Consolidated Financial Statements a. Acquisition cost Fair value of noncontrolling interest Total fair value Book value (= fair value of identifiable net assets) Goodwill

$ 38,700,000 17,300,000 56,000,000 (10,000,000) $ 46,000,000

Goodwill to controlling interest = $38,700,000 – (65% x $10,000,000) = $32,200,000 $32,200,000/$46,000,000 = 70%. Goodwill is allocated to PK and the noncontrolling interest in ShoeDaze in a 70:30 ratio. b. Reported NI GW impairment loss Confirmed BI profit, upstream Unconfirmed EI profit, upstream Confirmed profit, downstream equipment sale ($2,000,000/5) Total

Total $2,000,000 (300,000) 600,000 (500,000)

Equity in NI $1,300,000 (210,000) 390,000 (325,000)

NCI in NI $ 700,000 (90,000) 210,000 (175,000)

400,000 $2,200,000

400,000 $1,555,000

-$ 645,000

c. Acquisition cost 65% x change in book value to beginning of fiscal 2021 (65% x ($17,000,000 - $10,000,000) GW impairment to beginning of fiscal 2021 (70% x $2,000,000) Unconfirmed inventory profit, upstream, beginning of fiscal 2021 Unconfirmed land profit, downstream, beginning of fiscal 2021 Unconfirmed equipment profit, downstream, beginning of fiscal 2021 ($2,000,000 – (($2,000,000/5) x 2) Investment balance, beginning of fiscal 2021 Equity in NI, fiscal 2021 Investment balance, January 31, 2021

$38,700,000 4,550,000 (1,400,000) (390,000) (1,500,000) (1,200,000) 38,760,000 1,555,000 $40,315,000

d. Consolidation Working Paper Trial Balances Taken From Books

(in thousands)

PK Dr (Cr)

Cash and receivables

Eliminations

ShoeDaze Dr (Cr)

2,000

800

Inventories

40,000

16,500

Plant assets, net

300,000

92,000

500 (I-2)

Consolidated Balances Dr (Cr) $

2,300 56,500

(I-6)

400

1,500 (I-4)

389,700

1,200 (I-5) Investment in ShoeDaze

40,315

(I-4)

1,500

1,555 (C)

(I-5)

1,200

10,660 (E)

300 (O)

43,700

Liabilities

(285,760)

(90,300)

Capital stock

(50,000)

(3,000)

(E)

3,000

(50,000)

Retained earnings, beg.

(42,000)

(14,000)

(I-1)

600

(42,000)

(E)

13,400

44,000

Goodwill

Noncontrolling interest

(R)

30,800 (R)

(376,060)

5,740 (E) 13,200 (R) 645 (N)

Sales revenue

(250,000)

(150,000)

Equity in net income of ShoeDaze

(1,555)

(C)

1,555

Cost of goods sold

220,000

100,000

(I-2)

500

(19,585)

(I-3) 30,000

(370,000) -600 (I-1)

289,900

30,000 (I-3) Operating expenses Noncontrolling interest in NI $

27,000

48,000

(O)

300

(N)

645

_______

$97,100

400 (I-6)

74,900 645 $

e. Consolidated Income Statement Year Ended January 31, 2021 Sales revenue Costs of goods sold Gross margin Operating expenses Consolidated net income Noncontrolling interest in net income Consolidated net income to controlling interest

$ 370,000,000 (289,900,000) 80,100,000 (74,900,000) 5,200,000 (645,000) $ 4,555,000

Consolidated Balance Sheet, January 31, 2021 Assets Current assets: Cash and receivables Inventories Total current assets Plant assets, net Goodwill Total assets Liabilities and shareholders’ equity Total liabilities Shareholders’ equity Capital stock Retained earnings (1) Shareholders’ equity to PK Flyers Noncontrolling interest Total shareholders’ equity Total liabilities and shareholders’ equity (1)

$42,000,000 + $4,555,000 = $46,555,000.

2,300,000 56,500,000 58,800,000 389,700,000 43,700,000 $ 492,200,000

$ 376,060,000 50,000,000 46,555,000 96,555,000 19,585,000 116,140,000 $ 492,200,000

PROBLEMS P6.1

Consolidation Working Paper, Noncontrolling Interest, Intercompany Inventory Transactions a. Calculation of goodwill: Acquisition cost Fair value of noncontrolling interest Total fair value Book value of Seaport Previously unrecorded intangibles Goodwill

$ 24,575,000 2,925,000 27,500,000 $ 1,500,000 _ _2,000,000

3,500,000 $ 24,000,000

Allocation of goodwill between controlling and noncontrolling interests: Total goodwill Peninsula’s goodwill: $24,575,000 – (85% x $3,500,000) Goodwill to noncontrolling interest

$ 24,000,000 21,600,000 $ 2,400,000

Proportions: 90% to controlling interest and 10% to the noncontrolling interest b. Calculation of 2019 Equity in Net Income and Noncontrolling Interest in Net Income:

Seaport Company reported net income ($6,000,000 – $3,170,000 – $1,930,000) Upstream markup, beginning inventory Downstream markup, beg. inventory Upstream markup, ending inventory Downstream markup, ending inventory

Total

Equity in NI

$ 900,000 100,000 60,000 (80,000) (75,000) $ 905,000

$ 765,000 85,000 60,000 (68,000) (75,000) $ 767,000

Noncontrolling interest in NI $

135,000 15,000

(12,000) ________ $ 138,000

c. Consolidation Working Paper, December 31, 2019 Trial Balances Taken From Books Peninsula Dr (Cr)

Seaport Dr (Cr)

Current assets

$ 1,950,000

Investment in Seaport

25,600,500

Eliminations

980,000 --

Consolidated Balances Dr (Cr)

155,000 (I-3) (I-2) 60,000

435,500

(C)

2,890,000

(E)

22,335,000

(R)

$ 2,775,000

Property, plant and equipment, net

85,810,000

5,130,000

Intangibles

4,315,000

(R) 1,500,000

5,815,000

Goodwill

(R) 23,400,000

23,400,000

Liabilities

(106,355,000)

(2,100,000)

Capital stock

(3,000,000)

(1,200,000)

(E) 1,200,000

Retained earnings, Jan. 1

(6,500,000)

(2,250,000)

(I-2) 100,000

90,940,000

(108,455,000) (3,000,000)

(E) 2,150,000 Accumulated OCI, Jan. 1 Noncontrolling interest

Dividends

Sales

(200,000)

(50,000)

1,000,000

(E)

(6,500,000)

50,000

400,000

(200,000) 510,000

(E)

2,565,000

(R)

79,500

(N)

340,000

(C)

60,000

(N)

1,000,000

(115,000,000)

(6,000,000)

Equity in net income of Seaport

(767,000)

(C)

767,000

Equity in OCI of Seaport

(8,500)

(C)

8,500

109,050,000

3,170,000

Cost of goods sold

(I-1) 5,900,000

(3,154,500)

(I-3) 155,000

(115,100,000)

160,000 (I-2) 5,900,000 (I-1)

106,315,000

Operating expenses

4,150,000

1,930,000

6,080,000

Other comprehensive income

(45,000)

(10,000)

(55,000)

Noncontrolling interest in net income

(N)

138,000

Noncontrolling interest in OCI

(N)

1,500

_________

$ 35,430,000

$35,430,000

138,000 1,500 $

P6.2

Consolidation Working Paper, Noncontrolling Interest, Intercompany Merchandise Transactions (in thousands) a. Calculation of goodwill: Acquisition cost Fair value of noncontrolling interest Total fair value Book value of Wholesome Revaluations: Plant and equipment, net Intangibles Long-term debt Goodwill

$ 120,000 35,000 $ 155,000 $ 74,000 (15,000) 25,000 (4,000)

80,000 $ 75,000

Allocation of goodwill between controlling and noncontrolling interest: Total goodwill Kellogg’s goodwill: $120,000 – (75% x $80,000) Goodwill to noncontrolling interest

$ 75,000 60,000 $ 15,000

Proportions: $60,000/$75,000 = 80% to controlling interest and 20% to the noncontrolling interest b.

(in thousands) Wholesome’s reported net income for 2020 Revaluation write-offs for 2020: Plant & equipment ($15,000/10) Intangibles ($25,000/10) Goodwill (80/20 split) Intercompany sales adjustments: Upstream beg. inventory profit confirmed Upstream end. inventory profit unconfirmed Total

Total $

5,000

Equity in Net Income of Wholesome $

Noncontrolling Interest in Net Income of Wholesome

3,750

$ 1,250

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

1,125 (1,875) (800)

375 (625) (200)

2,400 (3,000) $ 2,400

1,800 (2,250) $ 1,750

600 (750) 650

Note: The long-term debt premium is completely amortized by 2020.

c. Consolidation Working Paper, December 31, 2020 Trial Balances Taken From Books

Eliminations

(in thousands)

Kellogg’s Dr (Cr)

Wholesome Dr (Cr)

Current assets

$ 35,000

Plant and equipment, net

262,650

192,000

Investment in Wholesome

128,850

Identifiable intangibles

20,000

Consolidated Balances Dr (Cr)

Cr 3,000 (I-3)

(O)

1,500

52,000

3,000

(R)

453,150

1,750

(C)

67,200

(E)

59,900

(R)

100,000

10,000

(R)

5,000

2,500

(O)

112,500

(R)

73,000

1,000

(O)

72,000

Current liabilities

(30,000)

(25,000)

(55,000)

Long-term debt

(350,000)

(100,000)

(450,000)

Capital stock

(80,000)

(54,000)

(E)

54,000

Retained earnings, Jan. 1

(57,750)

(38,000)

(I-2)

2,400

(E)

35,600

Goodwill

Noncontrolling interest

Sales revenue

(400,000)

(140,000)

Equity in NI of Wholesome

(1,750)

(C)

1,750

Cost of goods sold

250,000

65,000

(I-3)

3,000

(80,000)

(57,750) 22,400

(E)

15,100

(R)

650

(N)

(I-1) 60,000

(480,000) -2,400 (I-2) 60,000 (I-1)

Operating expenses

143,000

70,000

(O)

2,000

(N)

650

_______

$ 238,900

Noncontrolling interest in NI $

(38,150)

255,600 215,000 650 $

P6.3

Intercompany Transfers of Depreciable Assets a. December 31, 2020 working paper eliminating entries: June 30, 2016 downstream sale of equipment Investment in SAS (6.5 x ($350,000/10)) 227,500 Accumulated depreciation (3.5 x ($350,000/10)) 122,500 Equipment 350,000 To eliminate the intercompany gain unconfirmed in prior years, remove the excess depreciation recorded in prior years and reduce the asset account to its net book value at date of intercompany sale. Accumulated depreciation 35,000 Depreciation expense 35,000 To eliminate the excess annual depreciation expense recorded by SAS in 2020. Equipment 50,000 Accumulated depreciation To restate the asset and accumulated depreciation accounts to their original acquisition cost basis.

50,000

January 1, 2018 upstream sale of building Building 10,000,000 Retained earnings – SAS [18 x ($10,000,000/20)] 9,000,000 Accumulated depreciation [2 x ($10,000,000/20)] 1,000,000 To eliminate the intercompany loss unconfirmed in prior years, correct the understated depreciation recorded in prior years and increase the asset account to its net book value at date of intercompany sale. Depreciation expense 500,000 Accumulated depreciation To correct the understated depreciation recorded by Placer in 2020.

500,000

Building 4,000,000 Accumulated depreciation 4,000,000 To restate the asset and accumulated depreciation accounts to their original acquisition cost basis.

September 30, 2019 downstream sale of equipment Equipment 200,000 Investment in SAS (4.75 x $200,000/5) 190,000 Accumulated depreciation (0.25 x $200,000/5) 10,000 To eliminate the intercompany loss unconfirmed in prior years, correct the understated depreciation recorded in prior years and increase the asset account to its net book value at date of intercompany sale. Depreciation expense 40,000 Accumulated depreciation To correct the understated depreciation recorded by Placer in 2020.

40,000

Equipment 300,000 Accumulated depreciation 300,000 To restate the asset and accumulated depreciation accounts to their original acquisition cost basis. b. December 31, 2021 working paper eliminating entry for sale of equipment Investment in SAS 192,500 Gain on sale of equipment 192,500 To include in current year income the portion of the original intercompany gain of $350,000 which had not been confirmed through depreciation as of the beginning of the year; $192,500 = $350,000 – (4.5 x ($350,000/10)).

P6.4

Consolidated Financial Statements with Various Intercompany Transactions (in thousands) a. Equity in Net Income Serengeti’s reported net income ($73,000 + $2,000 - $47,000 $24,000 - $2,800) Plus confirmed profit in Puma’s beginning inventory Less unconfirmed profit in Serengeti’s ending inventory Plus Serengeti's unconfirmed loss on an intercompany sale of land Less Puma's unconfirmed gain on intercompany sale of machinery at beginning of year ($700,000 - $700,000/5) Plus Puma’s confirmed gain on sale of land Total

$ 1,200 500 (300) 200 (560) 250 $ 1,290

b. Investment original cost Change in Serengeti’s book value to beginning of current year ($1,500 + $24,500 - $10,000) Less goodwill impairment loss to beginning of current year Less unconfirmed profit on Puma’s beginning inventory Less Puma’s unconfirmed gain on sale of land Investment balance, beginning of current year Plus equity in net income for current year Investment balance, end of current year

$ 50,000 16,000 (2,000) (500) (250) 63,250 1,290 $ 64,540

c. Consolidation Working Paper Trial Balances Taken From Books

Eliminations

(in thousands)

Puma Dr (Cr)

Serengeti Dr (Cr)

Cash and receivables

$ 10,000

Consolidated Balances Dr (Cr)

4,000

14,000

Inventories

150,000

85,000

Land

200,000

120,000

(I-4)

200

Plant and equipment, net

600,000

380,000

(I-6)

140

Identifiable intangibles

(R)

8,000

Goodwill (1)

(R) 30,000

30,000

64,540

(I-7)

Investment in Serengeti

300 (I-2)

250

Liabilities

(750,250)

(561,800)

Capital stock

(2,000)

(1,500)

(E)

1,500

(267,000)

(24,500)

(I-1)

500

Retained earnings, beg. Dividends

1,290

(C)

25,500

(E)

38,000

(R)

979,440

-(2,000) (267,000) (419,000)

1,000

-(73,000)

(I-3) 4,000

Other income

(5,000)

(2,000)

(I-5)

700

Equity in net income

(1,290)

(C)

1,290

Cost of sales

275,000

47,000

(I-2)

300

Operating expenses

70,000

24,000

Other expenses

5,000

2,800

_______

$ 70,880

700 (I-5)

(E) 24,000 (350,000)

320,200

(1,312,050)

Sales revenue

234,700

1,000 250 (I-7)

(6,550) --

500 (I-1) 4,000 (I-3)

317,800

140 (I-6)

93,860

200 (I-4)

7,600

$ 70,880

(1) Original goodwill = $50,000 - $10,000 - $8,000 = $32,000; goodwill, beginning of current year = $32,000 $2,000 = $30,000.

Consolidated Income Statement For Current Year (in thousands)

Sales revenue Other income Total revenue Expenses: Cost of sales Operating expenses Other expenses Net income

$ 419,000 6,550 425,550 (317,800) (93,860) (7,600) $ 6,290

Consolidated Balance Sheet, End of Current Year (in thousands)

Assets Cash and receivables Inventories Total current liabilities Land Plant and equipment, net Identifiable intangibles Goodwill Total assets Liabilities and shareholders’ equity Liabilities Shareholders’ equity: Capital stock Retained earnings (2) Total shareholders’ equity Total liabilities and shareholders’ equity (2) $267,000 + $6,290 - $1,000 = $272,290

14,000 234,700 248,700 320,200 979,440 8,000 30,000 $1,586,340 $1,312,050 2,000 272,290 274,290 $1,586,340

P6.5

Equity in Net Income and Eliminating Entries—Intercompany Asset Transfers and Services a. Suro’s net income Plus intercompany profits in Suro’s beginning inventory (= $10,000 – ($10,000/1.25)) Less intercompany profits in Suro’s ending inventory (= $15,000 – ($15,000/1.25)) Less unconfirmed gain on intercompany sale of machinery (= $5,000 – ($5,000/5)) Equity in net income

$45,000 2,000 (3,000) (4,000) $40,000

b. Consolidation working paper eliminations: (C) Equity in net income of Suro 40,000 Dividends – Suro (40% x $45,000) Investment in Suro To eliminate the current year equity method entries made by Pohang.

18,000 22,000

(I-1) Shareholders’ equity (RE), beginning, Suro 5,000 Land 5,000 To eliminate the unconfirmed gain from the prior year upstream transfer of land and reduce the land account to original acquisition cost. (I-2) Sales

300,000

Cost of goods sold To eliminate intercompany merchandise sales.

300,000

(I-3) Investment in Suro 2,000 Cost of goods sold 2,000 To eliminate unconfirmed intercompany profit on downstream sales from beginning inventory. (I-4) Cost of goods sold Inventory

3,000 3,000

To eliminate unconfirmed intercompany profit on upstream sales from ending inventory. (I-5) Gain on sale of machinery Machinery, net To eliminate the gain on the intercompany sale of machinery.

5,000 5,000

(I-6) Machinery, net 1,000 Depreciation expense 1,000 To eliminate excess depreciation on the machinery acquired from Suro; this is the portion of the $5,000 gain confirmed to Suro in 2019. (I-7) Service revenue Service expense To eliminate intercompany revenue and expense. (I-8) Accounts payable Accounts receivable To eliminate intercompany receivables and payables.

20,000 20,000

1,000 1,000

(E) Shareholders’ equity – Suro (1) 310,000 Investment in Suro 310,000 To eliminate the remaining beginning shareholders’ equity of Suro against the investment. (1) $310,000 = $300,000 + $25,000 – (40% x $25,000) – $5,000 from elimination (I-1).

(R) Goodwill Investment in Suro To establish goodwill as of the beginning of the year.

1,200,000 1,200,000

Note that the above entries eliminate the Investment in Suro balance of $1,530,000, calculated as follows: Acquisition cost Equity in net income of Suro, 2018 (2) Dividends, 2018 (= 40% x $25,000) December 31, 2018 balance Equity in net income of Suro, 2019 Dividends, 2019 (= 40% x $45,000) December 31, 2019 balance (2) Equity in net income for 2018 calculation: Suro’s book income Unconfirmed upstream land profit Unconfirmed downstream profit in ending inventory Equity in net income of Suro, 2018

$1,500,000 18,000 (10,000) 1,508,000 40,000 (18,000) $1,530,000 $ 25,000 (5,000) (2,000) $ 18,000

P6.6

Comprehensive Problem: Consolidation Working Paper and Financial Statements (in thousands) a. Calculation of goodwill: Acquisition cost Fair value of noncontrolling interest Total fair value Book value of Selene Previously unrecorded intangibles Goodwill Acquisition cost 75% x $14,000 Goodwill to parent Goodwill to noncontrolling interest

$ 20,100 5,900 26,000 $ 10,000 4,000

14,000 $ 12,000

$ 20,100 10,500 $ 9,600 $ 2,400

80% 20%

b. Calculation of 2020 equity in net income and noncontrolling interest in net income:

(in thousands)

Total

Equity in NI

Noncontrolling Interest in NI

Selene’s reported net income ($50,000 – $35,000 – $7,900)

$ 7,100

$ 5,325

$ 1,775

Amortization, developed tech ($4,000/5)

(800)

(600)

(200)

Confirmed downstream gain on equipment ($2,000/10)

200

Upstream markup, beg. inv. ($1,800 – $1,800/1.2)

300

225

Upstream markup, end. inv. ($2,400 – $2,400/1.2)

(400)

(300)

(100)

Downstream markup, beg. inv. ($3,000 x 20%)

600

Downstream markup, end. inv. ($2,800 x 20%)

(560)

_____

$ 6,440

$ 4,890

$ 1,550

c. Consolidation Working Paper, December 31, 2020 Trial Balances Taken From Books

Eliminations

(in thousands)

Pierre Dr (Cr)

Selene Dr (Cr)

Cash

$ 1,000

$ 2,500

Receivables

5,600

10,000

Inventories

70,000

30,000

Investment in AFS debt securities

8,000

6,000

Plant and equipment, net

452,000

144,000

Investment in Selene

25,040

Consolidated Balances Dr (Cr)

3,500 15,600

960 (I-5)

99,040 14,000

(I-2)

200

(I-1)

1,600

2,565

(C)

(I-4)

600

16,275

(E)

8,400

(R)

800

(O)

Intangibles

(R)

1,600

Goodwill

(R)

9,000

1,600 (I-1)

594,600

-800 9,000

Current liabilities

(4,000)

(2,800)

(6,800)

Long-term debt

(489,825)

(163,700)

(653,525)

Capital stock

(5,000)

(2,000)

(E)

Retained earnings, January 1

(88,500)

(19,600)

(I-4)

300

(E)

19,300

(88,500)

(E)

400

(1,500)

Accumulated other comprehensive income, January 1

(1,500)

(400)

2,000

Noncontrolling interest

Dividends Sales revenue Equity in net income of Selene

40,000 (150,000)

3,000 (50,000)

(4,890)

Equity in OCL of Selene

(N)

2,250

(C)

750

(N)

960

Operating expenses

41,500

7,900

(O)

800

500

100

(C)

35,000 (I-3) 900 (I-4)

100,060

200 (I-2)

50,000 600

(N)

1,550

_____

_______

$ 78,200

40,000 --

Noncontrolling interest in net income

(8,400)

(165,000)

(I-5)

775

4,890

35,000

(R)

35,000

100,000

_____

(E)

2,200

(C)

Cost of sales

Noncontrolling interest in OCI

5,425

(I-3)

Unrealized losses on AFS investments (OCI)

(5,000)

(N)

(25) $

Note: The adjusting entry to record equity in net income and other comprehensive loss, reflected in Pierre’s trial balance above, is as follows: Investment in Selene Equity in OCL of Selene Equity in net income of Selene

4,815 75 4,890

d. Consolidated Statement of Income and Comprehensive Income For the Year 2020 (in thousands)

Sales revenue Costs of goods sold Gross margin Operating expenses Consolidated net income Noncontrolling interest in net income Consolidated net income to controlling interest

$ 165,000 (100,060) 64,940 (50,000) 14,940 (1,550) $ 13,390

Consolidated net income Unrealized losses on AFS investments Consolidated comprehensive income Noncontrolling interest in comprehensive income (1) Consolidated comprehensive income to controlling interest

14,940 (600) 14,340 (1,525) $ 12,815

(1)

$1,550 - $25 = $1,525.

Consolidated Balance Sheet, December 31, 2020 (in thousands)

Assets Current assets: Cash Receivables Inventories Investment in AFS debt securities Total current assets Plant and equipment, net Intangibles Goodwill Total assets Liabilities and shareholders’ equity Current liabilities Long-term debt Total liabilities Shareholders’ equity Capital stock Retained earnings (2) Accumulated other comprehensive income (3) Equity to Pierre Noncontrolling interest Total shareholders’ equity Total liabilities and shareholders’ equity (2) $88,500 + $13,390 – $40,000 = $61,890. (3) $1,500 - $600 + $25 = $925.

3,500 15,600 99,040 14,000 132,140 594,600 800 9,000 $ 736,540 $

6,800 653,525 660,325

5,000 61,890 925 67,815 8,400 76,215 $ 736,540

P6.7

Calculation of Investment and Consolidated Accounts Several Years After Acquisition (in millions) a. Pentland’s retained earnings from its own operations Equity in net income, 2017 – 2020: 75% of Sketchers’ total net income since acquisition (75% x $140) Less 75% of amortization on asset revaluation [75% x (($60/5) x 4)] Less 80% of goodwill impairment loss (80% x $5) (Note 1) Less 75% of unconfirmed gain on upstream land sale (75% x $30) Less unconfirmed gain on downstream patent sale [$10 – (($10/10) x 3)] Less 75% of unconfirmed profit on upstream ending inventory (75% x $20) Less unconfirmed profit on downstream ending inventory Equity in net income, 2017 – 2020 Consolidated retained earnings, December 31, 2020

$ 55 105 (36) (4) (22.5) (7) (15) (17) 3.5 $ 58.5

Note 1: Goodwill is shared in a 80:20 ratio, calculated as follows: Acquisition cost Fair value of noncontrolling interest Total fair value Book value Revaluation of intangibles

$ 180 50 230 $ 20 60

Goodwill

80 150

Goodwill to controlling interest [180 – (75% x $80)] Goodwill share to controlling interest ($120/$150)

120 80%

b. Investment in Sketchers, January 2, 2017 Plus equity in net income, 2017 - 2020 Less 75% of Sketchers’ dividends, 2017 – 2020 ($12 x 75%) Investment in Sketchers, December 31, 2020

$ 180 3.5 (9) $ 174.5

c. Fair value of noncontrolling interest, January 2, 2017 Plus noncontrolling interest in net income, 2017 – 2020: 25% of Sketchers’ total net income since acquisition (25% x $140) Less 25% of amortization on asset revaluation [25% x (($60/5) x 4)] Less 20% of goodwill impairment loss (20% x $5) (Note 1) Less 25% of unconfirmed gain on upstream land sale (25% x $30) Less 25% of unconfirmed profit on upstream ending inventory (25% x $20) Noncontrolling interest in net income, 2017 – 2020 Less 25% of Sketchers’ dividends, 2017 – 2020 ($12 x 25%) Consolidated noncontrolling interest, December 31, 2020

$ 50 35 (12) (1) (7.5) (5) 9.5 (3) $ 56.5

P6.8

Intercompany Financing, Service and Merchandise Transactions, Calculation of Adjusted Subsidiary Income Reported cost of goods sold Minus confirmed intercompany profit on beginning inventory Plus unconfirmed intercompany profit on ending inventory Adjusted cost of goods sold

$3,500,000 ($500,000 x 75%) – (($500,000 x 75%)/1.25) ($875,000 x 75%) – (($875,000 x 75%)/1.25)

Reported operating expenses Minus charges for intercompany services Adjusted operating expenses Reported interest expense Minus intercompany interest charges Adjusted interest expense

(75,000) 131,250 $3,556,250 $1,300,000 (130,000) $1,170,000

5% x $800,000

$ 100,000 (40,000) $ 60,000

Adjusted dealership income: Sales revenue Cost of goods sold Operating expenses Interest expense Income before tax Tax expense (40%) Adjusted income Bonus (10%)

$ 5,000,000 (3,556,250) (1,170,000) (60,000) 213,750 (85,500) $ 128,250 $ 12,825

P6.9

Consolidated Income Statement—Intercompany Transactions a. Salem reported net income Confirmed profit in BI-downstream Unconfirmed profit in EI-upstream Unconfirmed loss on asset sale-downstream Confirmed loss on asset sale-downstream = $500,000/5 (adjusts depreciation expense) Unconfirmed gain on land sale-upstream Confirmed gain (adjusts amortization expense) on patent sale-upstream = $150,000/5 Unconfirmed gain on prior year patent sale, as of beg.of year-upstream = $150,000/5 x 2

Total

Equity in NI

Noncontrolling Interest in NI

$6,200,000 800,000 (600,000) 500,000

$5,580,000 800,000 (540,000) 500,000

(100,000) (200,000)

(100,000) (180,000)

(20,000)

30,000

27,000

3,000

60,000 $6,690,000

54,000 $6,141,000

6,000 $549,000

$620,000 (60,000)

b. Portland Company and Salem Company Consolidated Income Statement Sales ($40,000,000 + $25,000,000 - $5,000,000) Other income ($6,000,000 + $2,000,000 - $200,000 + $60,000) Total revenue Cost of goods sold ($28,000,000 + $15,000,000 - $5,000,000 $800,000 + $600,000) Operating expenses ($7,000,000 + $5,000,000 + $100,000 - $30,000) Other expenses ($1,000,000 + $800,000 - $500,000) Total expenses Consolidated net income Noncontrolling interest in net income Net income to the controlling interest

$60,000,000 7,860,000 67,860,000 37,800,000 12,070,000 1,300,000 51,170,000 16,690,000 549,000 $16,141,000

Check: Consolidated net income to the controlling interest must equal Portland’s reported net income, including equity in net income. $16,141,000 = $10,000,000 + $6,141,000.

Note on the patent: The patent acquired internally from Salem had a net book value of $240,000 [= $600,000 - (3/5) x $600,000] when sold by Portland for $900,000. The $660,000 (= $900,000 - $240,000) external gain reported in other income is fully confirmed and does not affect the consolidation. This year’s $30,000 (= $150,000/5) excess amortization is eliminated—increasing income—because the patent was held internally for the entire year. The remaining $60,000 upstream intercompany gain [= $150,000 – (3 x $30,000)] is now fully confirmed by the external sale and is added to this year’s income.

P6.10 Comprehensive Intercompany Eliminations (I) Sales

60,000,000 Cost of goods sold

60,000,000

Investment in MC Shops Cost of goods sold $2,000,000 = 20% x $10,000,000 beginning inventory.

2,000,000

Cost of goods sold Other assets $2,600,000 = 20% x $13,000,000 ending inventory.

2,600,000

Franchise fee revenue Franchise fee expense

8,000,000

Interest revenue Interest expense

4,000,000

Liabilities Other assets

43,000,000

(E) Shareholders' equity – MC Shops Investment in MC Shops

2,000,000

2,600,000

8,000,000

4,000,000

43,000,000

7,000,000 7,000,000

P6.11 Consolidation of Equity Method Investments a. Consolidation Working Paper, September 27, 2015

(in millions)

Trial Balances Taken From Books Five Starbucks Companies Dr (Cr) Dr (Cr)

Current assets

$ 4,352.7

Equity investments

306.4

Eliminations

Consolidated Balances Dr (Cr)

402.8

36.7 (I-2)

42.8 (C)

4,718.8

178.6 (E) 85.0 (R) Other noncurrent assets

7,787.0

578.8

(R)

170.0

Current liabilities

(3,653.5)

(490.0)

(I-2)

36.7

(4,106.8)

Noncurrent liabilities

(2,972.8)

(38.7)

Shareholders’ equity, beg

(4,076.7)

(357.2)

Goodwill

Noncontrolling interest

8,365.8

(3,011.5) (E)

357.2

(4,076.7) 178.6 (E) 85.0 (R) 47.85 (N)

Dividends

1,016.2

296.4

Revenues

(19,162.7)

(2,688.0)

(249.9)

(311.45)

148.2 (C) 148.2 (N)

Equity method income Cost of sales and other operating expenses Other expenses Noncontrolling int. in NI $

15,811.6

2,261.6

841.7

34.3

(I-1)

153.4

(a)

58.9

(C)

191.0

(a)

94.5

153.4

(a)

1,016.2 (21,850.7) --

153.4 (I-1)

18,014.3 876.0

(N)

196.05

________

$ 1,257.75

196.05 $

Eliminating entries: (a) Removes equity investees’ intercompany revenues and cost of sales from the equity method income account and assigns them to revenues and cost of sales. (C) Removes the remaining equity method income balance, 50% of investee dividends, and adjusts the investment by the difference. (I-1) Removes intercompany revenues generated from investees. (I-2) Removes intercompany receivables and payables. (E) Eliminates investee beginning equity against the investment (50%) and noncontrolling interest (50%). (R) Recognizes the beginning-of-year goodwill balance. The remaining balance in the investment ($85.0 million) represents 50% of the total goodwill balance of $170.0 million. The remainder is credited to noncontrolling interest. (N) Recognizes $196.05 million noncontrolling interest in investee income (= 50% x $392.1 million), eliminates the noncontrolling interest’s dividends and updates the noncontrolling interest for the current year. b. Consolidated amount Starbucks’ reported Increase

Total Assets $ 13,254.6 12,446.1 $ 808.5

Revenues $ 21,850.7

Percentage increase

6.50%

14.03%

19,162.7

$ 2,688.0

Analysis of revenue less cost of sales and other operating expenses: Starbucks: ($19,162.7 - $15,811.6) = $3,351.1/$19,162.7 = 17.49% Consolidated: ($21,850.7 - $18,014.3) = $3,836.4/$21,850.7 = 17.56% The five equity method investments are slightly more profitable than Starbucks itself. Therefore when these companies’ revenues, cost of sales and operating expenses are added to those of Starbucks in consolidation, the outcome is a small improvement in operating income and operating income as a percent of sales revenue.

P6.12 Separate and Consolidated Balances, Intercompany Merchandise and Depreciable Asset Transactions a. Downstream merchandise transactions: 2019 Peco Inventories Sales revenue Cost of goods sold

-$16,875,000 12,500,000 (2)

Stetson $ 175,500 -16,699,500 (3)

Consolidated $ 130,000 (1) -12,370,000 (4)

(1) $175,500/1.35 = $130,000. (2) $16,875,000/1.35 = $12,500,000. (3) $16,875,000 - $175,500 = $16,699,500. (4) $16,699,500/1.35 = $12,370,000.

Eliminating entries: Sales revenue Cost of goods sold

16,875,000 16,875,000

Cost of goods sold Inventories

45,500 45,500

2020 Peco Inventories Sales revenue Cost of goods sold

-$12,825,000 9,500,000 (6)

Stetson $ 148,500 -12,852,000 (7)

Consolidated $ 110,000 (5) -9,520,000 (8)

(5) $148,500/1.35 = $110,000. (6) $12,825,000/1.35 = $9,500,000. (7) $175,500 + $12,825,000 - $148,500 = $12,852,000. (8) $12,852,000/1.35 = $9,520,000.

Eliminating entries: Sales revenue Cost of goods sold

12,825,000

Investment in Stetson Cost of goods sold

45,500

12,825,000

45,500

Cost of goods sold Inventories

38,500 38,500

Upstream machinery transaction: 2019 Machinery Accumulated depreciation Depreciation expense Gain on sale of machinery

Peco $700,000 (100,000) (9) 100,000 (9)

Stetson ---$140,000 (12)

Consolidated $ 900,000 (420,000) (10) 80,000 (11)

(9) $700,000/7 = $100,000. (10) $340,000 + [($900,000 - $340,000)/7] = $420,000. (11) [($900,000 - $340,000)/7] = $80,000. (12) $700,000 - ($900,000 - $340,000) = $140,000.

Eliminating entries: Gain on sale of machinery Machinery

140,000

Machinery Accumulated depreciation

340,000

Accumulated depreciation Depreciation expense

20,000

140,000

340,000

20,000

2020 Machinery Accumulated depreciation Depreciation expense

Peco $700,000 (200,000) (13) 100,000

(13) 2 x ($700,000/7) = $200,000. (14) $340,000 + 2 x [($900,000 - $340,000)/7] = $500,000.

Stetson ----

Consolidated $ 900,000 (500,000) (14) 80,000

Eliminating entries: Retained earnings, beginning Accumulated depreciation Machinery

120,000 20,000

Machinery Accumulated depreciation

340,000

Accumulated depreciation Depreciation expense

20,000

140,000

340,000

20,000

b. Loss on sale of machinery Depreciation expense

Peco $150,000 (15) 50,000 (17)

Stetson ---

Consolidated $60,000 (16) 40,000 (18)

(15) $300,000 – ($700,000 – 2 ½ x $700,000/7) = $(150,000). (16) $300,000 - [$900,000 - $340,000 – (2 ½ x ($900,000 - $340,000)/7)] = $(60,000). (17) $700,000/7 x ½ = $50,000. (18) ($900,000 - $340,000)/7 x ½ = $40,000.

Eliminating entry: Retained earnings, beginning Loss on sale of machinery Depreciation expense

100,000 90,000 10,000

P6.13 Calculation of Investment Balance, Comprehensive Eliminating Entries, Variety of Intercompany Transactions (in thousands) a.

Sugg reported net income Goodwill impairment loss (70:30 ratio, see note 1) Intercompany transactions: Upstream land loss Upstream confirmed profit on beg. inventory Upstream unconfirmed profit on end. inventory Downstream confirmed loss on facilities sale Total

Equity in NI $ 900 (700)

Noncontrolling Interest in NI $ 600 (300)

300 120 (174) (100) $ 346

200 80 (116) ______ $ 464

Note 1: Goodwill is shared in a 70:30 ratio, calculated as follows: Acquisition cost Fair value of noncontrolling interest Total fair value Book value Previously unreported trademarks Goodwill Goodwill to controlling interest [$39,500 – (60% x $25,000)] Goodwill share to controlling interest ($24,500/$35,000)

$ 39,500 20,500 60,000 $ 10,000 15,000

25,000 35,000 24,500 70%

b. Investment original cost Change in Sugg’s book value to beginning of current year ($19,000 $10,000) x 60% Less trademark impairment to beginning of current year 60% x $2,000 Less goodwill impairment to beginning of current year 70% x $5,000 Less upstream unconfirmed profit on beginning inventory 60% x $200 Plus unconfirmed loss on downstream facilities sale ($1,000 - $100) Investment balance, beginning of current year Plus equity in net income for current year Investment balance, end of current year c. (C) Equity in net income Investment in Sugg (I-1) Land

$ 39,500 5,400 (1,200) (3,500) (120) 900 40,980 346 $ 41,326

346 346

500 Loss on sale of land

500

(I-2) Equity, beginning - Sugg Cost of goods sold

200

(I-3) Cost of goods sold Inventories

290

200

290

(I-4) Sales revenue Cost of goods sold

6,000

(I-5) Facilities, net Investment in Sugg

900

(I-6) Depreciation expense Facilities, net

100

6,000

900

100

(E) Equity, beginning - Sugg Investment in Sugg Noncontrolling interest in Sugg (R) Trademarks Goodwill Investment in Sugg Noncontrolling interest in Sugg (O) Goodwill impairment loss Goodwill (N) Noncontrolling interest in NI Noncontrolling interest in Sugg

18,800 11,280 7,520

13,000 30,000 28,800 14,200

1,000 1,000

464 464

P6.14 Consolidation Working Paper Eliminations, Intercompany Merchandise Sales, Noncontrolling Interest, IFRS (in thousands) a. Calculation of current year equity in net income and noncontrolling interest in net income Equity in Net Loss Stabifoot’s reported net income (€500,000 – €300,000 – €192,000) = €8,000 Goodwill impairment loss Downstream beginning inventory profit confirmed (€22,500 x 20%) = €4,500 Downstream ending inventory profit unconfirmed (€25,000 x 20%) = €5,000 Upstream beginning inventory profit confirmed (€24,000 €24,000/1.2) = €4,000 Upstream ending inventory profit unconfirmed (€26,400 €26,400/1.2) = €4,400

€

4,080 (10,000)

Noncontrolling Interest in NI €

3,920 --

4,500

(5,000)

2,040

1,960

(2,244) €(6,624)

€

(2,156) 3,724

b. Consolidation Working Paper Trial Balances Taken From Books

Eliminations

(in thousands)

Pablo Dr (Cr)

Current assets

€ 80,000

Plant assets, net

210,440

137,000

Identifiable intangibles

10,000

(R)

(R) 120,000

10,000 (O)

178,236

(C)

6,624

48,960 (E)

(I-2)

4,500

140,400 (R)

Goodwill Investment in Stabifoot

Stabifoot Dr (Cr) €

60,000

9,400 (I-1)

40,000

(286,300)

(89,000)

Capital stock

(2,000)

(1,000)

(E)

1,000

(187,000)

(99,000)

(I-3)

4,000

(E)

95,000

Noncontrolling interest

€ 130,600 347,440

Liabilities

Retained earnings, beg.

Consolidated Balances Dr (Cr)

50,000 110,000

-(375,300)

(2,000)

(187,000) 47,040 (E) 19,600 (R) 3,724 (N)

Sales revenue

(800,000)

(500,000)

Equity in net loss

6,624

Cost of goods sold

650,000

300,000

(I-4) 255,000

(70,364) (1,045,000)

6,624 (C) (I-1)

9,400

4,500 (I-2) 4,000 (I-3) 255,000 (I-4)

Operating expenses Noncontrolling interest in NI €

140,000

192,000

(O)

10,000

(N)

3,724

_______

€ 549,248

€

695,900 342,000 3,724 €

P6.15 Consolidation Working Paper Eliminations, Intercompany Transactions, Noncontrolling Interest, IFRS (in thousands) a. Adaris Malaysia’s reported net income (£490,000 – £210,000 – £258,000) = €22,000 Goodwill impairment loss Downstream land sale gain confirmed Downstream beginning inventory profit confirmed (£10,400 £10,400/1.3) = £2,400 Downstream ending inventory profit unconfirmed (£14,300 £14,300/1.3) = £3,300 Upstream equipment sale loss confirmed (£20,000/5 = £4,000)

Equity in NI

Noncontrolling Interest in NI

£ 15,400 (10,000) 2,000

£ 6,600 ---

2,400

(3,300) (2,800) £ 3,700

-(1,200) £ 5,400

b. Consolidation Working Paper, 31 December 2019

(in thousands)

Trial Balances Taken From Books Adaris Adaris Malaysia Dr (Cr) Dr (Cr)

Current assets

£ 35,000

Plant assets, net

233,450

210,000

(I-5) 10,000

4,000 (I-6)

449,450

(R) 164,000

10,000

(O)

154,000

243,800

(I-1)

2,000

3,700

(C)

(I-2)

2,400

Goodwill Investment in Adaris Malaysia

Eliminations

Consolidated Balances Dr (Cr)

22,000

3,300 (I-3)

Liabilities

(337,550)

(105,000)

Capital stock

(40,000)

(30,000)

(E)

30,000

Retained earnings, beg.

(125,000)

(75,000)

(E)

85,000

Noncontrolling interest

80,500

(E)

164,000

(R)

-(442,550)

Sales revenue and gains

(600,000)

(490,000)

Equity in net income

(3,700)

(C)

3,700

Cost of goods sold

430,000

210,000

(I-3)

3,300

(I-4) 180,000

(40,000) 10,000 (I-5)

(125,000)

34,500

(E)

5,400

(N)

(39,900)

2,000 (I-1)

(912,000) --

2,400 (I-2) 180,000 (I-4)

Operating expenses

164,000

Noncontrolling interest in NI

258,000

-£

53,700

(O)

10,000

(I-6)

4,000

(N)

5,400

________

£ 499,800

460,900 436,000 5,400 £

c. Consolidated Income Statement For the Year Ended 31 December 2019 (in thousands)

Sales revenue and gains Costs of goods sold Gross margin Operating expenses Consolidated net income Noncontrolling interest in net income Consolidated net income to controlling interest

£ 912,000 (460,900) 451,100 (436,000) 15,100 (5,400) £ 9,700

Consolidated Balance Sheet, 31 December 2019 (in thousands)

Assets Current assets Plant assets, net Goodwill Total assets Liabilities and shareholders’ equity Liabilities Shareholders’ equity to Adaris: Capital stock Retained earnings (1) Shareholders’ equity to Adaris Noncontrolling interest Total shareholders’ equity Total liabilities and shareholders’ equity (1) £125,000 + £9,700 = £134,700

53,700 449,450 154,000 £ 657,150 £ 442,550 40,000 134,700 174,700 39,900 214,600 £ 657,150

P6.16 Equity Method, Intercompany Merchandise and Service Transactions, Consolidation (in thousands) a. Reported net income ($200,000 - $150,000 - $42,000) Revaluation write-offs: Plant assets ($20,000/20) Identifiable intangibles Intercompany transactions: Confirmed profit, BI, downstream ($10,000 – ($10,000/1.25)) Confirmed profit, BI, upstream (($3,600 – ($3,600/1.2)) Unconfirmed profit, EI, downstream (($7,500 – ($7,500/1.25)) Unconfirmed profit, EI, upstream (($6,000 – ($6,000/1.2)) Equity in NI

$ 8,000 1,000 (3,000) 2,000 600 (1,500) (1,000) $ 6,100

b. Acquisition cost Change in book value to beginning of year (($25,000 + $65,000 + $5,0000) - $50,000) Revaluation write-offs to beginning of year: Inventory Plant assets (4 x ($20,000/20)) Identifiable intangibles Goodwill Intercompany transactions to beginning of year: Unconfirmed profit, EI, downstream Unconfirmed profit, EI, upstream Investment balance, beginning of 2020 Equity in NI, 2020 Equity in OCI, 2020 Investment balance, December 31, 2020

$450,000

Acquisition cost Book value Excess over book value Revaluations: Plant assets Inventory Identifiable intangibles Goodwill

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

45,000 5,000 4,000 (1,000) (25,000) (2,000) (600) 475,400 6,100 300 $481,800

20,000 5,000 (40,000) $385,000

d. Consolidation Working Paper, December 31, 2020 Trial Balances Taken From Books

Eliminations

(in thousands)

Pearl Dr (Cr)

Sebogo Dr (Cr)

Cash and receivables

$ 50,000

10,000

1,900 (I-5)

600,000

120,000

2,500 (I-3)

717,500

5,000,000

1,000,000

(O)

1,000

16,000 (R)

5,985,000

(R)

39,000

3,000 (O)

36,000

(R) 360,000

481,800

(I-2)

Inventories Plant assets, net

Consolidated Balances Dr (Cr)

Identifiable intangibles Goodwill Investment in Sebogo

2,000

58,100

360,000 6,400

(C)

94,400

(E)

383,000

(R)

Liabilities

(5,853,400)

(1,026,700)

(I-5)

1,900

(6,878,200)

Capital stock

(100,000)

(25,000)

(E)

25,000

(100,000)

Retained earnings, beg.

(140,000)

(65,000)

(E)

64,400

(140,000)

(I-2)

600

(E)

5,000

(25,000)

(I-1) 85,000

(460,000)

AOCI, beg.

(25,000)

(5,000)

Sales revenue

(350,000)

(200,000)

Equity in net income

(I-4)

5,000

(6,100)

(C)

6,100

(300)

(C)

300

Cost of goods sold

230,000

150,000

(I-3)

2,500

85,000 (I-1)

294,900

Operating expenses

112,000

42,000

(O)

2,000

5,000 (I-4)

151,000

1,000

(300)

_______

700

$ 599,800

Equity in OCI

Other comprehensive (income) loss $

2,600 (I-2)

P6.17 Intercompany Merchandise Transactions, Calculation of Investment and Noncontrolling Interest, Eliminating Entries a. Acquisition cost Fair value of noncontrolling interest Total fair value Book value Plant assets Liabilities Identifiable intangibles Goodwill

$50,800,000 14,200,000 65,000,000 $ 5,000,000 (3,200,000) 200,000 4,000,000

6,000,000 $59,000,000

Goodwill to controlling interest = $50,800,000 – (60% x $6,000,000) = $47,200,000 (80%) Goodwill to noncontrolling interest = $59,000,000 - $47,200,000 = $11,800,000 (20%) b. Reported NI Revaluation write-offs: Plant assets $3,200,000/10 Liabilities $200,000/5 Identifiable intangibles $4,000,000/8 Goodwill $600,000, split 80:20 Intercompany transactions: Confirmed profit, downstream BI Unconfirmed profit, downstream, EI Plant assets upstream confirmed gain

Total $6,000,000

Equity in NI $3,600,000

NCI in NI $2,400,000

320,000 (40,000) (500,000) (600,000)

192,000 (24,000) (300,000) (480,000)

128,000 (16,000) (200,000) (120,000)

200,000 (250,000) 400,000 $5,530,000

200,000 (250,000) 240,000 $3,178,000

--160,000 $2,352,000

c. Investment Date of acquisition value $50,800,000 Change in book value ($11,000,000 - $5,000,000) 3,600,000 Revaluation write-offs, 2018-2019: Plant assets (2 x ($3,200,000/10)) 384,000 Liabilities (2 x ($200,000/5)) (48,000) Identifiable intangibles (2 x ($4,000,000/8)) (600,000) Goodwill $2,000,000, split 80:20 (1,600,000) Intercompany transactions adjustments, 2018-2019: Unconfirmed profit, downstream EI (200,000) Plant assets upstream unconfirmed gain ($4,000,000 – (($4,000,000/10) x 2)) (1,920,000) Land downstream unconfirmed loss 700,000 Balance, January 1, 2020 51,116,000 2020 income (equity in NI and NCI in NI) 3,178,000 2020 OCI ($200,000) 120,000 Balance, December 31, 2020 $54,414,000 d. (C) Equity in NI Equity in OCI

NCI $14,200,000 2,400,000 256,000 (32,000) (400,000) (400,000) -(1,280,000) -14,744,000 2,352,000 80,000 $17,176,000

3,178,000 120,000 Investment in Slam

(I-1) Sales revenue

3,298,000

10,000,000 Cost of goods sold

(I-2) Investment in Slam

10,000,000

200,000 Cost of goods sold

(I-3) Cost of goods sold

200,000

250,000 Inventory

(I-4) Retained earnings, beg.

250,000

3,200,000 Plant assets, net

3,200,000

(I-5) Plant assets, net

400,000 Operating expenses

(I-6) Land

400,000

700,000 Investment in Slam

(E) Capital stock Retained earnings, beg.

700,000

3,000,000 6,100,000

Treasury stock AOCL, beg. Investment in Slam Noncontrolling interest Debit to retained earnings, beg. = $9,300,000 - $3,200,000. (R) Liabilities Identifiable intangibles Goodwill

500,000 800,000 4,680,000 3,120,000

120,000 3,000,000 57,000,000

Plant assets, net 2,560,000 Investment in Slam 45,936,000 Noncontrolling interest 11,624,000 Credit to Investment in Slam = (60% x ($120,000 + $3,000,000 - $2,560,000)) + (80% x $57,000,000); credit to noncontrolling interest = (40% x ($120,000 + $3,000,000 $2,560,000)) + (20% x $57,000,000). (O) Plant assets, net Operating expenses

320,000 820,000 Liabilities Identifiable intangibles Goodwill

(N) Noncontrolling interest in NI Noncontrolling interest in OCI

40,000 500,000 600,000

2,352,000 80,000 Noncontrolling interest

2,432,000

Investment balance, December 31, 2020 (see req. c.) Eliminations affecting investment balance: (C) (I-2) (I-6) (E) (R)

Eliminations affecting noncontrolling interest: (E) (R) (N) Noncontrolling interest, December 31, 2020 (see req. c.)

$ 54,414,000 (3,298,000) 200,000 (700,000) (4,680,000) (45,936,000) $ 0

3,120,000 11,624,000 2,432,000 $ 17,176,000

CHAPTER 7 SOLUTIONS TO MULTIPLE CHOICE QUESTIONS, EXERCISES AND PROBLEMS

MULTIPLE CHOICE QUESTIONS 1.

a Remeasurement changes local currency accounts (euros) to the functional currency (krona). Translation changes the functional currency accounts (krona) to the reporting currency (U.S. dollars).

d Remeasure the equipment to U.S. dollars using the rates when the equipment was purchased. (€1,000,000 x $1.40) + (€3,000,000 x $1.50) = $5,900,000.

a €

Rate

U.S. $

Beginning net assets (€200,000 + €600,000) + Net income (€4,000,000 – €2,300,000 – €300,000 – €1,200,000) - Dividends

€ 800,000

1.45

$1,160,000

200,000 (100,000)

1.35 1.32

Ending net assets Translation loss

€ 900,000

1.30

270,000 (132,000) 1,298,000 1,170,000 $ 128,000

€

Rate

U.S. $

Beginning net monetary assets (€200,000 – €1,400,000) + Sales - Purchases [€2,300,000 + (€500,000 – €400,000)] - Out of pocket expenses - Dividends

€(1,200,000) 4,000,000 (2,400,000) (1,200,000) (100,000)

1.45 1.35 1.35 1.35 1.32

Ending net monetary assets (€180,000 – €1,080,000) Remeasurement gain

€ (900,000)

1.30

$ (1,740,000) 5,400,000 (3,240,000) (1,620,000) (132,000) (1,332,000) (1,170,000) $ 162,000

b Translation multiplies the current ratio numerator and denominator by the same rate.

c A steadily weakening dollar means the direct rate is rising. Translated assets are multiplied by an increasing rate.

b The direct rate is falling. Entry (R) debits goodwill at the lower ending rate, and eliminates the remaining investment balance, created at higher rates, leading to a debit to OCI. Entry (O) credits goodwill at the ending rate and debits impairment loss at the higher average rate, leading to a credit to OCI.

Reported net income Goodwill impairment Equity in net income

Rate

£ 500,000 (20,000) £ 480,000

1.65 1.65

$ 825,000 (33,000) $ 792,000

Note: the limited life intangibles were written off prior to 2021 . 9.

b IFRS: (10,000,000 x 400/100) x £0.01 = £400,000 U.S. GAAP: (10,000,000 x £0.05) = £500,000

10.

d For non-inflationary economies, IFRS and U.S. GAAP remeasurement and translation procedures are the same.

EXERCISES E7.1

Translation and Remeasurement of Inventory and Cost of Sales a. Translated ending inventory: £350,000 x $1.30 = $455,000 Translated cost of sales: Cost of sales, in pounds, is £400,000 + £5,000,000 - £350,000 = £5,050,000 £5,050,000 x $1.26 = $6,363,000. b. Remeasured ending inventory: £350,000 x $1.29 = $451,500 Remeasured cost of sales: Beginning inventory Purchases Ending inventory Cost of sales

E7.2

(£100,000 x $1.20) + (£300,000 x $1.23) = £5,000,000 x $1.26 = £350,000 x $1.29

489,000 6,300,000 (451,500) $ 6,337,500

Translation and Remeasurement of Depreciable Assets a. Translated depreciation expense: Buildings: (R175,000,000/25) x $0.08 = Equipment: (R325,000,000/10) x $0.08 = Total

560,000 2,600,000 $ 3,160,000

Translated buildings and equipment and accumulated depreciation: Buildings and equipment, at cost: R500,000,000 x $0.07 = $35,000,000 Accumulated depreciation: (R280,000,000 + R7,000,000 + R32,500,000) x $0.07 = $22,365,000 b. Remeasured depreciation expense: Buildings: (R175,000,000/25) x $0.15 = Equipment: R325,000,000/10) x $0.12 = Total

$ 1,050,000 3,900,000 $ 4,950,000

Remeasured buildings and equipment and accumulated depreciation: Buildings and equipment, at cost: (R175,000,000 x $0.15) + (R325,000,000 x $0.12) = $65,250,000 Accumulated depreciation: (R100,000,000 + R7,000,000) x $0.15 = $ 16,050,000 (R180,000,000 + R32,500,000) x $0.12 = 25,500,000 Total $ 41,550,000

E7.3

Translation and Remeasurement of Account Balances a. Cash

CHF4,000,000 x $1.09

$4,360,000

Inventory CHF3,000,000 x $1.08

$3,240,000

Machinery and equipment, original cost is remeasured at historical rates. Remaining equipment purchased in January, 2018; CHF4,000,000 x $1.02 Equipment purchased in January, 2019; CHF7,000,000 x $1.04 Total remeasured machinery and equipment

$ 4,080,000 7,280,000 $11,360,000

Depreciation expense is remeasured at the same historical rate(s) used to remeasure the related machinery and equipment. Depreciation expense on remaining January, 2018 equipment: $1.02 x (CHF4,000,000/10) Depreciation expense on January, 2019 equipment: $1.04 x (CHF7,000,000/10) Total remeasured depreciation expense

408,000

728,000 $ 1,136,000

b. Cash Inventory Machinery and equipment Depreciation expense

CHF 4,000,000 x $1.09 = CHF 3,000,000 x $1.09 = CHF11,000,000 x $1.09 = CHF 1,100,000 x $1.06 =

$ 4,360,000 $ 3,270,000 $11,990,000 $ 1,166,000

E7.4

Translation and Remeasurement Gain and Loss (in millions) a. Exposed position, 1/1/20 Acquisition of plant assets for debt Purchase of inventory Sales Operating expenses

C$ 700 (1,000) (3,500) 6,000 (1,200)

$/C$ 0.80 0.78 0.75 0.75 0.75

Exposed position, 12/31/20 Remeasurement loss

C$ 1,000

0.72

$ $ 560 (780) (2,625) 4,500 (900) 755 - 720 $ 35

NOTE: The following items did not affect the remeasurement gain or loss: 1. Collection of receivables has no net effect -- one exposed asset (receivables) is simply replaced by another (cash). 2. Depreciation expense does not affect the exposed position. 3. Refinancing of commercial paper has no net effect -- one liability is simply replaced by another. 4. Cost of goods sold does not affect the exposed position. b. Exposed position, 1/1/20 Net income in 2020 (C$6,000 – C$3,300 – C$400 - C$1,200) Exposed position, 12/31/20 Translation loss

C$ C$ 1,200

$/C$ 0.80

1,100

0.75

C$ 2,300

0.72

$ 960

825 1,785 - 1,656 $ 129

E7.5

Translation and Remeasurement Gains and Losses (in thousands) a. Calculation of remeasurement gain

2020 beginning exposed position Sales Purchases Cash operating expenses Dividends

2020 ending exposed position 2020 remeasurement gain

€ €(15,000,000) 72,000,000 (59,000,000) (9,500,000) (100,000)

$/€ 1.30 1.24 1.24 1.24 1.21

$ $(19,500,000) 89,280,000 (73,160,000) (11,780,000) (121,000) (15,281,000)

€(11,600,000)

1.20

-(13,920,000) $ (1,361,000)

€ €5,400,000 500,000

$/€ 1.30 1.24

$ $ 7,020,000 620,000

(100,000)

1.21

(121,000) 7,519,000

€5,800,000

1.20

-6,960,000 $559,000

b. Calculation of translation loss

2020 beginning exposed position Net income (€72,000 – €1,000 – €61,000 – €9,500) Dividends

2020 ending exposed position 2020 translation loss

E7.6

Translated and Remeasured Retained Earnings a. Beginning translated RE + Net income - Dividends Ending translated RE

$20,000,000 (€100,000,000 - €75,000,000 - €20,000,000) x $1.20 €1,000,000 x $1.18

6,000,000 (1,180,000) $24,820,000

We must calculate the remeasurement gain for 2020 because it is a component of net income: Beginning exposure €(50,000,000) $1.25 $(62,500,000) + Sales 100,000,000 1.20 120,000,000 - Purchases (75,000,000 + 1,500,000) 1.20 (91,800,000) - Out-of-pocket operating expenses (20,000,000 - 8,000,000) 1.20 (14,400,000) - Dividends (1,000,000) 1.18 (1,180,000) (49,880,000) Ending exposure €(39,500,000) 1.17 (46,215,000) Remeasurement gain $ 3,665,000 Calculation of remeasured net income: €100,000,000 See schedule below See schedule below See schedule above

$1.20

$120,000,000 (90,205,000) (25,600,000) 3,665,000 $ 7,860,000

Remeasured cost of sales: Beginning inventory + Purchases - Ending inventory Remeasured cost of sales

€ 2,000,000 76,500,000 3,500,000 €15,000,000

$1.25 1.20 1.17

$ 2,500,000 91,800,000 (4,095,000) $90,205,000

Remeasured operating expenses: Out-of-pocket expenses Depreciation/amortization Remeasured operating expenses

€12,000,000 8,000,000 €20,000,000

$1.20 1.40

$ 14,400,000 11,200,000 $ 25,600,000

Sales - Cost of sales - Operating expenses + Remeasurement gain Remeasured net income

Beginning remeasured RE + Net income - Dividends Ending remeasured RE

See schedule above €1,000,000 x $1.18

$15,000,000 7,860,000 (1,180,000) $21,680,000

E7.7

Effect of Translation and Remeasurement on Ratios (in thousands) a. Return on Assets 2,000/16,000 12.5%

= = =

Return on Sales 2,000/10,000 20%

x x x

Asset Turnover 10,000/16,000 62.5%

$ (remeasurement)

130/2,000 6.5%

= =

130/750 17.3%

x x

750/2,000 37.5%

$ (translation)

150/1,400 10.7%

= =

150/750 20%

x x

750/1,400 53.6%

Rands

Translation maintains the local currency relationships better than remeasurement. b. The direct exchange rate appears to be falling, meaning that the dollar is strengthening and the rand is weakening. This can be seen by observing that remeasured assets of $2,000,000 (remeasured at historical rates) are higher than translated assets of $1,400,000 (translated at average of beginning and ending current rates). Similarly, remeasured operating income of $130,000 is lower than translated operating income of $150,000, due to depreciation and amortization expenses being remeasured at higher historical rates when the functional currency is the dollar. The declining exchange rate causes the DuPont analysis performance measures to be distorted by the changing exchange rate. If performance measured in the local currency--rands--is the benchmark, translation does a better job of preserving the local currency results than remeasurement.

E7.8

Remeasured and Translated Trial Balance a. December 31, 2019 Remeasured Trial Balance

Cash Inventory (FIFO) Facilities, net Equipment, net Capital Sales Cost of sales (FIFO) Operating expenses Depreciation expense – facilities Depreciation expense – equipment Remeasurement gain (income) Note 1: Purchases Purchases Less ending inventory Cost of sales

P Dr (Cr) P 8,700,000 2,000,000 800,000 277,500 (10,000,000) (12,000,000) 7,000,000 3,000,000 200,000 22,500 -P 0 P3,000,000 x $0.06 6,000,000 x $0.07 2,000,000 x $0.07

$/P 0.08 0.07 0.05 0.06 0.05 0.07 Note 1 0.07 0.05 0.06 Note 2

$ Dr (Cr) $696,000 140,000 40,000 16,650 (500,000) (840,000) 460,000 210,000 10,000 1,350 (234,000) $ 0

$180,000 420,000 (140,000) $460,000

Note 2: Calculation of Remeasurement Gain

Exposed position, beginning Sales Facilities costs Equipment purchase Merchandise purchase Merchandise purchase Cash operating expenses Exposed position, ending Remeasurement gain (income)

P P10,000,000 12,000,000 (1,000,000) (300,000) (3,000,000) (6,000,000) (3,000,000)

$/P 0.05 0.07 0.05 0.06 0.06 0.07 0.07

P 8,700,000

0.08

$ $ 500,000 840,000 (50,000) (18,000) (180,000) (420,000) (210,000) 462,000 - 696,000 $ (234,000)

b. December 31, 2019 Translated Trial Balance

Cash Inventory Facilities, net Equipment, net Capital Sales Cost of goods sold Operating expenses Depreciation expense – facilities Depreciation expense – equipment Translation gain (OCI)

P Dr (Cr) P 8,700,000 2,000,000 800,000 277,500 (10,000,000) (12,000,000) 7,000,000 3,000,000 200,000 22,500 -P 0

$/P 0.08 0.08 0.08 0.08 0.05 0.07 0.07 0.07 0.07 0.07 Note 3

$ Dr (Cr) $ 696,000 160,000 64,000 22,200 (500,000) (840,000) 490,000 210,000 14,000 1,575 (317,775) $ 0

Note 3: Calculation of Translation Gain Exposed position, beginning Net income (P12,000,000 – P7,000,000 – P3,000,000 – P222,500) Exposed position, ending Translation gain (OCI)

P P10,000,000

$/P 0.05

1,777,500

0.07

P11,777,500

0.08

$ $

500,000

124,425 624,425 - 942,200 $ (317,775)

E7.9

Change from Remeasurement to Translation

Exposed position, beginning Net income Dividends Exposed position, ending Translation gain for 2020 (OCI)

C$ C$20,000,000 2,500,000 (1,000,000)

$/C$ 0.75 0.78 0.77

C$21,500,000

0.79

Cumulative translation balance, beginning (AOCI credit balance) (1) Translation gain for 2020 (OCI) Cumulative translation balance, ending (AOCI credit balance)

see above

$ $15,000,000 1,950,000 (770,000) 16,180,000 - 16,985,000 $ (805,000)

$(4,000,000) (805,000) $(4,805,000)

(1) Translated net assets: $0.75 x C$20,000,000 = Less remeasured net assets (given) Beginning balance of translation adjustment account (AOCI credit balance)

$ 15,000,000 (11,000,000) $

4,000,000

E7.10 Change from Translation to Remeasurement In general, there is no change in the translated U.S. dollar accounts at the time remeasurement is adopted. The change is handled prospectively. a. b.

The translated balances for Savingsplus’ assets and liabilities become the beginning remeasured balances. For assets on hand at the date remeasurement is adopted, their historical rate is the rate at the date of adoption, in this case $0.007/bolivar. Historical rates for assets acquired subsequent to adoption are the rates when the assets are acquired. The cumulative translation loss remains in AOCI. When remeasurement is adopted, the remeasurement gain/loss is reported in income and closed to retained earnings. As long as Partytime continues to own the subsidiary, the balance in AOCI remains static unless it reverts to translation again sometime in the future. Partytime’s choice of translation versus remeasurement is a matter of fact, depending on identification of the subsidiary’s functional currency and determination of whether Venezuela is highly inflationary or not. If the facts indicate that translation is now appropriate, Partytime can go back to translating Savingsplus’ accounts.

E7.11 Translated and Remeasured Trial Balances a. Translated Trial Balance, December 31, 2019 SAR $/SAR SAR 95,000,000 .250 25,000,000 .250 90,000,000 .250 (200,000,000) .300 10,000,000 .255 (85,000,000) .265 40,000,000 .265 10,000,000 .265 15,000,000 .265 -- see below SAR 0

Cash Inventory Plant assets Capital Dividends Sales Cost of goods sold Depreciation expense Other expenses Translation loss (OCI)

$ $ 23,750,000 6,250,000 22,500,000 (60,000,000) 2,550,000 (22,525,000) 10,600,000 2,650,000 3,975,000 10,250,000 $ 0

Schedule of 2019 Translation Loss Exposed position, beginning Net income Dividends Exposed position, ending 2019 translation loss (OCI)

SAR SAR200,000,000 20,000,000 (10,000,000)

$/SAR .300 .265 .255

SAR210,000,000

.250

$ $60,000,000 5,300,000 (2,550,000) 62,750,000 - 52,500,000 $10,250,000

b. Remeasured Trial Balance, December 31, 2019 Cash Inventory Plant assets Capital Dividends Sales Cost of goods sold Depreciation expense Other expenses Remeasurement loss (income)

SAR $/SAR SAR 95,000,000 0.250 25,000,000 (1) 90,000,000 0.300 (200,000,000) 0.300 10,000,000 0.255 (85,000,000) 0.265 40,000,000 0.300 10,000,000 0.300 15,000,000 0.265 -- see below SAR 0

$ $23,750,000 6,975,000 27,000,000 (60,000,000) 2,550,000 (22,525,000) 12,000,000 3,000,000 3,975,000 3,275,000 $ 0

Schedule of 2019 Remeasurement Loss Exposed position, beginning Sales Purchases Cash expenses Dividends Exposed position, ending 2019 remeasurement loss (income)

SAR SAR50,000,000 85,000,000 (15,000,000) (15,000,000) (10,000,000)

$/SAR 0.300 0.265 0.265 0.265 0 .255

SAR95,000,000

0.250

$ $15,000,000 22,525,000 (3,975,000) (3,975,000) (2,550,000) 27,025,000 - 23,750,000 $3,275,000

(1) Remeasurement of ending inventory balance Inventory purchased January 1, 2019 Inventory purchased evenly in 2019 Inventory balance, December 31, 2019

SAR SAR10,000,000 15,000,000 SAR25,000,000

$/SAR 0.300 0.265

$ $3,000,000 3,975,000 $6,975,000

E7.12 Exchange Rate Changes and Return on Assets a. Return on Assets (000,000 omitted)

2020 2021

$ 12/[0.5(112 + 95)] = 0.116 10.89/[0.5(95 + 95)] = 0.115

S$ 12/[0.5(93.33 + 118.75)] = 0.113 15.56/[0.5( 118.75+ 118.75)] = 0.131

Note: To calculate S$ amounts, divide the translated numbers by the relevant exchange rate. For 2020, 12 = 12/1.00; 93.33 = 112/1.20; 118.75 = 95/0.80 For 2021, 15.56 = 10.89/0.70; 118.75 = 95/0.80 b. Although the ROA based on Singapore dollar data increased by 15.9% [= (0.131 0.113)/0.113], translated data produced an ROA that declined slightly over the period. This distortion created by translation can be attributed to two factors. 1. The declining average exchange rate caused translated operating income to fall by 9.3% [= (10.89 - 12)/12] even though Singapore dollar income rose by 30% [= (15.56 – 12)/12]. Thus the numerator of the Singapore dollar ROA rose while the numerator of the translated ROA fell. 2. Translated average total assets decreased by 8.2% [= (95 -103.5)/103.5], whereas average Singapore dollar assets increased by 12% [= (118.75 – 106.04)/106.04]. This increased the denominator of the Singapore dollar ROA relative to the translated ROA. The net effect of the changing exchange rate on Singapore dollar income and average total assets creates a divergence between the Singapore dollar ROA -- which suggests improved profitability of the asset portfolio -- and the slightly weakening ROA based on translated data. Since the Singapore dollar is the entity's functional currency, the entity's financial performance is best measured by Singapore dollar data. Internal management has these Singapore dollar data and can decide whether to make decisions based on Singapore dollar data or translated data. Financial statement users outside the entity, however, cannot easily determine that translated data provide the wrong performance signal or are able to factor out the translation effects that produce the wrong performance signal.

E7.13 Comparison of Financial Performance: Translation versus Remeasurement a. The direct exchange rate has been steadily falling. This means that many remeasured expenses are higher than translated expenses, since historical rates are higher than average rates. Since Carrefour Asia has a positive exposed position for remeasurement, the decrease in rate will result in a remeasurement loss on the income statement. For these reasons, translated income is higher than remeasured income. b. Remeasured assets are higher than translated assets since historical rates are higher than the current rate. From above, remeasured income is lower than translated income. These factors combine to show translated ROA as higher than remeasured ROA. c. Remeasured current assets may be slightly higher than translated current assets, as inventories and possibly prepaids are remeasured at higher historical rates. Current liabilities are likely to be the same under both methods. Therefore, the remeasured current ratio is slightly higher than the translated current ratio. Remeasured and translated debt should be the same. Remeasured total assets are higher than translated total assets since the older noncurrent assets are remeasured at higher historical rates. Thus, translated debt to assets is higher than remeasured debt to assets.

E7.14 Cash Flow Statement Conversion The Luh Company Statement of Cash Flows For the Year Ended December 31, 2020 (in thousands) NT$ Operating Activities Net income Depreciation and amortization expense Gain on sale of long-term investments Decrease in other current operating assets Decrease in current operating liabilities Cash provided by operating activities Investing Activities Acquisition of plant assets Sale of long-term investments Cash used in investing activities Financing Activities Retirement of long-term debt Issuance of common stock Dividends paid Cash provided by financing activities Increase in cash Effect of exchange rate changes on cash Cash balance, January 1, 2020 Cash balance, December 31, 2020

NT$100,000,000 45,000,000 (4,000,000) 24,000,000 (32,000,000) 133,000,000

$/NT$

0.0400 0.0400 0.0400 0.0400 0.0400

$4,000,000 1,800,000 (160,000) 960,000 (1,280,000) 5,320,000

(85,000,000) 0.0423 50,000,000 0.0394 (35,000,000)

(3,595,500) 1,970,000 (1,625,500)

(98,000,000) 170,000,000 (65,000,000) 7,000,000 105,000,000 -210,000,000 NT$315,000,000

0.0394 0.0423 0.0400

0.0420 0.0390

(3,861,200) 7,191,000 (2,600,000) 729,800 4,424,300 (959,300)* 8,820,000 $12,285,000

Effect of exchange rate changes on cash: Beginning cash balance Cash provided by operations Sale of long-term investments Proceeds from stock issuance Acquisition of plant assets Retirement of long-term debt Dividends paid Ending cash balance Translation loss on cash

NT$ NT$210,000,000 133,000,000 50,000,000 170,000,000 (85,000,000) (98,000,000) (65,000,000)

$/NT$ 0.0420 0.0400 0.0394 0.0423 0.0423 0.0394 0.0400

NT$315,000,000

0.0390

$ $ 8,820,000 5,320,000 1,970,000 7,191,000 (3,595,500) (3,861,200) (2,600,000) 13,244,300 - 12,285,000 $ 959,300

E7.15 Consolidation of an International Subsidiary at Date of Acquisition

Price paid Book value Acquisition cost in excess of book value Overvaluation of inventories Overvaluation of noncurrent assets Unreported identifiable intangible assets Goodwill

P P 360,000,000 (100,000,000) 260,000,000 15,000,000 35,000,000 (10,000,000) P 300,000,000

$/P 0.05 0.05 0.05 0.05 0.05

U.S.$ $ 18,000,000 (5,000,000) 13,000,000 750,000 1,750,000 (500,000) $ 15,000,000

Entries to consolidate the balance sheets of parent and subsidiary (amounts are in U.S. dollars): (E) Capital stock Retained earnings Investment in subsidiary (R) Identifiable intangible assets Goodwill Inventories Noncurrent assets Investment in subsidiary

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

500,000 15,000,000 750,000 1,750,000 13,000,000

E7.16 Translation and Remeasurement Gain or Loss Calculations and Consolidation a. Remeasurement gain or loss

Exposed position, 9/10/20 Purchase of equipment Operating expenses Exposed position, 12/31/20 Remeasurement gain (income)

S/ S/10,000,000 (2,700,000) (2,900,000)

$/S/ 0.30 0.30 0.31

S/ 4,400,000

0.33

S/ S/10,000,000 (2,900,000)

$/S/ 0.30 0.31

S/ 7,100,000

0.33

$ $3,000,000 (810,000) (899,000) 1,291,000 - 1,452,000 $ (161,000)

b. Translation gain or loss

Exposed position, 9/10/20 Operating expenses Exposed position, 12/31/20 Translation gain (OCI)

$ $3,000,000 (899,000) 2,101,000 - 2,343,000 $ (242,000)

c. Globe’s entries, remeasurement Equity in net loss of sub Investment in sub

738,000 738,000

$(738,000) = operating expenses less the remeasurement gain: (S/2,900,000 x 0.31) – $161,000

Globe’s entries, translation Equity in net loss of sub Investment in sub Equity in OCI of sub $(899,000) = (S/2,900,000) x 0.31

899,000 657,000 242,000

d. Remeasurement consolidation Globe Dr (Cr)

Subsidiary Dr (Cr)

Consol. Dr (Cr)

Cash

500,000

$ 1,452,000

$ 1,952,000

PP&E

22,000,000

810,000

22,810,000

Investment in sub

2,262,000

3,000,000 (E)

Liabilities

(16,000,000)

Capital

(5,000,000)

RE, beg

(2,000,000)

Revenues

(15,000,000)

Equity in NL

738,000

(3,000,000)

12,500,000

899,000

Remeasurement gain

________

(161,000)

(5,000,000)

738,000 (C)

Expenses

(E) 3,000,000

-13,399,000

_________

________

$3,738,000 $3,738,000

(161,000) $

Translation consolidation Globe Dr (Cr)

Subsidiary Dr (Cr)

Consol. Dr (Cr)

Cash

500,000

$ 1,452,000

$ 1,952,000

PP&E

22,000,000

891,000

22,891,000

Investment in sub

2,343,000

3,000,000 (E)

Liabilities

(16,000,000)

Capital

(5,000,000)

RE, beg

(2,000,000)

Revenues

(15,000,000)

Equity in NL

899,000

Equity in OCI

(242,000)

Expenses

(16,000,000) (3,000,000)

(E) 3,000,000

(5,000,000)

899,000 (C) (C) 242,000

12,500,000

899,000

(242,000)

_________ _________

$3,899,000 $3,899,000

OCI $

-13,399,000 (242,000) $

E7.17 Hyperinflationary Economies a. Before Venezuela was labeled as hyperinflationary, both companies translated their Venezuelan subsidiary’s accounts for consolidation purposes. Plant assets were converted to dollars or euros using the current rate. U.S. Mart now remeasures the subsidiary’s plant assets, as if the subsidiary’s functional currency were the U.S. dollar. Plant assets are converted to dollars using the historical rate, when the plant assets were acquired. Euro Mart follows IFRS, which requires it to price-level adjust the plant asset balances, before translating as usual. The plant assets are expressed in VEF with the same current purchasing power, and then translated using the current rate. b. U.S. Mart: VEF10,000,000 x $0.52 = $5,200,000 Euro Mart: VEF10,000,000 x 400/100 = VEF40,000,000 x €0.10 = €4,000,000

PROBLEMS P7.1

Translating and Remeasuring Selected Accounts (in millions) a. TEurope AG Remeasurement of Selected Accounts into Dollars December 31, 2020 and December 31, 2019 CHF December 31, 2020 Accounts receivable (net) Inventories, at cost Property, plant and equipment Long-term debt Common stock December 31, 2019 Accounts receivable (net) Inventories, at cost Property, plant and equipment Long-term debt Common stock

$/CHF

CHF 40,000 1.13 80,000 1.10 163,000 Schedule 1 100,000 1.13 50,000 0.96 35,000 75,000 150,000 120,000 50,000

1.04 0.98 0.96 1.04 0.96

$ $ 45,200 88,000 160,800 113,000 48,000 36,400 73,500 144,000 124,800 48,000

Schedule 1 Remeasurement of Property, Plant, and Equipment (Net) into Dollars At December 31, 2020 Land purchased on 1/1/19 Plant and equipment purchased on 1/1/19: Original cost Accumulated depreciation Plant and equipment purchased on 7/4/20: Original cost Accumulated depreciation Total property, plant and equipment

CHF CHF 24,000

$/CHF 0.96

$ $ 23,040

140,000 (28,000) 112,000

0.96 0.96

134,400 (26,880) 107,520

30,000 (3,000) 27,000 CHF163,000

1.12 1.12

33,600 (3,360) 30,240 $160,800

b. TEurope AG Translation of Selected Accounts into Dollars December 31, 2020 and December 31, 2019 December 31, 2020 Accounts receivable (net) Inventories, at cost Property, plant and equipment Long-term debt Common stock December 31, 2019 Accounts receivable (net) Inventories, at cost Property, plant and equipment Long-term debt Common stock

P7.2

CHF

$/CHF

CHF 40,000 80,000 163,000 100,000 50,000

1.13 1.13 1.13 1.13 0.96

$ 45,200 90,400 184,190 113,000 48,000

35,000 75,000 150,000 120,000 50,000

1.04 1.04 1.04 1.04 0.96

36,400 78,000 156,000 124,800 48,000

Existing Subsidiary—Remeasurement

Supervalu Remeasured Trial Balance at December 31, 2019 Account Cash Accounts receivable, net Plant and equipment, net Accounts payable Notes payable Capital stock Retained earnings, January 1 Sales Depreciation expense Other expenses Remeasurement loss (income)

kr $/kr kr 240,000 0.16 360,000 0.16 2,000,000 0.13 (200,000) 0.16 (600,000) 0.16 (400,000) 0.13 (1,160,000) 0.13 (1,200,000) 0.14 320,000 0.13 640,000 0.14 ________ see below kr 0

$ $ 38,400 57,600 260,000 (32,000) (96,000) (52,000) (150,800) (168,000) 41,600 89,600 11,600 $ 0

Supervalu Remeasurement Loss for 2019 Exposed position, January 1 Sales Other expenses Exposed position, December 31 Remeasurement loss (income) 1 2

P7.3

kr kr (760,000)1 1,200,000 (640,000)

$/kr 0.13 0.14 0.14

kr (200,000)2

0.16

$ $ (98,800) 168,000 (89,600) (20,400) - (32,000) $ 11,600

Net exposure, January 1: kr(760,000) = kr175,000 + kr400,000 - kr535,000 - kr800,000 Net exposure, December 31: kr(200,000) = kr240,000 + kr360,000 - kr200,000 - kr600,000

Existing Subsidiary—Translation

Supervalu Translated Trial Balance at December 31, 2019 Account Cash Accounts receivable, net Plant and equipment, net Accounts payable Notes payable Capital stock Retained earnings, January 1 Sales Depreciation expense Other expenses Other comprehensive gain (OCI)

kr $/kr kr 240,000 0.16 360,000 0.16 2,000,000 0.16 (200,000) 0.16 (600,000) 0.16 (400,000) 0.13 (1,160,000) 0.13 (1,200,000) 0.14 320,000 0.14 640,000 0.14 ________ see below kr 0

$ $ 38,400 57,600 320,000 (32,000) (96,000) (52,000) (150,800) (168,000) 44,800 89,600 (51,600) $ 0

Supervalu Translation Gain for 2019 Exposed position, January 1 Net income, 2019 (kr1,200,000 kr320,000 - kr640,000) Exposed position, December 31 Translation gain (OCI) 1

P7.4

kr kr 1,560,0001

$/kr 0.13

$ $ 202,800

240,000

0.14

kr 1,800,000

0.16

33,600 236,400 - 288,000 $ (51,600)

Net exposure, January 1 = kr1,560,000 = kr400,000 + kr1,160,000

Statement of Cash Flows Conversion (in thousands) €

$/€

€9,980,000 (6,150,000) (2,700,000) 1,130,000

1.12 1.12 1.12

$11,177,600 (6,888,000) (3,024,000) 1,265,600

Cash used for investing activities Acquisition of plant assets

(1,520,000)

1.10

(1,672,000)

Cash from financing activities Loan Change in cash Effect of exchange rate changes on cash (loss) Beginning cash Ending cash

400,000 10,000 -30,000 € 40,000

1.09

436,000 29,600 (16,400) 32,400 45,600

Cash from operating activities Cash received from customers Cash paid to suppliers Cash paid for operating expenses

1.08 1.14

Calculations: Cash from customers = €10,000,000 – (€160,000 - €140,000) = €9,980,000. Cash paid to suppliers = €6,000,000 + (€400,000 – €200,000) – (€200,000 – €150,000) = €6,150,000.

Schedule of translation effect on cash: Cash balance, beginning Cash from operating activities Cash used for investing activities Cash from financing activities Cash balance, ending Effect of exchange rate changes on cash (loss)

€ € 30,000 1,130,000 (1,520,000) 400,000

$/€ 1.08 1.12 1.10 1.09

€

40,000

1.14

€ € 100,000 1,200,000 (20,000) (200,000) 50,000 € 1,130,000

$/€ 1.12 1.12 1.12 1.12 1.12

$ $ 32,400 1,265,600 (1,672,000) 436,000 62,000 45,600 $ 16,400

Reconciliation of net income to cash from operations: Net income + Depreciation expense - Increase in accounts receivable - Increase in inventory + Increase in accounts payable Cash from operations

$ $ 112,000 1,344,000 (22,400) (224,000) 56,000 $ 1,265,600

P7.5

Translation and Ratio Analysis (in thousands) a. Statement of Comprehensive Income (*) Sales Cost of sales Operating expenses Net income Other comprehensive loss Comprehensive loss

$ 550,000 (352,000) (159,500) 38,500 (87,000) $ (48,500)

* Except for OCL, $ amounts = € amounts x 1.1

Balance Sheet (*) Cash Merchandise inventory Plant assets

$ 4,500 180,000 225,000

Total assets

________ $409,500

Liabilities Capital stock (200,000 x $1.30) Retained earnings Accumulated other comprehensive income Total liabilities and equity

$198,000 260,000 38,500 (87,000) $409,500

* $ amounts of assets and liabilities = € amounts x 0.90

Translation Loss for 2020 Exposed position (net assets), January 1, 2020 Plus net income in 2020 (€500,000 - €465,000) Exposed position (net assets), December 31, 2020 Translation loss (OCL)

€ € 200,000 35,000

$/€ 1.30 1.10

€ 235,000

0.90

b. Statement of Comprehensive Income Sales (€500,000 x 1.1) Cost of sales (1) Cash operating expenses (€95,000 x 1.1) Depreciation expense (€50,000 x 1.3) Remeasurement gain (see schedule below) Net income and comprehensive income (1)

$ 550,000 (382,000) (104,500) (65,000) 63,000 $ 61,500

$ $ 260,000 38,500 298,500 - 211,500 $ 87,000

Purchases Ending inventory Cost of sales

€ €520,000 (200,000) €320,000

$/€ 1.10 0.95

$ $572,000 (190,000) $382,000

Balance Sheet Cash Merchandise inventory (2) Plant assets (3) Total assets

4,500 190,000 325,000 $519,500

Liabilities Capital stock Retained earnings Total liabilities and equity

$198,000 260,000 61,500 $519,500

(2) €200,000 x $0.95; (3) €250,000 x $1.30

Remeasurement Gain for 2020 € Exposed position, January 1, 2020 (€100,000 – €200,000) €(100,000) Plus sales 500,000 Less purchases (520,000) Less cash expenses (95,000)

$/€

1.30 1.10 1.10 1.10

€(215,000)

0.90

$(130,000) 550,000 (572,000) (104,500) (256,500) - (193,500) $ (63,000)

Exposed position, December 31, 2020 Remeasurement gain (income) c.

$ Net income/sales Net income/average assets

€

Translation

Remeasurement

0.070 = 35/500 0.082 = 35/427.5

0.070 = 38.5/550 0.083 = 38.5/464.75

0.112 = 61.5/550 0.118 = 61.5/519.75

Computation of average assets: € Translation (400 + 455)/2 = 427.5 ((400 x 1.30) + 409.5)/2 = 464.75

Remeasurement ((400 x 1.30) + 519.5)/2 = 519.75

Note to Instructor: The solution to this problem uses net income. Using operating income (excluding the remeasurement gain), the ratios using remeasured data are: Operating income/sales (1.5)/550 = Operating income/total assets (1.5)/519.75 =

(0.003) (0.003)

The ratios computed using translated data do a much better job of preserving the same relationships expressed in euros than do the remeasured ratios. With ratios like return on sales, gross margin percentage and the current ratio, the translated results will be the same as the euro results. This happens because in translation, the numerator and denominator of each ratio are multiplied by the same exchange rate. Return on assets using translated data will differ somewhat from the euro ratio depending on how much the exchange rate has changed during the year. In this example, translated net income reflects the weighted average exchange rate for a year while total assets are translated at a simple average of beginning and ending rates which may differ from the weighted average. Ratios based on remeasured data equal their euro counterparts only by coincidence. Because some items are translated at historical rates and others at the current rate or the average rate, the numerator and denominator do not reflect a constant which simply cancels out. d. If the euro continues to weaken, the ratios using translated data improve if the activity level is held constant. Return on sales is unaffected by the changing exchange rate but return on assets could increase over the previous year, since assets are translated at the ending (lower) rate while income is translated at the average (higher) rate. While the ratio signals improvement in performance, any new investments in that international country must be considered within the context of its weakening foreign currency. Use of remeasured data, however, shows a decline in the return on assets. Remeasured net income, the numerator, falls as it is largely remeasured at the lower average rate. In contrast, total assets, the denominator, remains high as it is remeasured largely at the higher historical rates. Ratio analysis should be viewed as a starting point for further analysis. Management should be aware that certain ratios based on translated data may provide incorrect signals due to the translation process.

P7.6

Translation and Remeasurement of Subsidiary Trial Balance (in thousands) a. Remeasured Trial Balance December 31, 2020 CHF

$/CHF

CHF 30,000

1.09

$ 32,700

Inventories

55,000

1.08

59,400

Plant and equipment, net

175,000

(1)

180,530

Accounts and notes payable

(120,000)

1.09

(130,800)

Common stock

(30,000)

1.03

(30,900)

Retained earnings, beginning

(80,000)

1.03

(82,400)

Dividends

20,000

1.09

21,800

Sales

(500,000)

1.06

(530,000)

Cost of sales

375,000

(2)

394,600

Operating expenses

75,000

(3)

79,370

see below

5,700

Cash, receivables

Remeasurement loss (income)

-CHF

(1) (CHF150,000 - CHF3,000) x 1.03 = (CHF30,000 - CHF2,000) x 1.04 = Plant and equipment, net

$ 151,410 29,120 $ 180,530

(2) Beginning inventory Purchases Ending inventory Cost of sales

CHF60,000 x 1.03 = CHF370,000 x 1.06 = CHF55,000 x 1.08 =

$ 61,800 392,200 (59,400) $ 394,600

Depreciation expense Depreciation expense Other operating expenses

CHF3,000 x 1.03 = CHF2,000 x 1.04 = CHF70,000 x 1.06 = Operating expenses

(3) 3,090 2,080 74,200 $ 79,370

Computation of Remeasurement Loss Year ended December 31, 2020 CHF $/CHF Beginning exposed position (CHF25,000 – CHF125,000) CHF(100,000) 1.03 Sales 500,000 1.06 Purchases (370,000) 1.06 Cash operating expenses (70,000) 1.06 Dividends (20,000) 1.09 Plant and equipment acquisition (30,000) 1.04 Ending exposed position (CHF30,000 – CHF120,000) Remeasurement loss (income)

CHF (90,000)

1.09

$ $(103,000) 530,000 (392,200) (74,200) (21,800) (31,200) (92,400) - (98,100) $ 5,700

b. Translated Trial Balance December 31, 2020 CHF $/CHF Cash, receivables CHF 30,000 1.09 Inventories 55,000 1.09 Plant and equipment, net 175,000 1.09 Accounts and notes payable (120,000) 1.09 Common stock (30,000) 1.03 Retained earnings, beginning (80,000) 1.03 Dividends 20,000 1.09 Sales (500,000) 1.06 Cost of sales 375,000 1.06 Operating expenses 75,000 1.06 Translation gain (OCI) -- see below CHF 0

$ $ 32,700 59,950 190,750 (130,800) (30,900) (82,400) 21,800 (530,000) 397,500 79,500 (8,100) $ 0

Computation of Translation Gain Year ended December 31, 2020 CHF $/CHF Beginning exposed position (CHF30,000 + CHF80,000) CHF110,000 1.03 Net income 50,000 1.06 Dividends (20,000) 1.09 Ending exposed position (CHF30,000 + CHF110,000) Translation gain (OCI)

P7.7

CHF 140,000

$ $113,300 53,000 (21,800) 144,500

1.09

- 152,600 $ (8,100)

$/C$

C$(321) (100) 92 51 (49) 3 (324)

0.75 0.75 0.75 0.75 0.75 0.75

$(240.75) (75.00) 69.00 38.25 (36.75) 2.25 (243.00)

257 257

0.75

192.75 192.75

Converting the Cash Flow Statement a. Sears Canada Inc. Statement of Cash Flows For the Year Ended January 28, 2017 (in millions) Operating activities Net loss Gains on sale of plant assets Depreciation expense Decrease in other current operating assets Decrease in accounts payable and accruals Increase in income taxes payable Cash from operating activities Investing activities Disposition of plant assets (Note 1) Cash from investing activities

continued

a. table continued Sears Canada Inc. Statement of Cash Flows For the Year Ended January 28, 2017 (in millions) Financing activities Payment of long-term debt Cash used in financing activities Effect of exchange rate changes on cash Decrease in cash Note 1:

$453 - $204 - $92 = $157; $157 + $100 = $257.

Note 2:

Schedule of translation effect on cash

Cash balance, January 30, 2016 Cash from operating activities Cash from investing activities Cash used in financing activities Cash balance, January 28, 2017 Effect of exchange rate changes on cash (gain) Note 3:

$/C$

(11) (11) -C$(78)

0.75

(8.25) (8.25) 11.78 $ (46.72)

(Note 2) (Note 3)

C$ C$314 (324) 257 (11)

$/C$ 0.72 0.75 0.75 0.75

C$236

0.76

$ $226.08 (243.00) 192.75 (8.25) 167.58 - 179.36 $ 11.78

Check of $46.72 decrease in cash: (C$236 x $.76) – (C$314 x $.72) = $(46.72)

b. The choice of remeasurement versus translation does not affect cash flow statement totals. Current period cash flows are always converted at current period exchange rates, repetitive cash transactions at the weighted average rate, and large discrete cash transactions at the rates in effect when the transactions occurred. But in the operating section, if the indirect approach is used, remeasured net income will differ from translated net income, and remeasured depreciation and inventory adjustments will differ from the translated adjustments.

P7.8

Analysis of Translation Adjustment Disclosure a. Appearance of the currency translation adjustment as a component of other comprehensive income, rather than net income, indicates that the functional currency of the U.S. subsidiary is its local currency, the U.S. dollar. b. The following analysis assumes the U.S. subsidiary had a positive exposure to translation gains and losses (local currency assets > liabilities) during this time period. In all three years, the translation adjustment is a gain, meaning that the Mexican peso on average weakened against the U.S. dollar. The Mex$/U.S.$ rate increased, causing translated net assets to increase. c. The cumulative currency translation adjustment balance at the beginning of 2014 is a gain, implying that the Mexican peso on average weakened against the U.S. dollar for periods prior to 2014, although not nearly as much as during the period 2014-2016, given the large size of the translation gains in that period. d. In order to measure the earnings impact of remeasurement, we must make an assumption about the nature of the U.S. subsidiary’s exposed position under remeasurement. A reasonable assumption is that assets measured at current money prices are less than liabilities, creating a negative (liability) exposure to exchange rate changes. Since exchange rates increased in 2016, there would be a remeasurement loss reported in income on the net liability exposure, since the net liability exposure is remeasured at higher current rates. Depreciation and amortization are remeasured at historical rates. The Mexican peso has generally been weakening against the U.S. dollar, implying that rates have on average increased, and historical rates were lower. Using lower historical rates to remeasure depreciation and amortization produces a positive effect on income. Cost of goods sold is most likely dominated by purchases made in the current year, and therefore the remeasured amount is unlikely to differ significantly from the translated amount. In summary, then, historical rates are lower than current or average rates for the U.S. subsidiary. So expenses remeasured at historical rates, such as depreciation and amortization, are lower than expenses measured at average rates. The table below shows the impact of remeasured expenses and the remeasurement loss on net income.

Expenses remeasured at historical rates Inclusion of remeasurement loss in income

Impact on 2016 Net Income increase decrease

The U.S. subsidiary’s remeasured operating income, excluding the remeasurement gain, would be higher than translated operating income. The remeasurement loss offsets this effect, so the effect of remeasurement on net income is not determinable.

P7.9

Translated/Remeasured Trial Balances (in millions) a. and b. $/£

$ Remeasurement Dr (Cr)

$/£

$ Translation Dr (Cr)

£2,660

1.30

$3,458

1.30

$3,458

Inventory

2,500

1.28

3,200

1.30

3,250

Plant assets

1,800

(a)

3,124

1.30

2,340

Accumulated depreciation

(560)

(b)

(979)

1.30

(728)

Accounts payable

(2,200)

1.30

(2,860)

1.30

(2,860)

Long-term debt

(1,100)

1.30

(1,430)

1.30

(1,430)

Equity, January 1

(2,100)

(c)

(3,196)

(c)

(2,520)

Sales

(4,000)

1.25

(5,000)

1.25

(5,000)

Cost of goods sold

2,000

(d)

2,271

1.25

2,500

Depreciation expense

160

(e)

259

1.25

200

Other operating expenses

840

1.25

1,050

1.25

1,050

(f)

103 (g)

(260)

Account

£ Dr (Cr)

Cash and receivables

Remeasurement loss (income) Translation gain (OCI)

_____ £

_____ $

(a) $3,124 = ($1.80 x £1,600) + ($1.22 x £200) (b) $979 = ($1.80 x £510) + ($1.22 x £50) (c) The remeasured (translated) balance of equity at January 1, 2019, is given as $3,196 ($2,520). (d) $2,271 = ($1.18 x £2,200) + ($1.25 x £2,300) – ($1.28 x £2,500) (e) $259 = ($1.80 x £110) + (1.22 x £50) (f) Calculation of remeasurement loss £ $/£ $ Exposed position, January 1, 2019 £(1,300) 1.20 $(1,560) Plus sales 4,000 1.25 5,000 Less purchase of plant assets (200) 1.22 (244) Less purchases (2,300) 1.25 (2,875) Less other operating expenses (840) 1.25 (1,050) (729) Exposed position, December 31, 2019 £ (640) 1.30 - (832) Remeasurement loss (income) $ 103 (g) Calculation of translation gain Exposed position (net assets), January 1, 2019 Plus net income in 2019 (£4,000-£2,000-£160-£840) Exposed position (net assets), December 31, 2019 Translation gain (OCI)

£ £2,100 1,000

$/£ 1.20 1.25

£3,100

1.30

$ $2,520 1,250 3,770 - 4,030 $ (260)

P7.10 Translated and Remeasured Financial Statements (in millions) StopnShop Trial Balance Year Ended December 31, 2020 (a) Remeasurement

(b)Translation

HK$

$/HK$

HK$ 60

0.15

$ 9.00

0.15

$ 9.00

Accounts receivable

0.15

1.50

0.15

1.50

Inventory

0.14

2.80

0.15

3.00

Equipment, net

0.11

3.96

0.15

5.40

Accounts payable

(25)

0.15

(3.75)

0.15

(3.75)

Contributed capital

(100)

0.10

(10.00)

0.10

(10.00)

Sales

(260)

0.12

(31.20)

0.12

(31.20)

Cost of goods sold

230

(1)

27.20

0.12

27.60

Operating expenses (cash)

0.12

3.00

0.12

3.00

Depreciation expense

0.11

0.44

0.12

0.48

Remeasurement gain (income)

see below

(2.95)

Translation gain (OCI)

see below

Cash

Total

HK$ 0

(1) Remeasured cost of goods sold: Purchases Less ending inventory Cost of goods sold

HK$ HK$250.00 (20.00) HK$230.00

Rate $ 0.12 0.14

$ $30.00 (2.80) $27.20

(5.03) $

Computation of remeasurement and translation gain: Remeasurement HK$ $/HK$

Translation $/HK$

0.10

$10.00

HK$

0.10

$10.00

HK$100

260

0.12

31.20

260

0.12

31.20

Inventory purchases

(250)

0.12

(30.00)

Equipment purchase

(40)

0.11

(4.40)

Cash operating expenses

(25)

0.12

(3.00)

(25)

0.12

(3.00)

(230)

0.12

(27.60)

(4)

0.12

(0.48)

Exposed position, Jan. 1, 2020 Plus: Sales revenue

HK$100

Less:

Cost of goods sold Depreciation expense

______

_____ 3.80

Exposed position, Dec. 31, 2020 Remeasurement/translation gain

HK$ 45

0.15

- 6.75

10.12 HK$101

0.15

$ (2.95)

$ (5.03)

Notes a HK$100 = cash (HK$100) = net assets carried at current money prices = net assets. b HK$45 = cash (HK$60) + receivables (HK$10) – accounts payable (HK$25) = net assets carried at current money prices. c HK$101 = capital (HK$100) + retained earnings (HK$1)

P7.11 Consolidated Financial Statements with an International Subsidiary Step 1: Translation of Standard’s December 31, 2020 trial balance: £ $/£ Cash and receivables £ 3,000,000 1.30 Inventory 3,000,000 1.30 Property, plant & equipment, net 5,000,000 1.30 Current liabilities (4,000,000) 1.30 Long-term debt (1,000,000) 1.30 Capital stock (2,000,000) 1.20 Retained earnings, January 1 (3,500,000) 1.20 Dividends 1,000,000 1.28 Sales (10,000,000) 1.25 Cost of goods sold 6,000,000 1.25 Depreciation expense 500,000 1.25 Other operating expenses 2,000,000 1.25 Other comprehensive income -see below £ 0

- 15.15

$ $ 3,900,000 3,900,000 6,500,000 (5,200,000) (1,300,000) (2,400,000) (4,200,000) 1,280,000 (12,500,000) 7,500,000 625,000 2,500,000 (605,000) $ 0

Calculation of translation adjustment for 2020: £ Net assets, January 1, 2020 £ 5,500,000 Net income 1,500,000 Dividends (1,000,000) Net assets, December 31, 2020 Translation gain (OCI)

£6,000,000

$/£ 1.20 1.25 1.28

$ $ 6,600,000 1,875,000 (1,280,000) 7,195,000 - 7,800,000 $ (605,000)

1.30

Step 2: Adjust investment for 2020 equity in net income and other comprehensive income Calculation of revaluations Price paid Book value Excess of cost over book value Inventories revaluation Property, plant and equipment revaluation Goodwill

$/ £

U.S.$

£ 8,000,000 5,500,000 2,500,000 100,000

1.20 1.20

$ 9,600,000 6,600,000 3,000,000 120,000

500,000 £ 1,900,000

1.20

600,000 $ 2,280,000

Calculation of equity in net income for 2020: Standard’s reported net income Revaluation write-offs: Cost of goods sold Depreciation expense [£500,000/20] Goodwill impairment Equity in net income

£ £1,500,000

$/£ 1.25

$ $1,875,000

(100,000) (25,000) (200,000) £1,175,000

1.25 1.25 1.25

(125,000) (31,250) (250,000) $1,468,750

Phillips’ entry to update the investment for 2020 equity in net income and its share of Standard’s translation gain: Investment in Standard Equity in net income of Standard Equity in other comprehensive income of Standard

2,073,750 1,468,750 605,000

Step 3: Consolidation working paper eliminations (C) Equity in net income of Standard Equity in OCI of Standard Dividends Investment in Standard To reverse equity method entries for 2017. (E) Capital Stock Retained earnings, beg. Investment in Standard To eliminate Standard’s shareholders’ equity as of 1/1.

1,468,750 605,000 1,280,000 793,750

2,400,000 4,200,000 6,600,000

(R) Inventory (£100,000 x $1.30) 130,000 PP&E, net (£500,000 x $1.30) 650,000 Goodwill (£1,900,000 x $1.30) 2,470,000 Investment in Standard 3,000,000 Other comprehensive income 250,000 To record the beginning-of-year revaluations. $250,000 = ($1.30 - $1.20) x (£100,000 + £500,000 + £1,900,000) (O) Cost of goods sold Depreciation expense Goodwill impairment Other comprehensive income Inventory Property, plant & equipment Goodwill To write off the revaluations for 2020. $125,000 = £100,000 x $1.25 $31,250 = (£500,000/20) x $1.25 $250,000 = £200,000 x $1.25 $16,250 = ($1.30-$1.25) x (£100,000 + £25,000 + £200,000)

125,000 31,250 250,000 16,250 130,000 32,500 260,000

$130,000 = £100,000 x $1.30 $32,500 = £25,000 x $1.30 $260,000 = £200,000 x $1.30

The 2020 consolidation working paper appears below. December 31, 2020 Consolidation Working Paper Phillips Dr (Cr)

Standard Dr (Cr)

Cash and receivables

$2,100,000

$3,900,000

Inventory

4,000,000

3,900,000

(R) 130,000

Property, plant and equipment, net

17,580,000

6,500,000

(R) 650,000

Investment in Standard

10,393,750

Consolidated Dr (Cr) $ 6,000,000

130,000 (O)

7,900,000

32,500 (O)

24,697,500

793,750 (C) 6,600,000 (E) 3,000,000 (R)

Goodwill

(R)2,470,000

260,000(O)

2,210,000

Current liabilities

(8,000,000)

(5,200,000)

(13,200,000)

Long-term debt

(4,000,000)

(1,300,000)

(5,300,000)

Capital stock

(10,000,000)

(2,400,000)

(E) 2,400,000

(10,000,000)

Retained earnings, 1/1

(8,000,000)

(4,200,000)

(E) 4,200,000

(8,000,000)

Dividends

2,000,000

1,280,000

Sales

(30,000,000)

(12,500,000)

Equity in net income

(1,468,750)

(605,000)

Equity in OCI Cost of goods sold

20,000,000

Depreciation expense Other operating expenses

1,280,000(C)

2,000,000 (42,500,000)

7,500,000

(O)

125,000

27,625,000

1,000,000

625,000

(O)

31,250

1,656,250

5,000,000

2,500,000

Goodwill impairment

Translation gain (OCI)

(605,000)

7,500,000 (O) 250,000 (O)

16,250

250,000 (R)

$12,346,250

Phillips Company and Subsidiary Consolidated Statement of Comprehensive Income For the Year Ended December 31, 2020 Sales Cost of goods sold Depreciation expense Other operating expenses Goodwill impairment Total expenses Net income Other comprehensive income Comprehensive income

250,000

$ 42,500,000 27,625,000 1,656,250 7,500,000 250,000 37,031,250 5,468,750 838,750 $ 6,307,500

(838,750) $

Phillips Company and Subsidiary Consolidated Balance Sheet December 31, 2020 Assets Cash and receivables Inventory Property, plant & equipment, net Goodwill Total assets Liabilities and shareholders’ equity Current liabilities Long-term debt Capital stock Retained earnings (1) Accumulated other comprehensive income Total liabilities and shareholders’ equity

$ 6,000,000 7,900,000 24,697,500 2,210,000 $40,807,500 $13,200,000 5,300,000 10,000,000 11,468,750 838,750 $40,807,500

(1) $8,000,000 + $5,468,750 - $2,000,000 = $11,468,750

P7.12 Hyperinflationary Economy, U.S. GAAP and IFRS a. Because the local currency is highly inflationary, U.S. GAAP requires remeasurement of the subsidiary’s local currency accounts into the reporting currency, U.S. dollars, even though the local currency is the subsidiary’s functional currency. Remeasurement of the December 31, 2020 balance sheet is as follows: (in millions)

Account Cash Plant assets, net Liabilities Capital stock Sales revenue Out of pocket operating expenses Depreciation expense Remeasurement loss (income)

Balance in LC Dr (Cr) 125,000 35,000 (50,000) (50,000) (200,000) 135,000 5,000 -0

$/LC 0.10 0.65 0.10 0.65 0.15 0.15 0.65 See sch. 1

$ Dr (Cr) $12,500 22,750 (5,000) (32,500) (30,000) 20,250 3,250 8,750 $ 0

Schedule 1:

Calculation of remeasurement loss

Beginning exposed position + Sales - Out of pocket operating expenses Ending exposed position (LC125,000 – LC50,000) Remeasurement loss (income)

LC 10,000 200,000 (135,000)

$/LC 0.65 0.15 0.15

$ $ 6,500 30,000 (20,250) 16,250

75,000

0.10

- 7,500 $ 8,750

Remeasured Balance Sheet December 31, 2020 (in millions) Cash Plant assets, net Total

$ 12,500 22,750 _______ $ 35,250

Liabilities Capital stock Retained earnings Total

5,000 32,500 (2,250) $ 35,250

Remeasured Statement of Comprehensive Income For the Year 2020 (in millions) Sales revenue Out of pocket operating expenses Depreciation expense Remeasurement loss Net loss and comprehensive loss

$ 30,000 (20,250) (3,250) (8,750) $ (2,250)

b. IFRS requires restatement of the LC accounts to the same price level, and then translation to the presentation currency, the U.S. dollar. (in millions) Balance in LC Dr (Cr)

Price-level Adjustment

Price-level Adjusted (LC) Dr (Cr)

$/LC

$ Dr (Cr)

Cash

125,000

0.10

$ 12,500

Plant assets, net

35,000

600/100

210,000

0.10

21,000

Liabilities

(50,000)

0.10

(5,000)

Capital stock

(50,000)

600/100

(300,000)

0.65

(195,000)

Sales revenue

(200,000)

600/400

(300,000)

0.15

(45,000)

Out of pocket op. expenses

135,000

600/400

202,500

0.15

30,375

5,000

600/100

30,000

0.15

4,500

Monetary loss (income)

See sch. 2

82,500

Translation loss (OCL)

Account

Depr. expense

Schedule 2

12,375 164,250

Calculation of monetary loss

Beginning monetary position + Sales - Out of pocket operating expenses Ending monetary position Monetary loss (income) Schedule 3

0.15 See sch. 3

Price-level LC adjustment 10,000 600/100 200,000 600/400 (135,000) 600/400 75,000

Price-level adjusted (LC) 60,000 300,000 (202,500) 157,500 - 75,000 82,500

Calculation of translation loss

Beginning exposed position - Net loss (LC300,000 – LC202,500 – LC30,000 – LC82,500) Ending exposed position Translation loss (OCL)

Price-level adjusted (LC) 300,000

$/LC 0.65

$ $195,000

(15,000)

0.15

285,000

0.10

(2,250) 192,750 - 28,500 $164,250

Translated Balance Sheet December 31, 2020 (in millions) Cash Plant assets, net

$ 12,500 21,000

Total

_______ $ 33,500

Liabilities Capital stock Retained earnings AOCI Total

5,000 195,000 (2,250) (164,250) $ 33,500

Translated Statement of Comprehensive Income For the Year 2020 (in millions) Sales revenue Out of pocket operating expenses Depreciation expense Monetary loss Net loss Translation loss (other comprehensive loss) Comprehensive loss

$ 45,000 (30,375) (4,500) (12,375) (2,250) (164,250) $(166,500)

P7.13 Remeasurement and Translation to Reporting Currency (in thousands) Organic Limited December 31, 2019, Trial Balance Remeasured £ €/£ € Cash and receivables £ 5,000 1.20 € 6,000 Inventories 85,000 1.19 101,150 Plant assets, net 143,000 (1) 160,720 Accounts payable (18,000) 1.20 (21,600) Loans payable (80,000) 1.20 (96,000) Capital stock (50,000) 1.12 (56,000) Retained earnings, Jan. 1 (70,000) 1.12 (78,400) Sales revenue (600,000) 1.18 (708,000) Cost of goods sold 500,000 (2) 584,650 Depreciation expense 12,000 (3) 13,480 Out-of-pocket expenses 73,000 1.18 86,140 Remeasurement loss -(4) 7,860 Translation loss (OCI) ---Total £ 0 € 0

Translated $/€ $ 1.22 $ 7,320 1.22 123,403 1.22 196,078.4 1.22 (26,352) 1.22 (117,120) 1.30 (72,800) 1.30 (101,920) 1.25 (885,000) 1.25 730,812.5 1.25 16,850 1.25 107,675 1.25 9,825 (5) 11,228.1 $ 0

(1) Remeasured plant assets, net: Acquired in 2019 On hand at date of acquisition Total

£ £ 28,000 115,000 £143,000

€/£ 1.14 1.12

€ € 31,920 128,800 €160,720

£ £ 75,000 510,000 (85,000) £500,000

€/£ 1.12 1.18 1.19

€ € 84,000 601,800 (101,150) €584,650

£ £ 2,000 10,000 £12,000

€/£ 1.14 1.12

€ € 2,280 11,200 €13,480

(2) Remeasured cost of goods sold: Beginning inventory Purchases Ending inventory Cost of goods sold (3) Remeasured depreciation expense Acquired in 2019 On hand at date of acquisition Total (4) Computation of remeasurement loss: Beginning exposed position (£10,000 - £20,000 £70,000) + Sales revenue - Purchases - Out of pocket expenses - Plant asset purchase Ending exposed position (£5,000 - £18,000 - £80,000) Remeasurement loss

€/£

€

£ (80,000) 600,000 (510,000) (73,000) (30,000)

1.12 1.18 1.18 1.18 1.14

£ (93,000)

1.20

€ (89,600) 708,000 (601,800) (86,140) (34,200) (103,740) - (111,600) € 7,860

€ € 134,400

$/€ 1.30

$ $174,720

15,870

1.25

€ 150,270

1.22

19,837.5 194,557.5 - 183,329.4 $ 11,228.1

(5) Computation of translation loss: Beginning exposed position (€56,000 + €78,400) + Net income (€708,000 - €584,650 - €86,140 - €13,480 €7,860) Ending exposed position Translation loss

P7.14 Consolidating an International Subsidiary, Year of Acquisition (in thousands) a.

Translation of Superbarn’s January 31, 2020 trial balance:

Cash and receivables Inventories Property and equipment, net Liabilities Capital stock Retained earnings, February 1 Sales revenue Cost of goods sold Operating expenses Translation loss (OCL)

A$ A$ 5,000 30,000 355,000 (345,000) (10,000) (20,000) (500,000) 400,000 85,000 -A$ 0

(1) Calculation of translation loss for fiscal 2020 A$ Net assets, beginning A$30,000 Net income 15,000 Net assets, ending Translation loss (OCL)

A$45,000

$/A$ 0.77 0.75 0.70

$/A$ 0.70 0.70 0.70 0.70 0.77 0.77 0.75 0.75 0.75 (1)

$ $ 3,500 21,000 248,500 (241,500) (7,700) (15,400) (375,000) 300,000 63,750 2,850 $ 0

$ $23,100 11,250 34,350 - 31,500 $ 2,850

Calculation of revaluations:

Acquisition cost Book value Excess of cost over book value Identifiable intangibles Goodwill

A$ A$ 150,000 30,000 120,000 10,000 A$ 110,000

$/A$ 0.77 0.77 0.77 0.77

$ $ 115,500 23,100 92,400 7,700 $ 84,700

Consolidation working paper eliminations: (C) Equity in net income of Superbarn Equity in OCL of Superbarn Investment in Superbarn To reverse equity method entries for fiscal 2020. (E) Capital stock Retained earnings, beginning Investment in Superbarn To eliminate Superbarn’s beginning equity.

6,000 2,850 3,150

7,700 15,400 23,100

(R) Identifiable intangibles (A$10,000 x $0.70) 7,000 Goodwill (A$110,000 x $0.70) 77,000 Other comprehensive loss 8,400 Investment in Superbarn 92,400 To record the beginning-of-year valuations and eliminate the remaining investment balance. (O) Operating expenses (A$7,000 x $0.75) Other comprehensive loss Identifiable intangibles (A$2,000 x $.70) Goodwill (A$5,000 x $0.70) To write off the revaluations for fiscal 2020.

5,250 350 1,400 3,500

Consolidation working paper Eliminations Pathway Dr (Cr)

(in thousands) Cash and receivables

15,000

Superbarn Dr (Cr) $

Consolidated Balances Dr (Cr)

3,500

18,500

Inventories

90,000

21,000

111,000

Plant and equipment, net

776,500

248,500

1,025,000

Investment in Superbarn

118,650

3,150 (C) 23,100 (E) 92,400 (R)

Identifiable intangibles

(R)

7,000

1,400 (O)

5,600

Goodwill

(R)

77,000

3,500 (O)

73,500

Liabilities

(874,000)

(241,500)

Capital stock

(25,000)

(7,700)

(E)

7,700

(25,000)

Retained earnings, February 1

(85,000)

(15,400)

(E)

15,400

(85,000)

2,000

(1,500,000)

(375,000)

(1,875,000)

Equity in net income—Superbarn

(6,000)

Equity in OCL—Superbarn

2,850

Cost of goods sold

1,000,000

300,000

Operating expenses

485,000

63,750

(O)

5,250

2,850

(R)

8,400

Dividends Sales revenue

Translation loss (OCL) Totals

(1,115,500)

(C)

6,000

-2,850 (C)

-1,300,000 554,000

350 (O)

$ 126,750 $ 126,750

10,900 $

b. Pathway Inc. and Subsidiary Consolidated Statement of Comprehensive Income For the Year Ended January 31, 2020 (in thousands) Sales revenue Cost of goods sold Gross margin Operating expenses Net income Translation loss (other comprehensive loss) Comprehensive income

$ 1,875,000 (1,300,000) 575,000 (554,000) 21,000 (10,900) $ 10,100

Pathway Inc. and Subsidiary Consolidated Balance Sheet January 31, 2020 (in thousands) Assets Cash and receivables Inventories Plant and equipment, net Identifiable intangibles Goodwill Total assets Liabilities and shareholders’ equity Liabilities Shareholders’ equity: Capital stock Retained earnings (1) Accumulated other comprehensive loss Total shareholders’ equity Total liabilities and shareholders’ equity

18,500 111,000 1,025,000 5,600 73,500 $1,233,600 $1,115,500 25,000 104,000 (10,900) 118,100 $1,233,600

(1) $85,000 + $21,000 - $2,000 = $104,000

P7.15 Consolidating an International Subsidiary, Second Year Following Acquisition (in thousands) a.

Translation of Superbarn’s January 31, 2021, Trial Balance: A$ $/A$ Cash and receivables A$ 6,000 0.60 Inventories 40,000 0.60 Property and equipment, net 410,000 0.60 Liabilities (399,000) 0.60 Capital stock (10,000) 0.77 Retained earnings, February 1 (35,000) (1) Accumulated OCL, February 1 -(2) Sales revenue (700,000) 0.65 Cost of goods sold 600,000 0.65 Operating expenses 88,000 0.65 Translation loss (OCL) -(3) A$ 0

$ $ 3,600 24,000 246,000 (239,400) (7,700) (26,650) 2,850 (455,000) 390,000 57,200 5,100 $ 0

(1) Translated beginning retained earnings is last year’s translated ending retained earnings: $15,400 + $11,250 = $26,650. (2) Beginning accumulated other comprehensive loss = last year’s OCL = $2,850. continued

(3) Calculation of translation loss for fiscal 2021 Net assets, beginning Net income Net assets, ending Translation loss (OCL)

A$ A$ 45,000 12,000

$/A$ 0.70 0.65

A$ 57,000

0.60

$ $ 31,500 7,800 39,300 - 34,200 $ 5,100

Consolidation working paper eliminations: (C) Equity in net income of Superbarn Equity in OCL of Superbarn Investment in Superbarn To reverse equity method entries for fiscal 2021. (E) Capital stock Retained earnings, beginning Accumulated OCL, beg. Investment in Superbarn To eliminate Superbarn’s beginning equity.

6,500 5,100 1,400

7,700 26,650 2,850 31,500

(R) Identifiable intangibles (A$8,000 x $0.60) 4,800 Goodwill (A$105,000 x $0.60) 63,000 Other comprehensive loss 19,350 Investment in Superbarn 87,150 To record the beginning-of-year valuations and eliminate the remaining investment balance. (O) Operating expenses (A$2,000 x $0.65) Other comprehensive loss Identifiable intangibles (A$2,000 x $0.60) To write off the revaluations for fiscal 2021.

1,300 100 1,200

Consolidation working paper Eliminations

(in thousands)

Pathway Dr (Cr)

Superbarn Dr (Cr)

Cash and receivables

$ 18,000

3,600

Consolidated Balances Dr (Cr) $

21,600

Inventories

95,000

24,000

119,000

Plant and equipment, net

906,500

246,000

1,152,500

Investment in Superbarn

120,050

1,400 (C) 31,500 (E)

87,150 (R) Identifiable intangibles

(R)

4,800

Goodwill

(R)

63,000

Liabilities

(990,500)

(239,400)

Capital stock

(30,000)

(7,700)

(E)

7,700

(30,000)

Retained earnings, February 1

(114,000)

(26,650)

(E)

26,650

(114,000)

Accumulated OCL, February 1

2,850

Dividends

1,500

(1,700,000)

(455,000)

(2,155,000)

Equity in net income—Superbarn

(6,500)

Equity in OCL—Superbarn

5,100

Cost of goods sold

1,200,000

390,000

Operating expenses

492,000

57,200

(O)

1,300

5,100

(R)

19,350

Sales revenue

Translation loss (OCL) Totals

1,200 (O)

3,600 63,000 (1,229,900)

2,850 (E)

(C)

2,850

6,500

-5,100 (C)

-1,590,000 550,500

100 (O)

129,300 $ 129,300

b. Pathway Inc. and Subsidiary Consolidated Statement of Comprehensive Income For the Year Ended January 31, 2021 (in thousands) Sales revenue $ 2,155,000 Cost of goods sold (1,590,000) Gross margin 565,000 Operating expenses (550,500) Net income 14,500 Other comprehensive loss (24,350) Comprehensive loss $ (9,850)

24,350 $

Pathway Inc. and Subsidiary Consolidated Balance Sheet January 31, 2021 (in thousands) Assets Cash and receivables Inventories Plant and equipment, net Identifiable intangibles Goodwill Total assets Liabilities and shareholders’ equity Liabilities Shareholders’ equity: Capital stock Retained earnings (1) Accumulated other comprehensive loss (2) Total shareholders’ equity Total liabilities and shareholders’ equity (1) $114,000 + $14,500 - $1,500 = $127,000 (2) $2,850 + $24,350 = $27,200

21,600 119,000 1,152,500 3,600 63,000 $ 1,359,700 $ 1,229,900 30,000 127,000 (27,200) 129,800 $1,359,700

P7.16 Consolidating an International Subsidiary, Year of Acquisition (in thousands) a.

Translation of Superpet’s June 30, 2020 trial balance:

Current assets Plant assets, net Liabilities Capital stock Retained earnings, July 1 Sales revenue Cost of goods sold Operating expenses Translation gain (OCI)

HK$ HK$ 170,000 820,000 (800,000) (50,000) (100,000) (3,000,000) 2,400,000 560,000 -HK$ 0

(1) Calculation of translation gain for fiscal 2020 HK$ Net assets, beginning HK$150,000 Net income 40,000 Net assets, ending Translation gain (OCI)

€/HK$ 0.10 0.14

HK$190,000

0.15

€/HK$ 0.15 0.15 0.15 0.10 0.10 0.14 0.14 0.14 (1)

€ € 25,500 123,000 (120,000) (5,000) (10,000) (420,000) 336,000 78,400 (7,900) € 0

€ €15,000 5,600 20,600 - 28,500 € 7,900

Original goodwill = HK$1,000,000 – HK$50,000 – HK$100,000 = HK$850,000. b.

Consolidation working paper eliminations: (C) Equity in net income of Superpet Equity in OCI of Superpet Investment in Superpet To reverse equity method entries for fiscal 2020. (E) Capital stock Retained earnings, beginning Investment in Superpet To eliminate Superpet’s beginning equity.

5,600 7,900 13,500

5,000 10,000 15,000

(R) Goodwill (HK$850,000 x $0.15) 127,500 Investment in Superpet 85,000 Other comprehensive income 42,500 To record the beginning-of-year goodwill and eliminate the remaining investment balance.

Consolidation working paper Eliminations Superpet Dr (Cr)

MascotaMart

(in thousands) Current assets

Dr (Cr) €

220,000

€

25,500

Plant assets, net

950,000

123,000

Investment in Superpet

113,500

Consolidated Balances Dr (Cr) 245,500 1,073,000

13,500 (C) 15,000 (E) 85,000 (R)

Goodwill

Liabilities

(700,000)

(120,000)

Capital stock

(20,000)

(5,000)

(E)

5,000

(20,000)

Retained earnings, July 1

(500,000)

(10,000)

(E)

10,000

(500,000)

(5,000,000)

(420,000)

Equity in net income—Superpet

(5,600)

(C)

5,600

Equity in OCI—Superpet

(7,900)

(C)

7,900

Cost of goods sold

3,500,000

336,000

3,836,000

Operating expenses

1,450,000

78,400

1,528,400

(7,900)

Sales revenue

Translation gain (OCI) Totals

€

(R)

127,500

127,500 (820,000)

(5,420,000)

_______

42,500 (R)

€ 156,000 € 156,000

(50,400) €

c. MascotaMart and Subsidiary Consolidated Statement of Comprehensive Income For the Year Ended June 30, 2020 (in thousands) Sales revenue Cost of goods sold Gross margin Operating expenses Net income Translation gain (other comprehensive gain) Comprehensive income

€ 5,420,000 (3,836,000) 1,584,000 (1,528,400) 55,600 50,400 € 106,000

MascotaMart and Subsidiary Consolidated Balance Sheet June 30, 2020 (in thousands) Assets Current assets Plant assets, net Goodwill Total assets Liabilities and shareholders’ equity Liabilities Shareholders’ equity: Capital stock Retained earnings (1) Accumulated other comprehensive gain Total shareholders’ equity Total liabilities and shareholders’ equity (1) $500,000 + $55,600 = $555,600

€

245,500 1,073,000 127,500 € 1,446,000 €

820,000

20,000 555,600 50,400 626,000 € 1,446,000

P7.17 Consolidating an International Subsidiary, Second Year Following Acquisition (in thousands) a.

Translation of Superpet’s June 30, 2021 trial balance: HK$ €/HK$ Current assets HK$ 165,000 0.20 Plant assets, net 970,000 0.20 Liabilities (920,000) 0.20 Capital stock (50,000) 0.10 Retained earnings, July 1 (140,000) (1) Accumulated OCI, July 1 -(2) Sales revenue (3,500,000) 0.17 Cost of goods sold 2,800,000 0.17 Operating expenses 675,000 0.17 Translation gain (OCI) -(3) HK$ 0

€ € 33,000 194,000 (184,000) (5,000) (15,600) (7,900) (595,000) 476,000 114,750 (10,250) € 0

(1) Translated beginning retained earnings is last year’s translated ending retained earnings: $10,000 + $5,600 = $15,600. (2) Beginning accumulated other comprehensive loss = last year’s OCI = $7,900. (3) Calculation of translation gain for fiscal 2021 HK$ Net assets, beginning HK$190,000 Net income 25,000 Net assets, ending Translation gain (OCI)

€/HK$ 0.15 0.17

HK$215,000

0.20

€ €28,500 4,250 32,750 - 43,000 €10,250

Consolidation working paper eliminations: (C) Equity in net income of Superpet Equity in OCI of Superpet Investment in Superpet To reverse equity method entries for fiscal 2021. (E) Capital stock Retained earnings, beginning Accumulated OCI Investment in Superpet To eliminate Superpet’s beginning equity.

2,550 10,250 12,800

5,000 15,600 7,900 28,500

(R) Goodwill (HK$850,000 x $0.20) 170,000 Investment in Superpet 85,000 Other comprehensive income 85,000 To record the beginning-of-year goodwill and eliminate the remaining investment balance. (O) Operating expenses (HK$10,000 x $0.17) Other comprehensive income Identifiable intangibles (HK$10,000 x $0.20) To write off goodwill for fiscal 2021.

1,700 300 2,000

Consolidation working paper Eliminations Superpet Dr (Cr)

MascotaMart

(in thousands) Current assets

Dr (Cr) €

260,000

Plant assets, net Investment in Superpet

€

33,000

1,020,000

194,000

126,300

Consolidated Balances Dr (Cr) 293,000 1,214,000

12,800 (C) 28,500 (E)

2,000 (O)

168,000

Liabilities

(750,000)

(184,000)

Capital stock

(20,000)

(5,000)

(E)

5,000

(20,000)

Retained earnings, July 1

(555,600)

(15,600)

(E)

15,600

(555,600)

Accumulated OCI, July 1

(7,900)

(E)

7,900

(7,900)

(5,500,000)

(595,000)

Equity in net income—Superpet

(2,550)

(C)

2,550

Equity in OCI—Superpet

(10,250)

(C)

10,250

Cost of goods sold

3,800,000

476,000

Operating expenses

1,640,000

114,750

(O)

1,700

(10,250)

(O)

300

Translation gain (OCI) Totals

€

170,000

Goodwill

Sales revenue

(R)

85,000 (R)

(934,000)

(6,095,000)

4,276,000 1,756,450 85,000 (R)

€ 213,300 € 213,300

(94,950) €

c. MascotaMart and Subsidiary Consolidated Statement of Comprehensive Income For the Year Ended June 30, 2021 (in thousands) Sales revenue Cost of goods sold Gross margin Operating expenses Net income Translation gain (other comprehensive gain) Comprehensive income

€ 6,095,000 (4,276,000) 1,819,000 (1,756,450) 62,550 94,950 € 157,500

MascotaMart and Subsidiary Consolidated Balance Sheet June 30, 2021 (in thousands) Assets Current assets Plant assets, net Goodwill Total assets Liabilities and shareholders’ equity Liabilities Shareholders’ equity: Capital stock Retained earnings (1) Accumulated other comprehensive gain (2) Total shareholders’ equity Total liabilities and shareholders’ equity (1) $555,600 + $62,550 = $618,150 (2) $7,900 + $94,950 = $102,850

€

293,000 1,214,000 168,000 € 1,675,000 €

934,000

20,000 618,150 102,850 741,000 € 1,675,000

CHAPTER 8 SOLUTIONS TO MULTIPLE CHOICE QUESTIONS, EXERCISES AND PROBLEMS MULTIPLE CHOICE 1.

d Fiscal 2019: ($1.05 - $1.08) x €100,000 = $3,000 gain on payable Fiscal 2020: ($1.12 – $1.05) x €100,000 = $7,000 loss on payable

d Fiscal 2019: ($1.11 - $1.10) x €100,000 = $1,000 gain on receivable Fiscal 2020: ($1.08 - $1.11) x €100,000 = $3,000 loss on receivable

Entries are: November 15, 2019 Inventory Accounts payable $705,000 = $0.705 x C$1,000,000 December 31, 2019 Exchange loss Accounts payable $60,000 = ($0.765 - $0.705) x C$1,000,000. Investment in forward Exchange gain $55,000 = ($0.750 - $0.695) x C$1,000,000. April 15, 2020 Accounts payable Exchange gain $25,000 = ($0.740 - $0.765) x C$1,000,000. Exchange loss Investment in forward $10,000 = ($0.740 - $0.750) x C$1,000,000

705,000 705,000

60,000 60,000 55,000 55,000

25,000 25,000 10,000 10,000

Accounts payable Cash Investment in forward 4.

740,000 695,000 45,000

a See entries in 3. above. $15,000 gain = $25,000 gain - $10,000 loss.

Entries are: December 31, 2019 Investment in forward Exchange gain $55,000 = ($0.750 - $0.695) x C$1,000,000. Exchange loss Firm commitment March 1, 2020 Exchange loss Investment in forward $35,000 = ($0.715 - $0.750) x C$1,000,000.

55,000 55,000

35,000 35,000

Firm commitment Exchange gain

35,000

Inventory Firm commitment Accounts payable

700,000 20,000

April 15, 2020 Exchange loss Accounts payable $20,000 = ($0.740 - $0.720) x C$1,000,000.

35,000

720,000

20,000 20,000

Investment in forward Exchange gain $25,000 = ($0.740 - $0.715) x C$1,000,000.

25,000

Accounts payable Cash

740,000

25,000

695,000

Investment in forward 6.

45,000

b See entries in 5. above.

c Entries are: December 31, 2019 Investment in forward OCI $55,000 = ($0.750 - $0.695) x C$1,000,000. April 15, 2020 OCI Investment in forward $10,000 = ($0.740 - $0.750) x C$1,000,000.

55,000 55,000

10,000 10,000

Foreign currency Investment in forward Cash

740,000

Inventory Foreign currency

740,000

45,000 695,000 740,000

a Entry to record cost of goods sold is: Cost of goods sold OCI Inventory

695,000 45,000 740,000

c ($0.740 - $0.715) x C$1,000,000 = $25,000 loss

10.

a IFRS nets the cash flow hedge gain against the carrying value of the equipment, reducing the equipment (asset) account. Depreciation expense is unaffected whether the cash flow hedge gain is reclassified

as an adjustment of the equipment, following IFRS, or as an adjustment of depreciation expense, following U.S. GAAP.

EXERCISES E8.1

Recording Import Transactions Dr. Purchases Inventories Accounts payable

152,000

Payments Foreign currency Cash

146,000

Accounts payable Exchange loss Exchange gain Foreign currency

E8.2

Australia Cr.

Thailand Dr. Cr. 27,600

152,000

659,500 27,600

29,200 146,000

152,000 --

Hong Kong Dr. Cr.

6,000 146,000

Jordan Cr.

705,000 659,500

681,000 29,200

27,600 1,600

Dr.

705,000

695,000 681,000

659,500 21,500 -29,200

695,000 705,000 --

-681,000

10,000 695,000

Recording Export Transactions Argentina Dr. Cr. Sales Accounts receivable Sales Collection Foreign currency Exchange loss Exchange gain Accounts receivable Cash Foreign currency

14,000

Dr.

Canada Cr.

292,800 14,000

12,250 1,750 -14,000

4,800

-292,800

7,400 7,400

7,700 -600 4,800

5,400 285,200

South Africa Dr. Cr.

4,800

5,400 --

285,200 12,250

India Cr.

292,800

285,200 7,600

12,250

Dr.

300 7,400 7,700

5,400

7,700

E8.3

Recording Import and Export Transactions Import Transactions Transaction 1 Transaction date: Inventory Accounts payable Payment date: Accounts payable Exchange gain Cash

3,300 3,300

3,300 500 2,800

Transaction 2 Transaction date: Inventory Accounts payable

168,000

Payment date: Accounts payable Exchange loss Cash

168,000 18,000

168,000

186,000

Export Transactions Transaction 3 Transaction date: Accounts receivable Sales revenue Payment date: Cash Exchange gain Accounts receivable

128,400 128,400

143,200 14,800 128,400

Transaction 4

E8.4

Transaction date: Accounts receivable Sales revenue

988,000

Payment date: Cash Exchange loss Accounts receivable

956,650 31,350

988,000

Adjusting Entry at Balance Sheet Date

Item 1 2 3 4 Net adjustment

Book balance ($) Dr (Cr) $ 65,000 165,000 (556,000) (56,000)

Dollar equivalent, 12/31 Adjustment Dr (Cr) Dr (Cr) $ 60,000 = $0.06 x 1,000,000 $ 5,000 loss 168,750 = $0.75 x 225,000 3,750 gain (564,000) = $1.41 x 400,000 8,000 loss (54,000) = $0.27 x 200,000 2,000 gain $ 7,250 loss

Adjusting entry Exchange loss 7,250 Accounts receivable ($5,000 - $3,750) 1,250 Accounts payable ($8,000 - $2,000) 6,000 To record the net exchange loss on the receivables and payables at December 31.

E8.5

Adjusting Entry at Balance Sheet Date Book balance ($) Dollar equivalent, 12/31 Item Dr (Cr) Dr (Cr) 1 $ 1,165,000 $ 1,180,000 = $1.18 x 1,000,000 2 512,500 520,000 = $1.04 x 500,000 3 (1,920,000) (1,950,000) = $1.30 x 1,500,000 4 (270,000) (260,000) = $0.13 x 2,000,000 Net adjustment

Adjustment Dr (Cr) $ 15,000 gain 7,500 gain 30,000 loss 10,000 gain $ 2,500 gain

Adjusting entry Accounts receivable ($15,000 + $7,500) 22,500 Exchange gain 2,500 Accounts payable ($30,000 - $10,000) 20,000 To record the net exchange gain on the receivables and payables at December 31.

E8.6

Recording International Investment a. October 1, 2019 Short-term investments 125,000 Cash To record the purchase of a 6-month certificate of deposit, face value kr1,000,000, from a Swedish bank. December 31, 2019 Short-term investments Exchange gain To record the exchange gain on the certificate of deposit; $19,500 = ($0.1445 x kr1,000,000) - $125,000.

125,000

19,500 19,500

Interest receivable 2,167.50 Interest income 2,167.50 To accrue interest income to December 31, 2019 based on the December 31 exchange rate; $2,167.50 = $0.1445 x (3/12) x 0.06 x kr1,000,000. March 31, 2020 Exchange loss 21,700 Short-term investments 21,700 To record the exchange loss on the certificate of deposit since December 31, 2019; $21,700 = ($0.1445 - $0.1228) x kr1,000,000. Exchange loss 325.50 Interest receivable 325.50 To record the exchange loss on the interest receivable; $325.50 = ($.1445-$.1228) x kr15,000; kr15,000 = 0.06 x (3/12) x kr1,000,000, the interest accrued on December 31, 2019. Interest receivable 1,842 Interest income 1,842 To record interest income for the period January 1, 2020 to March 31, 2020 based on the March 31exchange rate; $1,842 = $0.1228 x kr15,000 [(= (3/12) x 0.06 x kr1,000,000)].

Foreign currency 126,484 Short-term investments 122,800 Interest receivable 3,684 To record the receipt of foreign currency for principal and interest at maturity of the certificate of deposit; $126,484 = $0.1228 x kr1,030,000. Cash

126,484

Foreign currency To record conversion of kr1,030,000 into dollars.

126,484

b. This investment returned a gain of $1,484, the difference between the $125,000 paid to acquire the certificate and the $126,484 received at maturity, in six months. The annual rate of return is ($1,484/$125,000) x 2 = 2.37%. Overall, the U.S. dollar strengthened against the krona during the investment period, which reduced the amount of U.S. dollars received, and caused the rate of return to drop from 6% to 2.37%.

E8.7

Hedging Exposed Liability Position a. March 15, 2020 Inventory 75,000 Accounts payable To record goods purchased; $75,000 = $0.0750 x R1,000,000.

75,000

May 15, 2020 Exchange loss 400 Accounts payable 400 To restate payable at current spot rate; $400 = ($0.0754 - $0.0750) x R1,000,000. Investment in forward contract Exchange gain To restate forward contract to current fair value; $300 = ($0.0754 - $0.0751) x R1,000,000.

300 300

Foreign currency 75,400 Investment in forward contract 300 Cash 75,100 To record payment to the dealer at the contract rate of $0.0751, receipt of R1,000,000, valued at the current spot rate of $0.0754, and fulfillment of the forward purchase contract.

Accounts payable Foreign currency June 5, 2020 Cash Sales revenue Cost of goods sold Inventory

75,400 75,400

110,000 110,000 75,000 75,000

b. Dollars paid (to broker) with the hedge: Dollars that would have been paid at the current spot rate to purchase foreign currency for the supplier; ($0.0754 x 1,000,000): Cash gain (amount saved) from hedging:

E8.8

$ 75,100 - 75,400 $ 300

Hedging Exposed Liability Position with Adjusting Entries a. December 1, 2020 Inventory 1,289,000 Accounts payable 1,289,000 To record goods purchased; $1,289,000 = $0.1289 x HK$10,000,000. January 31, 2021 Exchange loss 10,000 Accounts payable 10,000 To restate payable at current spot rate; $10,000 = ($0.1299- $0.1289) x HK$10,000,000. Investment in forward contract Exchange gain To restate forward contract to current fair value; $11,000 = ($0.1304 - $0.1293) x HK$10,000,000.

11,000 11,000

March 1, 2021 Exchange loss 4,000 Accounts payable 4,000 To restate payable at current spot rate; $4,000 = ($0.1303- $0.1299) x HK$10,000,000. Exchange loss Investment in forward contract To restate forward contract to current fair value; $1,000 = ($0.1303 - $0.1304) x HK$10,000,000.

1,000 1,000

Foreign currency 1,303,000 Investment in forward contract 10,000 Cash 1,293,000 To record payment to the dealer at the contract rate of $0.1293, receipt of HK$10,000,000, valued at the current spot rate of $0.1303, and fulfillment of the forward purchase contract. Accounts payable Foreign currency

E8.9

1,303,000 1,303,000

Hedging Exposed Asset Position with Adjusting Entries a. November 3, 2020 Accounts receivable 10,534,400 Sales revenue To record sale to franchisee; $10,534,400 = $1.3168 x £8,000,000.

10,534,400

December 31, 2020 Exchange loss 3,200 Accounts receivable 3,200 To restate receivable at current spot rate; $3,200 = ($1.3164- $1.3168) x £8,000,000. Investment in forward contract Exchange gain To restate forward contract to current fair value; $2,400 = ($1.3163 - $1.3166) x £8,000,000. February 3, 2021 Exchange loss Accounts receivable To restate receivable at current spot rate; $1,600 = ($1.3162 - $1.3164) x £8,000,000.

2,400 2,400

1,600 1,600

Investment in forward contract Exchange gain To restate forward sale contract to current fair value; $800 = ($1.3162 - $1.3163) x £8,000,000.

800

Foreign currency Accounts receivable To record collection of pounds from the franchisee; $10,529,600 = $1.3162 x £8,000,000.

10,529,600

800

10,529,600

Cash

10,532,800

Investment in forward contract 3,200 Foreign currency 10,529,600 To record receipt of U.S. dollars from the dealer at the contract rate of $1.3166, delivery of £8,000,000, valued at the current spot rate of $1.3162, and fulfillment of the forward sale contract. b. Dollars received from the broker with the hedge: Dollars that would have been received at the current spot rate; ($1.3162 x £8,000,000): Cash gain (amount saved) from hedging:

$ 10,532,800 - 10,529,600 $ 3,200

E8.10 Hedged Purchase Commitment and Exposed Liability Position, with Adjusting Entries December 31, 2020 Investment in forward contract 11,000 Exchange gain 11,000 To record change in fair value of the forward contract; $11,000 = ($0.1304 $0.1293) x HK$10,000,000. Exchange loss Firm commitment To record the loss on the firm purchase commitment.

11,000 11,000

January 10, 2021 Exchange loss 2,000 Investment in forward contract To record change in fair value of the forward contract; $2,000 = ($0.1302 $0.1304) x HK$10,000,000.

2,000

Firm commitment Exchange gain To record the gain on the firm purchase commitment.

2,000

Inventories 1,301,000 Accounts payable To record delivery of the goods at the current spot rate of $0.1301.

1,301,000

Firm commitment 9,000 Inventories 9,000 To adjust the carrying value of the goods for the net accumulated loss on the firm commitment during the commitment period. April 10, 2021 Exchange loss 2,000 Accounts payable To record the loss on accounts payable; $2,000 = ($0.1303 - $0.1301) x HK$10,000,000.

2,000

Investment in forward contract 1,000 Exchange gain 1,000 To record increase in fair value of forward purchase contract; $1,000 = ($0.1303 $0.1302) x HK$10,000,000. Foreign currency Investment in forward contract Cash To record fulfillment of the forward contract.

1,303,000

Accounts payable Foreign currency To record payment to the supplier.

1,303,000

10,000 1,293,000

1,303,000

E8.11 Hedged Sale Commitment and Exposed Asset Position July 10, 2020 Exchange loss Investment in forward contract To record change in fair value of the forward contract; $4,000 = ($1.0511 - $1.0507) x CHF10,000,000.

4,000

Firm commitment 4,000 Exchange gain To record gain on U.S. dollar value of the firm sale commitment.

4,000

Accounts receivable 10,510,000 Sales revenue 10,510,000 To record delivery of goods to the customer; $10,510,000 = $1.0510 x CHF10,000,000.

Sales revenue 4,000 Firm commitment To adjust sales revenue for the change in value of the firm sales commitment.

4,000

September 10, 2020 Accounts receivable 2,000 Exchange gain 2,000 To record gain on accounts receivable; $2,000 = ($1.0512 - $1.0510) x CHF10,000,000. Exchange loss 1,000 Investment in forward contract 1,000 To record change in fair value of the forward contract; $1,000 = ($1.0512 - $1.0511) x CHF10,000,000. Foreign currency 10,512,000 Accounts receivable 10,512,000 To record receipt of Swiss francs from the U.K. customer, valued at the current spot rate of $1.0512. Cash 10,507,000 Investment in forward contract 5,000 Foreign currency 10,512,000 To record delivery of the currency to the dealer, and settlement of the forward contract.

E8.12 Hedged Sale Commitment and Exposed Asset Position, with Adjusting Entries December 31, 2020 Exchange loss 2,000 Investment in forward contract 2,000 To record loss on forward contract; $2,000 = ($1.3163 - $1.3161) x £10,000,000. Firm commitment 2,000 Exchange gain To record gain on U.S. dollar value of the firm sale commitment.

2,000

January 15, 2021 Exchange loss 4,000 Investment in forward contract 4,000 To record loss on forward contract; $4,000 = ($1.3167 - $1.3163) x £10,000,000. Firm commitment 4,000 Exchange gain To record gain on U.S. dollar value of the firm sale commitment.

4,000

Accounts receivable 13,165,000 Sales revenue 13,165,000 To record delivery of goods to the customer; $13,165,000 = $1.3165 x £10,000,000. Sales revenue 6,000 Firm commitment To adjust sales revenue for the change in value of the firm sale commitment.

6,000

March 15, 2021 Accounts receivable 15,000 Exchange gain 15,000 To record loss on accounts receivable; $15,000 = ($1.3180 - $1.3165) x £10,000,000. Exchange loss Investment in forward contract To record loss on forward contract; $13,000 = ($1.3180 - $1.3167) x £10,000,000.

13,000 13,000

Foreign currency 13,180,000 Accounts receivable 13,180,000 To record receipt of pounds from the U.K. customer, valued at the current spot rate of $1.3180. Cash 13,161,000 Investment in forward contract 19,000 Foreign currency 13,180,000 To record delivery of the currency to the dealer, and settlement of the forward contract.

E8.13 Hedged Forecasted Purchase June 30, 2020 Investment in forward contract Other comprehensive income To record increase in fair value of forward purchase contract; $6,000 = ($1.14 - $1.08) x €100,000.

6,000 6,000

Foreign currency Investment in forward contract Cash To record settlement of forward contract.

114,000

Inventory Foreign currency To record delivery of merchandise and payment to supplier; $114,000 = $1.14 x €100,000.

114,000

July 12, 2020 Cash Sales revenue To record merchandise sale.

6,000 108,000

114,000

150,000 150,000

Other comprehensive income 6,000 Cost of goods sold 108,000 Inventory 114,000 To record cost of sale, including release of gain on forward contract to cost of goods sold.

E8.14 Hedged Forecasted Sale November 30, 2020 Other comprehensive income 10,000 Investment in forward contract 10,000 To record decrease in value of forward contract; $10,000 = ($0.78 - $0.77) x C$1,000,000. Foreign currency 780,000 Sales revenue To record merchandise sale; $780,000 = $0.78 x C$1,000,000.

780,000

Sales revenue Other comprehensive income To reclassify the loss on the hedge to current earnings.

10,000

Cash Investment in forward contract Foreign currency To record settlement of forward contract.

770,000 10,000 780,000

E8.15 Hedged Forecasted Revenue with Adjusting Entry December 31, 2019 Investment in forward contract Other comprehensive income To record increase in fair value of forward sale contract; $20,000 = ($1.320 - $1.324) x £5,000,000. April 10, 2020 Investment in forward contract Other comprehensive income To record increase in fair value of forward sale contract; $5,000 = ($1.319 - $1.320) x £5,000,000.

20,000 20,000

5,000 5,000

Foreign currency 6,595,000 Franchise revenue To record franchise revenue; $6,595,000 = $1.319 x £5,000,000. Other comprehensive income Franchise revenue To release forward contract gains from OCI to income. Cash Investment in forward contract Foreign currency To record delivery of currency and receipt of U.S. dollars.

6,595,000

25,000 25,000

6,620,000 25,000 6,595,000

E8.16 Hedge of Net Investment in International Operations a. The amounts displayed in the statement of comprehensive are net of hedge gains and losses.

Net translation gain (loss) Less hedge gain (loss) Translation gain (loss) before hedge effects

2016 € 271 - (365) € 636

2015 € (481) - 617 €(1,098)

2014 € (25) - 412 € (437)

b. The accounts of Unilever’s subsidiaries are translated, and exposure to foreign currency risk is through subsidiary net assets. Assuming subsidiary net assets are on average positive, the translation gain for 2016 indicates that the euro weakened against the currencies of the subsidiaries, causing net assets, in euros, to increase. However, the translation losses for 2015 and 2014 indicate that the euro strengthened against the currencies of the subsidiaries, causing net assets, in euros, to decline. c. Again assuming Unilever is hedging a positive net asset exposure, losses are incurred when the euro value of the other currencies declines. To hedge this risk, Unilever must invest in forward contracts that gain in value when the euro value of the other currencies declines. Forward sales gain in value when the euro value of the other currencies declines, since they lock in the higher selling price. d. In 2014, hedge gains neutralized about 94% = [412 / (412 + 25)] of the total translation loss. In 2015, the hedge gains neutralized about 56% = [617 / (617 + 481)] of the total translation loss. In 2016, hedge losses neutralized about 57% = [365/ (365 + 271)] of the total translation gain. E8.17 Speculative Foreign Contracts a.

Forward purchase contract: ($0.018 - $0.020) x ₱10,000,000 = $20,000 current liability Forward sale contract: ($0.740 - $0.734) x S$10,000,000 = $60,000 current asset December 31, 2019 Investment in forward purchase contract 10,000 Exchange gain 10,000 To record gain accrued since December 16 on speculative forward purchase contract; $10,000 = ($0.019 - $0.018) x ₱10,000,000. Exchange loss 80,000 Investment in forward sale contract 80,000 To record loss accrued since December 16 on speculative forward sale contract;

$80,000 = ($0.742 - $0.734) x S$10,000,000. January 15, 2020 Investment in forward purchase contract 30,000 Exchange gain To record gain accrued since December 31 on speculative forward purchase contract; $30,000 = ($0.022 - $0.019) x ₱10,000,000.

30,000

Foreign currency 220,000 Investment in forward purchase contract 20,000 Cash 200,000 To record settlement of the forward purchase contract by paying cash at the $0.02 contract rate and receiving foreign currency valued at the $0.022 spot rate. Cash

220,000

Foreign currency To record conversion of ₱10,000,000 into dollars.

220,000

Investment in forward sale contract 60,000 Exchange gain 60,000 To record gain accrued since December 31 on speculative forward sale contract; $60,000 = ($0.736- $0.742) x S$10,000,000. Foreign currency 7,360,000 Cash 7,360,000 To record acquisition of S$ on the spot market to settle the forward sale contract. Cash

7,400,000

Investment in forward sale contract 40,000 Foreign currency 7,360,000 To record settlement of the forward sale contract by delivering foreign currency valued at the spot rate of $0.736 and receiving cash at the contract rate of $0.74.

PROBLEMS P8.1

Import/Export Transactions a. Canadian dollar receivable: Euro dollar receivable: Total receivables Mexican peso payable: Hong Kong dollar payable: Total payables

$0.722 x C$100,000 $1.188 x €2,000,000

= =

72,200 2,376,000 $ 2,448,200

$0.0588 x Mex$300,000 $0.131 x HK$600,000

= =

$ $

17,640 78,600 96,240

b. ($0.73 x C$1,000,000) + ($1.17 x €10,000,000)

$12,430,000

c. ($0.055 x Mex$2,800,000) + ($0.139 x HK$3,600,000)

654,400

d. Mexican peso inventory: Hong Kong dollar inventory: Total

= =

11,000 55,600 66,600

$0.055 x Mex$200,000 $0.139 x HK$400,000

e. Exchange gains and losses derive from the changing U.S. $ value of receivables and payables. Receivables C$700,000 x ($0.724 - $0.73) C$100,000 x ($0.722 - $0.73) €8,000,000 x ($1.185 - $1.17) €2,000,000 x (1.188 - $1.17)

= = = =

Payables Mex$2,700,000 x ($0.0582 - $0.055) Mex$300,000 x ($0.0588 - $0.055) HK$3,400,000 x ($0.133 - $0.139) HK$600,000 x ($0.131 - $0.139)

= = = =

Net exchange gain for 2020

4,200 loss 800 loss 120,000 gain 36,000 gain

8,640 loss 1,140 loss 20,400 gain 4,800 gain $ 166,420 gain

P8.2

Evaluation of Domestic and International Investments U.K. investment $1,495,000 can be invested in a CD worth £1,150,000 [=$1,495,000/$1.30]. The value of the CD at the end of 6 months is (£1,150,000) x 1.0175 = £1,170,125, which is converted to $1,515,311.88 (= $1.295 x £1,170,125). The annual effective yield is ($1,515,311.88 - $1,495,000)/$1,495,000) x 2 = 2.72%. German investment $1,495,000 can be invested in a CD worth €1,300,000 [=$1,495,000/$1.15]. The value of the CD at the end of 6 months is (€1,300,000) x 1.0125 = €1,316,250, which is converted to $1,518,952.50 (= $1.154 x €1,316,250). The annual effective yield is ($1,518,952.50 - $1,495,000)/$1,495,000) x 2 = 3.20%. Recommendation: The German CD yields the highest rate. However, the U.K. and German investment returns are significantly affected by exchange rate changes. The U.K. investment’s return is 2.72% on a CD with a stated rate of 3.5%, because the dollar is expected to strengthen against the pound. The German investment’s return is 3.20% on a CD with a stated rate of 2.5%, because the dollar is expected to weaken against the euro. If Organic is not willing to take on exchange rate risk, the extra 0.20% yield achieved by investing internationally instead of domestically may not be worth the risk.

P8.3

Analysis of International Investments Singapore investment $10,000,000 becomes an investment of S$13,586,956.50 (= $10,000,000/$0.736). The value of the investment at the end of 3 months is S$13,586,956.50 + (S$13,586,956.50 x 0.045/4) = S$13,739,809.80. The company enters into a forward contract locking in the sale of S$13,739,809.80 at $0.753, which will yield $10,346,076.70. The annual effective yield is ($10,346,076.70 - $10,000,000)/$10,000,000) x 4 = 13.84%. Canadian investment $10,000,000 becomes an investment of C$13,297,872.30 [=$10,000,000/$0.752]. The value of the investment at the end of 3 months is C$13,297,872.30 + (C$13,297,872.30 x 0.039/4) = C$13,427,526.60. To avoid exchange risk, the company would enter into a forward contract locking in the sale of C$13,427,872.60 at $0.781, which will yield $10,487,168.50. The annual effective yield is ($10,487,168.50 - $10,000,000)/$10,000,000) x 4 = 19.49%.

P8.4

Computation of Exchange Gain or Loss, Exposed Positions and Forward Contracts a. Computation of exchange adjustment on receivables

Country Belgium India Saudi Arabia

Foreign Currency Amount 300,000 1,200,000 90,000

Exchange Rate (12/31/20) $ 1.17340 0.01639 0.26660

Dollar amount of foreign currency receivables at 12/31/20 Less amount per books; $355,000 + $19,500 + $23,000 Exchange loss on receivables

Amount ($) $ 352,020 19,668 23,994 $ 395,682 (397,500) $ (1,818)

Computation of exchange adjustment on payables

Country Japan Mexico

Foreign Currency Amount (1,000,000) (500,000)

Exchange Rate (12/31/20) $ 0.00925 0.05500

Dollar amount of foreign currency payables at 12/31/20 Less amount per books; $(9,000) + $(28,120) Exchange gain on payables

Amount ($) $ (9,250 (27,500) $ (36,750) (37,120) $ 370

Computation of exchange adjustment on other assets (liabilities)

Item Forward purchase contract (pesos) Forward sale contract (euros)

(1) Foreign Currency Dr. (Cr.)

Amount ($)

Contract Rate

Forward Rate (12/31/20)

(contract rate – current forward rate) x (1)

500,000

$0.0556

$ 0.05365

(300,000)

$1.1785

1.1684

Dollar amount of other assets (liabilities) denominated in foreign currencies at 12/31/20 Less amount per books; $(525) + $480 Exchange gain on other assets (liabilities) Net exchange gain (loss) in 2020; $(1,818) + $370 + $2,100

(975) 3,030

$ 2,055 (45) $ 2,100 $ 652

Adjusting entry - books of International Distributors, Inc. Accounts payable 370 Investment in forward sale contract 2,550 Accounts receivable 1,818 Investment in forward purchase contract 450 Exchange gain 652 To record the exchange adjustments on accounts receivable, accounts payable, and the forward purchase and sale contracts at December 31, 2020; $(450) = $525 – $975; $2,550 = $3,030 - $480. b. The forward purchase contract is a hedge of the accounts payable to Mexican suppliers. Following is an analysis of the exchange gains and losses on the exposure and the hedge investment:

Accounts payable Investment in forward purchase contract Net exchange gain (loss) Percent of payable gain hedged

Book Value $(28,120) (525)

12/31/20 Value $(27,500) (975)

Exchange Gain (Loss) $ 620 (450) $ 170 73%

The forward sale contract is a hedge of the accounts receivable from Belgian customers. Following is an analysis of the exchange gains and losses on the exposure and the hedge investment:

Accounts receivable Investment in forward sale contract Net exchange gain (loss) Percent of receivable loss hedged

Book 12/31/20 Value Value $355,000 $352,020 480 3,030

Differences between changes in spot rates, reflecting the current value of the currency, and changes in forward rates, reflecting expectations on the future value of the currency, cause forwards to be less than perfect hedges of assets and liabilities valued using spot rates.

Exchange Gain (Loss) $ (2,980) 2,550 $ (430) 86%

P8.5

Hedging, Leverage, Return on Assets a. Note that the December 31, 2019 spot rate is $0.70 (= $350 million/C$500 million) and the forward rate in the contract is $0.78 (= $390 million/C$500 million). If the exchange rate is $0.73/C$ at the end of the first quarter, Cheesecake Factory incurs a net loss on the forward contract of $25 million, since the C$ could be bought for $0.73 instead of the $0.78 forward rate; ($25 million) = ($0.73 - $0.78) x C$500 million. Concurrently there is a $15 million [= ($0.73- $0.70) x C$500 million] exchange loss on the payable that increases liabilities. March 31, 2020 Exchange loss 25,000,000 Investment in forward contract 25,000,000 To accrue the exchange loss on the forward purchase contract; $25,000,0000 = ($0.73 - $0.78) x C$500,000,000 Exchange loss 15,000,000 Accounts payable 15,000,000 To revalue the account payable to the current exchange rates; $15,000,000 = ($0.73- $0.70) x C$500,000,000 Without the hedge, Cheesecake Factory's payable to the international supplier increases by $15 million and the $15 million exchange loss decreases equity, through retained earnings. There is no change in total assets. Using the data in the problem, measured leverage rises to 0.715 [= ($700 + $15)/$1,000]. With the hedge, the payable still increases by $15 million. The forward contract is shown as a current liability of $25 million. Using the data in the problem, measured leverage becomes 0.74 [= ($700 + $15 + $25)/$1,000]. b. If Cheesecake Factory did not use the forward contract, it could borrow $350 million now, at 4% interest for 3 months, and buy the needed foreign currency. This would cost $353,500,000 = [$350,000,000 + (4% x 3/12 x $350,000,000)] . The forward contract costs $390,000,000, or $36,500,000 more. In addition, if the company borrows, it could invest the C$ in short-term international investments until required by the international supplier, rather than paying the supplier now. This alternative dominates the forward contract.

P8.6

Recording a Hedged International Loan December 16, 2020

Cash

69,000,000

Loan payable 69,000,000 To record the dollar equivalent of £50 million borrowed from a London bank; $69,000,000 = $1.38 x £50,000,000. December 31, 2020 Loan payable Exchange gain To accrue the exchange gain on the loan payable; $1,000,000 = ($1.38 - $1.36) x £50,000,000.

1,000,000 1,000,000

Exchange loss Investment in forward contract To accrue the loss on the forward purchase contract; $1,005,000 = ($1.41 - $1.39) x £50,250,000.

1,005,000 1,005,000

Interest expense 170,000 Interest payable 170,000 To accrue interest expense on the loan payable from December 16 - December 31, 2020; $170,000 = $1.36 x £125,000. January 15, 2021 Loan payable Exchange gain To accrue the exchange gain on the loan payable; $1,500,000 = ($1.36 - $1.33) x £50,000,000.

1,500,000 1,500,000

Exchange loss 3,015,000 Investment in forward contract To accrue the exchange loss on the forward purchase contract; $3,015,000 =($1.39 - $1.33) x £50,250,000.

3,015,000

Interest payable 3,750 Exchange gain 3,750 To accrue the gain on the interest payable; $3,750 = ($1.36 - $1.33) x £125,000. Interest expense 166,250 Interest payable 166,250 To accrue interest expense on the loan payable from January 1 - January 15, 2021; $166,250 = $1.33 x £125,000. Foreign currency Investment in forward contract Cash To record settlement of the forward purchase contract.

66,832,500 4,020,000 70,852,500

Loan payable 66,500,000 Interest payable 332,500 Foreign currency 66,832,500 To record repayment of the loan and interest to the London bank with the foreign currency.

P8.7

Import/ Export Transactions and Hedged Commitment August 14, 2020 Exchange loss Investment in forward contract To record decline in fair value of forward contract; $80,000 = ($1.15 - $1.13) x €4,000,000.

80,000 80,000

Firm commitment 80,000 Exchange gain To record reduction in cost of firm commitment, in U.S. dollar terms. Foreign currency Investment in forward contract Cash To record settlement of forward purchase contract.

4,520,000 80,000 4,600,000

Inventory 4,520,000 Foreign currency To record delivery of merchandise and payment to supplier; $4,520,000 = $1.13 x €4,000,000. Inventory Firm commitment To adjust inventory balance for value of firm commitment.

80,000

4,520,000

80,000 80,000

September 1, 2020 Accounts receivable 840,000 Sales revenue 840,000 To record sales to customer in Poland; $840,000 = $0.28 x zł3,000,000. November 3, 2020 Exchange loss 60,000 Accounts receivable 60,000 To record decline in value of receivable; $60,000 = ($0.28 - $0.26) x zł3,000,000. Foreign currency Accounts receivable To record receipt of payment from customer.

780,000

Cash

780,000

Foreign currency To record exchange of zloty into dollars.

780,000

P8.8

Hedging a Foreign Currency Commitment—Effects on Income a. November 30, 2020 Exchange loss Investment in forward contract To record decline in value of forward sale contract; $2,000 = ($1.030 - $1.026) x CHF500,000.

2,000 2,000

Firm commitment 2,000 Exchange gain 2,000 To record increase in sales value of the agreement with the Swiss customer. Accounts receivable 517,000 Sales revenue To record delivery of the merchandise to the Swiss customer; $517,000 = $1.034 x CHF500,000.

517,000

Sales revenue 2,000 Firm commitment 2,000 To adjust sales revenue for the accumulated balance in the firm commitment account. December 31, 2020 Exchange loss 6,000 Accounts receivable To adjust accounts receivable balance to the new spot rate; $6,000 = ($1.022 - $1.034) x CHF500,000. Investment in forward contract Exchange gain To record increase in value of forward sale contract; $3,500 = ($1.023 - $1.030) x CHF500,000. January 31, 2021 Exchange loss Accounts receivable $1,000 = ($1.020 - $1.022) x CHF500,000. Investment in forward contract Exchange gain To record increase in value of forward sale contract; $1,500 = ($1.020 - $1.023) x CHF500,000.

6,000

3,500 3,500

1,000 1,000

1,500 1,500

Foreign currency 510,000 Accounts receivable 510,000 To record payment by Swiss customer; $510,000 = $1.020 x CHF500,000. Cash

513,000

Investment in forward contract Foreign currency To record settlement of the forward sale contract.

3,000 510,000

b. Exchange gain (loss) Sales revenue Net effect on income

2020 $ (2,500) 515,000 $ 512,500

2021 $ 500 -$ 500

Note that the income effects for the two years sum to $513,000, the U.S. dollar amount received from the sale and forward contract. c. With the forward contract, Orchid Foods received $513,000 from the sale. Without the contract, CHF500,000 would have been exchanged for $510,000 = $1.020 x CHF500,000. Therefore Orchid gained $3,000 due to hedging.

P8.9

Hedging a Forecasted Purchase Transaction December 31, 2019 Investment in forward contract Other comprehensive income To record increase in value of forward purchase contract; $8,000 = ($0.0490 - $0.0482) x L10,000,000.

8,000 8,000

January 29, 2020 Inventory 563,000 Accounts payable To record delivery of merchandise at current spot rate of $0.0563. March 1, 2020 Exchange loss Accounts payable To adjust the account payable to the current spot rate; $33,000 = ($0.0596 - $0.0563) x L10,000,000.

563,000

33,000 33,000

Investment in forward contract Other comprehensive income To record increase in value of forward purchase contract; $106,000 = ($0.0596 - $0.0490) x L10,000,000.

106,000 106,000

Other comprehensive income 33,000 Exchange gain To reclassify AOCI to income to offset loss on accounts payable.

33,000

Foreign currency Investment in forward contract Cash To record settlement of the forward contract.

596,000 114,000 482,000

Accounts payable Foreign currency To record payment to the supplier.

596,000

April 8, 2020 Cash Sales revenue To record sale to U.S. customer.

596,000

600,000 600,000

Cost of goods sold 482,000 Other comprehensive income 81,000 Inventory 563,000 To record cost of merchandise sold and release the remaining gain in AOCI on forward purchase contract to income.

P8.10 Hedging a Forecasted Sale Transaction January 31, 2021 Investment in forward contract Other comprehensive income To record increase in value of forward sale contract; $22,500 = ($0.7830 - $0.7839) x A$25,000,000. March 1, 2021 Investment in forward contract Other comprehensive income To record increase in value of forward sale contract; $85,000 = ($0.7796 - $0.7830 x A$25,000,000.

22,500 22,500

85,000 85,000

Accounts receivable 19,495,000 Sales revenue To record delivery of merchandise at current spot rate of $0.7798.

19,495,000

Other comprehensive income 107,500 Sales revenue 107,500 To reclassify AOCI to income at the time the hedged transaction impacts income. May 31, 2021 Exchange loss Accounts receivable To adjust the account receivable to the current spot rate; $120,000 = ($0.7750 - $0.7798) x A$25,000,000. Investment in forward contract Exchange gain To record increase in value of forward sale contract; $115,000 = ($0.7750 - $0.7796) x A$25,000,000.

120,000 120,000

115,000 115,000

Foreign currency Accounts receivable To record payment from the customer.

19,375,000

Cash

19,597,500

Investment in forward contract Foreign currency To record settlement of the forward contract.

19,375,000

222,500 19,375,000

P8.11 Hedged Forecasted Revenue a. December 31, 2019 Investment in forward 80,000 Other comprehensive income To record gain on forward; $80,000 = ($0.772 - $0.780) x A$10,000,000.

80,000

March 25, 2020 Investment in forward 70,000 Other comprehensive income To record gain on forward; $70,000 = ($0.765 - $0.772) x A$10,000,000. Foreign currency Franchise revenue To record franchise revenue at the current spot rate. Other comprehensive income Franchise revenue To release gains on the forward to income. Cash Investment in forward Foreign currency To close the forward contract.

70,000

7,650,000 7,650,000

150,000 150,000

7,800,000 150,000 7,650,000

b. If McDonald’s accrues A$2,000,000 of the revenue in 2019, then some of the hedged transaction impacts income. Some of the gains on the forward contract should be released to income, as an adjustment to the revenue recognized. It would be logical to release 1/5 (=$A2,000,000/A$10,000,000) of the amount in OCI to income ($16,000). As the receivable declines in value in 2020, OCI would be released to offset the exchange loss. The remaining balance in OCI is an adjustment to the sales revenue recognized in 2020.

P8.12 Hedge of Forecasted Transaction, Firm Commitment, and Foreign-Currency-Denominated Liability December 31, 2019 Investment in forward 100,000 Other comprehensive income To record gain on forward; $100,000 = ($1.12 - $1.11) x €10,000,000. January 15, 2020 Investment in forward 100,000 Other comprehensive income To record gain on forward; $100,000 = ($1.13 - $1.12) x €10,000,000. February 1, 2020 Investment in forward 100,000 Other comprehensive income To record gain on forward; $100,000 = ($1.14 - $1.13) x €10,000,000. Exchange loss Firm commitment To record loss on firm commitment established on January 15.

100,000

Other comprehensive income 100,000 Exchange gain To reclassify AOCI to income to offset the loss on the firm commitment.

100,000

Inventory 11,200,000 Firm commitment 100,000 Accounts payable 11,300,000 To record delivery of the merchandise and the payable at the spot rate, and close the firm commitment against the inventory balance. March 1, 2020 Investment in forward 100,000 Other comprehensive income To record gain on forward; $100,000 = ($1.15 - $1.14) x €10,000,000. Exchange loss 200,000 Accounts payable To record increase in payable; $200,000 = ($1.15 - $1.13) x €10,000,000.

100,000

200,000

Other comprehensive income Exchange gain To reclassify AOCI to income to offset the loss on the payable.

200,000 200,000

Foreign currency Investment in forward Cash To close the forward contract.

11,500,000

Accounts payable Foreign currency To pay the supplier.

11,500,000

March 15, 2020 Cash Sales revenue To record the sale of the merchandise.

400,000 11,100,000

11,500,000

25,000,000

Cost of sales 11,100,000 Other comprehensive income 100,000 Inventory To record cost of sales and reclassify remaining balance in AOCI.

25,000,000

11,200,000

P8.13 Interpretation of Financial Statement Disclosures a. Forward contracts lock in the U.S. dollar value of other currencies to be received or paid. To lock in the dollar value of royalties to be received, IBM enters forward sale contracts that allow it to sell the currency received from franchisees and others at a fixed price. To lock in the dollar value of cost transactions, IBM enters forward purchase contracts that allow it to buy the currency needed to pay for supplies, salaries, etc. at a fixed price. b. Forward sales hedge net foreign currency inflows. Therefore if the hedges are effective, the anticipated foreign currency royalty and cost transactions involve a net inflow of currency to IBM, locking in the future selling price of the currency to be received.

c. Because IBM incurred gains on the hedges, the U.S. dollar must have strengthened in 2016 and 2015 with respect to the hedged currencies (the $/FC rate declined). The hedge investments lock in the future selling price of the currency. Gains occur when the market selling price declines, since the company is locked in to a higher selling price. d. When the royalties are received, related gains on the hedge investments are reclassified from AOCI to adjust the royalty revenue. The journal entry debits OCI and credits royalty revenue. The accounts that IBM adjusts when cost transactions are recorded depend on the type of cost. In general, the journal entry debits OCI and credits an expense or loss, reducing the reported expense or loss. IBM’s 2016 footnotes indicate that selling and administrative expense, cost of goods sold, and other income/expense are adjusted for reclassifications from AOCI.

P8.14 Accounting for Forward Contracts—Hedging and Speculation a. December 31, 2019 Exchange loss Investment in forward contract To record decline in value of forward sale contract #1; $120,000 = ($0.165 - $0.105) x kr2,000,000.

120,000

Firm commitment 120,000 Exchange gain To record increase in value of firm commitment related to contract #1. Investment in forward contract 180,000 Other comprehensive income To record increase in value of forward purchase contract #2; $180,000 = ($0.165 - $0.105) x kr3,000,000.

120,000

180,000

Exchange loss 60,000 Investment in forward contract 60,000 To record loss on speculative contract #3; $60,000 = ($0.165 - $0.105) x kr1,000,000.

January 29, 2020 Exchange loss 54,000 Investment in forward contract 54,000 To record decline in value of forward sale contract #1 since December 31; $54,000 = ($0.192 - $0.165) x kr2,000,000. Firm commitment 54,000 Exchange gain 54,000 To record increase in sales value of firm commitment related to contract #1. Foreign currency 384,000 Sales revenue To record sale to Danish customer; $384,000 = $0.192 x kr2,000,000.

384,000

Sales revenue 174,000 Firm commitment 174,000 To adjust sales revenue for the accumulated balance in the firm commitment account. Cash Investment in forward contract Foreign currency To record the settlement of forward sale contract #1.

210,000 174,000 384,000

Investment in forward contract 81,000 Other comprehensive income To record increase in value of forward purchase contract #2; $81,000 = ($0.192 - $0.165) x kr3,000,000. Foreign currency Investment in forward contract Cash To record settlement of forward purchase contract #2.

576,000

Inventory Foreign currency To record purchase #2 at the current spot rate of $0.192.

576,000

81,000

261,000 315,000

576,000

Exchange loss Investment in forward contract To record loss on forward sale contract #3; $27,000 = ($0.192 - $0.165) x kr1,000,000.

27,000 27,000

Foreign currency 192,000 Cash 192,000 To record purchase of krone in the spot market, in anticipation of settlement of forward sale contract #3. Cash Investment in forward contract Foreign currency To record settlement of forward sale contract #3.

105,000 87,000 192,000

b. December 31, 2019 balance sheet: Investment in forward contracts has a net balance of zero. Firm commitment has a net debit balance of $120,000 (current asset). Other comprehensive income is increased by $180,000 (shareholders’ equity). 2019 income statement: Net exchange loss on speculative activity is $60,000. c. Observe that the forward contracts entered into by Futura represented a perfect hedge. That is, forward sale contracts #1 and #3 were hedged by forward purchase contract #2. One could argue that these forward exchange contracts were unnecessary, and whatever transaction costs were incurred by Futura in connection with the contracts represent an unnecessary loss to the firm.

P8.15 Analyzing the Performance of an Import/Export Department a. This problem is approached by evaluating the profit contributions of the import and export departments separately and then by reviewing the reasonableness of the forward contracts. Although the ultimate measure of profitability is cash received minus cash paid out, we are also interested in the change in the dollar equivalents of Bush's overseas purchases and sales between the transaction dates and the payment/collection dates. This may have some implications for credit and payment policies. Profit Contribution of the Import Transactions (2) $ Cost When Paid

(3) Total Net Revenue

(4) = (3) - (1)

(5) = (1) - (2)

(6) = (4) + (5)

Part #

(1) $ Cost When Purchased

Gross Contribution

Exchange Gain (Loss)

Total Contribution

K14

$ 10,624

$10,240

$ 15,500

$ 4,876

384

$ 5,260

KR08

83,300

98,600

102,000

18,700

(15,300)

3,400

L16

46,330

50,020

50,000

3,670

(3,690)

(20)

M29Q

93,240

80,640

92,000

(1,240)

12,600

11,360

Total

$233,494

$239,500

$259,500

$26,006

$ (6,006)

$20,000

Profit Contribution of the Export Transactions (2) $ Revenue When Paid

(3)

(4) = (1) - (3)

(5) = (2) - (1)

(6) = (4) + (5)

Part #

(1) $ Revenue When Purchased

Total Cost

Gross Contribution

Exchange Gain (Loss)

Total Contribution

A24

$ 31,752

$34,104

$ 27,720

$ 4,032

$ 2,352

$ 6,384

DD2

150,000

144,000

6,000

(6,000)

A27

220,000

232,000

178,000

42,000

12,000

54,000

B23

9,198

8,468

8,500

698

(730)

(32)

Total

$410,950

$418,572

$358,220

$52,730

$ 7,622

$60,352

Review of Forward Contracts Overall, the contracts entered for hedging purposes produced a net gain of $2,700. The forward purchase contract cost $130,200 (= 210,000 x $0.62) while at maturity the foreign currency could have been purchased for $123,900 (= 210,000 x $0.59), yielding a loss of $6,300 (= $130,200 - $123,900). The forward sale contract produced revenue of $270,000 (= 300,000 x $0.90) while at maturity the same amount of foreign currency could have been sold on the spot market for $261,000 (= 300,000 x $0.87), yielding a gain of $9,000 (= $270,000 - $261,000). The net gain amounted to $2,700 (= $9,000 - $6,300). Note that had the hedging not been undertaken, exchange rate movements would have produced losses on both the purchase and sale transactions. Ignoring interest rate effects, and considering spot rates only, the cost of the foreign currency to be purchased increased by $4,200 [=($0.59 - $0.57) x 210,000] between inception and maturity while the value of the foreign currency to be sold decreased by $3,000 [= ($0.87 - $0.88) x 300,000] between inception and maturity. In contrast, the speculative contracts were mistakes. The foreign currency acquired for $250,000 (= 1,000,000 x $0.25) in the purchase contract could be sold for only $220,000 (= 1,000,000 x $0.22) in the spot market at maturity, generating a loss of $30,000. Likewise, the currency sold for $740,000 (= 1,000,000 x $0.74) in the sale contract had to be purchased in the spot market at maturity for $850,000 (= 1,000,000 x $0.85) and a loss of $110,000 resulted. b.

Memorandum To: From: Subject:

Top Management, Bush Specialty Products Mr. X, Consultant Review of William Johnston's Import/Export Department

Mr. Johnston is doing a reasonable job in the import/export business. Both import and export transactions provided positive contributions toward fixed costs and profits of Bush. The export business has been the most successful with a much higher ratio of profit contribution to sales. Unfortunately, these reasonably satisfactory results have been wiped out by Mr. Johnston's activities in the forward markets for foreign exchange. Mr. Johnston entered into two speculative forward contracts which produced losses of $140,000, almost $60,000 more than the total profit contribution provided by the import/export transactions. I do not know whether he has been cautioned against speculating with the firm's capital and cannot recommend outright that Mr. Johnston be fired. At a minimum, he should be prohibited from entering into speculative forward contracts on behalf of the import/export department.

Mr. Johnston's credit and payment policies should be reviewed. Several of the import and export transactions resulted in large exchange gains and losses. Although there was a net exchange gain, several of the currencies Mr. Johnston transacts in seem to be quite volatile. Hence the timing of payments and collections should be closely monitored along with movements in the exchange rates. While hedging in the forward market eliminates this risk, there may be a more cost-effective solution.

P8.16 Hedge of Net Investment in an International Subsidiary a. 1) If the functional currency of the subsidiary is the U.S. dollar, PriceSmart’s exposed position is the subsidiary’s monetary assets less liabilities, typically a net liability position. As the direct exchange rate increases (the U.S. dollar weakens against the quetzal), PriceSmart incurs a remeasurement loss. Hedge investments that provide a gain when the direct exchange rate increases include forward purchases or call options in quetzals, or investments in quetzal-denominated financial assets, such as notes receivable. 2) If the value of the quetzal increases, in U.S. dollar terms, PriceSmart reports gains on forward purchases or call option hedges and losses on its net liability exposure to foreign currency risk. 3) The gains and losses are both reported on PriceSmart’s income statement, using normal accounting. b. 1) If the functional currency of the subsidiary is the quetzal, PriceSmart’s exposed position is the net assets of the subsidiary, typically a positive net asset position. As the direct exchange rate increases (the U.S. dollar weakens against the quetzal), PriceSmart incurs a translation gain. Hedge investments that provide a loss when the direct exchange rate increases include forward sales or put options in quetzals, or borrowings in quetzaldenominated financial liabilities, such as loans from Guatemalan banks. 2) If the value of the quetzal increases, in U.S. dollar terms, PriceSmart reports losses on forward sales and put options used as hedges of net asset exposure, and gains on its net asset exposure to foreign currency risk. 3) The gains and losses affect OCI, following hedge accounting, and are reported on PriceSmart’s statement of comprehensive income, in the cumulative translation adjustment component of PriceSmart’s AOCI, which is part of shareholders’ equity on the balance sheet.

P8.17 Hedge Accounting Procedures Derivatives that qualify as hedges are still categorized as fair value, cash flow, and net investment hedges. Coca-Cola’s reporting for fair value hedges remains the same; the ASU requires that the income effect of the hedge and the hedged item be reported in the same income statement line item, and Coca-Cola already complies with this requirement. Similarly, its reporting for cash flow hedges and net investment hedges remains the same. The increased flexibility in qualifying investments as hedge instruments will likely allow Coca-Cola to use hedge accounting for more of its derivative investments. Nonqualifying derivative gains and losses are reported in income as they occur; following the ASU more derivative gains and losses are likely to be deferred in OCI and released to income when the hedged item impacts income. Coca-Cola’s initial procedures and documentation of hedge effectiveness stay the same, but unlike 2016 standards, subsequent evaluation of hedge effectiveness may be qualitative. Coca-Cola currently completes a formal assessment at least quarterly; this assessment may not be as complex under the ASU. Currently Coca-Cola recognizes the ineffective part of a derivative’s gain or loss in income. Following the new requirements, hedge ineffectiveness is no longer treated differently. Therefore, all changes in the value of cash flow hedges are reported in OCI and released to income when the hedged item impacts income. There is no need to separate out hedge ineffectiveness.

CHAPTER 9 SOLUTIONS TO MULTIPLE CHOICE QUESTIONS, EXERCISES AND PROBLEMS

MULTIPLE CHOICE QUESTIONS 1.

a $905,000 = $1,000,000 – ($1,340,000 – $1,245,000)

d $90,000 = $1,400,000 – $1,310,000; asset because prices declined on a short position.

c Sales revenue Cost of sales $1,000,000 – ($1,340,000 - $1,200,000) Gross margin

$1,290,000 860,000 $ 430,000

b Call options lock in the future purchase price; they cannot hedge investments already purchased. Put options hedge existing investments by locking in their selling price.

a (0.020 – 0.018) x ½ x $10,000,000 = $10,000

c Intrinsic value increases by $10,000, but the cap increases in value by only $9,500. Therefore, the time value change is a $500 loss.

d $6,000 = (3.0% – 1.8%)/2 x $1,000,000 net cash received to settle the swap.

b A receive fixed/pay variable swap is a fair value hedge of the fixed rate debt. Both the debt and the swap are marked to market, with value changes reported in income. Because interest rates declined, the fair value of the debt, measured as the present value of the future principal and interest payments, increased, creating a loss.

a A receive fixed/pay variable swap is a fair value hedge of the fixed rate debt. Both the debt and the swap are marked to market, with value changes reported in income. Because interest rates declined, Sunny pays the lower variable rate, increasing the net inflow on the swap to Sunny. The fair value of the swap, measured by the present value of the future swap net inflows, increased, creating a gain.

10.

c A receive variable/pay fixed swap is a cash flow hedge of the variable rate interest payments. The swap is marked to market, with value changes reported in OCI. The debt is not revalued. Because interest rates declined, the net expected swap inflow declined, creating a loss. The loss will be reclassified to interest expense in future periods, adding to the lower variable interest recorded on the variable rate debt.

EXERCISES E9.1

Fair Value Hedge: Short in Commodity Futures a. January 6, 2020 Investment in futures 20,000 Cash To record the initial margin deposit on the sale of commodity futures.

20,000

February 19, 2020 Cost of goods sold 50,000 Investment in futures 20,000 Cash 30,000 To settle the contract; the loss on hedging is $50,000 (= $1,150,000 - $1,100,000), and net cash paid is the $50,000 loss less the initial margin deposit of $20,000. Inventory 50,000 Cost of goods sold 50,000 To adjust the carrying value of the hedged inventory for the change in fair value. March 2, 2020 Cash Sales revenue To record sale of commodities. Cost of goods sold Inventory To recognize the cost of sales.

1,175,000 1,175,000

1,050,000 1,050,000

b. If AIPC had not hedged by selling futures short, it would have avoided the $50,000 loss sustained when the short futures, sold for $1,100,000, were closed by purchasing an offsetting long contract for $1,150,000. AIPC’s profit, which was $125,000 (= $1,175,000 – $1,050,000) under the hedge, would therefore have increased by $50,000 to $175,000 (= $1,175,000 – $1,000,000 inventory acquisition cost) if the hedge was not undertaken.

E9.2

Cash Flow Hedge: Long in Commodity Futures February 10, 2020 Investment in futures 5,000 Cash To record the initial margin deposit on the purchase of commodity futures.

5,000

May 10, 2020 Investment in futures 25,000 Other comprehensive income 25,000 To record the gain on the long position; $25,000 = ($2,050 – $2,000) x 500. Cash

30,000

Investment in futures To close the futures contract; $30,000 = $5,000 + $25,000.

30,000

Commodity inventories 1,025,000 Cash 1,025,000 To record the purchase of cocoa beans in the spot market; $1,025,000 = $2,050 x 500. At the time products containing cocoa are sold Cost of goods sold Other comprehensive income Commodity inventories To record the cost of the cocoa in products sold.

E9.3

1,000,000 25,000 1,025,000

Hedge of Firm Commitment: Short in Commodity Futures The short position in the futures contract hedges a firm sale commitment and is a fair value hedge. a. May 1, 2021 Investment in futures 10,000 Cash To record the initial margin deposit of $10,000 paid to the clearinghouse.

10,000

May 30, 2021 Investment in futures 20,000 Sales revenue 20,000 To mark the short futures position to market and recognize the gain in earnings; $20,000 [= ($5.00 – $4.80) x 100,000]. Sales revenue 20,000 Firm commitment 20,000 To recognize the loss on the firm sale commitment due to a decline in selling prices.

July 29, 2021 Investment in futures 5,000 Sales revenue 5,000 To mark the short futures position to market and recognize the resulting gain; $5,000 [= ($4.80 – $4.75) x 100,000]. Sales revenue 5,000 Firm commitment 5,000 To recognize the loss on the firm sale commitment due to a decline in selling prices. Commodities inventory Cash To record purchase of the commodities.

460,000 460,000

August 28, 2021 Sales revenue 2,000 Investment in futures 2,000 To mark the futures contract to market; $2,000 [= $4.77 – $4.75) x 100,000]. Firm commitment 2,000 Sales revenue To recognize the gain on the firm sale commitment due to a price increase.

2,000

Cash

33,000 Investment in futures 33,000 To close out the short futures position and recover from the clearinghouse the initial margin deposit; $33,000 (= $10,000 + $20,000 + $5,000 – $2,000). b. Cash Firm commitment Sales revenue To record the sale and close the firm commitment liability. Cost of goods sold Commodities inventory To record the cost of sales.

477,000 23,000 500,000

460,000 460,000

Note that the hedge locked in the sales revenue at $500,000. Without the hedge, sales revenue would be $477,000, the current spot price.

E9.4

Economics of Hedging with Futures a. If the spot price is $9.50 per bushel, Great Lakes closes its long futures position for $9.50, incurring a cash loss of $0.45 (= $9.50 – $9.95). Added to the spot price of $9.50, the $0.45 loss increases the cost to $9.95 per bushel. Similarly, if the spot price is $10.40 per bushel, Great Lakes closes its long futures position for $10.40 per bushel, for a cash gain of $0.45 (= $10.40 – $9.95). Subtracting the $0.45 gain from the $10.40 spot price leaves the net cost of the soybeans at $9.95 per bushel. b. Cash

25,000

Cost of goods sold To close the futures position. $25,000 = ($10.20 – $9.95) x 100,000. Cost of goods sold 25,000 Firm commitment To record the higher cost of fulfilling the obligation to the customer. Commodities inventory Cash To record purchase of the soybeans.

1,020,000

Cash

1,025,000

25,000

1,020,000

Sales revenue To record sales revenue; $1,025,000 = $10.25 x 100,000. Cost of goods sold Commodities inventory To record purchase of the commodities.

25,000

1,025,000

1,020,000

Firm commitment 25,000 Cost of goods sold To categorize the hedge gain as a reduction of cost of goods sold.

1,020,000

25,000

c. There is no difference in this case. Without hedge accounting, the firm commitment would not be recorded or netted against cost of goods sold, but the gain on hedging would reduce cost of goods sold directly.

E9.5

Fair Value Hedge: Short in Interest Rate Futures June 1, 2021 Cash Short-term loan payable To record the floating rate loan.

5,000,000 5,000,000

Investment in futures 6,000 Cash 6,000 To record the margin deposit on the sale of $5 million face value 91-day Treasury bill futures. August 30, 2021 Interest expense Cash Investment in futures To record the loss on the futures position and close it; $3,125 = (0.9875 – 0.985)/4 x $5,000,000.

3,125 2,875 6,000

Firm commitment 3,125 Interest expense To record the gain due to the decline in the borrowing cost of the loan. Interest expense Cash To record interest on the floating rate loan; $30,625 = 0.0245/4 x $5,000,000; 0.0245 = 0.015 + 0.0095.

3,125

30,625 30,625

Short-term loan payable (old) 5,000,000 Discount on short-term payable (new) 3,125 Firm commitment 3,125 Short-term loan payable (new) 5,000,000 To roll over the floating rate loan and reclassify the firm commitment asset as a discount on the new loan payable. November 29, 2021 Interest expense Discount on short-term loan payable Cash To record interest on the floating rate loan; $27,500 = 0.022/4 x $5,000,000; 0.022 = 0.0125 + 0.0095.

30,625 3,125 27,500

E9.6

Cash Flow Hedge: Interest Rate Cap July 2, 2020 Investment in interest rate cap 15,000 Cash 15,000 To record premium paid on 2.05% interest rate cap payable in full immediately; $15,000 = $10,000,000 x 0.00075 x 2. December 31, 2020 Interest expense Cash To record interest payable on the loan for the first six months; $100,000 = $10,000,000 x 0.02/2.

100,000 100,000

Interest expense (loss in time value) 3,500 Investment in interest rate cap 3,500 To recognize the decline in fair value of the time value portion of the premium; $3,500 = $11,500 – $15,000. The cap remains out of the money and still has no intrinsic value. June 30, 2021 Interest expense Cash To record interest payable on the loan for the next six months; $107,500 = $10,000,000 x 0.0215/2.

107,500 107,500

Investment in interest rate cap 2,000 Interest expense (loss in time value) 3,000 Interest expense (gain in intrinsic value) 5,000 To record the net $2,000 increase (= $13,500 – $11,500) in fair value of the interest rate cap. The cap goes in the money by $5,000 [= $10,000,000 x (0.0215 - 0.0205)/2], which reduces interest expense to $102,500 (= $107,500 – $5,000). At the same time the cap loses $3,000 of its time value; $3,000 = $2,000 – $5,000. [Note that because the cap is in the money, interest expense, adjusted for the gain in intrinsic value, equals the cap rate; ($102,500/$10,000,000) x 2 = 2.05%.] Cash

5,000

Investment in interest rate cap 5,000 To record collection of the excess interest due under the interest rate cap agreement.

E9.7

Fair Value Hedge: Put Options June 15, 2020 Investment in bonds Cash To record purchase of AFS bonds at par. December 31, 2020 OCI Investment in bonds To record decline in value of the unhedged bonds; $15,000 = (.985 – 1.000) x $1,000,000. February 1, 2021 OCI Investment in bonds To record decline in value of the unhedged bonds; $5,000 = (.980 – .985) x $1,000,000.

1,000,000 1,000,000

15,000 15,000

5,000 5,000

Investment in options 31,000 Cash 31,000 To record purchase of put options; $31,000 = 10,000 x $3.10; 10,000 = $1,000,000/$100. December 31, 2021 Nonoperating loss 10,000 Investment in bonds 10,000 To adjust the carrying value of the bond investment; $10,000 = (0.97 – 0.98) x $1,000,000. Although AFS investment value changes are normally reported in OCI, when they are hedged the gains and losses are reported in income. Investment in options 11,000 Nonoperating gain To record the gain on options; $11,000 = 10,000 x ($4.20 – $3.10). Cash Investment in options To record the sale of put options; $42,000 = 10,000 x $4.20 = $31,000 + $11,000.

11,000

42,000 42,000

Note that on February 1, 2021, the intrinsic value of the options was $3.00 (= $101 - $98) and their time value was $0.10 (= $3.10 - $3.00). On December 31, 2021, the options’ intrinsic value was $4 (= $101 - $97) and time value was $0.20 (= $4.20 - $4.00) The December 31, 2021 entry to record the $11,000 gain on options consists of a $10,000 increase in intrinsic value (= ($4.00 - $3.00) x 10,000) and a $1,000 increase in time value (= ($0.20 - $0.10) x 10,000). The change in the market value of the bonds exactly offsets the change in intrinsic value of the options.

2022 entry to record sale of bonds Cash 970,000 Nonoperating loss 20,000 Investment in bonds 970,000 OCI 20,000 To record sale of bonds and release of OCI to income for the unhedged loss on the bonds.

E9.8

Cash Flow Hedge: Call Options The entry to record the sale of the options is as follows: Cash Cost of goods sold (time value) Investment in options Other comprehensive income (intrinsic value)

500,000 250,000 650,000 100,000

Cash received is $500,000 = $0.50 x 1,000,000. Investment in options was on the books for its cost, $0.65 x 1,000,000. Hedge accounting is used to record the change in the intrinsic value of the options. When purchased, the full option price is time value, since the options are out of the money. On June 30, the intrinsic value is $0.10 per option (= $3.40 – $3.30). Therefore, the intrinsic value increased by $0.10 x 1,000,000 = $100,000. The hedge qualifies as a cash flow hedge, so the gain is reported in OCI until the hedged transaction affects income, which is when the commodity is sold. At that time, the gain will be reclassified as a reduction in cost of goods sold. The change in time value is reported directly in income, following normal accounting. The time value was $0.65 per option when the options were purchased, and was $0.40 per option on June 30, for a loss of ($0.40 – $0.65) x 1,000,000 = $250,000. Because the options were a hedge of a commodity price, it is likely that the appropriate income line to report the change in time value is cost of goods sold.

E9.9

Call Options Hedging Foreign Currency Debt a. Hedge accounting is used when normal accounting does not achieve matching of hedge gains and losses with losses and gains on the hedged item. In this situation, the hedged item is recorded debt denominated in another currency. Normal accounting marks this debt to market, the current spot rate, with the gain or loss appearing in income. Normal accounting for the hedge is also to mark the investment to market, with the loss or gain appearing in income. Therefore, normal accounting achieves matching, and hedge accounting is not appropriate. b. July 1, 2020 Investment in options 28,000 Cash To record purchase of call options; $28,000 = £2,000,000 x $0.014. December 31, 2020 Investment in options Gain on options To record gain on foreign currency call options; $110,000 = ($0.069 – $0.014) x £2,000,000.

28,000

110,000 110,000

Exchange loss 100,000 Loan payable 100,000 To mark the loan payable to market; $100,000 = ($1.35 – $1.30) x £2,000,000. June 30, 2021 Investment in options Gain on options To record gain on foreign currency call options; $102,000 = ($0.12 – $0.069) x £2,000,000.

102,000 102,000

Exchange loss 120,000 Loan payable 120,000 To mark the loan payable to market; $120,000 = ($1.41 - $1.35) x £2,000,000. Cash

240,000

Investment in options To record the sale of put options; $240,000 = £2,000,000 x $0.12 = $28,000 + $110,000 + $102,000.

240,000

E9.10 Fair Value Hedge: Put Options a. September 1, 2021 Investment in options Cash To record investment in put options.

150 150

November 1, 2021 Investment in options 450 Cost of goods sold (loss in time value) 150 Cost of goods sold (gain in intrinsic value) 600 To record the increase in value of the options; $450 = $600 - $150. The intrinsic value increases $600 (= $2.30 – $2.24) x 10,000; the time value declines from $150 to zero (= $600 – $450). To clarify the hedge mechanism, the change in option value is split between intrinsic and time value changes. Cost of goods sold 600 Inventory 600 To record the hedged decline in the value of the inventory. During the hedge period, the inventory spot price declines from $2.30 to $2.24; $600 = ($2.30 – $2.24) x 10,000. Cash

600

Investment in options To record the sale of the options. Cash

600

22,400

Sales revenue To record sale of copper in the spot market; $22,400 = $2.24 x 10,000. Cost of goods sold Inventory To record cost of copper sold; $20,900 = ($2.15 x 10,000) – $600.

22,400

20,900 20,900

b. The locked in gross margin is $1,500 (= $2.30 option price - $2.15 cost) x 10,000 lbs.). The actual gross margin is $1,350, computed as follows: Sales revenue Cost of goods sold Gross margin as reported

10,000 x $2.24 $20,900 + $150 - $600 + $600

$22,400 21,050 $1,350

The reported gross margin is reduced by the loss in time value of the options ($150).

E9.11 Cash Flow Hedge with Adjusting Entry: Call Options June 1, 2020 Investment in options 900,000 Cash To record investment in call options; $900,000 = $0.18 x 5,000,000.

900,000

June 30, 2020 Other comprehensive income (loss in intrinsic value) 300,000 Cost of goods sold (loss in time value) 50,000 Investment in options 350,000 To record the decline in value of the options; $350,000 = ($0.18 - $0.11) x 5,000,000. The intrinsic value declines $300,000 [= ($0.10 - $0.04) x 5,000,000]; the time value declines $50,000 [= ($0.08 - $0.07) x 5,000,000)]. September 1, 2020 Cost of goods sold (loss in time value) 350,000 Investment in options 150,000 Other comprehensive income (gain in intrinsic value) 200,000 To record the decline in value of the options; $150,000 = ($0.11 - $0.08) x 5,000,000. Intrinsic value increases $200,000 [= ($0.08 - $0.04) x 5,000,000]; time value declines $350,000 [= ($0.07 - $0.00) x 5,000,000)]. Cash

400,000

Investment in options To record the sale of the options; $400,000 = $0.08 x 5,000,000.

400,000

September 4, 2020 Inventory 12,850,000 Cash 12,850,000 To record purchase of oats in the spot market; $12,850,000 = $2.57 x 5,000,000. October 2, 2020 Cost of goods sold Other comprehensive income Inventory To record cost of oats included in products sold.

12,950,000 100,000 12,850,000

E9.12 Fair Value Hedge of a Foreign Currency Firm Commitment: Call Options a. May 1, 2020 Investment in options 80,000 Cash 80,000 To record purchase of call options; $80,000 = $0.008 x €10,000,000. The options are at the money so their entire value is time value. June 30, 2020 Investment in options 330,000 Cost of goods sold 330,000 To record increase in value of call options; $330,000 = ($0.041 - $0.008) x €10,000,000. The gain in intrinsic value is $350,000 [= ($0.035 - $0.00) x €10,000,000]; the loss in time value is $20,000. Both effects are reported currently in income. Cost of goods sold 350,000 Firm commitment 350,000 To record liability for increased $ cost of the firm purchase commitment; $350,000 = ($1.238 - $1.203) x €10,000,000. August 1, 2020 Investment in options 10,000 Cost of goods sold 10,000 To record increase in value of call options; $10,000 = ($0.042 - $0.041) x €10,000,000. The gain in intrinsic value is $70,000 [= ($0.042 - $0.035) x €10,000,000]; the loss in time value is $60,000. Both effects are reported currently in income. Cash Investment in options To record sale of call options; $420,000 = $0.042 x €10,000,000.

420,000 420,000

Cost of goods sold 40,000 Firm commitment 40,000 To record liability for increased $ cost of the firm purchase commitment; $40,000 = ($1.242 - $1.238) x €10,000,000.

Inventory 12,030,000 Firm commitment 390,000 Cash 12,420,000 To record delivery of the inventory, $12,420,000 payment to the supplier (= $1.242 x €10,000,000) and closing of the firm commitment. b.

($350,000 + $70,000)/-($350,000 + $40,000) = 1.08 The hedge is not perfect because the intrinsic value of the options changes with the spot rate and the value of the firm commitment changes with the forward rate.

E9.13 Interest Rate Swap: Profit and Default a. Intermediary’s inflows and outflows: Inflows: floating rate from Queen Fixed rate from Prince Total inflows Outflows: fixed rate to Queen Floating rate to Prince Total outflows Net interest rate spread

LIBOR + 30

LIBOR + 20

2.6% 2.4% 5.0% 2.3% 2.5% 4.8% 0.2%

With a 0.2% net spread, Intermediary was earning $2,000 (= 0.002 x $1,000,000) a year. b. Intermediary receives 2.4% from Prince, while it is paying LIBOR + 20, the equivalent of 2.5% when LIBOR = 2.3%. Thus the money Intermediary was making was derived from its arrangements with Queen, not Prince. When LIBOR increases by 20 bp, the floating rate rises to 2.7% (= LIBOR of 2.5% + 0.2%) and Intermediary's loss on the arrangement with Prince increases to 0.3% (= 2.7% - 2.4%). After Queen's default, Intermediary is losing $3,000 a year (= 0.003 x $1,000,000.

E9.14 Fair Value Hedge: Interest Rate Swap January 1, 2020 Cash Loan payable To record the fixed rate loan.

5,000,000 5,000,000

June 30, 2020 Interest expense 62,500 Cash To record the interest payment on the loan; $62,500 = $5,000,000 x 0.025/2.

62,500

Interest expense 7,500 Cash 7,500 To record the net payment on the swap; $7,500 = (0.028 – 0.025)/2 x $5,000,000. Interest expense Investment in swap To record the decline in value of the fair value hedge.

5,000 5,000

Loan payable 5,000 Interest expense To record the decline in present value of the hedged fixed rate loan. December 31, 2020 Interest expense 62,500 Cash To record the interest payment on the loan; $62,500 = $5,000,000 x 0.025/2.

5,000

62,500

Interest expense 17,500 Cash 17,500 To record the net cash outflow on the swap; $17,500 = (0.032 – 0.025)/2 x $5,000,000. Interest expense Investment in swap To record the decline in value of the fair value hedge.

1,000

Loan payable 1,000 Interest expense To record the decline in present value of the hedged fixed rate loan.

1,000

E9.15 Cash Flow Hedge: Interest Rate Swap January 1, 2020 Cash Loan payable To record the variable rate loan.

5,000,000 5,000,000

Investment in swap 25,000 Other comprehensive income 25,000 To record the swap agreement. The swap is an asset because Greentree expects to receive $7,500 [= (.028 - .025)/2 x $5,000,000] each period on the swap. June 30, 2020 Interest expense 70,000 Cash To record the interest payment on the loan; $70,000 = $5,000,000 x 0.028/2.

70,000

Cash

7,500 Investment in swap 7,500 To record the net cash inflow on the swap; $7,500 = (0.028 – 0.025)/2 x $5,000,000. Other comprehensive income Interest expense To adjust interest expense to the actual rate paid.

7,500 7,500

Investment in swap 5,000 Other comprehensive income 5,000 To revalue the swap to its new present value; $5,000 = $22,500 – ($25,000 - $7,500). December 31, 2020 Interest expense 80,000 Cash To record the interest payment on the loan; $80,000 = $5,000,000 x 0.032/2.

80,000

Cash

17,500 Investment in swap 17,500 To record the net cash inflow on the swap; $17,500 = (0.032 – 0.025)/2 x $5,000,000. Other comprehensive income Interest expense To adjust interest expense to the actual rate paid.

17,500 17,500

Investment in swap 1,000 Other comprehensive income 1,000 To revalue the swap to its new present value; $1,000 = $6,000 – ($22,500 - $17,500).

E9.16 Interest Rate Swap a. January 1 Cash Note payable To record issue of a note payable for cash.

10,000,000 10,000,000

June 30 Interest expense 150,000 Cash 150,000 To record interest for the first six months; $150,000 = (0.03 x $10,000,000)/2. Cash 35,000 Interest expense 35,000 To record net cash receipt on the swap; $35,000 = [(0.03 – 0.023)/2] x $10,000,000; 0.023 = 0.017 (average LIBOR) + 60 bp. Investment in swap Interest expense To record the change in fair value of the swap.

225,000

Interest expense Note payable To mark the hedged debt to market.

225,000

We can conclude that LIBOR declined, since the present value of the debt increased. b. The swap in a. is a fair value hedge (receive fixed/pay variable) and value changes are reported in earnings. In b., however, Marshall is hedging the variable interest payments on its variable rate debt and has a cash flow hedge (receive variable/pay fixed). Value changes in cash flow hedges are reported in OCI. To adjust reported interest expense to the fixed rate paid, AOCI is released as an adjustment to interest expense. If the variable rate declines, the present value of the future swap payments increases, increasing the swap liability, and the loss is reported in OCI.

E9.17 Cash Flow Hedge: Interest Rate Swap The swap requires Organic Farms to pay $20,000 at the end of 2020 (= $0.032 – 0.030) x $10,000,000. If we assume the 2021 payment will also be $20,000, the present value of the swap obligation is ($20,000/1.03) + ($20,000/1.032) = $38,269. January 1, 2020 Other comprehensive income Investment in swap To record the swap liability

38,269 38,269

December 31, 2020 Interest expense 300,000 Cash To record the variable interest payment; $300,000 = 0.03 x $10,000,000. Investment in swap Cash To record the payment on the swap.

20,000

Interest expense Other comprehensive income To adjust interest expense to the actual fixed rate of 3.2%.

20,000

300,000

20,000

The variable rate is reset to 3.1%, so the remaining swap payment at the end of 2021 is $10,000 (= .032 - .031) x $10,000,000, and the new present value of the swap obligation is $10,000/1.031 = $9,699. The current balance for the swap obligation is $18,269 (= $38,269 - $20,000). Therefore, the swap obligation is reduced by $8,570 (= $18,269 $9,699). Investment in swap Other comprehensive income To adjust the swap obligation to its current present value.

8,570 8,570

December 31, 2021 Interest expense 310,000 Cash To record the variable interest payment; $310,000 = 0.031 x $10,000,000. Investment in swap Cash To record the payment on the swap.

10,000

Interest expense Other comprehensive income To adjust interest expense to the actual fixed rate of 3.2%.

10,000

300,000

10,000

The swap liability is now zero. Its current balance is a debit of $301 (= $9,699 $10,000). Since the swap is completed, the remaining amount in accumulated other comprehensive income, which is also $301, is also closed out. Other comprehensive income Investment in swap To close the swap obligation and remaining AOCI.

301 301

PROBLEMS P9.1

Commodity Futures: Fair Value Hedge a. August 1, 2021 Investment in futures 80,000 Cash To record the margin deposit of $80,000 paid to the broker.

80,000

September 30, 2021 Cost of goods sold 50,000 Cash 50,000 To record the loss on the futures contract; $50,000 = 10,000 x ($320 – $315). Inventory (soybean meal) 60,000 Cost of goods sold 60,000 To recognize the value change in the inventory; $60,000 = 10,000 x ($306 – $300). October 28, 2021 Investment in futures 70,000 Cost of goods sold 70,000 To record the gain on the short futures position caused by the decline in the futures price; $70,000 = ($313 – $320) x 10,000. Cost of goods sold Inventory (soybean meal) To recognize the value change in the inventory; $75,000 = 10,000 x ($298.50 – $306).

75,000

Cash

150,000

75,000

Investment in futures To record closing the short position and settling with the broker; $150,000 = $80,000 + $70,000.

150,000

b. When Davis sells the soybean meal in the spot market, it realizes a gain of $110,000 {= [$299 – ($290 + $5 – $7)] x 10,000}, analyzed as follows. Gain on sale, ignoring the hedge [10,000 x ($299 – $290)] Net gain on the hedge [10,000 x ($7 – $5)] Net gain OR Gain on sale assuming delivery pursuant to futures contract [($315 – $290) x 10,000] Gain on futures contract [($315 - $313) x 10,000] Loss resulting from decision to sell on the spot market instead of delivering under the futures contract [($315 – $299) x 10,000] Net gain

$ 90,000 20,000 $110,000

$250,000 20,000 (160,000) $110,000

c. Had Davis purchased (rather than sold) the futures for $315, later closing out this position by selling futures for $313, a $20,000 [= ($315 - $313) x 10,000] net cash loss is sustained. Because Davis already owns the soybean meal inventory, and does not have a firm commitment to fulfill, purchase of soybean meal futures is either speculative or, if the futures purchase is hedging an anticipated transaction, a cash flow hedge. The accounting treatments of the short gain and the long loss are as follows: Short Gain: Because the sale of futures qualifies as a fair value hedge in this problem, the net $20,000 short gain in a. enters earnings but is offset by the value change in the hedged inventory. Long Loss: If the purchase of futures is speculative, the $20,000 net loss on the futures is recognized in earnings when realized, with no offset. But if the futures purchase qualifies as a cash flow hedge, the $20,000 net loss is first accumulated in OCI and later released to earnings when the hedged forecasted transaction impacts earnings.

P9.2

Interest Rate Futures: Cash Flow Hedge a. The long position in Treasury bill futures hedges the forecasted roll-over of Hilldale’s short-term Treasury bill investments. On June 30, Hilldale realizes a $2,500 gain, entering it in OCI pending completion of the roll-over. A further $1,250 gain, realized on August 30, enters OCI. The $3,750 total is reclassified from OCI to earnings over time after the new bills are purchased. It has the same effect as a discount that reduces the cost of the new Treasury bills and is subsequently amortized to income as part of interest revenue.

June 1 Investment in futures 10,000 Cash To record the initial $10,000 margin deposit paid to the broker.

10,000

June 30 Investment in futures 2,500 Other comprehensive income 2,500 To mark the Treasury bill futures to market and enter the resulting gain in OCI; $2,500 = (0.97 – 0.96)/4 x $1,000,000. August 30 Investment in futures 1,250 Other comprehensive income 1,250 To mark the Treasury bill futures to market and enter the resulting gain in OCI; $1,250 = (0.975 – 0.97)/4 x $1,000,000. Cash 6,250* Investment in treasury bills (new) 993,750 Investment in treasury bills (old) 1,000,000 To record the roll-over of the investment in the Treasury bills. * Cash received from redemption of old securities Cost of new securities: $1,000,000 – [$1,000,000 x (0.025/4)] Net cash received

Cash

$1,000,000 (993,750) $ 6,250

13,750

Investment in futures To close the futures position; $13,750 = $10,000 + $2,500 + $1,250.

13,750

As interest revenue on the new Treasury bills is recorded, it is augmented by a prorata share of the $3,750 gain released from OCI.

b. The cost of the new Treasury bills is $993,750, which reflects the current 2.5% annual discount yield (0.625% quarterly). However, the $3,750 gain on the futures contracts currently in other comprehensive income will increase interest income by $3,750 over the 91-day term of the new Treasury bills. Thus, the total return on the new Treasury bills is $10,000 (= $6,250 + $3,750), which reflects a 4% annual discount yield (1% quarterly); $10,000 = 0.01 x $1,000,000.

P9.3

Interest Rate Futures: Fair Value Hedge a. Sanders needs $504,000 (= $3.50 x 144,000) to buy the corn. At 96, each $1,000 bond has a value of $960 and futures contracts for 525 bonds (= $504,000/$960) are sold to protect the value of Sanders’ bonds that ultimately will be sold to pay for the corn. b. Cash

10,500

Nonoperating gains To settle the futures contract; $10,500 = (0.96 – 0.94) x $525,000.

10,500

Nonoperating losses 10,500 AFS investments 10,500 To record the decline in value of the AFS investments. Because they are hedged, the change in value is reported in income, not OCI, to offset the gain on the futures. Cash

493,500

AFS investments To record the sale of the bonds; $493,500 = $525,000 x 0.94.

493,500

Corn inventory 504,000 Cash 504,000 To record the purchase of the corn. Note that cash received from the hedge and the sale of AFS investments equals the amount required to pay for the corn; $504,000 = $10,500 + $493,500. c. At any intervening balance sheet date, the futures are revalued to fair value along with the AFS bonds, the hedged item. Both value changes are recognized in earnings. Investment in futures 7,875 Nonoperating gains To record unrealized gain on futures; $7,875 = (0.96 – 0.945) x $525,000.

7,875

Nonoperating losses AFS investments To record unrealized loss on AFS investments.

7,875

When the futures position is settled, the entries are: Cash Investment in futures Nonoperating gains To settle the futures contract.

10,500 7,875 2,625

Nonoperating losses 2,625 AFS investments 2,625 To record the decline in value of the AFS investments; $2,625 = (0.945 – 0.94) x $525,000. The remaining entries are the same as in part b.

P9.4

Evaluating Hedging with Futures Contracts a. Advantages of hedging with futures contracts include: • fixing the sale price of the commodity at the futures price ($4.75 in this case) when the contract is entered. • eliminating the possibility of loss. Disadvantages of hedging with futures contracts include: • tying up capital ($200,000 in this case) in a non-interest bearing margin deposit. • eliminating the possibility of gain. b. If the commodities are hedged with futures contracts, 1,000,000 bushels will be worth $4,750,000 when harvested in six months. However, interest of $4,000 (= 0.5 x 0.04 x $200,000) on the margin deposit is foregone. Thus in six months the net proceeds from, or value of, the commodities is $4,746,000 (= $4,750,000 – $4,000), implying that $4.746 per bushel is the price at which the company is indifferent. At a spot price below $4.746, hedging dominates not hedging. If the price exceeds $4.746, not hedging dominates. c. Financial statement effects [Dr (Cr)]: (1)

Cash Inventory Gain on growing crops Loss on futures contracts Interest income

No Hedge $ 4,000 (2) 5,250,000 (5,250,000) 0 (4,000)

(2) (3) = (1) - (2) Hedge with Futures Contracts Difference (1) $ (500,000) $ 504,000 (2) 5,250,000 0 (5,250,000) 0 (1)

500,000 0

(1) Reflects $500,000 [= ($4.75 – $5.25) x 1,000,000] loss on futures contracts. (2) Carried at market; $5.25 x 1,000,000.

(500,000) (4,000)

P9.5

Evaluating Hedging with Option Contracts a. Advantages of hedging with option contracts include: • eliminating the possibility of loss—a decline in the commodity's price will, in the case of put options, be offset by a gain on the option. • not negating any gain created by an increase in the commodity's price. The principal disadvantage of hedging with option contracts is paying the nonrefundable premium ($350,000 in this case). b. If the commodities are hedged with option contracts and the options are exercised or in the money at expiration, 1,000,000 bushels will be worth a net of $4,650,000 [= ($5 x 1,000,000) – $350,000]. Thus, at a $4.65 spot price the company is indifferent. For spot prices below $4.65, hedging dominates not hedging. For spot prices above $4.65, not hedging dominates hedging. Lost interest is ignored in the options case because the $350,000 cash paid for the options is gone permanently; $350,000 is the present value of interest and principal repayment foregone. In the futures case, the margin deposit caused temporary nonuse of the cash—the cash received when the margin deposit is returned has a lower present value than the cash originally deposited. The lost interest approximates this reduction in present value. c. Financial Statement Effects Dr (Cr): (1)

Cash Inventory Gain on growing crops Net loss on options

No Hedge $ 0 (2) 4,750,000 (4,750,000) $ 0

(2) Hedge with Option Contracts (1) $ (100,000) (2) 4,750,000 (4,750,000) (1) $ 100,000

(3) = (1) - (2) Difference $ 100,000 0 0 $ (100,000)

(1) $(100,000) = $250,000 [= ($5.00 – $4.75) x 1,000,000] cash gain on puts - $350,000 premium. (2) Carried at market; $4.75 x 1,000,000.

P9.6

Call Options: Cash Flow Hedge a. July 1, 2021 Investment in options Cash To record investment in options.

225,000 225,000

September 1, 2021 Cost of goods sold (loss in time value) 140,000 Other comprehensive income (gain in intrinsic value) 50,000 Investment in options 90,000 To mark the options to market. On July 1, the options’ intrinsic value was $25,000 [= ($1.40 – $1.35) x 500,000]. On September 1, intrinsic value is $75,000 [= ($1.50 – $1.35) x 500,000]. The time value on July 1 was $200,000 (= $225,000 – $25,000), and is $60,000 on September 1 (= $135,000 – $75,000). The increase in intrinsic value is a hedge of the forecasted purchase, reported in OCI until the forecasted purchase impacts income. Cash

135,000

Investment in options To record the sale of the options.

135,000

October 1, 2021 Coffee inventory 775,000 Cash 775,000 To record the inventory purchase at the spot price; $775,000 = $1.55 x 500,000. b. Cost of goods sold Other comprehensive income Coffee inventory To record the cost of coffee included in products sold.

725,000 50,000 775,000

The cost of the coffee, recognized when products containing the coffee are sold, is the spot price, $775,000 (= $1.55 x 500,000) less the gain on the hedge, equal to the change in its intrinsic value during the hedging period; $50,000 = ($1.50 – $1.40) x 500,000. c. Without hedging, Kraft purchases the coffee for $775,000 in the spot market and includes this cost in cost of goods sold when products containing the coffee are sold. Cost of goods sold Coffee inventory To record the cost of coffee included in products sold.

775,000 775,000

P9.7

Present Value Analysis of Interest Rate Cap and Journal Entries a. This is a capital budgeting problem in which the $250,000 outlay for the cap is compared with the present value of the interest savings under the assumed prime rates. Savings begin on July 1, 2021 [$100,000 = (0.035 – 0.025) x $10,000,000] and increase in each of the two years beginning on July 1, 2022 to $300,000 [= (0.055 – 0.025) x $10,000,000]. These savings are realized at the end of each fiscal year when the interest is due and the bank settles up. PV of savings

= $100,000/(1.035)2 + $300,000/(1.055)3 + $300,000/(1.055)4 = $93,351 + $255,484 + $242,165 = $591,000

Since $591,000 > $250,000, purchase of the cap is a good economic decision if the prime rate increases as expected. b. A similar approach is used here except that savings are based on comparing the new lower 0.5% prime rate with the original 1.5% [$100,000 = (0.015 - 0.005) x $10,000,000]. PV of savings

= $100,000/(1.005)2 + $100,000/(1.005)3 + $100,000/(1.005)4 = $99,007 + $98,515 + $98,025 = $295,547

Since $295,547 > $250,000, the projected interest savings more than offset the cost of the cap. Given the assumptions in a. and b., the cap hedges the potential loss from higher interest rates and the potential savings from lower interest rates hedge the cost of the cap. c. December 31, 2021 Interest expense Interest payable To record interest on the loan accrued since 6/30/21; $175,000 = (0.035 x $10,000,000)/2.

175,000 175,000

Investment in interest rate cap 50,000 Interest expense To record the gain on the cap and reduce interest expense accordingly; $50,000 = [(0.035 – 0.025) x 10,000,000]/2. Interest expense Investment in interest rate cap To recognize the decline in fair value of the cap.

50,000

31,250 31,250

June 30, 2022 Interest expense Interest payable To record interest on the loan accrued since 12/31/21. Interest payable Cash To pay interest accrued since 6/30/21.

175,000 175,000

350,000 350,000

Investment in interest rate cap 50,000 Interest expense To record the gain on the cap and reduce interest expense accordingly. Cash

50,000

100,000

Investment in interest rate cap 100,000 To record collection of one year's excess interest due under the interest rate cap. Interest expense Investment in interest rate cap To recognize the decline in fair value of the cap.

P9.8

31,250 31,250

Fair Value Hedge: Put Options a. November 1, 2020 Other comprehensive income 5,000 Investments in debt securities 5,000 To revalue the AFS bond investment to market value; the decline in value from par to 99.5 is reported in OCI because the investments are unhedged during this period. Investment in options Cash To record purchase of the put options.

3,500 3,500

Because the strike price is 99.8 and the bonds are selling for 99.5, the put options are in the money by $3,000 (= $998,000 - $995,000). The time value is therefore $500 (= $3,500 - $3,000). December 31, 2020 Investment in options 1,800 Nonoperating gains (losses) 1,800 To mark the options to market; $1,800 = $5,300 - $3,500. The gain consists of an increase in intrinsic value of $2,000 and a decline in time value of $200.

Nonoperating gains (losses) 2,000 Investment in debt securities To mark the hedged securities to market; $2,000 = $995,000 - $993,000.

2,000

b. January 31, 2021 Investment in options 700 Nonoperating gains (losses) 700 To mark the options to market; $700 = $6,000 - $5,300. The gain consists of an increase in intrinsic value of $1,000 and a decline in time value of $300. Nonoperating gains (losses) 1,000 Investment in debt securities To mark the hedged securities to market; $1,000 = $993,000 - $992,000. Cash

1,000

6,000

Investment in options To record the sale of the options.

6,000

Cash 992,000 Nonoperating gains (losses) 5,000 Investment in debt securities 992,000 Other comprehensive income 5,000 To record the sale of the debt securities and release of unhedged loss to income. Proceeds from sale of debt securities Proceeds from sale of put options Total proceeds Cost of debt securities Cost of put options Total cost Net cash loss

992,000 6,000 998,000 1,000,000 3,500 1,003,500 $ (5,500)

c. 2020: The intrinsic value of the put options serves as a hedge of AFS securities carried at market and changes in the puts' intrinsic value are recognized in income. Because value changes of hedged AFS securities are also recognized in income using hedge accounting, the value changes in the options’ intrinsic value and the AFS securities offset and have no net effect; 2020 income is reduced only by the $200 decrease in the time value of the options. 2021: Once the securities are sold, all unrealized gains and losses accumulated in OCI during unhedged periods are released to earnings. There is a net unrealized loss of $5,000 in OCI from unhedged changes in the bond investment. This loss is now realized and, coupled with the $300 remaining time value that is zero at expiration, 2021 income is reduced by $5,300.

P9.9

Speculative Straddle: Journal Entries and Profit Calculation a. January 31, 2020 Cash 25,500 Options written (calls) 10,000 Options written (puts) 15,500 To record straddle written on 5,000 shares of Exland Farm Services stock when puts sold for $3.10 and calls for $2. February 28, 2020 Options written (calls) 10,000 Loss on options 11,000 Cash 21,000 To record closing out calls written by purchasing 5,000 calls for $4.20 each, a total of $21,000. Options written (puts) 11,500 Gain on options 11,500 To mark the outstanding written puts to market and recognize the unrealized gain. (The cost to close out the puts and remove the related obligation has fallen); $11,500 = ($3.10 – $.80) x 5,000. March 31, 2020 Options written (puts) 4,000 Gain on options 4,000 To recognize expiration of the puts and the remaining premium as income; $4,000 = $15,500 original premium – $11,500 gain recognized on February 28. b. Fastbuck made $4,500 on the straddle; $25,500 in premiums were received when the straddle was written and $21,000 was paid when the calls were closed out.

P9.10 Futures and Options as Hedging Alternatives a. Hedging with futures and options provides the same loss-neutralization capability, when similar contracts are available for the needed commodity. The principal difference between futures and options is that options are one-sided, in that they remove the chance of loss while retaining the chance of gain. The user pays a premium (the time value of the option) for this package. In contrast, futures contracts are two-sided and, by requiring performance whether prices increase or decrease, negate both the chance of loss and the chance of gain. The user pays no premium for a futures contract but typically makes a margin deposit with the clearinghouse. Thus, even though Sami is hedging an exposure, the option contract contains a speculative component, the option’s time value, whereas the futures contract is a pure hedge. Whether Sami uses futures or options depends on the firm’s tolerance for risk. Futures contracts remove the risk at very low (transaction) cost whereas options are more like lottery tickets or gambles in which you pay (the premium) for a chance at a gain. b. Hedging with futures (fair value hedge of a firm commitment) Investment in futures Cash To record payment of margin deposit.

20,000

Cost of goods sold Cash To record loss from decline in value of futures contracts; $2,000 = ($690 – $710) x 100.

2,000

20,000

2,000

Firm commitment 2,000 Cost of goods sold 2,000 To record gain from reduced cost to fulfill firm commitment and related commitment asset. Cash

20,000

Investment in futures 20,000 To record receipt of the margin deposit when the futures contract is closed. Inventory 70,200 Cash 68,200 Firm commitment 2,000 To record purchase of the commodity and close the firm commitment against the inventory account; $68,200 = 100 x $682.

c. Hedging with options (cash flow hedge of forecasted purchase) Investment in options Cash To record purchase of call options; $5,000 = 100 x $50.

5,000 5,000

Cost of goods sold 5,000 Investment in options 5,000 To record expiration of the options (they remained out of the money) and the $5,000 decline in time value from $5,000 to zero. Inventory 68,200 Cash To record purchase of the commodity; $68,200 = 100 x $682.

68,200

Because the options are never in the money, there is no change in intrinsic value, which is the hedge. Therefore, no hedge gain or loss is reported in OCI. d. Commodity cost with futures hedge ($68,200 + $2,000 loss on futures) Commodity cost without hedging Cash loss from hedging as opposed to not hedging with futures

$ 70,200 (68,200) $ 2,000

The futures contracts locked in the $710 price and lost $2,000 when the futures price dropped to $690. This offset the $2,000 gain produced by purchasing the commodity at a lower spot price. Commodity cost with options hedge ($68,200 + $5,000 option premium) Commodity cost without hedging Cash loss from hedging as opposed to not hedging with options

$ 73,200 (68,200) $ 5,000

The option, a kind of insurance, expired without being used. Thus, its cost—the premium—is an additional cost, reducing income.

P9.11 Hedge Accounting Versus Normal Accounting for Cash Flow Hedge with Options: Financial Statement Impacts a. 1. 2. 3. 4.

$30,000 gain for increase in options intrinsic value $10,000 added to cost of goods sold for the decline in options time value $4,470,000 (cash cost) $4,420,000 (= $4,470,000 - $50,000 total gain in intrinsic value, released from AOCI). Income effects using hedge accounting (gain) loss 2020 Decline in time value $10,000 _____ Total $10,000

2021 Decline in time value Products sold Total

30,000 4,420,000 $4,450,000

Journal entries using hedge accounting (not required): October 1, 2020 Investment in options 40,000 Cash To record investment in call options; $40,000 = $0.04 x 1,000,000.

40,000

December 31, 2020 Cost of goods sold (loss in time value) 10,000 Investment in options 20,000 Other comprehensive income (increase in intrinsic value) 30,000 To record the increase in value of the options; $20,000 = ($0.06 - $0.04) x 1,000,000. The intrinsic value increases $30,000 [= ($0.03 - $0.00) x 1,000,000]; the time value declines $10,000 [= ($0.04 - $0.03) x 1,000,000)]. April 1, 2021 Cost of goods sold (loss in time value) 30,000 Investment in options 10,000 Other comprehensive income (gain in intrinsic value) 20,000 To record the decline in value of the options; $10,000 = ($0.06 - $0.05) x 1,000,000. Intrinsic value increases $20,000 [= ($0.05 - $0.03) x 1,000,000]; time value declines $30,000 [= ($0.03 - $0.00) x 1,000,000)]. Cash Investment in options To record the sale of the options; $50,000 = $0.05 x 1,000,000.

50,000 50,000

Inventory 4,470,000 Cash 4,470,000 To record purchase of wheat in the spot market; $4,470,000 = $4.47 x 1,000,000. When products containing the wheat are sold: Cost of goods sold Other comprehensive income Inventory To record cost of wheat included in products sold.

4,420,000 50,000 4,470,000

b. 1. 2. 3. 4.

$20,000 $4,470,000 (cash cost) $4,470,000 $10,000 Income effects using normal accounting (gain) loss 2020 Gain on options $(20,000) _____ Total $(20,000)

2021 Loss on options Products sold Total

10,000 4,470,000 $4,480,000

Journal entries using normal accounting (not required): October 1, 2020 Investment in options 40,000 Cash To record investment in call options; $40,000 = $0.04 x 1,000,000.

40,000

December 31, 2020 Investment in options 20,000 Nonoperating gains (losses) 20,000 To record the increase in value of the options; $20,000 = ($0.06 - $0.04) x 1,000,000. April 1, 2021 Nonoperating gains (losses) 10,000 Investment in options 10,000 To record the decline in value of the options; $10,000 = ($0.06 - $0.05) x 1,000,000. Cash Investment in options To record the sale of the options; $50,000 = $0.05 x 1,000,000.

50,000 50,000

Inventory 4,470,000 Cash 4,470,000 To record purchase of wheat in the spot market; $4,470,000 = $4.47 x 1,000,000. When products containing the wheat are sold: Cost of goods sold Inventory To record cost of wheat included in products sold.

4,470,000 4,470,000

P9.12 Hedge Accounting Versus Normal Accounting for Fair Value Hedge with Options: Financial Statement Impacts a. Cost of goods sold reported at the time of sale, using hedge accounting, is $732,000 [= (($0.741 x S$1,000,000)) cash payment – (($0.741 - $0.732) x S$1,000,000) change in value of the firm commitment. Cost of goods sold reported at the time of sale, using normal accounting, is $741,000, the cash payment. b.

Income effects using hedge accounting (gain)/loss 2020 Increase in option value $(2,000) Increase in firm commitment 7,000 _____ Total $ 5,000

2021 Increase in option value Increase in firm commitment Sale of food products Total

Income effects using normal accounting (gain)/loss 2020 2021 Increase in option value $(2,000) Increase in option value Sale of food products Total $(2,000) Total

$ (2,000) 2,000 732,000 $732,000

$ (2,000) 741,000 $739,000

Journal entries using hedge accounting (not required) November 1, 2020 Investment in options 7,000 Cash 7,000 To record purchase of call options; $7,000 = $0.007 x S$1,000,000. The options are at the money so their entire value is time value.

December 31, 2020 Investment in options 2,000 Cost of goods sold 2,000 To record increase in value of call options; $2,000 = ($0.009 - $0.007) x S$1,000,000. The gain in intrinsic value is $5,000 [= ($0.005 - $0.00) x S$1,000,000]; the loss in time value is $3,000. Both effects are reported currently in income. Cost of goods sold 7,000 Firm commitment 7,000 To record liability for increased $ cost of the firm purchase commitment; $7,000 = ($0.739 - $0.732) x S$1,000,000. May 1, 2021 Investment in options 2,000 Cost of goods sold 2,000 To record increase in value of call options; $2,000 = ($0.011 - $0.009) x S$1,000,000. The gain in intrinsic value is $6,000 [= ($0.011 - $0.005) x S$1,000,000]; the loss in time value is $4,000. Both effects are reported currently in income. Cash Investment in options To record sale of call options; $11,000 = $0.011 x S$1,000,000.

11,000 11,000

Cost of goods sold 2,000 Firm commitment 2,000 To record liability for increased $ cost of the firm purchase commitment; $2,000 = ($0.741 - $0.739) x S$1,000,000. Inventory 732,000 Firm commitment 9,000 Cash 741,000 To record delivery of the inventory, $741,000 payment to the supplier (= $0.741 x S$1,000,000) and closing of the firm commitment.

Journal entries using normal accounting (not required) November 1, 2020 Investment in options 7,000 Cash 7,000 To record purchase of call options; $7,000 = $0.007 x S$1,000,000. The options are at the money so their entire value is time value.

December 31, 2020 Investment in options 2,000 Nonoperating gains (losses) 2,000 To record increase in value of call options; $2,000 = ($0.009 - $0.007) x S$1,000,000. May 1, 2021 Investment in options 2,000 Nonoperating gains (losses) 2,000 To record increase in value of call options; $2,000 = ($0.011 - $0.009) x S$1,000,000. Cash Investment in options To record sale of call options; $11,000 = $0.011 x S$1,000,000.

11,000 11,000

Inventory 741,000 Cash 741,000 To record delivery of the inventory and $741,000 payment to the supplier (= $0.741 x S$1,000,000.

P9.13 Evaluate Strategies to Hedge Against Rising Interest Rates a. The swap converts the variable LIBOR + 80 bp rate to a fixed 4% rate. If LIBOR stays at 3%, Apple will pay 20 extra basis points in interest each year under the swap, a total of $400,000 (= 0.002 x $100,000,000 x 2). In these circumstances payment of $400,000 for the 4% cap, which will not go in the money, should make Apple indifferent between the swap and the cap. b. If LIBOR is allowed to vary, the problem is much more complicated and in some sense depends on Apple’s ability to predict movements in LIBOR better than its potential counterparties. If LIBOR rises above 3.2%, the swap protects Apple at no cost, whereas the cap provides the protection at a cost. But if LIBOR falls, Apple is exposed to considerable variable opportunity losses under the swap whereas the cap’s cost is fixed and there is no return from it. Risk aversion seems to favor the cap that has a fixed known cost. Greater tolerance for risk favors the swap as long as increases in LIBOR are likely and the opportunity losses incurred when LIBOR falls are viewed as real cash payments. c. When the futures are hedging against rising interest rates, they should be sold. If Apple sells futures at 96 and the discount yield rises to 7%, meaning more interest payments on Apple’s variable debt, being able to buy back the futures at 93 and realize the 3-point gain will offset the higher interest payments.

Of course, futures are double-edged swords and require performance whether conditions are favorable or not. Thus if interest rates go down, and interest payments on the debt fall, those opportunity gains are wiped out by the losses incurred to cover the short futures position when repurchasing at a higher cost. Of the three alternatives—swap, options (interest rate cap) and futures—only the options retain the opportunity for gain, but at a known fixed cost. If Apple seeks to minimize risk then it must consider the terms and cost of available caps offered by counterparties in the light of its own assessment of future interest rate movements.

P9.14 Interest Rate Swap: Journal Entries and Valuation a. Interest expense 75,000 Cash 75,000 To record interest expense on the variable rate debt; $75,000 [= (0.03/4 x $10,000,000). Note that the fixed rate paid (3%) equals the variable rate received during this period. b. The swap hedges fixed rate investments, and is therefore a fair value hedge. Both the swap and investments are adjusted for the value change, with the offsetting gain and loss reported in income. The swap increases in value, and the investments decline in value due to the increase in interest rates. Investment in swap 50,000 Gain on hedge activity 50,000 To mark the swap to market, indicating the decrease in present value of the expected net payments to intermediary. Loss on hedge activity 50,000 Investments (fixed-rate) 50,000 To mark the fixed rate investments to market, indicating the decrease in present value of the investments' fixed receipts. Although HTM debt investments are normally reported at amortized cost, when hedged the loss in value is reported in income to offset the hedge gain. c. Interest expense Cash To record interest expense on the variable rate debt; $87,500 [= (0.035/4 x $10,000,000). Cash

87,500 87,500

12,500 Interest expense 12,500 To record the net cash inflow on the swap; $12,500 = (0.035 – 0.03)/4 x $10,000,000.

d. Interest expense Cash To record interest expense on the variable rate debt; $87,500 [= (0.035/4 x $10,000,000).

87,500 87,500

Cash

12,500 Investment in swap 12,500 To record the net cash inflow on the swap; $12,500 = (0.035 – 0.03)/4 x $10,000,000.

Other comprehensive income Interest expense To adjust interest expense to the fixed rate paid.

12,500

Investment in swap Other comprehensive income To mark the swap to market.

50,000

12,500

50,000

P9.15 Cash Flow Hedge: Interest Rate Swap The swap requires Turtlemountain to pay $100,000 on December 31, 2019 (= $0.034 – 0.032)/2 x $100 million. If we assume future payments will also be $100,000, the present value of the swap obligation, discounted using the variable rate of 3.2%, is ($100,000/1.016) + ($100,000/1.0162) + ($100,000/1.0163)+ ($100,000/1.0164) = $384,498. July 1, 2019 Other comprehensive income Investment in swap To record the swap liability

384,498 384,498

December 31, 2019 Interest expense 1,600,000 Cash 1,600,000 To record the variable interest payment; $1,600,000 = 0.032/2 x $100 million. Investment in swap Cash To record the payment on the swap.

100,000

Interest expense Other comprehensive income To adjust interest expense to the actual fixed rate of 3.4%.

100,000

The variable rate is reset to 3.15%, so the remaining swap payments are expected to be $125,000 (= .034 - .0315)/2 x $100 million, and the new present value of the swap obligation (annuity of $125,000 for 3 periods, discounted at the variable rate of 3.15%, is $363,490. The current balance for the swap obligation is $284,498 (= $384,498 $100,000). Therefore, the swap obligation is increased by $78,992 (= $363,490 $284,498). Other comprehensive income Investment in swap To adjust the swap obligation to its current present value.

78,992 78,992

June 30, 2020 Interest expense 1,575,000 Cash 1,575,000 To record the variable interest payment; $1,575,000 = 0.0315/2 x $100 million. Investment in swap Cash To record the payment on the swap.

125,000

Interest expense Other comprehensive income To adjust interest expense to the actual fixed rate of 3.4%.

125,000

The variable rate is reset to 3.05%, so the remaining two swap payments are expected to be $175,000 per period (= .034 - .0305)/2 x $100 million, and the new present value of the swap obligation (annuity of $175,000 for 2 periods, discounted at 3.05%, is $342,153. The current balance for the swap obligation is $238,490 (= $363,490 - $125,000). Therefore, the swap obligation is increased by $103,663 (= $342,153 - $238,490). Other comprehensive income Investment in swap To adjust the swap obligation to its current present value.

103,663 103,663

P9.16 Interpreting Derivatives Disclosures (in millions) a. Fair value hedges of interest rate risk convert fixed rate debt into variable rate debt. If interest rates rise, the derivatives lose value, since Kellogg’s pays a higher variable rate of interest. These contracts are reported as liabilities. Conversely, if interest rates fall, Kellogg’s benefits from the lower variable rate and the contracts are reported as assets. b. Derivatives investments 170 Interest expense 170 To recognize the increase in value of receive fixed/pay variable interest rate swaps. Interest expense 152 Fixed rate debt 152 To recognize the increase in value of receive fixed/pay variable interest rate swaps. Since the present value of fixed rate debt increased, interest rates must be falling. Kellogg’s pays a lower variable rate, so the swaps increased in value. c. Other comprehensive income 126 Derivatives investments To recognize the effective portion of unrealized losses on cash flow hedges.

126

Interest expense 17 Other comprehensive income To reclassify OCI to income when the hedged item affects income.

P9.17 Interpreting Interest Rate Swap Disclosures a. In fiscal 2016, General Mills swapped fixed rate payments of 1.8% for variable rate payments of 1.1%. Therefore, its receive fixed/pay variable swaps (fair value hedges) were profitable. In fiscal 2017, General Mills again profited from converting its fixed rate debt to floating payments, receiving 1.8% to cover fixed rate debt, and paying a floating rate of 1.6%, thereby benefitting from lower variable rates. The net benefit in fiscal 2016 was 0.7% (= 1.8% – 1.1%). The net benefit in fiscal 2017 was not as high, 0.2% (= 1.8% – 1.6%). When interest rates are falling, swapping fixed for variable payments is more profitable than swapping variable for fixed payments.

b. The change in the value of the swaps used to hedge the interest rate risk associated with these notes is accumulated in AOCI and reclassified to earnings over the remaining term of the notes. Therefore, these swaps are cash flow hedges, and the related debt is variable rate debt. c. The swaps are initially recorded at the present value of the future expected swap payments. If the variable rate is greater than the fixed rate, General Mills receives payments on the swap and records the swap as an asset, with a corresponding credit to OCI. Subsequent changes in present value adjust the amount reported in AOCI, but as long as the expected future payments are a net inflow, the amount in AOCI is a credit (gain). Since the 3.15% notes have a related credit balance in AOCI, we can conclude that the fixed rate on the swap is less than the variable rate on the notes. When interest expense is recorded on the notes, the variable rate is adjusted to the lower fixed rate with a debit to OCI and a credit to interest expense. If the fixed rate is greater than the variable rate, General Mills makes payments on the swap and records the swap as a liability, with a corresponding debit to OCI. Since the 3.65% notes have a related debit balance in AOCI, we can conclude that the fixed rate on the swap is greater than the variable rate on the notes. When interest expense is recorded on the notes, the variable rate is adjusted to the higher fixed rate with a credit to OCI and a debit to interest expense. Overall, General Mills reports a net loss of $23 million remaining in AOCI, related to its receive variable/pay fixed interest rate swaps. On average, the swap agreements require General Mills to pay a fixed rate that is higher than the variable rate. d. These gains (losses) will ultimately be reclassified as a decrease (increase) in interest expense that offsets the higher (lower) future variable rate interest. For the swaps with debit balances in AOCI, the entry debits interest expense and credits OCI to increase the variable rate to the fixed rate. For the swaps with credit balances in AOCI, the entry debits OCI and credits interest expense to reduce the variable rate to the fixed rate.

CHAPTER 10 SOLUTIONS TO MULTIPLE CHOICE QUESTIONS, EXERCISES AND PROBLEMS

MULTIPLE CHOICE QUESTIONS 1.

d Appropriations (= $20,000,000 + $500,000) Less expenditures Less encumbrances Available funds

$ 20,500,000 (7,600,000) (75,000) $ 12,825,000

The budget entry added $243,000 to fund balance, as follows: Estimated revenues Estimated other financing sources Appropriations Estimated other financing uses Fund balance—unassigned

1,290,000 60,000 1,085,000 22,000 243,000

Therefore, the fund balance prior to the budget entry was $285,000 – $243,000 = $42,000. 7.

d Closing entries are: Property tax revenues Speeding ticket revenues Transfers in Bond proceeds Estimated revenues Estimated other financing sources Fund balance—unassigned

950,000 400,000 8,000 50,000 1,290,000 60,000 58,000

Appropriations Estimated other financing uses General expenditures Capital outlay Debt service: principal Debt service: interest Transfers out Fund balance—unassigned

1,085,000 22,000 1,015,000 25,000 2,000 8,000 20,000 37,000

$58,000 + $37,000 = $95,000 8.

d General expenditures Capital outlay Debt service: principal payments Debt service: interest payments Total expenditures

$1,015,000 25,000 2,000 8,000 $1,050,000

b Cash Taxes receivable, net ($113,000 – $45,000) Due from other funds Total

10.

$371,000 68,000 12,000 $451,000

b Original assessment of 2020 taxes ($1,000,000 – $25,000) End of year adjustment in allowance [($60,000 – $15,000) – $25,000] Excess cash collected on 2019 taxes ($30,000 – $21,000) Total property tax revenue for 2020

$975,000 (20,000) 9,000 $964,000

Or alternatively, 2020 taxes collected Uncollected 2020 taxes expected to be collected in early 2021 Excess collections on 2019 taxes ($30,000 – $21,000) Total property tax revenue for 2020

$940,000 15,000 9,000 $964,000

EXERCISES E10.1 Identify Appropriate Fund 1. 2. 3. 4. 5. 6. 7.

General fund Capital projects fund Enterprise fund Custodial fund Internal service fund Pension trust fund Investment trust fund

8. Capital projects fund 9. Debt service or general fund 10. General fund 11. Special revenue fund 12. Debt service fund 13. Permanent fund 14. Custodial fund

E10.2 Identify Appropriate Fund(s) 1. General fund (for transfer to debt service fund), debt service fund 2. Special revenue fund 3. General fund (for transfer to capital projects fund and for processing and receiving the assessments), capital projects fund (for construction activities), custodial fund (for accumulation of assessments and payment to bondholders) 4. General fund (for processing assessments and receiving and distributing money from the assessments), capital projects fund (for construction activities), and debt service fund (for receiving the assessments from the general fund and servicing the debt) 5. Capital projects fund 6. General fund (for transfer of withheld wages), pension trust fund 7. General fund (expenditure for premium paid) 8. Internal service fund 9. General fund 10. General fund 11. General fund (for transfer of withheld wages), custodial fund 12. General fund (if museum activities are reported in the general fund), permanent fund 13. Investment trust fund

E10.3 Identify Appropriate Fund 1. Special revenue fund 2. Capital projects fund 3. Enterprise fund 4. Custodial fund 5. Special revenue fund 6. Special revenue fund 7. Pension and other employee benefit trust fund 8. Internal service fund 9. Special revenue fund 10. Permanent fund E10.4 Property Tax Rate and Revenues a. Last year’s property tax revenue was: $8,500,000 = $0.85 x ($1,000,000,000/$100) b. Property tax revenue required is $9,600,000 = $10,500,000 – $900,000 $9,600,000/($1,050,000,000/$100) = $0.914 per $100 of assessed valuation c. $0.85 x ($1,050,000,000/$100) = $8,925,000

E10.5 Computing Available Funds (all dollar amounts in thousands) a. Funds available for encumbrance consist of: Appropriations – Expenditures – Outstanding Encumbrances Appropriations are $5,150,000 (= estimated revenue of $5,000,000 + budgetary deficit of $150,000). Thus, Available funds = $5,150,000 – 4,550,000 – 350,000 = $250,000 The other numerical data given are irrelevant to this calculation. b. Operating costs average about $445,000 per month [= (4,550,000 + 350,000)/11]. Yet, there is only $250,000 remaining to cover operating costs of $445,000 in the last month of the fiscal year. City departments should be advised to drastically limit their expenditures, and delay spending to the next budget year wherever possible.

E10.6 Reconstruct Budget Entry, Compute Fund Balance The detailed budget may be reconstructed as follows: Actual

Over (Under) Budget

Budget

304,931

$ 7,315,881

Revenues: Taxes

$ 7,620,812

Licenses and permits

622,317

55,364

566,953

Fees and fines

158,871

(62,633)

221,504

Intergovernmental

1,708,176

(2,379,023)

4,087,199

Charges for services

287,878

12,092

275,786

Miscellaneous

569,395

(44,788)

614,183

$10,967,449

$ (2,114,057)

$13,081,506

$ 1,269,990

$ (1,425,158)

$ 2,695,148

Public safety

5,962,703

(1,296,202)

7,258,905

Public works

3,691,476

(2,248,253)

5,939,729

Debt service

630,109

(87,295)

717,404

Total

$11,554,278

$ (5,056,908)

$16,611,186

Other financing sources

$ 1,606,638

$ (1,558,983)

$ 3,165,621

Total Expenditures: General government

a. Therefore, the budget entry was: Estimated revenues Estimated other financing sources Fund balance-unassigned Appropriations

13,081,506 3,165,621 364,059 16,611,186

b. Fund balance, beginning of year Budget entry effect (planned decrease) Excess of budgeted revenues over actual revenues Excess of appropriations over actual expenditures Excess of estimated over actual other financing sources Fund balance, end of year

$6,160,872 (364,059) (2,114,057) 5,056,908 (1,558,983) $7,180,681

Alternative calculation: Fund balance, beginning of year Actual revenues Actual expenditures Actual other financing sources Fund balance, end of year

$ 6,160,872 10,967,449 (11,554,278) 1,606,638 $ 7,180,681

E10.7 Transactions, Closing Entries, Budgetary Comparison Schedule, and Balance Sheet (in thousands) a. Journal entries: (1) Estimated revenues Fund balance—unassigned Appropriations

65,000 3,000

(2) Taxes receivable Property tax revenues

50,000

(3) Cash Property tax revenues Taxes receivable

4,950 50

Cash

46,000

68,000

50,000

5,000

Taxes receivable (4) Expenditures Accounts payable Encumbrances Fund balance—assigned (5) Accounts payable Cash (6) Cash

46,000

66,500 66,500 1,000 1,000

67,000 67,000

13,500 Fee and service revenues

13,500

b. Closing entries: Property tax revenues Fee and service revenues Fund balance—unassigned Estimated revenues

49,950 13,500 1,550

Appropriations

68,000

65,000

Fund balance—unassigned Expenditures Encumbrances

500 66,500 1,000

c. $54,950 = $59,000 - $3,000 - $1,550 + $500 d. Budgetary Comparison Schedule For the Year Ended June 30, 2020

Budget $65,000 68,000 $(3,000)

Revenues Expenditures Change in fund balances (1)

Variance— Favorable Actual (Unfavorable) $63,450 $ (1,550) 66,500 1,500 $(3,050) $ (50)

(1) Closing entries $(1,550) + 500 = $(1,050) Increase in assigned fund balance 1,000 Change in fund balances $ (50)

e. TOWN OF HILLER General Fund Balance Sheet June 30, 2020 (in thousands) Cash…………………… Taxes receivable………. Total assets………………

$57,450 4,000 _____ $61,450

Accounts payable…………… Fund balance—assigned……. Fund balance—unassigned…. Total liabilities and fund balances

$5,500 1,000 54,950 $61,450

E10.8 Property Tax Transactions a. Taxes receivable—current 30,000,000 Allowance for uncollectible taxes—current Revenues To record tax levy and establish allowance for uncollectible taxes.

1,200,000 28,800,000

Cash 9,009,000 Revenues 91,000 Taxes receivable—current 9,100,000 To record collection of taxes prior to due date and reduction of revenues by 1% discount ($9,100,000 = $9,009,000/0.99). Cash

18,900,000

Taxes receivable—current To record collection of taxes prior to January 1; $18,900,000 = $30,000,000 - $9,100,000 - $2,000,000. Taxes receivable—delinquent Taxes receivable—current To reclassify taxes declared delinquent on January 1.

18,900,000

2,000,000 2,000,000

Allowance for uncollectible taxes—current 1,200,000 Revenues 600,000 Allowance for uncollectible taxes— delinquent 1,800,000 To adjust the allowance for delinquent taxes to $1,800,000 (= $2,000,000 – $200,000). Cash 300,000 Allowance for uncollectible taxes—delinquent 1,800,000 Taxes Receivable—delinquent Revenues To record collection of delinquent taxes subsequent to January 1. Expenditures Cash To record cash expenditures for the year.

2,000,000 100,000

25,000,000 25,000,000

b. Balance sheet accounts Cash ($850,000 + $9,009,000 + $18,900,000 + $300,000 - $25,000,000)

$ 4,059,000

Fund balance: Actual revenues ($28,800,000 - $91,000 – $600,000 + $100,000) Estimated revenue Decrease in fund balance with closing entry Beginning fund balance after the budget entry Ending fund balance

$28,209,000 29,000,000 (791,000) 5,200,000 $ 4,409,000

E10.9 Inventory Accounting a. Consumption method Expenditures (1) Inventory (2) Cash Accounts payable Fund balance – nonspendable (2) Fund balance—unassigned (2)

15,075,000 75,000 14,100,000 900,000 75,000 75,000

Purchases method Expenditures Cash Accounts payable

15,000,000 14,100,000 900,000

(1) $15,075,000 = $200,000 + $15,000,000 – $125,000 (2) $75,000 = $125,000 – $200,000

E10.10 Closing Entries a. Revenues Estimated revenues

3,501,000

Appropriations Expenditures

3,449,000

Revenues Estimated revenues

3,501,000

Appropriations Expenditures Fund balance—unassigned

3,449,000

Revenues Fund balance—unassigned Estimated revenues

3,440,000 61,000

Appropriations Expenditures Fund balance—unassigned

3,449,000

3,501,000

3,449,000

b. 3,501,000

3,427,000 22,000

3,501,000

3,440,000 9,000

d. Revenues Fund balance—unassigned Estimated revenues

3,495,000 6,000

Appropriations Expenditures Fund balance—unassigned

3,449,000

3,501,000

3,443,000 6,000

E10.11 Carryover Encumbrances a. Legal budgetary basis Expenditures—prior year encumbrances 2,497,000 Accounts payable To record invoices for goods and services ordered in 2019.

2,497,000

Fund balance—assigned 2,500,000 Fund balance—unassigned 3,000 Expenditures—prior year encumbrances 2,497,000 To close encumbrances carried over from 2019 and related expenditures. b. GAAP budgetary basis Encumbrances Fund balance—unassigned To restore encumbrances carried over from 2019.

2,500,000 2,500,000

Fund balance—assigned 2,500,000 Encumbrances To reverse encumbrances for goods and services received.

2,500,000

Expenditures Accounts payable To record invoices for goods and services.

2,497,000

No special closing entry is required; expenditures are closed in the normal manner.

E10.12 Interfund Transactions 1. Balance sheet asset: Due from special revenue fund 2. Statement of revenues, expenditures, and changes in fund balances: Transfers out, listed under other financing uses 3. Statement of revenues, expenditures, and changes in fund balances: Transfer in, listed under other financing sources 4. Statement of revenues, expenditures, and changes in fund balances: Expenditures 5. Balance sheet asset: Due from enterprise fund 6. Balance sheet: reduces Due from special revenue fund

E10.13 Adjusting and Closing Entries, Balance Sheet a. Adjustments: Revenues 150,000 Allowance for uncollectible taxes 150,000 To adjust the allowance balance; $150,000 = ($900,000 - $350,000) - $400,000. Supplies 10,000 Expenditures To adjust ending supplies balance; $10,000 = $190,000 - $180,000.

10,000

Fund balance—unassigned Fund balance—nonspendable To adjust nonspendable fund balance.

10,000 10,000

Deferred inflows of resources Revenues To adjust deferred inflows; $50,000 = $300,000 - $250,000.

50,000 50,000

Closing entries: Revenues 12,100,000 Estimated revenues Fund balance—unassigned To close revenues; $12,100,000 = $12,200,000 - $150,000 + $50,000.

12,000,000 100,000

Appropriations Expenditures Encumbrances Fund balance—unassigned To close expenditures and encumbrances.

10,665,000 250,000 85,000

11,000,000

b. Assets Cash Taxes receivable (less $550,000 allowance for uncollectible delinquent taxes) Due from other funds Supplies

Total

$1,500,000

350,000 210,000 190,000 _________ $2,250,000

Liabilities and fund balances Accounts payable

Due to other funds Deferred inflows of resources Fund balances: Nonspendable Assigned Unassigned Total

Unassigned fund balance = $335,000 - $10,000 + $100,000 + $85,000 = $510,000.

E10.14 General Fund Capital Asset and Long-Term Debt Transactions

$ 900,000

150,000 250,000 190,000 250,000 510,000 $2,250,000

a. 1. Capital outlay Cash

3,420,000 3,420,000

2. Cash

75,000 Proceeds from sale of capital assets

3. Debt service: interest Debt service: principal Cash

75,000

250,000 1,000,000 1,250,000

b. All transactions are reported in the general fund’s statement of revenues, expenditures, and changes in fund balances. Capital outlay of $3,420,000 is reported as an expenditure. Proceeds from sale of capital assets of $75,000 is reported as other financing sources. Debt service: principal of $1,000,000 and debt service: interest of $250,000 are reported as expenditures. c. Effect on general fund unassigned fund balance: $(4,595,000) = $(3,420,000) + $75,000 – $250,000 - $1,000,000.

E10.15 Identifying the Reporting Entity 1. The school district is a discretely presented component unit. The city is financially accountable for the school district—the city approves its budget and is legally liable for its debt. The city also provides significant funding. Financial results are discretely presented rather than blended because the district has a different governing body. 2. The housing authority is not a component unit of the city. The city is not financially accountable for it. 3. The landfill is a discretely presented component unit. The city is financially accountable because it controls the board and sets landfill rates. 4. The sewer district is not a component unit of the city, since the city does not control its board, and is not financially liable for its activities. 5. The building authority is a blended component unit of the city. It is a component unit because the city appoints the board and is liable for the authority’s debts. The building authority’s financial information is blended with that of the city because the authority provides services entirely to the city.

E10.16 Classifying General Fund Balance (in millions) Fund balances: Nonspendable (1) Restricted (2) Committed (3) Assigned (4) Unassigned (5) Total fund balances

76.7 467.5 1,378.4 151.6 604.4 $2,678.6

(1) $7.8 + $68.9 (2) $158.6 + $122.2 + $78.3 + $108.4 (3) $200.0 + $114.3 + $74.3 + $71.6 + $55.3 + $862.9 (4) $75.5 + $28.0 + $14.5 + $33.6 (5) $2,678.6 - $76.7 - $467.5 - $1,378.4 - $151.6

E10.17 Accounting for Property Taxes

Taxes receivable Allowance for uncollectible taxes Property tax revenues To record fiscal 2020 property tax levy. Cash

40,000,000 500,000 39,500,000

275,000

Taxes receivable To record collection of fiscal 2019 taxes.

275,000

Allowance for uncollectible taxes 200,000 Taxes receivable 175,000 Property tax revenues 25,000 To record collection of fiscal 2019 taxes and write-off of remaining uncollected taxes. Cash

165,000

Deferred inflows of resources To record taxes collected in advance.

165,000

Deferred inflows of resources 125,000 Property tax revenues 125,000 To record taxes paid in advance in fiscal 2019 that are now available to spend. Cash

38,695,000

Taxes receivable 38,695,000 To record collection of fiscal 2020 taxes; $38,695,000 = $39,135,000 - $275,000 $165,000. Allowance for uncollectible taxes 145,000 Property tax revenues 145,000 To adjust the year-end allowance balance to the amount not expected to be collected within 60 days; $145,000 = [($40,000,000 - $38,695,000) –$950,000] - $500,000.

PROBLEMS P10.1 Determining the Reporting Entity 1. Megalopolis is the primary government. The Convention Authority (CA) should be included with Megalopolis for financial reporting purposes. The city appoints the CA's governing board and, even though it appears that the city will not be subsidizing the CA, bonds issued by the CA and backed (guaranteed) by the city impose a financial burden on the city. Megalopolis is financially accountable to its constituents for the activities of the CA. 2. Megalopolis remains the primary government. However, the CA now appears to be a separate financial reporting entity. Even though the city appoints the governing board, the activities of the CA are essentially independent of the city. The CA may levy its own sales tax and issue its own bonds. The bonds are not backed by the city and, presumably, will be repaid with the CA's revenue. Council has no authority to approve or disapprove the CA's plans and is neither financially impacted by nor financially accountable for the CA's activities. 3. Alameda County is the primary government. Although the Flood Control Districts are legally separate from the county, they are reported as if they were part of the primary government because the Flood Control Districts governing board is composed solely of the members of the County Board of Supervisors and the county has operational responsibility for the Flood Control Districts. 4. The State of Georgia is the primary government. The Georgia Higher Education Facilities Authority is included with the state, as a blended component unit, for financial reporting purposes. The Authority exists to provide services to the State. 5. The State of Michigan is the primary government. The Great Lakes Protection Fund (GLPF) is a separate joint venture not included with the state for financial reporting purposes. Although Michigan is represented on the Board of the GLPF, the GLPF has its own Articles of Incorporation and Michigan does not have control over decisions made. The GLPF is also not fiscally dependent on the State of Michigan. 6. The State of Georgia is the primary government. The Georgia Public Telecommunications Commission is included as a component unit in the State financial reports. The State has control over the Commission's ability to spend, and the Commission is financially accountable to the State.

P10.2 General Fund Entries and Financial Statements a. Journal entries for fiscal 2020: Estimated revenues 8,100,000 Fund balance—unassigned 1,500,000 Appropriations 6,600,000 To record 2020 budget. Estimated revenues are $8,100,000 (= $3,200,000 + $3,700,000 + $800,000 + $400,000) and appropriations are $6,600,000 (= $4,300,000 + $950,000 + $920,000 + $250,000 + $180,000). Taxes receivable Tax revenues To accrue taxes receivable.

3,200,000

Cash

3,200,000

Taxes receivable To record collection of property taxes. Waste management expenditures Cash To record expenditures for waste management.

3,200,000

4,290,000 4,290,000

Court expenditures Cash To record expenditures for court costs.

920,000

Cash

550,000

920,000

Accounts receivable—waste management To record receipt of payment on 2019 waste management bills. Cash Accounts receivable—waste management Waste management revenues To record revenues from waste management. Cash

2,480,000 320,000 2,800,000

850,000

Court fines To record revenues from court fines. Salaries and operating expenditures Cash To record salaries and operating expenditures.

550,000

850,000

880,000 880,000

Investments Interest revenue To record interest revenue from investments.

450,000

Miscellaneous expenditures Cash To record miscellaneous expenditures.

160,000

450,000

160,000

Supplies expenditures 250,000 Waste management supplies To record consumption of supplies inventory ($515,000 – $265,000).

250,000

Fund balance—nonspendable Fund balance—unassigned To adjust the nonspendable fund balance.

250,000

Closing entries: Tax revenues Waste management revenues Court fines Interest revenue Fund balance—unassigned Estimated revenues To close revenues to fund balance. Appropriations Waste management expenditures Court expenditures Salaries and operating expenditures Miscellaneous expenditures Supplies expenditures Fund balance—unassigned To close expenditures to fund balance.

250,000

3,200,000 2,800,000 850,000 450,000 800,000 8,100,000

6,600,000 4,290,000 920,000 880,000 160,000 250,000 100,000

b. Town of Jones Falls General Fund Statement of Revenues, Expenditures, and Changes in Fund Balance For the Year Ended September 30, 2020 Revenues: Property taxes Waste management Court fines Interest

$ 3,200,000 2,800,000 850,000 450,000 7,300,000

Expenditures: Waste management Court costs Salaries and expenditures Supplies Miscellaneous Total expenditures Excess of revenues over (under) expenditures Fund balances—October 1, 2019 Fund balances—September 30, 2020

4,290,000 920,000 880,000 250,000 160,000 6,500,000 800,000 8,565,000 $ 9,365,000

Town of Jones Falls General Fund Balance Sheet September 30, 2020 Assets Cash (1) Investments (2) Accounts receivable—waste management Waste management supplies

Liabilities and fund balances $3,330,000 5,450,000 320,000 265,000 $9,365,000

Fund balance—nonspendable Fund balance –unassigned (3)

$ 265,000 9,100,000

________ $9,365,000

(1) $3,330,000 = $2,500,000 + $3,200,000 – $4,290,000 - $920,000 + $550,000 + $2,480,000 + $850,000 - $880,000 – $160,000. (2) $5,450,000 = $5,000,000 + $450,000 (3) $9,100,000 = $8,050,000 + $1,500,000 + $250,000 – $800,000 + $100,000.

P10.3 General Fund Adjustments and Financial Statements a. Adjusting and closing entries for the general fund: (1) Due from enterprise fund 2,000,000 Accounts receivable To reclassify receivable from Golf Course Fund for advance. (2) Revenues Allowance for uncollectible taxes To record allowance for uncollectible taxes.

2,000,000

2,000,000 2,000,000

(3) Expenditures 40,000,000 Bonds payable 40,000,000 To correct recording of retirement of general obligation bonds and payment of interest. (4) Expenditures Supplies To change to the purchases method of recording supplies.

400,000 400,000

(5) Encumbrances 4,500,000 Fund balance—assigned 4,500,000 To record encumbering of appropriations for purchase orders outstanding at year end. (6) Due from State 9,000,000 Revenues To record Town's portion of gasoline taxes collected by State.

9,000,000

(7a) Expenditures Town property To correct recording of purchase of equipment. (7b) Town property Proceeds from sale of capital assets To correct recording of sale of equipment.

20,000,000 20,000,000

1,000,000 1,000,000

Closing entries: Appropriations 380,000,000 Expenditures 375,000,000 Encumbrances 4,500,000 Fund balance—unassigned 500,000 To close expenditures and encumbrances; $375,000,000 = $314,600,000 + $400,000 + $40,000,000 + $20,000,000. Revenues 407,000,000 Proceeds from sale of capital assets 1,000,000 Fund balance—unassigned 12,000,000 Estimated revenues To close revenues and other financing sources accounts; $407,000,000 = $400,000,000 - $2,000,000 + $9,000,000.

420,000,000

b. Town of Fountain Inn General Fund Statement of Revenues, Expenditures and Changes in Fund Balances For the Year Ended June 30, 2020 Revenues Expenditures Excess of revenues over (under) expenditures Other financing sources (uses): Proceeds from sale of capital assets Excess of revenues and other financing sources over expenditures and other financing uses Fund balances—July 1, 2019 (1) Fund balances—June 30, 2020 (2) (1) The beginning total fund balance is $(4,000,000), calculated as follows:

$ 407,000,000 375,000,000 32,000,000 1,000,000 33,000,000 (4,000,000) $ 29,000,000

Fund balances, beginning (calculate) Add: Amount credited in budget entry ($420,000,000 estimated revenues less $380,000,000 appropriations) Amount per trial balance (2) Assigned Unassigned Total fund balances

$ (4,000,000)

40,000,000 36,000,000

$ 4,500,000 24,500,000 $29,000,000

Town of Fountain Inn General Fund Balance Sheet June 30, 2020 Assets Cash Taxes receivable Allowance for uncollectible taxes Due from enterprise fund Due from State Total assets Liabilities and fund balances Accounts payable Fund balances: Assigned Unassigned Total liabilities and fund balances

$ 28,000,000 $ $10,000,000 (2,000,000)

8,000,000 2,000,000 9,000,000 $ 47,000,000 $ 18,000,000 4,500,000 24,500,000 $ 47,000,000

P10.4 Reconstructing General Fund Journal Entries (in thousands) Cash

8,000

Investments To record liquidation of investments.

8,000

Due from state government Revenues To record anticipated state grant.

60,000

Cash

98,000

60,000

Due from federal government To record receipt of grant from federal government.

98,000

Expenditures—prior year encumbrances Accounts payable To record expenditures for prior year's encumbrances.

16,000

Expenditures (1) Accounts payable To record expenditures.

100,000

(1) Computation of expenditures: Unassigned fund balance decrease ($80,000 - $118,000) Decrease from budget entry Increase from prior year's encumbrances Revenues less than budgeted Expenditures less than appropriations (plug) Unassigned fund balance decrease Appropriations Excess of appropriations over expenditures Expenditures

16,000

100,000

$ (38,000) (30,000) 2,000 (15,000) 5,000 (38,000) 105,000 (5,000) $ 100,000

Accounts payable 108,000 Cash To record payment of accounts payable; $108,000 = $32,000 + $16,000 + $100,000 - $40,000. Revenues Fund balance—unassigned Estimated revenues To close revenues.

108,000

60,000 15,000 75,000

Appropriations Expenditures Fund balance—unassigned To close expenditures. Fund balance—assigned Expenditures—prior year encumbrances Fund balance—unassigned To close prior year encumbrance accounts.

105,000 100,000 5,000

18,000 16,000 2,000

P10.5 General Fund—Corrections, Adjustments, and Financial Statements a. Reclassification and adjusting entries for general fund (in thousands): (1) Due from Water Utility Fund Accounts receivable To reclassify receivable from water utility fund. (2a) Taxes receivable—delinquent Taxes receivable—current To reclassify current taxes now considered delinquent.

1,500 1,500

30,000 30,000

(2b) Revenues 24,000 Allowance for uncollectible taxes— delinquent 24,000 To establish an allowance account for taxes estimated to be uncollectible. (3) Expenditures 52,000 Bonds payable 52,000 To correct recording of retirement of general obligation bonds and payment of interest. (4) Supplies inventory 44,000 Fund balance—nonspendable 44,000 To record supplies inventory at June 30, 2016: Inventory on hand at June 30, 2016 = $128,000 – $84,000 = $44,000.

(5a) Expenditures—prior year encumbrances 11,200 Expenditures 11,200 To record purchase orders outstanding at June 30, 2019, and charged to expenditures in the following year. (5b) Fund balance—unassigned Fund balance—assigned To adjust fund balance at beginning of year.

11,200 11,200

(5c) Encumbrances 5,000 Fund balance—assigned To record encumbrances for purchase orders at June 30, 2020. (6) Due from State Revenue Dept. Revenues To record Town's portion of state tax due from State. (7) Expenditures General property To correct recording of purchase of equipment. General property Proceeds from sale of capital assets To correct recording of sale of equipment.

5,000

34,000 34,000

90,000 90,000

4,600 4,600

(8) No journal entry is recorded under modified accrual accounting relating to capital assets.

Closing entries: Appropriations 520,000 Expenditures 512,800 Encumbrances 5,000 Fund balance—unassigned 2,200 To close expenditures and encumbrances; $512,800 = $382,000 + $52,000 - $11,200 + $90,000. Revenues 570,000 Proceeds from sale of capital assets 4,600 Estimated revenues 520,000 Fund balance—unassigned 54,600 To close revenues and other financing sources; $570,000 = $560,000 - $24,000 + $34,000.

Fund balance—assigned Expenditures—prior year encumbrances To close prior year encumbrance accounts.

11,200 11,200

b. (in thousands) Salleytown Statement of Revenues, Expenditures, and Changes in Fund Balances General Fund For the Year Ended June 30, 2020 Revenues Expenditures: Operating expenditures (1) Debt service: principal Debt service: interest Capital outlay Excess of revenues over expenditures Other financing sources (uses): Proceeds from sale of capital assets Excess of revenues and other financing sources over expenditures and other financing uses Fund balances—July 1, 2019 (2) Prior year expenditures Increase in nonspendable fund balance Fund balances—June 30, 2020 (3)

$ 570,000 $ 370,800 40,000 12,000 90,000

512,800 57,200 4,600 61,800 7,700 (11,200) 44,000 $ 102,300

(1) Operating expenditures = total expenditures – debt service payments - capital outlays = $512,800 – 52,000 - 90,000. (2) Fund balances—July 1, 2019: Because the budget is balanced (estimated revenues = appropriations), the fund balance—unassigned reported in the trial balance equals the fund balance—unassigned prior to the budget entry. (3) Fund Balances—June 30, 2020 = the sum of all fund balances; see Balance Sheet in requirement c.: $102,300 = $5,000 + $44,000 + $53,300.

c. (in thousands) Salleytown Balance Sheet—General Fund As of June 30, 2020 Assets Cash Short-term investments Accounts receivable Due from Water Utility Due from State Taxes receivable—delinquent (net of allowance of $24,000) Supplies Total assets Liabilities and fund balances Accounts payable Fund balances: Nonspendable Assigned Unassigned Total fund balances Total liabilities and fund balances

$ 16,800 40,000 10,000 1,500 34,000 6,000 44,000 $152,300 $ 50,000 44,000 5,000 53,300 102,300 $152,300

P10.6 Comprehensive General Fund Review Requirement a: 1. D 2. D 3. C 4. D 5. N Requirement e: 21. N 22. N 23. C 24. D 25. N

Requirement b: 6. D 7. N 8. C 9. C 10. N

Requirement c: 11. D 12. C 13. N 14. N 15. N

Requirement f: 26. C 27. N 28. D 29. D 30. C 31. D 32. C 33. N 34. N 35. N 36. N

37. C 38. C 39. N 40. N

Requirement d: 16. C 17. D 18. D 19. C 20. N

P10.7 Comprehensive General Fund—Entries and Statements a. Journal entries for fiscal 2020: (1a) Estimated revenues Appropriations Estimated other financing uses Fund balance—unassigned To record budget.

3,400,000 3,310,000 80,000 10,000

(1b) Encumbrances 20,000 Fund balance—unassigned To reverse the fiscal 2019 closing entry for outstanding encumbrances. (1c) Taxes receivable 4,000,000 Tax revenues Allowance for uncollectible taxes To record tax levy. (2) Cash

3,400,000 600,000

3,225,000

Taxes receivable To record collection of taxes; $3,225,000 = $425,000 + $2,800,000. (3a) Allowance for uncollectible taxes Tax revenues Taxes receivable To write off remaining 2019 receivables.

20,000

3,225,000

100,000 25,000 75,000

(3b) Allowance for uncollectible taxes 360,000 Tax revenues 360,000 To correct allowance account. Taxes receivable = $500,000 + $4,000,000 – $3,225,0000 – $75,000 = $1,200,000. Allowance account = $600,000. Ending balance in allowance account should be 20% x $1,200,000 = $240,000; adjustment = $360,000. (4) Cash Proceeds from sale of capital assets To record sale of old desks.

10,000 10,000

(5) Expenditures Cash To record purchase of desks.

500,000 500,000

(6) Expenditures Cash To record expenditures for repairs and cleaning. (7) Expenditures Cash To record salary expenditures.

20,000 20,000

2,500,000

(8a) Fund balance—assigned Encumbrances To reverse encumbrances from fiscal 2019. 8(b) Inventory Accounts payable To record delivery of inventory ordered in fiscal 2019. 8(c) Inventory Accounts payable To record inventory ordered and delivered in fiscal 2020.

2,500,000

20,000 20,000

170,000 170,000

8(d) Expenditures 215,000 Inventory 215,000 To adjust inventory to its fiscal 2020 ending balance; $215,000 = $150,000 + $20,000 + $170,000 - $125,000. (8e) Fund balance—nonspendable Fund balance—unassigned To adjust nonspendable fund balance to $125,000. 9(a) Encumbrances Fund balance—assigned To record encumbrances outstanding at the end of fiscal 2020.

25,000 25,000

50,000 50,000

9(b) Accounts payable 195,000 Cash 195,000 To adjust accounts payable to its fiscal 2020 ending balance; $195,000 = $30,000 + $20,000 + $170,000 - $25,000. (10) Transfer out Cash To record transfer to enterprise fund.

80,000 80,000

Closing entries at June 30, 2020: Tax revenues 3,785,000 Proceeds from sale of capital assets 10,000 Fund balance—unassigned 395,000 Estimated revenues 3,400,000 To close revenues and other financing sources; $3,785,000 = $3,400,000 + $25,000 + $360,000. Appropriations 3,310,000 Estimated other financing uses 80,000 Expenditures Encumbrances Transfer out Fund balance—unassigned To close expenditures and encumbrances; $3,235,000 = $500,000 + $20,000 + $2,500,000 + $215,000.

3,235,000 50,000 80,000 25,000

b. Quarryville School District General Fund Statement of Revenues, Expenditures, and Changes in Fund Balances For the Year Ended June 30, 2020 Tax revenues Expenditures Excess of revenues over expenditures Other financing sources (uses): Transfer out Proceeds from sale of capital assets Total other financing sources (uses) Excess of revenues and other financing sources over expenditures and other financing uses Fund balances—July 1, 2019 Fund balances—June 30, 2020

$ 3,785,000 3,235,000 550,000 (80,000) 10,000 (70,000) 480,000 1,720,000* $ 2,200,000

* $150,000 + $20,000 + $1,550,000

Quarryville School District General Fund Balance Sheet June 20, 2020 Assets Cash Taxes receivable (net of $240,000 allowance for uncollectible taxes) Inventory Total Liabilities and fund balances Accounts payable Fund balance: Nonspendable Assigned Unassigned Total fund balances Total

$ 1,140,000 960,000 125,000 $ 2,225,000 $

25,000

125,000 50,000 2,025,000 2,200,000 $ 2,225,000

The T-accounts below show computations for ending balances of cash, taxes receivable, allowance for uncollectible taxes, and fund balance.

Cash $1,200,000 $ 500,000 3,225,000 20,000 10,000 2,500,000 195,000 80,000 $1,140,000

Beginning balance (2) (4)

Ending balance

(5) (6) (7) (9b) (10)

Taxes Receivable $500,000 4,000,000 $3,225,000 75,000 $1,200,000

Beginning balance (1c) Ending balance

(2) (3a)

Allowance for Uncollectible Taxes $ 100,000 (3a) $100,000 600,000 (3b) 360,000 $240,000 Fund Balance—unassigned $1,550,000 10,000 20,000 25,000 395,000 25,000 $2,025,000

Beginning balance (1c) Ending balance

Beginning balance (1a) (1b) (8e) (c) (c) Ending balance

P10.8 Employee Compensated Absences a. Expenditures for compensated absences Cash

75,000,000 75,000,000

No liability for future compensated absence payments is reported. b. Compensated absence expense Cash Liability for compensated absences

(1) 87,179,000 75,000,000 12,179,000

(1) $87,179,000 = $224,251,000 - $212,072,000 + $75,000,000.

The general fund would report a total liability for compensated absences at fiscal year-end of $224,251,000. c. The general fund balance sheet, prepared using modified accrual accounting, will not reveal any information concerning the State’s future obligation for compensated absences. Expenditures are recorded as incurred.

P10.9 General Fund Reporting a. Budget and encumbrance entries Estimated revenues Estimated other financing sources Fund balance—unassigned Appropriations Estimated other financing uses To record budget entry. Encumbrances Fund balance—unassigned To re-establish beginning of year encumbrances.

8,500,000 500,000 50,000 8,800,000 250,000 78,000 78,000

Net effect on fund balance—unassigned: $78,000 – $50,000 = $28,000 cr b. Entries made during 2020 for property taxes (not required): Property taxes receivable—current Allowance for uncollectible taxes—current Property tax revenues To accrue property taxes for 2020.

8,600,000 100,000 8,500,000

Allowance for uncollectible taxes—current Property taxes receivable—current To write off current property taxes.

60,000

Allowance for uncollectible taxes—delinquent Property taxes receivable—delinquent To write off delinquent property taxes.

10,000

Cash Allowance for uncollectible taxes—delinquent Property taxes receivable—delinquent Property tax revenues To record collection of delinquent property taxes.

15,000 15,000

Cash Property taxes receivable—current To record collection of current property taxes; $8,420,000 = $8,600,000 – ($100,000 – $40,000) – $120,000.

60,000

10,000

15,000 15,000

8,420,000 8,420,000

Property taxes receivable—delinquent 120,000 Allowance for uncollectible taxes—current 40,000 Property tax revenues 80,000 Allowance for uncollectible taxes—delinquent Property taxes receivable—current To fully reserve unpaid property taxes and reclassify them as delinquent.

120,000 120,000

Property tax revenues for 2020 = $8,500,000 + $15,000 – $80,000 = $8,435,000. Cash collected for 2020 = $8,420,000 + $15,000 = $8,435,000. c. Zero. Interest is not accrued until the year it will be paid. d. Other entries for 2020 (not required): Cash

500,000

Bond proceeds To record issuance of bonds. Cash

500,000

6,000

Proceeds from sale of capital assets To record sale of equipment. Transfers out Cash To record transfers to capital projects and enterprise funds. Expenditures Cash or accounts payable To record expenditures for the year. Encumbrances Fund balance—assigned To record net increase in encumbrances for the year. Closing entries for 2020: Property tax revenues Bond proceeds Proceeds from sale of capital assets Fund balance—unassigned Estimated revenues Estimated other financing sources To close revenue and other financing sources accounts.

6,000

250,000 250,000

8,720,000 8,720,000

50,000 50,000

8,435,000 500,000 6,000 59,000 8,500,000 500,000

Appropriations 8,800,000 Estimated other financing uses 250,000 Fund balance—unassigned 50,000 Expenditures Transfers out Encumbrances To close expenditure, encumbrance, and other financing uses accounts.

8,720,000 250,000 130,000

e. City of Middletown Budgetary Comparison Schedule For the year 2020

Property tax revenues Expenditures Excess of revenues over (under) expenditures Other financing sources (uses): Transfers out Proceeds from sale of capital assets Bond proceeds Total other financing sources Excess of revenues & other sources over (under) expenditures & other uses

Budget $ 8,500,000 8,800,000

Actual $8,435,000 8,720,000

Variance Favorable (Unfavorable) $ (65,000) 80,000

(300,000)

(285,000)

15,000

(250,000) --500,000 250,000

(250,000) 6,000 500,000 256,000

--6,000 --6,000

$ (50,000)

$ (29,000)

$ 21,000

P10.10 General Fund—Entries and Financial Statements a. 2020 journal entries Beginning of year: Encumbrances Fund balance—unassigned To restore beginning of year encumbrances.

6,000

Estimated revenues—property taxes Estimated revenues—licenses and fines Estimated revenues—federal grants Fund balance—unassigned Appropriations—general government Appropriations—human services Estimated other financing uses To establish budget.

500,000 35,000 100,000 31,000

Property taxes receivable—current

500,000

6,000

250,000 402,000 14,000

Allowance for uncollectible taxes—current Property tax revenues To accrue property taxes. Cash

50,000 450,000

430,000

Property taxes receivable—current To record collection of current property taxes.

430,000

Cash 60,000 Allowance for uncollectible taxes—delinquent 40,000 Property taxes receivable—delinquent 65,000 Property tax revenues 35,000 To record collection of delinquent property taxes and write-off of remainder. Property taxes receivable—delinquent 70,000 Allowance for uncollectible taxes—current 50,000 Property tax revenues 5,000 Property taxes receivable—current 70,000 Allowance for uncollectible taxes—delinquent 55,000 To reclassify uncollected taxes as delinquent and provide for a $55,000 allowance. Due from federal government Revenues—federal grants To accrue federal grants.

100,000

Cash

95,000

100,000

Due from federal government To record collection of federal grants. Cash

95,000

34,000

Revenues—licenses and fines To record collection of license and fine revenues. Expenditures—general government Expenditures—human services Inventories ($18,000 – $15,000) Accounts payable ($30,000 – $15,000) Cash To record cash expenditures.

34,000

234,000 400,000 3,000 15,000 652,000

Fund balance—unassigned 3,000 Fund balance—nonspendable 3,000 To adjust the nonspendable fund balance to the ending $18,000 inventory balance. Fund balance—assigned Encumbrances

2,000 2,000

To record net reduction in encumbrances for the year. Transfers out Cash To record transfers to debt service fund.

14,000

Cash

2,000

14,000

Due from other funds To record collection of cash advance to enterprise fund.

2,000

Due from other funds Cash To record advance to capital projects fund.

5,000

Cash

25,000

5,000

Due to other funds To record advance from enterprise fund.

25,000

Closing entries: Property tax revenues ($450,000 + $35,000 – $5,000) Revenues—licenses and fines Revenues—federal grants Fund balance—unassigned Estimated revenues—property taxes Estimated revenues—licenses and fines Estimated revenues—federal grants To close revenues.

480,000 34,000 100,000 21,000

Appropriations—general government Appropriations—human services Estimated other financing uses Expenditures—general government Expenditures—human services Transfers out Encumbrances Fund balance—unassigned To close expenditures, encumbrances and transfers.

250,000 402,000 14,000

500,000 35,000 100,000

234,000 400,000 14,000 4,000 14,000

b. (1) City of Los Alvos Statement of Revenues, Expenditures, and Changes in Fund Balances General Fund For the Year Ended December 31, 2020 Revenues Property taxes $ 480,000 Licenses and fines 34,000 Federal grants 100,000 Total revenues 614,000 Expenditures General government 234,000 Human services 400,000 Total expenditures 634,000 Excess of revenues over (under) expenditures (20,000) Other financing sources (uses) Transfers out (14,000) Total other financing sources (uses) (14,000) Excess of revenues and other financing sources over (under) expenditures and other financing uses (34,000) Fund balances—December 31, 2019 52,000 Fund balances—December 31, 2020 $ 18,000 (2) City of Los Alvos Balance Sheet General Fund December 31, 2020 Assets Cash Property taxes receivable—delinquent (net) Due from other funds Due from federal government Inventories Total assets Liabilities and fund balances Accounts payable Due to other funds Total liabilities Fund balances: Nonspendable Assigned Unassigned Total fund balances Total liabilities and fund balances

5,000 15,000 5,000 15,000 18,000 $ 58,000 $ 15,000 25,000 40,000 18,000 4,000 (4,000) 18,000 $ 58,000

(3) City of Los Alvos Budgetary Comparison Schedule General Fund For the Year Ended December 31, 2020

Revenues Property taxes Licenses and fines Federal grants Total revenues Expenditures General government Human services Total expenditures Excess of revenues over (under) expenditures Other financing sources (uses) Transfers out Total other financing sources (uses) Excess of revenues and other financing sources over (under) expenditures and other financing uses Fund balance—December 31, 2019 Fund balance—December 31, 2020

Budget

Actual

Variance-Favorable (Unfavorable)

$ 500,000 35,000 100,000 635,000

$ 480,000 34,000 100,000 614,000

$ (20,000) ( 1,000) -(21,000)

250,000 402,000 652,000 (17,000)

234,000 400,000 634,000 (20,000)

16,000 2,000 18,000 (3,000)

14,000 (14,000)

---

(31,000) 52,000 $ 21,000

(34,000) 52,000 $ 18,000

(3,000) -$ (3,000)

P10.11 General Fund—Budget and Closing Entries, Financial Statements (in thousands) a. Estimated revenues Estimated other financing sources Appropriations Estimated other financing uses Fund balance—unassigned To establish budget.

260,000 2,000 257,000 4,800 200

b. In addition to the budget entry, an entry was made at the beginning of the year to reverse the encumbrances write-off from 2019: Encumbrances Fund balance—unassigned

800 800

Therefore the beginning fund balance—unassigned was $23,000 – $200 – $800 = $22,000. c. Revenues—property taxes Revenues—income taxes Revenues—fines and licenses Revenues—state grants Proceeds from sale of capital assets Fund balance—unassigned Estimated revenues Estimated other financing sources To close revenues and other financing sources.

55,000 180,000 18,000 6,000 2,300 700

Appropriations Estimated other financing uses Encumbrances Expenditures—general government Capital outlay Transfers out Debt service—interest Debt service—principal Fund balance—unassigned To close expenditures and other financing uses.

257,000 4,800

260,000 2,000

500 130,400 11,000 4,500 35,000 80,000 400

d. City of Akron General Fund Statement of Revenues, Expenditures, and Changes in Fund Balances For the Year Ended December 31, 2020 (in thousands) Revenues Property taxes Income taxes Fines and licenses State grants Total revenues Expenditures General government Capital outlay Debt service Interest payments Principal payments Total expenditures Excess of revenues over (under) expenditures Other financing sources (uses) Proceeds from sale of capital assets Transfers out Total other financing sources (uses) Excess of revenues and other financing sources over expenditures and other financing uses Fund balance—December 31, 2019 (1) Fund balance—December 31, 2020 (2)

$ 55,000 180,000 18,000 6,000 259,000 130,400 11,000 35,000 80,000 256,400 2,600 2,300 (4,500) (2,200) 400 22,800 $ 23,200

(1) Fund balance—unassigned = Fund balance—assigned =

$22,000 800 $22,800

(2) Fund balance—unassigned: $23,000 - $700 + $400 = Fund balance—assigned =

$22,700 500 $23,200

e. City of Akron General Fund Balance Sheet At December 31, 2020 (in thousands) Assets Cash Investments Property taxes receivable (net) Due from other funds Total assets Liabilities and fund balances Accounts payable Due to other funds Total liabilities Fund balances: Assigned Unassigned Total fund balances Total liabilities and fund balances

5,000 14,000 36,000 9,000 $ 64,000 $ 33,200 7,600 40,800 500 22,700 23,200 $ 64,000

P10.12 General Fund—Entries and Financial Statements a. Estimated revenues Fund balance—unassigned Appropriations Estimated other financing uses To establish budget.

410,500 9,500 370,000 50,000

Encumbrances 3,000 Fund balance—unassigned To reverse outstanding encumbrance closing entry from last year.

3,000

State grant receivable State grant revenue To accrue state grant.

40,000

b. Transactions for the year: Taxes receivable Property tax revenue Allowance for uncollectible taxes To record property tax bills.

300,000

Cash

280,000

285,000 15,000

Taxes receivable To record property tax collection. Cash

280,000

25,000

State grant receivable To record state grant cash received. Cash

25,000

10,000

Taxes receivable To record collection of fiscal 2019 taxes.

10,000

Allowance for uncollectible taxes Taxes receivable Property tax revenue To write off uncollected fiscal 2019 taxes.

14,000

Transfers out Cash To record transfer to special revenue fund.

50,000

Cash

65,000

12,500 1,500

50,000

Fee and license revenue To record fee and license revenue received in cash. Fund balance—assigned Encumbrances

65,000

3,000 3,000

Expenditures 3,200 Accounts payable To record receipt of inventories on purchase orders sent last year.

3,200

Due from capital projects fund Cash To record advance to capital projects fund.

8,000

Cash

12,000

Due from special revenue fund To record collection of loan to special revenue fund.

12,000

Expenditures Accounts payable To record inventories purchased on account.

45,000

Expenditures Accounts payable To record other expenditures for the year.

320,000

Encumbrances Fund balance—assigned To record purchase orders outstanding at year-end. Accounts payable Cash To record payment of accounts payable. Adjusting entries at year-end: Fund balance—nonspendable Inventories To adjust the inventories balance to current year-end amount.

45,000

320,000

1,600 1,600

367,000 367,000

1,500 1,500

Allowance for uncollectible taxes 3,000 Property tax revenue 3,000 To adjust allowance for uncollectible taxes; $3,000 = $15,000 – ($20,000 - $8,000). c. Closing entries: Property tax revenue Fee and license revenue State grant revenue Fund balance—unassigned Estimated revenue To close revenues against estimated revenues.

289,500 65,000 40,000 16,000 410,500

Appropriations 370,000 Estimated other financing uses 50,000 Transfers out 50,000 Expenditures 368,200 Encumbrances 1,600 Fund balance—unassigned 200 To close expenditures and other financing uses against appropriations and estimated other financing uses. d. Montana County General Fund Statement of Revenues, Expenditures, and Changes in Fund Balances For the Year Ended June 30, 2020 (in thousands) Revenues: Property taxes Fees and licenses State grant Total revenues Expenditures Excess of revenues over (under) expenditures Other financing sources (uses) Transfers out Excess of revenues over (under) expenditures and other financing uses Fund balances—July 1, 2019 (1) Change in fund balance—nonspendable Fund balances—June 30, 2020 (2) (1) Fund balance — Fund balance — Fund balance —

nonspendable assigned unassigned

7,500 3,000 133,000 $143,500

(2) Fund balance — nonspendable Fund balance — assigned Fund balance — unassigned

6,000 1,600 110,700 $118,300

$ 289,500 65,000 40,000 394,500 (368,200) 26,300 (50,000) (23,700) 143,500 (1,500) $ 118,300

e. Montana County General Fund Balance Sheet At June 30, 2020 (in thousands) Assets Cash Property taxes receivable (net of $12,000 allowance for uncollectibles) State grant receivable Due from special revenue fund Due from capital projects fund Inventories Total assets Liabilities and fund balances Accounts payable Fund balances: Nonspendable Assigned Unassigned Total fund balances Total liabilities and fund balances

$ 87,000 8,000 15,000 3,000 8,000 6,000 $ 127,000 $

8,700

6,000 1,600 110,700 118,300 $ 127,000

P10.13 Capital Asset and Debt Transactions: Modified Accrual and Full Accrual Accounting a. Entries under modified accrual accounting: Capital outlay – fire truck Cash To record purchase of fire truck. Cash

250,000 250,000

10,000,000

Other financing sources – bond proceeds To record bond proceeds. Expenditures – bond interest Cash To record bond interest paid.

10,000,000

400,000 400,000

Expenditures – bond principal Cash To record bond principal paid. Cash

1,000,000 1,000,000

40,000

Other financing sources – asset sale To record sale of fire truck.

40,000

b. Entries under full accrual accounting: Fire truck Cash To record purchase of fire truck. Cash

250,000 250,000

10,000,000

Bonds payable To record bond proceeds.

10,000,000

Interest expense Cash To record bond interest paid.

400,000

Bonds payable Cash To record bond principal paid.

1,000,000

Cash Accumulated depreciation Loss on sale of fire truck Fire truck To record sale of fire truck.

40,000 200,000 10,000

400,000

1,000,000

250,000

c. 2018 Balance sheet presentation: 1. Under modified accrual accounting, neither the fire truck nor the bonds payable are presented in the 2018 Balance Sheet. 2. Under full accrual accounting, the fire truck and bonds payable appear as follows: Assets Fire truck, net of accumulated depreciation of $100,000 (1) Liabilities: Bonds payable (2)

$150,000

$9,000,000

(1) (250,000/5) x 2 years depreciation expense = $100,000 accumulated depreciation (2) $10,000,000 – $1,000,000 2018 principal payment.

P10.14 Identify Appropriate Fund(s) 1. 2. 3. 4. 5. 6. 7. 8.

Capital projects fund General fund Capital projects fund Special revenue fund General fund Special revenue fund Enterprise fund Internal service fund

9. Permanent fund 10. Special revenue fund 11. Capital projects fund (transfer out), debt service fund (transfer in) 12. Debt service fund 13. Enterprise fund 14. General fund (due to other funds), special revenue fund (due from other funds)

P10.15 Budget and Closing Entries (in millions) a. Estimated revenues Estimated other financing sources Fund balance—unassigned Appropriations Estimated other financing uses

52,252 18,042 2,498

Transfers in Tax revenues Miscellaneous revenues Fund balance—unassigned Estimated revenues Estimated other financing sources

17,871 45,963 5,842 618

Appropriations Estimated other financing uses Transfers out Local assistance grant expenditures State operations expenditures General state charges Fund balance—unassigned

57,772 15,020

52,252 18,042

11,375 43,314 7,955 5,397 4,751

c. Expected change in fund balance—unassigned (budget entry) Excess of budgeted over actual revenues and other financing sources Excess of budgeted over actual expenditures and other financing uses Net change in fund balance—unassigned

$ (2,498) (618) 4,751 $ 1,635

d. Expenditures and other financing uses were budgeted to exceed revenues and other financing sources by $2,498 million. However, actual revenues and other financing sources exceeded expenditures and other financing uses by $1,635 million, so New York State’s actual performance significantly exceeded budgeted performance. Major causes of the positive performance as compared with the budget are: Local assistance grants expenditures below budget Transfers to other funds below budget

$ 839 3,645

General state charges and state operations were $267 million less than budget, but tax revenues were $469 million below budget, so New York State’s ability to provide future services may have declined. The decline in transfers out was the major reason for the positive variance from budget. [Note: New York State’s 2016 CAFR states that $209 million was added to the general state charges budget near the end of the year, to avoid overspending. Without additional spending authority, it appears that general state charges would have been over budget.] P10.16 Property Tax Transactions a. The summary entry leading to the beginning balances for uncollected fiscal 2019 property taxes is: Taxes receivable—delinquent Allowance for uncollectible taxes—delinquent Deferred inflows of resources Property tax revenues

350,000 225,000 4,000 121,000

Property tax revenue on uncollected fiscal 2019 taxes, reported in fiscal 2019, is $121,000. Of the $350,000 of uncollected taxes, collection in fiscal 2020 of any amount in excess of $121,000 is considered property tax revenue of fiscal 2020. b. Taxes receivable—current 20,000,000 Allowance for uncollectible taxes—current Property tax revenues To record tax levy and establish allowance for uncollectible taxes. Cash

500,000 19,500,000

19,900,000

Taxes receivable—delinquent Taxes receivable—current Deferred inflows of resources To record collection of taxes. Allowance for uncollectible taxes—delinquent 225,000 Taxes receivable—delinquent Property tax revenues To write off the allowance and the receivable for fiscal 2019 taxes.

135,000 19,753,000 12,000

215,000 10,000

Deferred inflows of resources 4,000 Property tax revenues 4,000 To recognize revenue on expected collections of fiscal 2019 taxes beyond the 60-day limit. Note that these two entries report additional property tax revenue, in fiscal 2020, of

$14,000, related to fiscal 2019 taxes; $14,000 = $135,000 - $121,000. Deferred inflows of resources 6,000 Property tax revenues To recognize as revenue fiscal 2020 taxes collected in fiscal 2019. Allowance for uncollectible taxes—current Allowance for uncollectible taxes—delinquent Deferred inflows of resources Property tax revenues

6,000

500,000 37,050 12,350 450,600

Uncollected fiscal 2020 taxes are $247,000 (= $20,000,000 - $19,753,000). Of this amount, $197,600 (= 80% x $247,000) are expected to be collected within 60 days of year-end, and are included in revenues of fiscal 2020; $12,350 (= $247,000 x 5%) are deferred inflows expected to be collected after 60 days, and $37,050 are uncollectible. The delinquent allowance should therefore be $37,050. Note that this entry plus the initial recognition of fiscal 2020 property tax revenues for the tax levy equals $19,950,600 for revenue recognized (= $19,500,000 + $450,600). This amount is verified by the cash collected of $19,753,000 plus amounts expected to be collected within 60 days, $197,600. c. Fiscal 2020 tax levy: collections Fiscal 2020 tax levy: to be collected within 60 days Fiscal 2020 taxes paid in fiscal 2019 Fiscal 2019 taxes paid in fiscal 2020 Total property tax revenues reported in fiscal 2020

$19,753,000 197,600 6,000 14,000 $19,970,600

This total equals the balance in property tax revenues reflected in the above journal entries.

P10.17 General Fund Entries and Financial Statements a. 2020 journal entries Beginning of year: Encumbrances Fund balance—unassigned To restore beginning of year encumbrances.

200 200

Estimated revenues—property taxes Estimated revenues—licenses and fees Estimated revenues—state grants Estimated other financing sources Appropriations—general government Appropriations—public safety Appropriations—capital outlay Appropriations—debt service To establish balanced budget.

880,000 100,000 20,000 75,000

Property taxes receivable Allowance for uncollectible taxes Property tax revenues To accrue fiscal 2020 property taxes.

900,000

Cash

580,000 375,000 90,000 30,000

20,000 880,000

4,000

Property taxes receivable To record collection of fiscal 2019 property taxes.

4,000

Deferred inflows of resources 1,200 Allowance for uncollectible taxes 3,300 Property taxes receivable 3,000 Property tax revenues 1,500 To record collection of fiscal 2019 property taxes and write-off of remainder. Cash Property taxes receivable To record collection of fiscal 2020 property taxes.

890,000 890,000

Allowance for uncollectible taxes 14,000 Deferred inflows of resources 1,800 Property tax revenues 12,200 To adjust the allowance for uncollectible taxes and recognize deferred inflows.

Cash

20,000

Revenues—state grant To record receipt of state grant. Cash

20,000

87,000

Revenues—licenses and fees To record collection of license and fee revenues. Cash

87,000

500

Due from special revenue fund To record repayment of special revenue fund loan. Due from special revenue fund Cash To record loan to special revenue fund. Expenditures—general government Expenditures—public safety Expenditures—capital outlay Cash Accounts payable To record expenditures.

500

200 200

579,500 374,800 89,000 1,043,200 100

Fund balance—assigned 200 Encumbrances To record delivery of goods encumbered at beginning of year.

200

Encumbrances Fund balance—assigned To record encumbrances outstanding at year-end.

120 120

Expenditures—debt service Cash To record payment of principal and interest on bonds.

30,000

Inventories Fund balance—nonspendable To adjust for increase in inventories on hand at year-end.

Cash

30,000

1,000

Proceeds from sale of capital assets To record sale of equipment. Cash

1,000

75,000

Bond proceeds To record bond issue.

75,000

Closing entries: Property tax revenues Revenues—licenses and fees Revenues—state grant Proceeds from sale of capital assets Bond proceeds Estimated revenues—property taxes Estimated revenues—licenses and fees Estimated revenues—state grant Estimated other financing sources Fund balance—unassigned To close revenues and other financing sources.

893,700 87,000 20,000 1,000 75,000

Appropriations—general government Appropriations—public safety Appropriations—capital outlay Appropriations—debt service Expenditures—general government Expenditures—public safety Expenditures—capital outlay Encumbrances Expenditures—debt service Fund balance—unassigned To close expenditures and encumbrances.

580,000 375,000 90,000 30,000

880,000 100,000 20,000 75,000 1,700

579,500 374,800 89,000 120 30,000 1,580

b. Lake County Statement of Revenues, Expenditures, and Changes in Fund Balances General Fund For the Year Ended June 30, 2020 Revenues Property taxes $ 893,700 Licenses and fees 87,000 State grant 20,000 Total revenues 1,000,700 Expenditures General government 579,500 Public safety 374,800 Debt service 30,000 Capital outlay 89,000 Total expenditures 1,073,300 Excess of revenues over (under) expenditures (72,600) Other financing sources (uses) Proceeds from sale of capital assets 1,000 Bond proceeds 75,000 Total other financing sources (uses) 76,000 Excess of revenues and other financing sources over (under) expenditures and other financing uses 3,400 Fund balances—July 1, 2019 1,050 Increase in nonspendable fund balance 80 Fund balances—June 30, 2020 $ 4,530 Lake County Balance Sheet General Fund June 30, 2020 Assets Cash $ 8,100 Property taxes receivable, net of $6,000 allowance for uncollectible taxes 4,000 Due from special revenue fund 200 Inventories 130 Total assets $ 12,430 Liabilities, deferred inflows, and fund balances Accounts payable $ 6,100 Total liabilities 6,100 Deferred inflows of resources 1,800 Fund balances: Nonspendable 130 Assigned 120 Unassigned 4,280 Total fund balances 4,530 Total liabilities, deferred inflows and fund balances $ 12,430

CHAPTER 11 SOLUTIONS TO MULTIPLE CHOICE QUESTIONS, EXERCISES AND PROBLEMS

MULTIPLE CHOICE QUESTIONS 1.

c All funding sources are restricted. The ending balance sheet appears as follows: Cash Total

$19,000,000 _________ $19,000,000

Accounts payable Fund balance—restricted Total

$ 1,000,000 18,000,000 $19,000,000

Enterprise funds use full accrual accounting. Cash received is $200,000 and book value is $1,000,000, for a nonoperating loss of $800,000. 8.

10.

a Custodial funds report taxes collected for other governments as additions, and amounts owing for taxes collected as deductions, even if not yet paid out.

11.

c The present value of the future lease payments is reported as expenditures (capital outlay) and other financing sources. The first lease payment of $500,000 is an expenditure, divided into interest of $120,000 (= 4% x $3,000,000) and principal of $380,000 (= $500,000 – $120,000).

12.

Governmental funds do not report accrued liabilities unless they will be paid from this year’s available resources.

EXERCISES E11.1

Special Revenue Fund Transactions 1. Cash

36,000 Transfers in Due to general fund

18,000 18,000

Picnic table expenditure (capital outlay) 36,000 Cash To record transfer from general fund and purchase of equipment. Cash

36,000

15,000

Park fee revenue To record collection of park fees.

15,000

Security system expenditure (capital outlay) Cash To record payment of cleanup fees.

25,000

Lawn maintenance expenditures Accounts payable To record billing for lawn maintenance expense.

10,000

Wages expenditures Cash To pay park employee wages.

12,000

25,000

10,000

12,000

E11.2 Permanent Fund Transactions Cash—principal Fund balance—nonspendable To record donation.

2,500,000

Investments—principal Cash—principal To record investment of scholarship fund.

2,500,000

Cash—income Investment income To record earnings on investments.

2,500,000

100,000 100,000

Expenditures Cash—income To record administrative expenses charged to income.

2,000

Expenditures Cash—income To record expenditures for tutoring.

75,000

2,000

75,000

Investments—income 80,000 Unrealized gain on investments 80,000 To record appreciation in investments value; $80,000 = $2,580,000 – $2,500,000 Investment income Unrealized gain on investments Expenditures Fund balance—restricted To close income and expenditures.

100,000 80,000 77,000 103,000

E11.3 Capital Projects Fund Transactions Capital Projects Fund Bonds authorized—unissued Appropriations To record budget.

1,000,000

Cash

1,010,000

1,000,000

Bond proceeds To record issuance of bonds at 101.

1,010,000

Transfer out Cash To record transfer of bond premium to debt service fund. Capital outlay Cash To record building renovation.

10,000 10,000

1,000,000 1,000,000

Debt Service Fund Cash Transfer in To record transfer of bond premium from capital projects fund.

10,000 10,000

Cash

15,000

Transfer in To record transfer from general fund. Expenditure: interest Cash To record interest payment.

15,000

15,000 15,000

General Fund Transfer out Cash To record transfer to debt service fund.

15,000 15,000

E11.4 Capital Project Transactions a. Budget entry on 2/1/20: Bonds authorized—unissued Appropriations To record budget for levee. 2/10/20 Cash

20,000,000 20,000,000

500,000

Due to general fund To record advance from general fund. 3/1/20 Expenditures Cash To record initial planning costs. 3/15/20 Cash

500,000

350,000 350,000

20,200,000

Bond proceeds To record bond issuance.

20,200,000

Transfer out Cash To record remittance to debt service fund.

200,000

Due to general fund Cash To record repayment of general fund advance.

500,000

3/20/20 Encumbrances

200,000

500,000

19,000,000

Fund balance—restricted To record awarding of contract. 6/10/20 Fund balance—restricted Encumbrances Expenditures Contracts payable—retainage Cash To record submission and payment of bills.

19,000,000

3,000,000 3,000,000 3,000,000 300,000 2,700,000

6/30/20 closing entries: Appropriations 20,000,000 Expenditures 3,350,000 Transfer out 200,000 Encumbrances 16,000,000 Fund balance—restricted 450,000 To close expenditures, transfers and encumbrances against appropriations. Bond proceeds 20,200,000 Bonds authorized—unissued Fund balance—restricted To close other financing sources against estimated revenues.

20,000,000 200,000

b. City of Fargo Statement of Revenues, Expenditures, and Changes in Fund Balance Capital Projects Fund For the Year Ended June 30, 2020 Expenditures Other financing sources (uses): Transfer out Bond proceeds Change in fund balance Fund balance—beginning Fund balance—ending

$(3,350,000) (200,000) 20,200,000 16,650,000 0 $ 16,650,000

City of Fargo Balance Sheet—Capital Projects Fund June 30, 2020 Assets Cash (1) Total

$ 16,950,000 ___________ $ 16,950,000

Liabilities and fund balances Contracts payable—retainage Fund balance—restricted Total

300,000 16,650,000 $ 16,950,000

(1) $16,950,000 = $500,000 - $350,000 + $20,200,000 – $200,000 – $500,000 – $2,700,000.

E11.5

Capital Asset Transactions 1. Recorded in general fund: Capital outlay 2,400,000 Cash 2,400,000 Reported as a reduction in fund balance (expenditure); asset is not reported in general fund balance sheet. 2. Recorded in internal service fund: Equipment 10,000 Cash Reported as a long-term asset in the internal service fund’s balance sheet. 3. Recorded in capital projects fund: Cash Bond proceeds

10,000

20,000,000 20,000,000

Capital outlay 20,000,000 Cash 20,000,000 Outlay reported as a reduction in fund balance (expenditure); asset not reported in capital projects fund’s balance sheet. Bond proceeds increase fund balance (other financing sources); liability not reported in balance sheet. 4. Recorded in enterprise fund: Cash Loan payable

30,000 30,000

Equipment 30,000 Cash 30,000 Machinery and equipment reported as an asset in the enterprise fund’s balance sheet. Loan reported as liability in balance sheet.

E11.6 Debt Service Fund Transactions a. 1. Estimated other financing sources Estimated earnings Appropriations (1) Fund balance—committed

1,250,000 20,000 500,000 770,000

(1) $500,000 = 0.05 x $10,000,000

2. Cash

1,250,000 Transfers in

Investments Cash

1,250,000 1,250,000 1,250,000

3. Cash

315,000 Investments Realized gain on investments

300,000 15,000

Expenditure: interest Cash

250,000

Cash Realized loss on investments Investments

260,000 10,000

Expenditure: interest Cash

250,000

Cash

45,000

250,000

270,000

250,000

5. Investment income

45,000

6. Unrealized loss on investments (2) Investments (2) $(20,000) = $660,000 – ($1,250,000 – $300,000 – $270,000)

20,000 20,000

Closing entries: Transfers in Investment income Realized gain on investments Realized loss on investments Unrealized loss on investments Estimated other financing sources Estimated earnings Fund balance—committed Appropriations Expenditure: interest

1,250,000 45,000 15,000 10,000 20,000 1,250,000 20,000 10,000 500,000 500,000

b. City of Yuma, AZ Debt Service Fund Statement of Revenues, Expenditures, and Changes in Fund Balances For the Year Ended June 30, 2020 Revenues Investment income Realized gains (losses) Unrealized gains (losses) Net investment income Expenditures Debt service: interest Excess of revenues over (under) expenditures Other financing sources (uses) Transfers in Change in fund balance Fund balance—beginning Fund balance—ending

45,000 5,000 (20,000) 30,000 (500,000) (470,000)

1,250,000 780,000 0 $ 780,000

City of Yuma, AZ Debt Service Fund Balance Sheet June 30, 2020 Assets Cash Investments Total assets

$120,000 660,000 $780,000

Fund Balance Fund balance—committed Total fund balance

$780,000 _______ $780,000

E11.7 Debt Service Fund Errors The debt service fund is a governmental fund that uses modified accrual accounting. No investment income or interest on bonds is accrued. The bond issuance is recorded directly in the capital projects fund; only the bond premium is recorded in the debt service fund as a transfer from the capital projects fund. The following corrections are required: Bonds payable Transfer to capital projects fund

8,000,000 8,000,000

Interest payable Interest expense

200,000

Bond premium revenue Transfer in

100,000

200,000

100,000

Investment income Accrued investment income receivable

3,000 3,000

Corrected trial balance: Cash…………………………………….. Short-term investments………………… Investment income……………………... Transfer in……………………………… Total…………………………………….

Dr (Cr) 1,000 100,000 (1,000) (100,000) $ 0 $

E11.8 Internal Service Fund Financial Statements a. City of Winston-Salem Central Supplies Storehouse Statement of Revenues, Expenses, and Changes in Net Position For the Year 2020 (in thousands) Operating revenues Operating expenses (1) Operating income Capital contributions Change in net position Total net position—beginning Total net position—ending

$ 14,400 13,500 900 15,000 15,900 0 $ 15,900

City of Winston-Salem Central Supplies Storehouse Statement of Net Position At fiscal year-end 2020 (in thousands) Assets Current assets: Cash (2) Due from general fund Inventory (3) Total assets Net position Unrestricted Total net position Supporting calculations: (1) Cost of goods sold ($14,400/1.2) Other operating expenses Total operating expenses

$ 14,400 500 1,000 $ 15,900 $ 15,900 $ 15,900

$ 12,000 1,500 $ 13,500

(2) Beginning cash balance General fund transfer Collections from other funds ($14,400 - $500) Operating expenses Purchase of supplies Ending cash balance

0 15,000 13,900 (1,500) (13,000) $ 14,400

Beginning inventory balance Plus: Purchases Less: Cost of goods sold Ending inventory balance

(3) 0 13,000 (12,000) $ 1,000

E11.9 Enterprise Fund Profitability Analysis a. Modified accrual accounting: ROA

ROS

TATO

$(2,900) $310

$(2,900) $1,100

$1,100 $310

(9.355)

(2.636)

3.548

Note: $310 = ($300 + $320)/2 Business accounting: ROA

ROS

TATO

$300 $3,300

$300 $1,300

$1,300 $3,300

0.091

0.231

0.394

Note: $3,300 = ($3,050 + $3,550)/2 b. The business accounting data produce conventional results—a reasonable ROA and ROS but a very low TATO—whereas the modified accrual accounting data produce negative return measures but a very high TATO. An analysis of this kind, using modified accrual accounting data, is of limited value for the following reasons: 1. The capital assets that make up most of the asset portfolio are not present under modified accrual accounting. Thus, the denominator of the ROA and TATO is significantly understated. 2. Using modified accrual accounting, capital asset acquisitions are recorded as expenditures and not capitalized in the fund. This treatment causes income measures to be drastically understated when capital asset acquisitions are significant.

E11.10 Enterprise Fund Transactions 1. Accounts receivable Sewer revenues

55,000

Cash

52,000

55,000

Accounts receivable To record sewer billings and collections.

52,000

2. Sewer supplies Cash Accounts payable To record purchase of sewer supplies.

25,000 10,000 15,000

3. Capital assets 250,000 Notes payable To record purchase of capital assets, financed by a note payable.

250,000

4. Cash

5,500

Sewer tap-in fee revenue To record charges for sewer tap-in fees.

5,500

5. Interest expense Notes payable Cash To record payment of note payable interest and principal.

25,000 50,000 75,000

E11.11 Proprietary Fund Statement of Cash Flows Operating income Adjustments to reconcile operating income to cash provided by operations: Depreciation expense Decrease in accounts receivable Increase in inventories Increase in net pension liability Increase in OPEB liability Decrease in accounts payable Cash provided by operations E11.12 Special Assessment Project

$2,700,000

2,400,000 560,000 (3,000) 194,000 450,000 (70,000) $6,231,000

a. To find the amount of an annuity (the annual assessments) with present value sufficient to cover the $3,000,000 bond liability, we divide the present value of a 10-payment ordinary annuity of $1 discounted at 3% into the $3,000,000 present obligation. $351,700 = $3,000,000/8.53 b. Capital projects fund Cash Bond proceeds (other financing source)

3,000,000 3,000,000

Debt service fund Assessments receivable Revenue from assessments

351,700

Cash

351,700

Assessments receivable

351,700

Expenditures—interest Cash $90,000 = 0.03 x $3,000,000.

90,000

Investments Cash Amount invested = $351,700 – $90,000 = $261,700.

261,700

c. Capital projects fund Cash Bond proceeds (other financing source)

90,000

261,700

3,000,000 3,000,000

Custodial fund Assessments receivable Additions (collections from property owners)

351,700

Cash

351,700

Assessments receivable

351,700

Deductions (payments of bond interest) Cash

90,000

Investments Cash

261,700

E11.13 Custodial Fund Transactions

90,000

261,700

1. No entry is recorded in the custodial fund for bond issuance. 2. Assessments receivable Additions—collections from property owners To record special assessment levy.

280,000

Cash

280,000

3. Assessments receivable To record collection of assessments.

280,000

Deductions—payments on special assessment debt 280,000 Cash To record payment of $200,000 bond principal and $80,000 interest.

280,000

E11.14 Hedging with Derivatives June 30, 2020 Interest expense—bonds 320,000 Interest expense—counterparty 30,000 Cash 350,000 To record interest payment on the debt. The cash payment is 3.5% x $10 million, and the variable interest expense is 3.2% x $10 million. Deferred outflows of resources Investment in swap To record the decline in value of the swap.

50,000 50,000

June 30, 2021 Interest expense—bonds 310,000 Interest expense—counterparty 40,000 Cash 350,000 To record interest payment on the debt. The cash payment is 3.5% x $10 million, and the variable interest expense is 3.1% x $10 million. Investment in swap Deferred outflows of resources To record the increase in value of the swap.

4,000 4,000

E11.15 Accounting for Landfills Operating expenses—current operations

14,500,000

Capital assets, net Cash Accounts payable To record operating expenses.

1,800,000 12,500,000 200,000

Operating expenses—closure and postclosure costs 600,000 Liability for closure and postclosure costs 600,000 To adjust the liability for closure and postclosure costs; = ($50,000,000 x 20%) $9,400,000.

E11.16 Lease Transactions a. The present value of the lease is $2,180,720, computed as follows: Present value of annuity of 5 payments, 4%: 4.4518 x $400,000 = Plus first payment Total present value July 1, 2019 Expenditures—capitalized leases (capital outlay) Other financing sources—capitalized leases Expenditures—principal Cash June 30, 2020 Expenditures—interest Expenditures—principal Cash Interest = 4% x ($2,180,720 – $400,000) = $71,229.

$1,780,720 400,000 $2,180,720

2,180,720 2,180,720 400,000 400,000

71,229 328,771

June 30, 2021 Expenditures—interest 58,078 Expenditures—principal 341,922 Cash Interest = 4% x ($2,180,720 – $400,000 – $328,771) = $58,078

400,000

b. July 1, 2019 Leased capital assets, net Lease liability Lease liability Cash June 30, 2020 Interest expense Lease liability Cash Interest = 4% x ($2,180,720 – $400,000) = $71,229. Depreciation expense Leased capital assets, net $436,144 = $2,180,720/5.

2,180,720 2,180,720 400,000 400,000

71,229 328,771 400,000

436,144 436,144

June 30, 2021 Interest expense 58,078 Lease liability 341,922 Cash Interest = 4% x ($2,180,720 – $400,000 – 328,771) = $58,078. Depreciation expense Leased capital assets, net $436,144 = $2,180,720/5.

400,000

436,144 436,144

E11.17 Debt Refunding a. $2,000,000 + $200,000 = $2,200,000. b. Cash

2,200,000

Other financing source—refunding debt issued To record issuance of 3% debt.

2,200,000

Other financing use—payment to escrow agent Cash To record payment to escrow agent.

2,200,000

Bonds payable, 5% Deferred outflows—loss on refunding Bonds payable, 3%

2,000,000 200,000

2,200,000

PROBLEMS P11.1 Special Revenue Fund a. Cash

1,600,000 Transfers in Federal grant revenue To record transfer from general fund and receipt of federal grant.

800,000 800,000

Investments Cash To record investment.

600,000

Encumbrances Fund balance—restricted Fund balance—committed To record award of contract.

1,200,000

Fund balance—restricted Fund balance—committed Encumbrances To reverse encumbrances for contract.

800,000 400,000

Expenditures Accounts payable To record delivery of wildlife, and billings. Cash

800,000 400,000

1,200,000

1,200,000 1,200,000

30,000

Investment income To record investment revenue. Cash

30,000

600,000

Investments To record liquidation of investments. Accounts payable Cash To record payment to contractor.

600,000

1,100,000

Transfers out 400,000 Due to general fund To reclassify fund balance to be transferred to general fund.

1,100,000

400,000

Federal grant revenue 800,000 Transfers in 800,000 Investment income 30,000 Expenditures Transfers out Fund balance—committed To close revenues, transfers in, expenditures, and transfers out.

1,200,000 400,000 30,000

b. Grand City Special Revenue Fund Balance Sheet December 31, 2020 Assets Cash (1)

$ 530,000 ________ $ 530,000

Liabilities and fund balance Accounts payable Due to general fund Fund balance—committed

100,000 400,000 30,000 530,000

(1) $530,000 = $1,600,000 - $600,000 + $30,000 + $600,000 - $1,100,000

P11.2 Reporting for Endowment a. The trust benefits county public programs, and only earnings may be used to subsidize the center’s education activities. Therefore its activities are reported in a permanent fund. b. Journal entries (not required): Investment in bonds—principal Investment in CDs—principal Fund balance—nonspendable To record initial bequest and investment of cash in CDs.

485,000 25,000

Cash—income Transfers in To record transfer from the county.

30,000

Education expenditures Cash—income Accounts payable—income To record education expenditures for the year.

55,000

510,000

30,000

50,000 5,000

Interest receivable Cash—income Interest revenue—income To record CD interest. $750 = $25,000 x 3%.

375 375 750

Cash—income 25,000 Investment in bonds—income 4,100 Interest revenue To record interest on bonds, using the effective interest method. $29,100 = 6% x $485,000, and $25,000 = 5% x $500,000.

29,100

Douglas County Education Trust Fund Statement of Revenues, Expenditures and Changes in Fund Balances For the Year Ended December 31, 2019 Revenues: Bond interest revenue CD interest income Expenditures Excess of revenues over (under) expenditures Other financing sources: Transfer in from County Excess of revenues and other financing sources over expenditures

$ 29,100 750 29,850 (55,000) (25,150) 30,000 $ 4,850

Douglas County Education Trust Fund Balance Sheet December 31, 2019 Assets Cash—income ($30,000 + $375 - $50,000 + $25,000) Interest receivable—income Investment in bonds—income Investment in CDs—principal Investment in bonds—principal Total assets Liabilities and fund balances Accounts payable—income Fund balance—nonspendable Fund balance—restricted Total liabilities and fund balances

5,375 375 4,100 25,000 485,000 $519,850

5,000 510,000 4,850 $519,850

Note: Using the effective interest method, the reported investment increases each year. This increase represents spendable income.

P11.3 Special Revenue Fund Entries and Operating Statement a. Cash and investments 168,000 Investment income Unrealized gains on investments To record investment income and increase in fair value of investments. Cash and investments Receivables Occupancy tax revenue To record occupancy tax revenue.

8,772,000

Transfers out Cash and investments To record transfers to Inlet Maintenance Fund.

1,850,000

Due from capital projects fund Cash and investments To record advance to capital projects fund.

2,306,000

Expenditures Accounts payable Cash and investments To record expenditures.

2,522,000 379,000

Cash and investments Transfers in To record transfers from capital projects fund.

1,592,000

142,000 26,000

100,000 8,672,000

1,850,000

2,306,000

2,901,000

1,592,000

b. Beach Nourishment Fund Statement of Revenues, Expenditures and Changes in Fund Balance For the Year Ended June 30, 2016 Revenues: Occupancy taxes Investment income and unrealized gains on investments Total revenues Expenditures Excess of revenues over expenditures Other financing sources (uses): Transfer in from capital projects fund Transfer out to Inlet Maintenance Fund Net other financing sources (uses) Excess of revenues and other financing sources over expenditures and other financing uses Fund balance, July 1, 2015 Fund balance, June 30, 2016

$8,672,000 168,000 8,840,000 (2,522,000) 6,318,000 1,592,000 (1,850,000) (258,000) 6,060,000 25,425,000 $31,485,000

P11.4 Capital Projects and Debt Service Activities a. Books of Capital Projects Fund Journal entries for fiscal 2019: (1) Bonds authorized—unissued Estimated financing sources—federal grant Appropriations To record the budget for the capital project. Due from federal government Federal grant revenue To record federal grant. (2) Cash

9,000,000 1,000,000 10,000,000

1,000,000 1,000,000

500,000

Due to general fund To record advance from general fund. (3) Expenditures Cash To record engineering and architectural costs.

500,000

250,000 250,000

(4) Cash

9,090,000

Bond proceeds Due to debt service fund To record issuance of $9,000,000 bonds for $9,090,000. Due to debt service fund Cash To record transfer of bond premium to debt service fund. (5) Cash

9,000,000 90,000

90,000 90,000

800,000

Due from federal government To record partial receipt of federal grant.

800,000

(6) Encumbrances 9,600,000 Fund balance—restricted To record award of contracts for construction and fire equipment. (7) Due to general fund Cash To record repayment to general fund. (8) Fund balance—restricted Encumbrances To reverse encumbrances for invoices received.

9,600,000

500,000 500,000

8,200,000 8,200,000

Expenditures Contracts payable Contracts payable—retainage To record billing from contractors.

8,200,000

Contracts payable Cash To record payment to contractors.

7,000,000

7,380,000 820,000

7,000,000

September 30, 2019 closing entries: Federal grant revenue 1,000,000 Bond proceeds 9,000,000 Bonds authorized—unissued Estimated financing sources—federal grant To close actual against budgeted revenues and other financing sources.

9,000,000 1,000,000

Appropriations 10,000,000 Expenditures Encumbrances Fund balance—restricted To close actual expenditures and encumbrances against appropriations.

8,450,000 1,400,000 150,000

Journal entries for fiscal 2020: Encumbrances Fund balance—restricted To restore encumbrances closed at year-end.

1,400,000

Fund balance—restricted Appropriations To establish appropriations for the year.

1,400,000

(3) Cash

1,400,000

200,000

Due from federal government To record receipt of balance of federal grant. (4) Fund balance—restricted Encumbrances To record reversal of encumbrances.

200,000

1,400,000 1,400,000

Expenditures Contracts payable Contracts payable—retainage To record invoices.

1,400,000

Contracts payable Cash To record payment to contractors.

1,640,000

(5) Contracts payable—retainage Cash To record payment of retainage.

1,260,000 140,000

1,640,000

960,000 960,000

Transfers out 150,000 Cash 150,000 To record transfer of remaining cash to debt service fund. $150,000 = $500,000 -$250,000 + $9,090,000 - $90,000 + $800,000 - $500,000 $7,000,000 + $200,000 - $1,640,000 - $960,000. Closing entries for 2020:

Fund balance—restricted 150,000 Appropriations 1,400,000 Expenditures Transfers out To close expenditures and transfers against appropriations.

1,400,000 150,000

Books of Debt Service Fund Journal entries for fiscal 2019: No budget entry is required because no earnings, transfers-in, or expenditures are planned for 2019. (4) Cash

90,000

Transfers in To record transfer of bond premium.

90,000

Closing entry for 2019: Transfers in Fund balance—committed To record closing of transfer.

90,000 90,000

Journal entries for fiscal 2020: Estimated transfers in Appropriations To record budget for 2020. (1) Cash

450,000 450,000

450,000

Transfers in To record transfer from general fund. (2) Expenditures Cash To record payment of bond interest. (5) Cash Transfers in To record cash transferred from capital projects fund. Closing entries for 2020:

450,000

450,000 450,000

150,000 150,000

Transfers in Estimated transfers in Fund balance—committed

600,000

Appropriations Expenditures

450,000

450,000 150,000

450,000

b. County of Clackamas Fire Station Capital Projects Fund Balance Sheet As of September 30, 2019 Assets Cash Due from federal government Total assets Liabilities and fund balance Contracts payable Contracts payable—retainage Fund balance—restricted Total liabilities and fund balance

$ 2,550,000 200,000 $ 2,750,000 $

380,000 820,000 1,550,000 $ 2,750,000

c. County of Clackamas Debt Service Fund Balance Sheet As of September 30, 2020 Cash Fund balance—committed

$ $

240,000 240,000

P11.5 Capital Projects and Debt Service Activities a. Journal entries in capital projects fund, fiscal 2019 (1) Bonds authorized - unissued Appropriations To record approval of construction of recreation center. (2a) Cash

10,000,000 10,000,000

800,000

Due to general fund To record advance from general fund. (2b) Expenditures Cash To record partial payment for land.

800,000

800,000 800,000

(2c) Encumbrances 400,000 Fund balance—restricted 400,000 To record remaining obligation for land contract. Note that only $400,000 needs to be encumbered since expenditures of $800,000 have already been recorded. (3) Cash

10,200,000

Bond proceeds Due to debt service fund To record issuance of $10,000,000 bonds for $10,200,000. (4) Encumbrances Fund balance—restricted To record award of contract for recreation center. (5a) Due to general fund Cash To record repayment of advance. (5b) Fund balance—restricted Encumbrances To reverse encumbrance on land contract. (5c)

10,000,000 200,000

7,800,000 7,800,000

800,000 800,000

400,000 400,000

Expenditures Cash To record remaining expenditure for land.

400,000 400,000

(6a) Fund balance—restricted 6,400,000 Encumbrances To remove encumbrances for amount billed by contractor. (6b) Expenditures Contracts payable Contracts payable—retainage To record billings by contractor. (7) Contracts payable Cash To record payments to contractor. (8) Due to debt service fund Cash To record transfer of premium to debt service fund. Closing entries: Bond proceeds Bonds authorized— unissued To close bond proceeds. Appropriations Expenditures Encumbrances Fund balance—restricted To close expenditures and encumbrances.

6,400,000

6,400,000 6,200,000 200,000

6,200,000 6,200,000

200,000 200,000

10,000,000 10,000,000

10,000,000 7,600,000 1,400,000 1,000,000

Journal entries in capital projects fund, fiscal 2020 Encumbrances 1,400,000 Fund balance—restricted To re-establish encumbrances outstanding at end of 2019. (9) Encumbrances Fund balance—restricted To record additional contract price. (10a) Fund balance—restricted Encumbrances To reverse encumbrances related to contract. (10b) Expenditures Contracts payable To record billings by contractor. (11) Contracts payable Contracts payable—retainage Cash To record payment to contractor. (12) Transfers out Cash To transfer remaining cash to debt service fund. Closing entries: Fund balance—restricted Expenditures Transfers out To close expenditures and transfers.

1,400,000

1,000,000 1,000,000

2,400,000 2,400,000

2,300,000 2,300,000

2,300,000 200,000 2,500,000

100,000 100,000

2,400,000 2,300,000 100,000

b. City of Lander Capital Projects Fund - Recreation Center Balance Sheet June 30, 2019 Cash

$2,600,000 _________ $2,600,000

Contracts payable—retainage Fund balance—restricted

$ 200,000 2,400,000 $2,600,000

c. Journal entries in debt service fund, fiscal 2019 Estimated transfers in Estimated earnings Fund balance—committed Appropriations To record budget.

450,000 5,000 45,000

Cash

200,000

500,000

Transfers in To record receipt of bond premium from capital projects fund. Cash

200,000

450,000

Transfers in To record transfers from general fund. Investments Cash To record purchase of investments. Cash

450,000

650,000 650,000

5,000

Revenues To record income from investments. Cash

5,000

500,000

Investments To liquidate investments. Debt service: principal Cash To pay bond installment.

500,000

500,000 500,000

Closing entry: Appropriations Revenues Transfers in Estimated transfers in Estimated earnings Debt service: principal Fund balance—committed To close temporary accounts.

500,000 5,000 650,000 450,000 5,000 500,000 200,000

Journal entries in debt service fund, fiscal 2020: Estimated transfers in Estimated earnings Appropriations Fund balance—committed To record budget.

550,000 5,000

Cash

550,000

500,000 55,000

Transfers in To record transfer from general fund.

550,000

Cash

100,000 Transfers in To record receipt of unspent bond proceeds from capital project fund.

100,000

Investments Cash To record purchase of investments.

650,000 650,000

Cash

500,000

Investments To liquidate investments. Debt service: principal Cash To record payment of principal due. Cash Revenues To record income from investments.

500,000

500,000 500,000

4,000 4,000

Closing entry: Appropriations Revenues Transfers in Debt service: principal Estimated transfers in Estimated earnings Fund balance—committed To close revenues and transfers in.

500,000 4,000 650,000 500,000 550,000 5,000 99,000

P11.6 Evaluating Municipality Financial Condition a. "Fungible" refers to common, substitutable goods, any part of which can replace, or is indistinguishable from, any other part. "Fungible financial resources" can thus be thought of as indistinguishable units of money, any of which can be used to pay for expenditures or liquidate debts. A fund balance earmarks financial resources for the fund's specific purposes. When there are multiple funds, though, the overall cash balance is fungible, irrespective of source. Through interfund transfers, such as loans, subsidies, and advances, that cash balance could be used by any of the funds. b. Although these data are incomplete, they do provide several signals suggesting deteriorating financial position that should be investigated. 1. There is an increasing shortfall, both in absolute and percentage terms, of actual revenues compared to budgeted revenues. 2016 shortfall = $3,400 - $3,360 = $40; $40/$3,400 = 1.2% 2020 shortfall = $4,100 - $3,900 = $200; $200/$4,100 = 4.9% This could mean that the revenue base is unexpectedly shrinking. 2. Short-term borrowings are growing, in absolute and percentage terms (when compared with estimated revenue), suggesting an increasing reliance on shortterm borrowings to cover revenue shortfalls (suggested in 1. above) or operating deficits. 3. Note that there are considerably more capital projects fund debt proceeds being generated ($2,790) than are being spent on capital projects ($2,190). Although possibly illegal, these unspent bond proceeds might be used to cover current obligations of the general fund; an interfund loan/advance transfers the cash with no concurrent effect on the fund balance of either fund involved in the transfer.

4. The fund balance, combined for all governmental funds, can mask dramatically different results in the individual funds. The data suggest operating deficits that cause the general fund balance to fall. Concurrently, the capital projects fund balance appears to be increasing. Bond proceeds exceed capital projects fund expenditures and, although treated as other financing sources, the bond proceeds increase the fund balance in the same way as revenue. In the latter part of the five-year period, the declining combined fund balance probably signals substantially larger general fund operating deficits. Overall, these signals suggest that the general fund is experiencing difficulty funding all its expenditures with appropriate revenues. Creditors of this governmental unit are increasingly at risk. c. Modified accrual accounting does not recognize obligations that are not to be funded with current financial resources. Examples are accrued interest on long-term debt and future pension payments arising from current service. In addition, depreciation is not recognized on fixed assets, nor are the fixed assets themselves, or their long-term liabilities. Therefore, future payments arising from current operations, in the form of debt payments and replacement of fixed assets, are concealed.

P11.7 Evaluating Status of Capital Project a. Probably the first thing you notice is the negative (debit balance) unassigned fund balance. This deficit seems peculiar in that the project appears nowhere near completion. You wonder whether your colleagues on the Board realize what this may mean to the budget. Note: Although capital projects funds generally do not have unassigned fund balance, a deficit is reported as unassigned. b. Your analysis should certainly focus on the availability of financial resources in the capital projects fund to liquidate its obligations. Financial resources available Cash Interest receivable Temporary investments Interfund receivable from general fund Total resources Obligations to be satisfied Accounts payable Contracts payable Outstanding encumbrances Total obligations Shortfall (excess of obligations over resources)

$ 1,400 200 9,700 1,000 $ 12,300 $

960 1,340 12,600 14,900 $ (2,600)

Thus, it appears that an additional $2,600 will be needed by the already-strapped school district to complete the construction project.

P11.8 Critique Enterprise Fund Accounting a. Because the data in the report are drawn from the general fund without adjustment, they reflect the modified accrual basis of accounting used in governmental funds. Of importance to the swimming pool situation is the fact that asset acquisitions are recorded as expenditures in the period acquired and no periodic depreciation expense is charged against revenue. b. The township swimming pool qualifies as an enterprise fund. As such, it should follow full accrual accounting and have its own separate chart of accounts. Under accrual accounting, the swimming pools and diving board are shown as pool assets and are depreciated over their useful lives. c. The township manager's boasting is somewhat premature. Not only does the pool's operating statement fail to reflect depreciation expense, the pool has not been charged with its (nontrivial) portion of the township's liability insurance. A more accurate picture of pool financial operations would show: Excess of revenues over expenditures (per report) Insurance expense Depreciation expense (1) Excess of expenses over revenues

29,000 (42,000) (185,000) $ (198,000)

(1) $185,000 = ($3,000,000/20) + ($500,000/25) + ($150,000/10) Thus, the pool is actually operating at a deficit under full accrual accounting and its cash flow from operations is $(13,000) = $29,000 – $42,000.

d. If the price elasticity of demand (= percentage change in quantity/percentage change in price) is 2.5, demand is elastic (2.5 > 1). Thus, the percentage increase in quantity (q) will, in this case, be 2.5 times as great as the percentage decrease in price (p). The current number of passes sold is 250 (= $50,000/$200). We are given the elasticity and the proposed price decrease. Therefore, we use these parameters and the elasticity formula to solve for Δq as follows: 2.5

1.0 Δq

= = = = =

-(Δq/q)/(Δp/p) -(Δq/250)/(-80/200) -(Δq/250)/(-0.4) (Δq/250) 250

Reducing the price of the nonresident season pass by 40%, from $200 to $120, should lead to sale of 250 more (Δq) nonresident season passes. Note that 2.5 x 40% = 100%. With an elasticity of 2.5, the 250 passes sold at $200 should increase to 500 passes sold at $120. Total revenue from nonresident season passes increases to $60,000 (= 500 x $120) from $50,000.

P11.9

Enterprise Net Position Total net position, September 30, 2016: $11,000,987 + $2,702,308 - $13,490,523 - $74,248 = $138,524 Calculation of net investment in capital assets, September 30, 2016: Net investment in capital assets, October 1, 2015 - Depreciation expense + Acquired capital assets not financed by debt + Principal payments on capital asset-related debt - Book value of capital assets sold Net investment in capital assets, September 30, 2016 Calculation of restricted net position: Restricted for capital projects: Restricted for debt service:

$(1,313,011) (1,223,000) 357,230 645,020 (5,000) $(1,538,801)

$1,343,675 - $40,957 = $1,302,718 $137,541 - $59,695 = $ 77,846

Calculation of unrestricted net position: $138,524 + $1,538,801 - $1,302,718 - $77,846 = $296,761 Net position section of the Solid Waste Fund, September 30, 2016: Net investment in capital assets………………….. $(1,538,801) Restricted for: Capital projects…………………………… 1,302,718 Debt service………………………………. 77,846 Unrestricted……………………………………….. 296,761 Total net position…………………………. $ 138,524

P11.10 Internal Service Fund (in thousands) a. (1) Materials and supplies Accounts payable To record purchases on account. (2) Materials and supplies expense (1) Materials and supplies To record materials and supplies used. (1) $9,000 = $8,000 + $7,500 - $6,500

7,500 7,500

9,000 9,000

(3) Salaries, wages and benefits expense Cash To record compensation paid. (4) Utilities expense Cash To record payment of utilities charges.

40,000 40,000

3,000 3,000

(5) Depreciation expense 3,800 Capital assets, net To record depreciation expense on building, machinery and equipment. (6) Cash Loss on sale of capital assets Capital assets, net To record sale of machinery. (7) Cash

100 200 300

200

Transfers in To record transfer from general fund. (8) Receivable from general fund Receivable from water and sewer fund Receivable from special revenue fund Service revenue To record billings to departments for services rendered. (9) Cash Receivable from general fund (1) Receivable from water and sewer fund Receivable from special revenue fund (2) To record collection of receivables.

3,800

200

36,000 17,000 9,000 62,000

62,500 37,000 17,000 8,500

(1) $37,000 = $3,000 + $36,000 - $2,000; (2) $8,500 = $0 + $9,000 - $500

(10) Accounts payable (1) Cash To record payment of accounts payable. (1) $10,000 = $6,000 + $7,500 - $3,500

b. Closing entries:

10,000 10,000

Service revenue Transfers in Unrestricted net position Materials and supplies expense Salaries, wages and benefits expense Utilities expense

62,000 200

Net investment in capital assets Depreciation expense Loss on sale of capital assets To close revenue and expense accounts.

4,000

Net investment in capital assets Unrestricted net position To record liquidation of capital assets.

100

10,200 9,000 40,000 3,000

3,800 200

100

c. County of Lexington Statement of Net Position Motor Pool Internal Service Fund December 31, 2020 Assets: Current assets: Cash Receivable from general fund Receivable from special revenue fund Materials and supplies Total current assets Noncurrent assets: Capital assets, less $10,500 accumulated depreciation Total noncurrent assets Total assets Liabilities: Current liabilities: Accounts payable Total current liabilities Net position: Net investment in capital assets Unrestricted Total net position Total liabilities and net position P11.11 Enterprise Fund Statement of Cash Flows

$ 27,800 2,000 500 6,500 36,800 33,300 33,300 $ 70,100

3,500 3,500

33,300 33,300 66,600 $ 70,100

State Lottery Statement of Cash Flows For the Year Ended June 30, 2020 (in thousands) Cash flows from operating activities Cash from retailers (1) Cash paid for prizes (2) Cash paid for operating expenses (3) Net cash provided by operating activities

$ 886,000 (449,000) (182,000) 255,000

Cash flows from noncapital financing activities Transfer out to state

(258,000)

Cash flows from capital and related financing activities Acquisition of capital assets Proceeds from sale of capital assets (4) Net cash provided by capital and related financing activities

(14,000) 16,000 2,000

Cash flows from investing activities Proceeds from maturing investments (5) Acquisition of investments Net cash used in investing activities Net decrease in cash and cash equivalents Cash and cash equivalents—beginning Cash and cash equivalents—ending

9,000 (15,000) (6,000) (7,000) 21,000 $ 14,000

(1) $900,000 – ($39,000 - $25,000) = $886,000 (2) $450,000 – ($86,000 - $85,000) = $449,000 (3) $180,000 – ($35,000 - $40,000) - $3,000 = $182,000 (4) Original cost of capital assets sold = $60,000 + $14,000 - $51,000 = $23,000 Accumulated depreciation on capital assets sold = $12,000 + $3,000 - $13,000 = $2,000; ($23,000 $2,000) - $5,000 = $16,000 proceeds (5) Book value of maturing investments = $38,000 + $15,000 - $2,000 - $42,000 = $9,000

Reconciliation of operating income to net cash provided by operating activities: Operating income Plus depreciation expense Less increase in accounts receivable Less decrease in current operating liabilities Plus increase in prize liabilities Net cash provided by operating activities

$270,000 3,000 (14,000) (5,000) 1,000 $ 255,000

P11.12 Enterprise Fund Financial Statements City of Richardson, Texas Solid Waste Fund Statement of Cash Flows Year ended September 30, 2016 (in thousands) Cash from operating activities: Cash received from customers Cash paid for supplies Cash paid for other operating expenses Cash from operating activities

$ 13,100 (429) (12,460) 211

Cash from noncapital financing activities: Interest expense Borrowing, net Other financing expense Cash from noncapital financing activities

(147) 455 (12) 296

Cash from capital and related financing activities: Proceeds from sale of capital assets Cash used to acquire capital assets Cash used for capital and related financing activities

85 (432) (347)

Cash from investing activities: Interest income Purchase of investments Cash used for investing activities Net change in cash Cash balance, beginning Cash balance, ending Reconciliation of operating income to cash from operating activities: Operating income Increase in accounts receivable Decrease in supplies Decrease in prepaid expenses Increase in accounts payable and accrued expenses Depreciation expense Cash from operating activities

20 (1,550) (1,530) (1,370) 4,961 $ 3,591

(914) (245) 3 23 121 1,223 211

Summary journal entries (not required): Cash Accounts receivable

13,100 245 Operating revenues

Operating expenses - supplies

13,345 432

Supplies Cash Operating expenses - depreciation

3 429 1,223

Accumulated depreciation Other operating expenses

1,223 12,604

Prepaid expenses Accounts payable and accrued expenses Cash Cash

23 121 12,460 20

Interest revenue Interest expense

20 148

Interest payable Cash Investments

1 147 1,550

Cash Cash Bond and lease obligations Deferred outflow—pensions

1,550 455 239 1,929

Deferred outflow—refunding Current maturities of long-term debt Postemployment benefit liabilities Pension and compensated absence liabilities Deferred inflow—pensions Cash Accumulated depreciation

3 168 137 2,249 66 85 266

Capital assets Gain on disposal of capital assets

271 80

Other financing expenses

12 Cash

Capital assets

432 Cash

432

P11.13 Custodial Fund a. To record tax levy for fiscal 2020 on July 1, 2019: Tax custodial fund Taxes receivable—property tax collections Additions—property taxes collected for county, city, and town Deductions—property taxes paid to county, city, and town Due to county, city, and town—property taxes Dial County general fund Taxes receivable Property tax revenue Allowance for uncollectible taxes Eton City general fund Taxes receivable Property tax revenue Allowance for uncollectible taxes Bart Township general fund Taxes receivable Property tax revenue Allowance for uncollectible taxes

60,000,000 60,000,000

36,000,000 35,000,000 1,000,000

18,000,000 17,400,000 600,000

6,000,000 5,600,000 400,000

Gross distribution Less 2% adm. cost Adm. cost to Dial Distribution

Eton City $4,320,000 (86,400) _________ $4,233,600

Bart Township $1,440,000 (28,800) ________ $1,411,200

c. To record the October 1, 2019 collection and distribution:

Dial County $8,640,000 115,200 $8,755,200

Total $14,400,000 (115,200) 115,200 $14,400,000

Tax custodial fund Cash Taxes receivable—property tax collections

14,400,000 14,400,000

Due to county, city, and town Due to Dial County Due to Eton City Due to Bart Township

14,400,000

Due to Dial County Due to Eton City Due to Bart Township Cash

8,755,200 4,233,600 1,411,200

14,400,000

Dial County general fund Cash Taxes receivable Revenues

8,755,200 8,640,000 115,200

Eton City general fund Cash Expenditures Taxes receivable

4,233,600 86,400

Bart Township general fund Cash Expenditures Taxes receivable

1,411,200 28,800

4,320,000

1,440,000

P11.14 Reporting for Landfills a. The total liability for landfill development and postclosure care costs is $8,954,072. The 2016 expense for final development and postclosure costs is $40,088. If the landfill is at 55% of capacity, total current cost of total closure and postclosure costs is $8,954,072/0.55 = $16,280,131. Expenses reported in previous years are $8,954,072 – $40,088 = $8,913,984 b. Before the landfill reaches capacity, it is unlikely that any of the costs require current financial resources. Therefore no expenditures or liabilities will appear in the governmental funds financial statements. c. Total estimated cost Reported as of end of 2016 To be reported

$16,280,131 8,954,072 $ 7,326,059

Average expense per year = $7,326,059/14 = $523,290 The low amount reported in 2016 ($40,088) may be due to an expansion in the landfill’s capacity or a reduction in estimated closure and postclosure costs. Both factors would cause previous expense recognition to be overstated, leading to a correction that lowers the current expense. Note: A look at Mecklenburg County’s prior CAFRs reveals that $40,088 has been reported as closure and postclosure expense every year for the last several years. Therefore, it seems unlikely that this number is calculated based on estimated current closure costs and landfill capacity, as stated in the footnotes. Further investigation reveals that remaining estimated costs are $6.4 million; the actual amount reported as expense is considerably lower than the $6,400,000/14 = $457,143 estimated remaining cost per year.

P11.15 Leases in Governmental and Proprietary Funds Calculation of the present value of the minimum lease payments: $25,547,000/(1.04) + $17,434,000/(1.04)2 + $13,147,000/(1.04)3 + $11,857,000/(1.04)4 + $11,633,000/(1.04)5 + [$3,393,000 x 4.4518]/(1.04)5 = $84,481,000. (4.4518 = present value of a 5-year annuity at 4%) Numbers are rounded so yours may be slightly different. a.

Proprietary fund reporting in fiscal 2017 July 1, 2016 Leased assets Lease liabilities To record leases.

84,481,000

June 30, 2017 Interest expense 3,379,000 Lease liabilities 22,168,000 Cash To record lease payment; $3,379,000 = $84,481,000 x 4%. Depreciation expense 8,448,000 Leased assets To record depreciation on leased assets; $8,448,000 = $84,481,000/10.

84,481,000

25,547,000

8,448,000

Impacts on fiscal 2017 financial statements: • •

Fund assets increase $76,033,000 (= $84,481,000 - $8,448,000). Fund liabilities increase $62,313,000 (= $84,481,000 - $22,168,000).

• • b.

Fund expenses decrease $13,720,000 [= $25,547,000 – ($8,448,000 + $3,379,000)]. Net position increases $13,720,000.

Governmental fund reporting in fiscal 2017 July 1, 2016 Expenditures—leases (capital outlay) Other financing sources—leases To record leases.

84,481,000 84,481,000

June 30, 2017 Expenditures—interest 3,379,000 Expenditures—principal 22,168,000 Cash To record lease payment; $3,379,000 = $84,481,000 x 4%.

25,547,000

Impacts on fiscal 2017 financial statements: • • • •

Fund assets are not affected. Fund liabilities are not affected. Fund expenditures increase $84,481,000. The change in fund balances is the same; expenditures for principal and interest payments equal the cash payment previously reported as an expenditure. Capital outlay (expenditure) equals other financing sources in fiscal 2017.

P11.16 Debt Refundings and Swaps a. July 1, 2019 Cash Bonds payable-variable To record issuance of variable rate debt.

10,000,000

December 31, 2019 Interest expense-bonds 200,000 Interest expense-counterparty 25,000 Cash To record interest payments; $200,000 = 4% x ½ x $10,000,000; $25,000 = (4.5% – 4%) x ½ x $10,000,000.

10,000,000

225,000

Deferred outflow-swap Investment in swap To record decline in value of swap.

20,000 20,000

June 30, 2020 Interest expense-bonds 175,000 Interest expense-counterparty 50,000 Cash To record interest payments; $175,000 = 3.5% x ½ x $10,000,000; $50,000 = (4.5% – 3.5%) x ½ x $10,000,000. Deferred outflow-swap Investment in swap To record decline in value of swap.

2,000

Investment in swap Cash To close the swap.

22,000

Bonds payable-variable Deferred outflow-refunding Deferred outflow-swap Bonds payable-fixed To record refunding of variable debt with fixed debt.

225,000

2,000

22,000 10,000,000 272,000 22,000 10,250,000

b. December 31, 2020 Interest expense 211,700 Cash Deferred outflow-refunding To record interest on the fixed debt; $184,500 = 3.6% x ½ x $10,250,000; $27,200 = $272,000/5 x ½.

184,500 27,200

P11.17 Special Revenue and Proprietary Fund Reporting a. Community Projects Fund entries: Due to general fund Cash To record repayment of loan from general fund.

500

Cash

200

500

Due to general fund To record loan from general fund. Cash

200

Due from water utility To record collection of loan to water utility. Cash

10,000

Federal grant revenues To record federal grant received. Expenditures—projects Expenditures—capital outlay Accounts payable Cash To record expenditures for community projects.

10,000

7,400 3,000 10 10,410

Water Utility journal entries: Cash Accounts receivable Operating revenues To record repayment of loan from general fund.

35,750 250 36,000

Due to community projects fund 20 Cash To record partial repayment of loan from community projects fund. Operating expenses: out-of-pocket, inventories, and depreciation Accumulated depreciation Inventories Accounts payable Cash To record operating expenses.

33,600 2,000 20 210 31,370

Operating expenses: pensions Deferred outflows of resources—pensions Pension liability Cash To record pension information for the year.

765 175

Operating expenses: OPEB OPEB liability Cash To record OPEB information for the year.

245

850 90

200 45

Cash 190 Investments 185 Investment income 375 To record investment income received in cash, and unrealized investment gains. Interest expense Cash To record interest expense on bonds.

800

Cash

600

800

Bonds payable To record bond issue. Bonds payable Cash To record bond principal payment.

600

3,000 3,000

Capital assets Cash To record acquisition of capital assets.

500

Cash Loss on sale of capital assets Accumulated depreciation Capital assets To record sale of capital assets.

125 50 475

500

650

b. Lake County Statement of Revenues, Expenditures, and Changes in Fund Balances Community Projects Fund For the Year Ended June 30, 2020 Revenues Federal grant $ 10,000 Expenditures Community projects 7,400 Capital outlay 3,000 Total expenditures 10,400 Excess of revenues over (under) expenditures (400) Fund balance—July 1, 2019 480 Fund balance—June 30, 2020 $ 80

Lake County Balance Sheet Community Projects Fund June 30, 2020 Assets Cash Due from water utility Total assets Liabilities and fund balance Accounts payable Due to general fund Total liabilities Fund balance: Restricted Total liabilities and fund balance

340 5 345

$ $

65 200 265

80 $ 345

c. Lake County Statement of Revenues, Expenses, and Changes in Net Position Water Utility Fund For the Year Ended June 30, 2020 Operating revenues $ 36,000 Operating expenses 34,610 Operating income 1,390 Nonoperating revenues (expenses): Interest expense (800) Loss on sale of capital assets (50) Investment income 375 Total nonoperating revenues (expenses) (475) Change in net position 915 Net position—July 1, 2019 31,050 Net position—June 30, 2020 $ 31,965

Lake County Statement of Net Position Water Utility Fund June 30, 2020 Assets Cash Accounts receivable Inventories Investments Capital assets, net of $21,525 accumulated depreciation Total assets Deferred outflows of resources—pensions Total assets and deferred outflows of resources Liabilities and net position Liabilities Accounts payable Due to community projects fund Pension liability OPEB liability Bonds payable Total liabilities Net position Net investment in capital assets (1) Unrestricted Total net position Total liabilities and net position (1) Net investment in capital assets, July 1, 2019 $25,000 Less depreciation expense (2,000) Plus capital-related bond principal paid 1,200 Less capital-related bonds issued (400) Plus capital assets acquired 500 Less book value of capital assets sold (175) Net investment in capital assets, June 30, 2020 $24,125

$ 2,340 6,750 230 9,310 53,325 71,955 1,175 $73,130

510 5 6,850 1,200 32,600 41,165

24,125 7,840 31,965 $73,130

Lake County Statement of Cash Flows Water Utility Fund For the Year Ended June 30, 2020 Cash flows from operating activities Cash received from customers Cash paid for operating expenses (2) Net cash provided by operating activities Cash flows from noncapital financing activities Bonds issued Bond principal paid Loan to community service project paid Interest payments Net cash used for noncapital financing activities Cash flows from capital and related financing activities Capital assets acquired Capital assets sold Capital asset-related bonds issued Capital asset-related bond principal paid Interest payments Net cash used for capital and related financing activities Cash flows from investing activities Cash received from investment income Net cash provided by investing activities Net increase in cash Cash balance, July 1, 2019 Cash balance, June 30, 2020 Reconciliation of operating income to cash provided by operations: Operating income Depreciation expense Increase in accounts receivable Decrease in inventory Increase in accounts payable Increase in pension liability Increase in deferred outflows—pensions Increase in OPEB liability Net cash provided by operating activities (2)

Cash paid for out-of-pocket operating expenses Cash paid for pensions Cash paid for OPEB Cash paid for operating expenses

$35,750 (31,505) 4,245 200 (1,800) (20) (100) (1,720) (500) 125 400 (1,200) (700) (1,875) 190 190 840 1,500 $2,340

$1,390 2,000 (250) 20 210 850 (175) 200 $4,245 $ 31,370 90 45 $ 31,505

CHAPTER 12 SOLUTIONS TO MULTIPLE CHOICE QUESTIONS, EXERCISES AND PROBLEMS

MULTIPLE CHOICE QUESTIONS 1.

a $138 – $690 – $130 + $790 - $128 + $48 = $28

c $(1,370) – $3,353 + $11,832 + $5,676 – $7,382 – $585 + $5,193 – $15,641 = $(5,630)

c $885,000 = $860,000 – $50,000 + $75,000

10.

a $(12,000) = $18,000 – [$50,000 – (4 x $50,000/10)]

EXERCISES E12.1 Fund and Government-Wide Reporting 1. Fund statements Capital projects fund: Cash Bond proceeds (other financing source) Expenditures Cash Transfers out Cash Debt service fund: Cash Transfers in (other financing source)

10,000,000 10,000,000 9,925,000 9,925,000 75,000 75,000

75,000 75,000

Government-wide statements (in governmental activities) Cash Bonds payable Capital assets Cash

10,000,000 10,000,000 9,925,000 9,925,000

2. Fund statements General fund: Cash Proceeds from sale of police vehicle (other financing source) Capital outlay (expenditure) Cash

2,000 2,000 50,000 50,000

Government-wide statements (in governmental activities) Cash Loss on sale of capital assets Capital assets Capital assets Cash

2,000 3,000 5,000 50,000 50,000

3. Fund statements Enterprise fund Cash Bonds payable

750,000 750,000

Government-wide statements (in business-type activities)—same entry as above 4. Fund statements Internal service fund: Capital assets Cash

15,000 15,000

Government-wide statements (in governmental activities)—same entry as above. 5. Fund statements Special revenue fund: Capital outlay (expenditure) Cash

300,000 300,000

Government-wide statements (governmental activities) Capital assets Cash

300,000 300,000

6. Fund statements Permanent fund: Transfers out (other financing uses) Cash - income General fund: Cash Transfers in (other financing sources) Capital outlay (expenditure) Cash

15,000 15,000

15,000 15,000 15,000 15,000

Government-wide statements (governmental activities) Capital assets Cash

15,000 15,000

7. Same as 6, except the special revenue fund is used instead of the permanent fund.

E12.2 Fund and Government-Wide Reporting 1. Fund statements Investment trust fund: Investments Cash

200,000 200,000

Government-wide statements: no effect (trusts are not reported) 2. Fund statements Custodial fund: Deductions: interest payments to bondholders Cash (assumes deductions were not previously accrued)

90,000 90,000

Government-wide statements: no effect (custodial funds are not reported) 3. Fund statements General fund: Property taxes receivable Property tax revenue

4,200,000 4,200,000

Government-wide statements (governmental activities)—same entry 4. Fund statements Permanent fund: Expenditures Cash—income (assumes park activities reported in the permanent fund) Government-wide statements (governmental activities) Recreation expenses Cash

75,000 75,000

5. Fund statements Enterprise fund: Benefits expenses Cash

70,000

Government-wide statements (business-type activities): Unemployment compensation benefit plan expenses Cash

70,000

Enterprise fund is used because the benefits are available to all citizens, not just government employees. 6. Fund statements Enterprise fund: Interest expense Interest payable

65,000 65,000

Government-wide statements (business-type activities) Parking garage expenses 65,000 Interest payable 65,000 Note: Typically business-type expenses are categorized by enterprise activity. 7. Fund statements—no entry in general fund because the interest is not due this year Government-wide statements (governmental activities) Interest expense Interest payable

E12.3 Fund and Government-Wide Financial Statements 1. 2. 3. 4. 5.

b, d b e b c

50,000 50,000

E12.4 Transaction Reporting in Fund and Government-Wide Statements 1. Fund statements Capital projects fund: Cash Bond proceeds (other financing sources) Expenditures Cash

10,000,000 10,000,000 12,000,000 12,000,000

Bond proceeds and expenditures reported in the governmental funds statement of revenues, expenditures, and changes in fund balances. Government-wide statements (governmental activities): Cash Bonds payable

10,000,000 10,000,000

Capital assets Cash

12,000,000

Unrestricted net position Net investment in capital assets

2,000,000

12,000,000

2,000,000

Bonds payable, capital assets, and categories of net position reported in the government-wide statement of net position. 2. Fund statements Debt service fund: Expenditures: principal Expenditures: interest Cash

500,000 25,000 525,000

Expenditures reported in the governmental funds statement of revenues, expenditures, and changes in fund balances. Government-wide statements (governmental activities): Long-term general obligation debt Interest expense Cash

500,000 25,000 525,000

Interest expense reported in statement of activities, debt reported in statement of net position. If the payment reduces a legal restriction imposed by a debt covenant, there may be a reduction in net position restricted for debt service and an increase in the unrestricted component of net position in that amount. 3. Fund statements

General fund: Expenditures (capital outlay) Cash

150,000 150,000

Capital outlay reported in the expenditures section of the governmental funds statement of revenues, expenditures and changes in fund balances. Government-wide statements (governmental activities): Capital assets Cash Unrestricted net position Net investment in capital assets

150,000 150,000 150,000 150,000

Capital assets and net position balances reported in the government-wide statement of net position. 4. Fund statements General fund Cash Proceeds from sale of capital assets (other financing source)

40,000 40,000

Proceeds reported in governmental funds statement of revenues, expenditures, and changes in fund balances. Government-wide statements (governmental activities): Cash Loss on sale of capital assets Capital assets, net $20,000 loss = $40,000 – ($300,000 – ($300,000/5 x 4)) Net investment in capital assets Unrestricted net position

40,000 20,000 60,000

60,000 60,000

Reduction in capital assets, net and recategorization of net position reported in government-wide statement of net position. Loss on sale reported in statement of activities (governmental activities).

5. Fund statements Custodial fund: Cash Additions: collection of town property taxes Deductions: property taxes owing to town Liability to town for property taxes

225,000 225,000 225,000 225,000

Additions and deductions reported in statement of changes in fiduciary net position. Government-wide statements: not reported. 6. Fund statements Pension trust fund: Investments Cash

550,000 550,000

Investments reported in statement of fiduciary net position. Government-wide statements: not reported. 7. Pension trust fund: Investments Unrealized gains on investments

11,000 11,000

Investments reported in statement of fiduciary net position. Unrealized gains reported in statement of changes in fiduciary net position. Government-wide statements: not reported. 8. Fund statements Special revenue fund: Cash Revenues

200,000 200,000

Revenues reported in the governmental fund statement of revenues, expenditures, and changes in fund balances. Government-wide statements (governmental activities): same entry Revenues reported as program revenues on the statement of activities. The program category could be community development or education, shown under governmental activities.

E12.5 Fund and Government-Wide Reporting 1. Fund statements General fund: Property taxes receivable Property tax revenues

4,500,000 4,500,000

Revenues reported in the governmental funds statement of revenues, expenditures and changes in fund balances; receivable reported in the governmental funds balance sheet. Government-wide statements (governmental activities): same entry Revenues reported as general revenues in the governmental activities column of the statement of activities; receivable reported in the assets section of the government-wide statement of net position. 2. Fund statements Special revenue fund: Cash Revenues

850,000 850,000

Revenues reported as special revenue fund revenues in the governmental funds statement of revenues, expenditures and changes in fund balances; adds to fund balance: restricted. Government-wide statements (governmental activities): same entry Revenues reported as public safety program revenues in the statement of activities; increases the restricted component of net position in the statement of net position. 3. Fund statements Debt service fund: Cash Investment income

55,000 55,000

Investment income reported as revenue of the debt service fund in the governmental funds statement of revenues, expenditures and changes in fund balances; adds to fund balance: restricted or committed. Government-wide statements (governmental activities): same entry Investment income appears with general revenues in the statement of activities; adds to restricted net position.

4. Fund statements Permanent fund: Cash Investment income

85,000 85,000

Investment income reported with revenues of a permanent fund in the governmental funds statement of revenues, expenditures and changes in fund balances; adds to fund balance restricted to cultural activities in the permanent fund column in the governmental funds balance sheet. Government-wide financial statements (governmental activities): same entry Investment income reported as program revenues under governmental activities. Adds to governmental activity net position in the statement of net position, in a restricted category. 5. Fund statements Enterprise fund: Cash Revenues

45,000 45,000

Revenues reported as revenues of an enterprise fund in the proprietary funds statement of revenues, expenses, and changes in net position. Government-wide statements (business-type activities): same entry Revenues reported as charges for services under business-type activities in the statement of activities. 6. Fund statements: not reported Government-wide statements (governmental activities): Depreciation expense Capital assets, net

35,000 35,000

Depreciation reported as expenses of public safety governmental activities in the government-wide statement of activities; reduces governmental activity capital assets and net investment in capital assets in the government-wide statement of net position.

7. Fund financial statements General fund: Cash Investment income

25,000 25,000

Investment income reported in the governmental funds statement of revenues, expenditures, and changes in fund balances. Government-wide statements (governmental activities): same entry Investment income reported under general revenues (governmental activities) in the statement of activities. 8. Fund financial statements Internal service fund: Due from other funds Revenues

32,000 32,000

Revenues reported as operating revenues of internal service funds in the proprietary funds statement of revenues, expenses, and changes in net position. Due from other funds reported in proprietary funds statement of net position. Government-wide statements (governmental activities): same entry Revenues reported as revenue from charges for services, most likely in the general category of governmental activities in the statement of activities. Due from other funds appears in the government-wide statement of net position as internal balances, to the extent that amounts are owing from proprietary funds. Amounts due from/to funds included in governmental activities (governmental funds and internal service funds) are eliminated. 9. Fund financial statements: not reported Government-wide statements (governmental activities): Interest expense 30,000 Interest payable 30,000 Interest expense reported with governmental activities expenses in the statement of activities. Interest payable reported with governmental activities liabilities in the statement of net position.

E12.6 Choice of Fund Type

1. 2. 3. 4. 5. 6.

Fund Type Custodial Special revenue Internal service Permanent Enterprise Debt service

Accounting Method Full accrual Modified accrual Full accrual Modified accrual Full accrual Modified accrual

E12.7 Reporting Capital Assets in the Government-Wide and Fund Statements a. Government-wide statement of activities Expense Loss on sale of capital assets

$215,000 (45,000) (1)

(1) $(45,000) = $100,000 – ($385,000 - $240,000) b. Government-wide statement of net position Capital assets, at cost Less accumulated depreciation Capital assets, net c. Governmental funds statement of revenues, expenditures, and changes in fund balances Expenditures:capital outlay Other financing source: proceeds from sale of capital assets d. Governmental funds balance sheet No information on capital assets reported.

$3,190,000 (1,275,000) $1,915,000

$375,000 100,000

E12.8 Major Funds Calculation of thresholds:

Element Assets

Total for Governmental Funds $ 500,000

Total for Governmental and Enterprise Funds $ 700,000

10% Test $ 50,000

5% Test $ 35,000

Liabilities

460,000

46,000

580,000

29,000

Revenues

2,000,000

200,000

5,500,000

275,000

Expenses/expenditures

1,890,000

189,000

4,600,000

230,000

Tests:

Buildings, equipment and improvements Highways, roads, bridges and equipment Olean County Medical Center

Assets

Liabilities

Revenues

Expenses/ Expenditures

10% test

Yes

5% test

Yes

10% test

10% test 5% test

5% test

No No

Yes

The highways, roads, bridges and equipment, and Olean County Medical Center capital projects funds are reported as major funds in the governmental funds financial statements.

E12.9 Reconciliation of Governmental Funds Balance Sheet to Government-Wide Statement of Net Position (in thousands) Fund balances, governmental funds Plus capital assets, net of accumulated depreciation Less accrued compensated absences and OPEB costs Less bonds payable Less accrued interest payable Plus internal service fund net position Net position, governmental activities

$ 403,000 280,000 (65,000) (250,000) (3,000) 5,000 $ 370,000

E12.10 Reconciliation of Governmental Funds Statement of Revenues, Expenditures, and Changes in Fund Balances to Government-Wide Statement of Activities (in thousands) Change in fund balances, governmental funds Plus capital outlay Less depreciation expense Plus debt principal payments Less bond proceeds Less accrued pension and OPEB costs Less accrued interest expense Less proceeds from sale of capital assets Less loss on sale of capital assets Plus change in internal service fund net position Change in net position, governmental activities

$ 44,000 70,000 (40,000) 90,000 (125,000) (95,000) (3,000) (15,000) (5,000) 800 $ (78,200)

E12.11 Reconciliation of Budgetary Basis to GAAP Basis (in thousands) Excess of revenues and other financing sources over expenditures and other financing uses—budgetary basis Less encumbrances, January 1 Plus encumbrances, December 31 Excess of revenues and other financing sources over expenditures and other financing uses—GAAP basis

$ (8,965) (2,889) 2,466 $ (9,388)

E12.12 Reporting Compensated Absences in Government-Wide and Fund Statements (in thousands) a.

d. e.

Government-wide statement of activities: Governmental activities, expense $1,031 Business-type activities, expense 96 Government-wide statement of net position: Governmental activities, liability $2,600 Business-type activities, liability 239 Statement of revenues, expenditures, and changes in fund balances, governmental funds: Expenditure $1,020 - $41 = $ 979 Balance sheet, governmental funds Liability $ 0 Statement of revenues, expenses, and changes in net position, proprietary funds: Enterprise fund expense $ 96 Internal service fund expense 43 Statement of net position, proprietary funds: Enterprise fund liability 239 Internal service fund liability 61

E12.13 Reconciliation of Budgetary Basis to GAAP Basis (in thousands) Excess of revenues and other financing sources over expenditures and other financing uses—budgetary basis

65,835

Encumbrances reported as budgetary expenditures

383,015

Prior year encumbrances expended in current year

(290,571)

Unbudgeted expenditures

(144,006)

Budgeted net revenues not reported in general fund

(1,233)

General fund borrowings

(8,015)

GAAP revenues less expenditures in excess of budgetary revenues less expenditures

62,441

Excess of revenues and other financing sources over expenditures and other financing uses—GAAP basis

67,466

E12.14 Major Funds (in thousands) A fund that does not meet the 10% threshold must be below each of the following thresholds: Total assets and deferred outflows of enterprise funds: Total liabilities and deferred inflows of enterprise funds: Total revenues of enterprise funds: Total expenses of enterprise funds:

$2,515 x 10% = $251.5 $2,052 x 10% = $205.2 $3,265 x 10% = $326.5 $3,272 x 10% = $327.2

The Sewer Fund is below the 10% threshold on all four elements. The other funds are above the threshold on all four elements. Therefore the sewer fund is not a major fund. The remaining funds must also meet the 5% threshold: Total assets and deferred outflows of governmental and enterprise funds: Total liabilities and deferred inflows of governmental and enterprise funds: Total revenues of governmental and enterprise funds: Total expenses of governmental and enterprise funds:

$9,700 x 5% = $485 $9,600 x 5% = $480 $13,000 x 5% = $650 $12,500 x 5% = $625

The Water Fund meets the 5% threshold for assets and deferred outflows, revenues, and expenses, so it is a major fund. The Airport Fund meets the 5% threshold for all four elements, so it is a major fund. The Harbor Fund does not meet the 5% threshold for any element. Therefore, the Harbor Fund is not a major fund. The Water Fund and the Airport Fund are reported separately as major funds. The Sewer Fund and Harbor Fund are reported together in one column.

E12.15 Investments a. Investment income, $3,500,000: a line in the revenues section of the governmental funds statement of revenues, expenditures, and changes in fund balances. Investment income, $420,000: a line in the nonoperating revenues (expenses) section of the enterprise funds statement of revenues, expenses, and changes in net position. Realized gains, $600,000: included in investment income in the revenues section of the governmental funds statement of revenues, expenditures, and changes in fund balances. Unrealized losses, $10,000: included in investment income in the revenues section of the governmental funds statement of revenues, expenditures, and changes in fund balances. Unrealized losses, $35,000: included in nonoperating revenues (expenses) on the enterprise funds statement of revenues, expenses, and changes in net position. Unrealized gains and losses on derivative hedge investments are not reported by governmental funds. Accumulated unrealized gains on derivative hedge investments, enterprise funds: $20,000: reported as deferred inflows on the enterprise funds statement of net position, on the liability side. These gains are not reported in the enterprise funds’ operating statement. The investments appear as assets. Accumulated unrealized losses on derivative hedge investments, enterprise funds: $90,000: reported as deferred outflows on the enterprise funds statement of net position, on the asset side. These losses are not reported in the enterprise funds’ operating statement. The investments appear as liabilities. b. Statement of Activities Governmental activities: Investment income Business-type activities: Investment income

$4,090,000 (1) $ 385,000 (2)

Statement of Net Position Assets Governmental activities: Investment in derivatives Business-type activities: Investment in derivatives Deferred outflows Governmental activities: Deferred outflows on derivatives Business-type activities: Deferred outflows on derivatives Liabilities Governmental activities: Investment in derivatives Business-type activities: Investment in derivatives Deferred inflows Governmental activities: Deferred inflows on derivative instruments Business-type activities: Deferred inflows on derivative instruments (1) $4,090,000 = $3,500,000 + $600,000 - $10,000

7,000 20,000

2,500 90,000

7,000 20,000

(2) $385,000 = $420,000 - $35,000

E12.16 Accounting for Pensions Deferred outflows—pensions Pension expense Deferred inflows—pensions Pension liability

45,000,000 142,000,000

Pension liability Cash

80,000,000

2,000,000 185,000,000

80,000,000

E12.17 Statement of Activities Colusa County Statement of Activities For the Year Ended June 30, 2020 (amounts in thousands)

Program Revenues

Functions/Programs

Expenses

Charges Grants & for Services Contributions

Net (Expense) Revenue and Changes in Net Position Governmental Activities

Business-Type Activities

$(10,000)

$ --

$(10,000)

Total

Governmental activities: General government

$11,800

$ 1,800

Public safety

30,900

5,300

(25,600)

Education

23,100

350

(22,750)

Transportation

800

(800)

Total governmental activities

66,600

7,100

350

(59,150)

Water utility

11,900

13,200

1,300

Total primary government

$78,500

$20,300

350

$(59,150)

1,300

$(57,850)

Property taxes

50,200

Occupancy taxes

9,600

Investment income

500

Total general revenues

60,300

Excess (deficiency) of revenues over expenses

1,150

1,300

2,450

Net position-beginning

7,600

15,400

23,000

Net position-ending

$ 8,750

$16,700

$25,450

Business-type activities:

General Revenues

PROBLEMS P12.1 Reconcile Fund Statements to Statement of Net Position Total fund balances—governmental funds

$ 51,000,000

Capital assets used in governmental activities, net of accumulated depreciation

135,500,000

Long-term liabilities used to finance governmental activities

(75,000,000)

Internal service fund net position included in the statement of net position but not included in the governmental funds balance sheet Net position—governmental activities

3,000,000 $ 114,500,000

P12.2 Reconcile Fund Statements to Statement of Activities Change in total fund balances—governmental funds

Excess of general capital outlays over depreciation expense ($85,000 - $45,000)

90,000 40,000

Book value of general capital assets sold (1)

(110,000)

General revenues not providing current resources

21,000

Repayments in excess of proceeds from general long-term debt ($116,000 - $73,000)

43,000

General expenses not requiring current resources

(15,000)

Change in net position—internal service funds

4,000

Change in net position—governmental activities

73,000

(1) Governmental fund balances already include the $35,000 proceeds. Subtracting the $110,000 book value leaves the $75,000 loss reported under accrual accounting in the government-wide statement of activities.

P12.3 Government-Wide Statement of Activities City of Daysville Statement of Activities For the Year Ended December 31, 2020 (amounts in thousands) Net (Expense) Revenue and Changes in Net Position

Program Revenues

Functions/Programs

Expenses

Charges Grants & for Services Contributions

Governmental Activities

Business-Type Activities

Total

Governmental activities: General government

$26,000

$14,000

$ --

$(12,000)

$ --

$(12,000)

Public safety

19,000

900

5,000

(13,100)

Health & Sanitation

9,000

4,500

(4,500)

Interest on long-term debt

550

(550)

54,550

19,400

5,000

(30,150)

1,100

1,500

400

$55,650

$20,900

$5,000

$(30,150)

$(29,750)

Property taxes

32,000

Unrestricted grants & contributions

5,000

Investment income

Special item: Gain on sale of assets

Total

37,125

Excess (deficiency) of revenues over expenses

6,975

400

7,375

Net position-beginning

18,000

550

18,550

Net position-ending

$24,975

$950

$25,925

Total governmental activities

Business-type activities: Parking garage Total primary government

General Revenues

P12.4 Government-Wide Statement of Net Position Governmental Activities

Business-Type Activities

Total

820,000 (1)

$ 57,000 (8) $

877,000

Taxes receivable

1,100,000 (2)

1,100,000

Investments

14,090,000

Capital assets, net

85,450,000 (3)

555,000 (9)

86,005,000

101,460,000

612,000

102,072,000

Assets Cash

Total assets

Liabilities Accounts payable

1,080,000 (4)

22,000 (10)

1,102,000

Long-term debt

40,110,000 (5)

200,000

40,310,000

41,190,000

222,000

41,412,000

49,740,000 (6)

375,000 (11)

50,115,000

26,000 (12)

26,000

(11,000) (13)

10,519,000

Total liabilities Net position Net investment in capital assets Restricted for Community Center projects Unrestricted Total net position

-10,530,000 (7) $ 60,270,000

$ 390,000

$ 60,660,000

Calculations: (1) $820,000 = $1,500,000 + $14,900,000 + $230,000 - $540,000 - $14,920,000 - $300,000 - $50,000. (2) $1,100,000 = $1,000,000 + $15,000,000 - $14,900,000. (3) $85,450,000 = $85,000,000 + $540,000 + $410,000 - $500,000. (4) $1,080,000 = $1,000,000 + ($15,500,000 - $500,000) - $14,920,000. (5) $40,110,000 = $40,000,000 + $410,000 - $300,000 (6) $49,740,000 = $50,000,000 + $540,000 - $500,000 - $300,000. (7) $10,530,000 = $10,500,000 + $15,000,000 + $230,000 - $540,000 + ($14,090,000 - $14,000,000) $15,500,000 + $300,000 - $50,000 + $500,000. (8) $57,000 = $40,000 + 20,000 + $1,200,000 - $1,178,000 - $25,000. (9) $555,000 = $560,000 + $25,000 - $30,000. (10) $22,000 = $25,000 + ($1,205,000 - $30,000) - $1,178,000. (11) $375,000 = $380,000 + $25,000 - $30,000. (12) $26,000 = $6,000 + $20,000. (13) $(11,000) = $(11,000) + $1,200,000 - $1,205,000 - $25,000 + 30,000.

Note: Sales taxes collected and remitted to the state are not included in the statement of net position, because custodial funds are not reported in the government-wide statements.

Journal entries to record the events of 2020 (not required) Governmental activities Taxes receivable Revenues (net position, unrestricted)

15,000,000

Cash

14,900,000

15,000,000

Taxes receivable Cash

14,900,000 230,000

Revenues (net position, unrestricted)

230,000

Capital assets Cash

540,000

Net position, unrestricted Net investment in capital assets

540,000

Capital assets Long-term debt

410,000

Investments Gains (net position, unrestricted)

90,000

Long-term debt Cash

300,000

Net investment in capital assets Net position, unrestricted

300,000

Expenses (net position, unrestricted) Cash

50,000

Expenses (net position, unrestricted) Capital assets Cash Accounts payable

15,500,000

Net investment in capital assets Net position, unrestricted

540,000

410,000

90,000

300,000

50,000

500,000 14,920,000 80,000 500,000 500,000

Community Center (Business-type activities) Cash

1,200,000 Revenues (net position, unrestricted)

1,200,000

Capital assets Cash

25,000

Net position, unrestricted Net investment in capital assets

25,000

Expenses (net position, unrestricted) Accounts payable Capital assets Cash

1,205,000 3,000

25,000

30,000 1,178,000

Net investment in capital assets Net position, unrestricted

30,000

Cash

20,000

30,000

Net position, restricted for C.C. projects

20,000

P12.5 Reconciliation of Modified Accrual to Full Accrual Accounting Revenues in excess of expenditures and other financing sources (uses) Depreciation expense Decrease in compensated absences payable Increase in inventory Payment of debt principal Capital outlay Decrease in accrued interest payable Increase in OPEB and pension liabilities Increase in deferred outflows of resources for pensions Book value of capital assets sold Amortization of deferred outflow on debt refunding Amortization of bond premium Change in net position

$ 2,210,797 (2,399,477) 9,720 2,428 1,055,000 1,074,054 9,666 (638,585) 185,123 (6,434) (26,971) 96,054 $ 1,571,375

P12.6 Government-Wide Statement of Net Position Central City Statement of Net Position September 30, 2020 Governmental Business-Type Activities Activities

(in thousands) Assets Cash and cash equivalents Property taxes receivable, net Internal balances Supplies Capital assets: Depreciable, net Nondepreciable Total assets Liabilities Accounts payable Accrued current liabilities Bonds payable Total liabilities Net Position Net investment in capital assets Restricted: Grant activities Capital projects Debt service Unrestricted (deficit) (3) Total net position (1) (2) (3)

150,000 130,000 12,000 35,000

40,000 -(12,000) 2,000

$ 190,000 130,000 -37,000

300,000 62,000 689,000

120,000 19,000 169,000

420,000 81,000 858,000

34,000 8,000 200,000 242,000

21,000 4,000 56,000 81,000

55,000 12,000 256,000 323,000

162,000 (1)

83,000 (2)

245,000

35,000 220,000 140,000 (110,000) $ 447,000

$162,000 = $300,000 + $62,000 - $200,000. $83,000 = $120,000 + $19,000 - $56,000. plug number

Total

-1,000 -4,000 $ 88,000

35,000 221,000 140,000 (106,000) $ 535,000

P12.7 Statement of Activities Canyon County, Idaho Statement of Activities For the Year Ended September 30, 2016

Program Revenues

Functions/Programs

Expenses

Charges Grants and for Services Contributions

Net (Expense) Revenue and Changes in Net Position Governmental Activities

Business-Type Activities

Total

Governmental activities: General government $40,535,726 $10,881,104

$1,071,858

$(28,582,764)

$ --

$(28,582,764)

Public safety

27,465,586

4,418,002

1,444,520

(21,603,064)

Public works

866,727

106,449

(760,278)

Health and welfare

4,021,491

404,648

22,850

(3,593,993)

Culture and recreation

2,479,021

698,274

32,504

(1,748,243)

Total governmental activities

75,368,551

16,508,477

2,571,732

(56,288,342)

4,211,048

3,842,441

(368,607)

$79,579,599 $20,350,918

$2,571,732

$(56,288,342)

Business-type activities: Landfill Total primary government

(368,607) $(56,656,949)

General Revenues Property taxes

39,958,900

Sales taxes

10,463,288

Interest and investment earnings

1,081,419

207,668

1,289,087

51,503,607

207,668

51,711,275

Change in net position

(4,784,735)

(160,939)

(4,945,674)

Net position, beginning

63,912,642

17,146,236

81,058,878

Net position, ending

$59,127,907

$16,985,297

$76,113,204

Total

P12.8 Major Funds Calculation of thresholds: Element

Total for Governmental Funds

10% Test

Total for Governmental and Enterprise Funds

5% Test

Assets

$ 234,000

$ 23,400

$ 1,094,000

$ 54,700

Liabilities

195,800

19,580

1,015,800

50,790

Revenues

1,405,000

140,500

3,245,000

162,250

Expenses/expenditures

1,400,000

140,000

3,133,000

156,650

Tests:

Grants special revenue fund Parks and recreation special revenue fund

Assets

Liabilities

Revenues

Expenses/ Expenditures

10% test

Yes

5% test

Yes

10% test

Yes

5% test 10% test

Licensed gaming special revenue fund

5% test 10% test

Roads: capital projects fund

Bridges: capital projects fund Buildings: capital projects fund

5% test 10% test

Yes

5% test

10% test

Yes

5% test

The general fund, grants special revenue fund and roads capital projects fund are reported separately as major funds in the governmental funds financial statements.

P12.9 Long-Term Liabilities in the Government-Wide and Fund Statements An amortization schedule for each bond is below. This solution uses the effective interest method, and assumes the total annual interest expense reported for the second bond is split equally between the two fiscal years. Bond #1 Interest Expense 7/1/17 6/30/18 6/30/19 6/30/20

Change in Liability

$3,256 3,234 3,211

$744 766 789

Ending Liability Bal. $108,531 107,787 107,021 106,232

Bond #2 Interest Expense 1/1/19 6/30/19 12/31/19 6/30/20

Change in Liability

$1,372 1,372 1,383

a. 2020 Statement of Activities: Interest expense 6/30/20 Statement of Net Position: Interest payable Bonds payable

$372 372 383

Ending Liability Bal. $91,470 91,842 92,214 92,597

$3,211 + $1,372 + $1,383 =

5,966

$106,232 + $92,597 =

$ 1,000 $198,829

b. 2020 Statement of revenues, expenditures, and changes in fund balances: Interest expenditure $4,000 + $2,000 = $ 6,000 No recognition of the bond principal balance or interest payable, since neither is due currently.

P12.10 Fund and Government-Wide Financial Statements 1. 2. 3. 4. 5.

b, d b a b d

6. h, i 7. b, f, g 8. d 9. h 10. b

P12.11 Analysis of the City of St. Louis CAFR a. Governmental activities report the operations of the general fund, special revenue funds, capital projects funds, debt service funds, permanent funds, and internal service funds. Business-type activities report the operations of the enterprise funds. b. The governmental funds balance sheet reports on the modified accrual basis, where assets are defined as resources available to pay current obligations, and liabilities are defined as obligations to be paid with current financial resources. Therefore longterm assets and liabilities, such as capital assets and long-term liabilities, are not reported. The statement of net position uses full accrual accounting, therefore longterm assets and liabilities are reported as assets and liabilities. c. (1) The statement of activities reports revenues as program revenues and general revenues. Program revenues can be charges for program services, or grants and contributions specific to programs. General revenues are used to finance the deficit of program expenses over program revenues. The statement of revenues, expenditures, and changes in fund balances reports revenues by source, such as taxes, licenses and permits, and court fines. (2) There are three additional expenditure lines on the governmental funds operating statement that do not appear on the statement of activities: capital outlay, debt service: principal payments, and advance refunding escrow. The modified accrual basis reports outlays for capital assets and payment of principal on debt as reductions in fund balance, while full accrual accounting reports principal payments as reductions in liabilities and capital outlay as increases in assets, with no effect on net position. (3) The accounts related to long-term debt (issuance of bonds, notes and loans, premium on bond issuances, payment to refunded escrow agent) are increases and decreases in long-term liabilities on the statement of net position. Transfers in and transfers out are not reported in the statement of activities unless they involve transfers between governmental and business-type activities, such as the $9,957,000 transfer from business-type to governmental activities. The nature of the proceeds from agreement with Forest Park Forever is not clear, but alert students will find this item in the Exhibit 12.6 reconciliation, showing the proceeds as a loan, and therefore an increase in liabilities on the statement of net position. (4) Expenses differ from expenditures because expenses are recognized using full accrual accounting, while expenditures are reported only if they use current resources. Expenditures do not include accrued expenses that will not be paid this period, such as pension and OPEB benefits for current employees, and asset write-offs from depreciation or impairment.

d. Enterprise fund revenues and expenses are reported in the business-type activities section of the government-wide statement of activities. However, they are packaged differently on the two statements. Business-type expenses reported on the statement of activities = $230,735,000 Expenses reported for enterprise funds on the statement of revenues, expenditures, and changes in net position: Total operating expenses Interest expense Loss on disposal of capital assets Total expenses

$ 191,774,000 38,447,000 514,000 $ 230,735,000

Business-type revenues reported on the statement of activities: Charges for services Operating grants and contributions Capital grants and contributions Unrestricted investment earnings Extraordinary item—natural disaster Total

$237,444,000 692,000 9,378,000 3,585,000 ___678,000 $251,777,000

Enterprise fund revenues reported on the statement of revenues, expenses and changes in net position: Operating revenues Intergovernmental revenue Investment income Passenger facility charges Miscellaneous, net Capital contributions Extraordinary item—natural disaster Total

$210,338,000 692,000 3,585,000 25,785,000 1,321,000 9,378,000 _ _678,000 $251,777,000

e. Fiduciary fund balances are not reported in the government-wide statements.

P12.12 Capital Leases in Government-Wide and Fund Statements a. The general fund lease is reported using modified accrual accounting, as follows: July 1, 2019 Expenditures—capital leases (capital outlay) 55,502 Other financing sources—capital leases 55,502 To record capital lease at inception. $55,502 is the present value of lease payments of $20,000 per year for 3 years at 4%. June 30, 2020 Expenditures—interest Expenditures—principal Cash To record lease payment. $2,220 = $55,502 x 4%.

2,220 17,780 20,000

The water department lease is reported using full accrual accounting, as follows: July 1, 2019 Leased equipment 90,748 Lease liability 90,748 To record capital lease at inception. $90,748 is the present value of lease payments of $25,000 per year for 4 years at 4%. June 30, 2020 Interest expense Lease liability Cash To record lease payment. $3,630 = $90,748 x 4%.

3,630 21,370 25,000

Depreciation expense 22,687 Leased equipment 22,687 To record depreciation expense on the leased equipment. $22,687 = $90,748/4.

b. On the government-wide statements, the water department lease is reported the same as in the funds statements. The general fund lease is reported using full accrual accounting, as follows: July 1, 2019 Leased equipment Lease liability To record capital lease at inception. June 30, 2020 Interest expense Lease liability Cash To record lease payment; $2,220 = $55,502 x 4%.

55,502 55,502

2,220 17,780 20,000

Depreciation expense 18,501 Leased equipment 18,501 To record depreciation expense on the leased equipment. $18,501 = $55,502/3. c. To reconcile the fund balances of governmental funds to net position of governmental activities at June 30, 2021: Add leased asset, net of accumulated depreciation [$55,502 – (2 x ($18,501)] Subtract principal of lease obligation ($55,502 - $17,780 - $18,491) $18,491 = $20,000 – [($55,502 - $17,780) x 4%].

$18,500 (19,231)

To reconcile the change in fund balances of governmental funds to change in net position of governmental activities for the year ended June 30, 2021: Subtract depreciation expense Add principal payment on lease

$(18,501) 18,491

P12.13 Analysis of Reconciliation Data a. Net position of internal service funds Included in governmental activities but not in governmental funds. No adjustment in the balance because internal service funds use full accrual accounting. Subtract a negative position. Accrued interest payable on long-term debt Not reported in governmental funds because it does not require current resources; recorded as a liability in government-wide statements. Subtract. Other postemployment benefit obligations Not reported in governmental funds because it does not require current resources; recorded as a liability in government-wide statements. Subtract. Revenues not to be received in cash within 60 days Reported as receivables in the government-wide statements, not recorded in the governmental funds because it does not provide resources within 60 days. Add. Governmental capital assets less accumulated depreciation Capital assets are recorded as assets, with no effect on net position. Depreciation reduces net position. Governmental funds report the outlay for capital assets as an expenditure, reducing fund balances, with no depreciation reported. Add. Total accrued compensated absences Not reported in governmental funds because it does not require current resources; recorded as a liability in government-wide statements. Subtract. Net unamortized premium on bond issues Premiums are additional resources received above the face value of bonds issued. These are liabilities on the government-wide statements, but they increase fund balances (additional other financing sources), on the governmental funds statements. Subtract. Long-term claims payable Not reported in governmental funds because current resources are not used; recorded as a liability in government-wide statements. Subtract. Deferred outflows on refunding The additional costs of refunding reduce governmental fund balance, but are reported as deferred outflows (debit balance) on the government-wide statement of net position. Add. Net pension liability Not reported in governmental funds because it does not require current resources; recorded as a liability in government-wide statements. Subtract.

Long-term bonds and notes payable Proceeds reported as other financing sources and adds to governmental fund balance; liability and no effect on net position on government-wide statements. Subtract. Net deferred outflows related to pensions These are net increases in pension liabilities that are deferred in the government-wide statement of net position. Since the total pension liability is subtracted, an adjustment is needed to reflect the deferred portion, which is a reduction in the liability. Add.

b. (in thousands) Total fund balances—governmental funds Net position of internal service funds Accrued interest payable on long-term debt Other postemployment benefit obligations Revenues not to be received in cash within 60 days Governmental capital assets less accumulated depreciation Total accrued compensated absences Net unamortized premium on bond issues Long-term claims payable Deferred outflows on debt refunding Net pension liability Long-term bonds and notes payable Net deferred outflows related to pensions Net position of governmental activities

$ 439,333 (4,451) (87,410) (56,584) 49,856 4,294,558 (35,787) (66,285) (55,345) 53,787 (569,038) (1,595,558) 90,622 $2,457,698

c. The major reconciliation items are capital assets and long-term debt. For St. Louis, long-term debt exceeds capital assets. For Kansas City, capital assets exceed longterm debt. St. Louis has a relatively larger debt level, and therefore its financial health looks better using modified accrual accounting, where debts are equivalent to revenue. Kansas City has relatively more capital assets, and therefore its financial health looks better using full accrual accounting, where capital assets are assets rather than expenditures.

P12.14 Reconciliation of Government-Wide and Fund Financial Statements (in thousands) Net change in fund balances—governmental funds Capital expenditures of governmental funds Depreciation expense on capital assets of governmental funds Depreciated cost of capital assets sold by governmental funds Compensated absences earned in excess of payments made, governmental funds Pension and other postemployment benefits earned, governmental funds Other expenses of governmental funds not requiring current resources General obligation debt principal repayment Face value of general obligation debt issued Premium on general obligation debt issued Amortization of general obligation bond premium Increase in net position, internal service funds Amount by which increase in deferred inflows of governmental activities exceeded increase in deferred inflows of governmental funds Change in net position—governmental activities

$ 227,406 53,312 (22,067) (8,227) (4,834) (66,636) (5,462) 24,645 (167,900) (33,278) 2,117 218

(180) (886)

Note: • • •

Items pertaining to fiduciary funds are not included because fiduciary fund information is not in the government-wide statements. Governmental funds charges for services are recorded the same way in the government-wide statements. Fair value of donated assets results in no change in net position.

P12.15

Fund and Government-Wide Financial Statements 1. a, e 2. a, c 3. a, e, g 4. a, e, g 5. b, d 6. b 7. c 8. f (only proprietary funds use operating/nonoperating classifications) 9. b, f, possibly h, if reported as a separate line 10. g 11. h 12. a, e, g 13. a, c, e, possibly g 14. b, d, f, h 15. g 16. a, e, possibly g 17. c (government-wide statements do not report internal balances between governmental funds) 18. a, c, e 19. c 20. b, f, h

P12.16 Deferred Outflows and Inflows of Resources Deferred outflows Debt refunding deferred outflows occur when a government calls in high interest debt and replaces it with lower interest debt. A deferred outflow results when the amount of lower rate debt issued is greater than the book value of the higher rate debt. Deferred outflows for debt refunding appear on the government-wide statement of net position and the proprietary funds statement of net position. The outflow is subsequently amortized as an increase in interest expense on the new debt. Hedging derivatives deferred outflows occur when hedge investments have a credit fair value. This most commonly occurs with receive variable/pay fixed interest rate swaps, which lose value when interest rates fall. These deferred outflows typically appear on the government-wide statement of net position and the proprietary funds statement of net position. Deferred outflows for pensions occur when the pension liability increases due to changes in economic or demographic assumptions, or differences between expected and actual investment results. These deferred outflows typically appear on the government-wide statement of net position and the proprietary and fiduciary funds statement of net position. The deferred outflows are subsequently amortized as an increase in pension expense. Deferred inflows Deferred inflows for unavailable revenues occur when taxes are collected in advance of the period in which they may be used. These deferred inflows appear on the governmental funds balance sheet, using modified accrual accounting. The deferred inflows become tax revenues during the period in which they may be used. Debt refunding deferred inflows occur when a government calls in high interest debt and replaces it with lower interest debt. A deferred inflow results when the amount of lower rate debt issued is lower than the book value of the higher rate debt. Deferred inflows for debt refunding appear on the government-wide statement of net position and the proprietary funds statement of net position. The inflow is subsequently amortized as an reduction in interest expense on the new debt. Deferred inflows for pensions occur when the pension liability decreases due to changes in economic or demographic assumptions, or differences between expected and actual investment results. These deferred inflows typically appear on the government-wide statement of net position and the proprietary and fiduciary funds statement of net position. The deferred inflows are subsequently amortized as a reduction in pension expense.

P12.17 Comprehensive Government-Wide Financial Statements (in thousands) a.

General fund entries for events described in P10.17, using full accrual accounting: Property taxes receivable Allowance for uncollectible taxes Property tax revenues To accrue fiscal 2020 property taxes.

900,000

Cash

890,000

20,000 880,000

Property taxes receivable To record collection of fiscal 2020 taxes.

890,000

Allowance for uncollectible taxes 14,000 Property tax revenues 14,000 To adjust allowance for uncollectible taxes. Note: taxes to be collected after 60 days are still revenues using full accrual accounting. Cash 4,000 Allowance for uncollectible taxes 3,300 Property taxes receivable 7,000 Property tax revenues 300 To record collection of fiscal 2019 taxes and write-off of the remainder. Cash

20,000

Revenues—state grant To record receipt of state grant. Cash

20,000

87,000

Revenues—licenses and fees To record collection of license and fee revenues. Cash

87,000

500

Due from special revenue fund 500 To record repayment of special revenue fund loan. Note: internal balances between governmental funds are not reported in the government-wide statements. Due from special revenue fund 200 Cash 200 To record loan to special revenue fund loan. Note: internal balances between governmental funds are not reported in the government-wide statements. Bonds payable—capital asset related Bonds payable—general Cash

18,000 7,000 25,000

To record payment of bond principal. Interest expense Accrued interest payable Cash To record interest expense and payment.

4,900 100 5,000

Expenses—general government Expenses—public safety Inventories Accumulated depreciation Cash Accounts payable To record general fund expenses.

607,420 374,800 80

Capital assets Cash To record acquisition of capital assets.

89,000

Cash Accumulated depreciation Loss on sale of capital assets—general government Capital assets To record sale of general government capital assets.

1,000 12,000

Cash

75,000

28,000 954,200 100

89,000

2,000 15,000

Bonds payable To record issuance of general bonds. Pension and OPEB expense—general government Pension and OPEB expense—public safety Deferred outflows—pensions Pension and OPEB liabilities To record accrual of pension and OPEB expenses.

75,000

2,900 300 1,500 4,700

Community projects fund entries for events described in P11.17, using full accrual accounting: Due to general fund 500 Cash 500 To record repayment of loan from general fund. Note: internal balances between governmental funds are not reported in the government-wide statements.

Cash

200 Due to general fund 200 To record loan from general fund. Note: internal balances between governmental funds are not reported in the government-wide statements. Cash

20 Due from water utility 20 To record collection of loan to water utility. Note: internal balances between governmental activities and business-type activities are reported in the governmentwide statements. Cash Federal grant revenues To record federal grant received.

10,000 10,000

Expenses—community projects fund 9,000 Capital assets 3,000 Accounts payable 10 Cash 10,410 Accumulated depreciation 1,600 To record community projects fund expenses and capital assets acquired.

Lake County Statement of Activities For the Year Ended June 30, 2020 (in thousands)

Program Revenues

Functions/Programs

Expenses

Charges Grants and for Services Contributions

Net (Expense) Revenue and Changes in Net Position Governmental Activities

Business-Type Activities

Total

Governmental activities: General government (1)

$ 612,320

$ (612,320)

375,100

20,000

Community projects

9,000

Interest charges

4,900

Total governmental activities

Public safety (2)

$ (612,320)

(355,100)

10,000

1,000

(4,900)

$1,001,320

30,000

(971,320)

35,460

36,000

540

1,036,780

36,000

30,000

(971,320)

540

(970,780)

Property taxes

894,300

Licenses and fees

87,000

Investment income

375

981,300

375

981,675

9,980

915

10,895

(113,270)

31,050

(82,220)

$ (103,290)

$ 31,965

$ (71,325)

Business-type activities: Water utility Total primary government

General Revenues

Total general revenues Change in net position Net position, beginning (deficit)…………. Net position, ending

(1) $612,320 = $607,420 + $2,000 + $2,900. (2) $375,100 = $374,800 + $300

Lake County Statement of Net Position June 30, 2020 (in thousands) Governmental Activities Assets Cash Property taxes receivable, net of $6,000 allowance for uncollectible taxes Accounts receivable Internal balances Inventories Investments Capital assets: Original cost Accumulated depreciation Capital assets, net Total assets Deferred outflows—pensions Total assets and deferred outflows Liabilities Accounts payable Accrued interest payable Pension and OPEB liabilities Bonds payable Total liabilities Net Position Net investment in capital assets (3) Restricted (4) Unrestricted (deficit) Total net position Total liabilities and net position

Business-Type Activities

Total

8,440

$ 2,340

10,780

4,000 -5 130 --

-6,750 (5) 230 9,310

4,000 6,750 -360 9,310

506,000 (200,600) 305,400 317,975 7,500 $ 325,475

74,850 (21,525) 53,325 71,950 1,175 $ 73,125

580,850 (222,125) 358,725 389,925 8,675 $ 398,600

6,165 900 21,700 400,000 428,765

510 -8,050 32,600 41,160

6,675 900 29,750 432,600 469,925

123,400 1,480 (228,170) (103,290) $ 325,475

24,125 -7,840 31,965 $ 73,125

147,525 1,480 (220,330) (71,325) $ 398,600

(3) Beginning balance + capital asset purchases + capital asset purchase - depreciation expense - depreciation expense - book value of capital assets sold + bond principal paid Ending balance (4) Beginning balance + grant revenue - expenses Ending balance

$46,000 89,000 3,000 (28,000) (1,600) (3,000) 18,000 $123,400

480 10,000 9,000 $ 1,480

b. Reconciliation of change in fund balances—governmental funds to change in net position—governmental activities for the year ended June 30, 2020 (in thousands) Change in fund balances—governmental funds $3,480 + $(400) $ 3,080 Plus capital outlays $89,000 + $3,000 92,000 Less depreciation expense $28,000 + $1,600 (29,600) Less book value of capital assets sold $15,000 - $12,000 (3,000) Plus increase in deferred outflows—taxes 600 Plus decrease in accrued interest payable 100 Less bond proceeds (75,000) Plus principal payments 25,000 Less increase in pension and OPEB liabilities (4,700) Plus increase in deferred outflows—pensions 1,500 Change in net position—governmental activities $ 9,980 Reconciliation of fund balances—governmental funds to net position—governmental activities June 30, 2020 (in thousands) Fund balances—governmental funds $4,530 + $80 $ 4,610 Plus capital assets less accumulated depreciation $506,000 -$200,600 305,400 Less bonds payable (400,000) Less accrued interest payable (900) Less pension and OPEB liabilities (21,700) Plus deferred outflows—pensions 7,500 Plus deferred outflows—taxes 1,800 Net position—governmental activities $(103,290)

CHAPTER 13 SOLUTIONS TO MULTIPLE CHOICE QUESTIONS, EXERCISES AND PROBLEMS

MULTIPLE CHOICE QUESTIONS 1.

d Answers to questions 1 – 5 are based on the following entries and financial statements:

Journal entries for 2020: Cash-operations Contributions—unrestricted

4,500,000 4,500,000

Contributions receivable Contributions—time restricted Discount on contributions receivable

500,000

Discount on contributions receivable Contributions—time restricted Increase in present value of pledge during 2020 = 5% x $431,918.

21,596

Cash-operations Contributions—use restricted

200,000

Net assets released—use restricted Net assets released—unrestricted

500,000

Operating expenses Cash—operations

500,000

Accounts payable Operating expenses Cash—operations

50,000 4,200,000

431,918 68,082

21,596

200,000

500,000

4,250,000

Operating expenses Contributions—unrestricted

25,000

Operating expenses Equipment & furnishings, net Building, net

850,000

25,000

250,000 600,000

Geneva Preschool Statement of Activities for 2020 Net Assets Without Donor Restrictions Revenues and other support: Cash contributions Promises Contributions of services Net assets released from restrictions Total revenues and other support Expenses Change in net assets Beginning net assets Ending net assets

$ 4,500,000 -25,000 500,000 5,025,000 (5,575,000) (550,000) 3,400,000 $ 2,850,000

Net Assets With Donor Restrictions $

200,000 453,514 -(500,000) 153,514 -153,514 1,500,000 $ 1,653,514

Geneva Preschool Balance Sheet, December 31, 2020 Assets Cash Contributions receivable, net Equipment & furnishings, net Building, net Total assets

50,000 453,514 1,250,000 2,900,000 __________ $ 4,653,514

Liabilities Accounts payable

Net assets Net assets without donor restrictions Net assets with donor restrictions Total liabilities and net assets

2,850,000 1,653,514 $ 4,653,514

150,000

Geneva Preschool Statement of Cash Flows for 2020 Cash for operating activities (indirect format): Change in net assets Reconciliation items: Increase in contributions receivable Decrease in accounts payable Depreciation expense Cash used for operating activities Beginning cash balance Ending cash balance

(396,486)

(453,514) (50,000) 850,000 (50,000) 100,000 50,000

b The securities themselves are held in perpetuity, regardless of their value, as part of net assets with donor restrictions. Any changes in fair value are adjustments to net assets with donor restrictions.

c The $10,000,000 contribution is the amount held in perpetuity, as part of net assets with donor restrictions. Changes in the value of investments using this contribution do not affect net assets with donor restrictions. The donor leaves income unrestricted, so fair value gains and losses affect net assets without donor restrictions.

10.

EXERCISES E13.1 Reporting Various Contributions 1. Increases net assets without donor restrictions 2. Increases net assets without donor restrictions (contribution) and decreases net assets without donor restrictions (expense) 3. No effect on net assets (does not meet criteria for recognizable service contributions) 4. Increases net assets with donor restrictions (there is documentation for the promise; since it is not to be received until future years, there is an implicit time restriction) 5. Increases net assets without donor restrictions 6. Increases net assets with donor restrictions

E13.2 Reporting Various Contributions 1. 2. 3. 4. 5. 6.

$4,000,000; increase in net assets without donor restrictions $5,000,000; increase in net assets with donor restrictions $7,000; increase in net assets without donor restrictions $1,000; increase in net assets without donor restrictions $5,000; increase in net assets without donor restrictions $4,000; increase and decrease (revenue and expense) in net assets without donor restrictions 7. Not recorded 8. $750; increase and decrease (revenue and expense) in net assets without donor restrictions

E13.3 Reporting Various Activities 1. 2. 3. 4. 5. 6.

Net assets without donor restrictions; dr cash, cr contributions revenue No effect on either net asset category; dr cash, cr liability No effect on either net asset category; dr cash, cr conference deposits (liability) No entry because it is not a donor restriction The expense reduces net assets without donor restrictions; dr expense, cr facilities, net The expense reduces net assets without donor restrictions; dr expense, cr OPEB liability 7. The revenue increases net assets without donor restrictions; dr liability, cr revenue 8. Net assets with donor restrictions; dr cash, cr contributions revenue—restricted

E13.4 Journal Entries for Contributions 1. Restricted cash Refundable contributions (liability) 2. Restricted cash Contributions—restricted

5,000,000 5,000,000

500,000 500,000

Investment in securities Restricted cash

500,000

Cash

15,000

500,000

Investment income—restricted Unrealized loss on investment—unrestricted Investment in securities

15,000 3,000 3,000

3. No entry; donor could change her mind. 4. Equipment Contributions—restricted 5. Net assets released from use restrictions—restricted Net assets released from use restrictions— unrestricted Depreciation expense (reduces net assets without donor restrictions) Accumulated depreciation 6. Cash

20,000 20,000

3,000 3,000

6,000,000 Contributions—unrestricted

No entry to record the board-designated restriction.

6,000,000

E13.5 Reporting Promises Contributions receivable Contributions—restricted Discount on contributions receivable $74,342 = $20,000 x 3.7171

80,000

Discount on contributions receivable Contributions—restricted $2,230 = 3% x $74,342

2,230

Net assets released from time restriction—restricted Net assets released from time restriction— unrestricted

20,000

Cash

20,000 Contributions receivable

74,342 5,658

2,230

20,000

E13.6 Statement of Activities Net assets without donor restrictions Operating revenues and other support Admissions revenues Membership fees Grants and contributions Total operating revenues and other support Operating expenses Programs Membership development Fund-raising Total operating expenses Excess of operating revenues and other support over operating expenses Nonoperating items Interest expense Unrealized gains on securities Total nonoperating items Change in net assets without donor restrictions

$ 240,000 150,000 50,000 440,000 305,000 90,000 42,000 437,000 3,000 2,000 (3,000) (1,000) $ 4,000

E13.7

Statement of Cash Flows (in thousands) Walker Aquarium Statement of Cash Flows Cash flows from operating activities Contributions ($6,000 + $65) Grant Investment income Program expenditures ($425 + $150 + $5,610*) Net cash from operating activities Cash flows from investing activities Equipment purchases ($200 + $125) Investment purchases Sale of investments Net cash used for investing activities Cash flows from financing activities Endowments Net cash from financing activities Increase in cash Beginning cash balance Ending cash balance

$6,065 500 20 (6,185) 400 (325) (150) 35 (440) 45 45 5 120 $ 125

* $5,610 = $5,700 - $40 - $50.

E13.8 Endowment Contributions Cash

40,000 Investment income—restricted

40,000

Investments Unrealized gains—restricted

2,000

Net assets released from use restrictions—restricted Net assets released from use restrictions— unrestricted

43,000

Program expenses (reduces net assets without donor restrictions) Cash E13.9 Donation of Goods and Services

2,000

43,000

43,000 43,000

1. Supplies In-kind contributions revenue—unrestricted

5,000 5,000

2. No entry 3. Administrative expense (reduces net assets without donor restrictions) Contributions of services—unrestricted 4. Facilities (long-lived asset) Contributions of services—unrestricted

10,000 10,000

25,000 25,000

E13.10 Donated Long-Lived Assets Facilities (long-lived asset) Contributions revenue—restricted

5,000,000

Net assets released from time restriction—restricted Net assets released from time restriction— unrestricted $1,000,000 = $5,000,000/5.

1,000,000

Depreciation expense (reduces net assets without donor restrictions) Accumulated depreciation $200,000 = $5,000,000/25

5,000,000

1,000,000

200,000 200,000

E13.11 Donation of Cash for Long-Lived Assets Net assets released from use restrictions—restricted Net assets released from use restrictions— unrestricted

1,000,000

Facilities (long-lived asset) Restricted cash

1,000,000

Depreciation expense Accumulated depreciation $25,000 = ½ x ($1,000,000/20). E13.12 Investments

25,000

1,000,000

25,000

Net assets

1. 2. 3.

without donor restrictions Unrealized loss…………………… $ (3,000) Dividend income…………………. 2,000 Unrealized gain…………………… 1,500 Dividend income…………………. 2,500 Unrealized loss…………………… -Dividend income…………………. --

with donor restrictions ----$ (4,000) 2,400

E13.13 Statement of Cash Flows (in thousands) Cash from operating activities Change in net assets $ 5,600 Gain on sale of equipment (400) Depreciation and amortization 8,000 Contribution of securities (250) Decrease in pension liability (1,000) Increase in inventories (40) Unrealized gain on investments (100) Contribution of services to build facilities (425) Decrease in contributions receivable 390 Cash from operating activities $11,775 Note: contribution of legal services has no net effect on net assets or cash, and is therefore not a reconciliation item. E13.14 Split-Interest Agreement Cash

600,000

Annuity payable Contribution revenue—restricted $297,550 = $20,000 x 14.8775 NOTE: Answers may vary due to rounding.

297,550 302,450

Investments Cash

600,000

Cash Investments Annuity payable

17,000 1,000

Annuity payable Cash E13.15 Split-Interest Agreement Cash

600,000

18,000 20,000 20,000

600,000

Contribution revenue—restricted

600,000

Investments Cash

600,000

Cash Investments Life income payable

17,000 1,000

Life income payable Cash

18,000

600,000

18,000

E13.16 University Transactions 1. Cash

10,000 Contribution revenue—restricted

2. Cash

10,000

1,000,000 Contribution revenue—restricted

Cash

1,000,000 35,000

Contribution revenue—restricted 3. Net assets released from use restrictions—restricted Net assets released from use restrictions— unrestricted Tuition revenue (contra revenue, reduces net assets without donor restrictions) Cash 4. Salaries expense (program expense, reduces net assets without donor restrictions) Cash

5. Tuition revenue (contra revenue, reduces net assets without donor restrictions) Tuition receivable Assumes full tuition already accrued.

35,000

50,000 50,000

1,800,000 1,800,000

100,000 100,000

6. Assistantship expense (program expense, reduces net assets without donor restrictions) Tuition receivable Assumes full tuition already accrued. 7. Cash

100,000 100,000

75,000

Liability to student organizations No change in net assets. 8. Depreciation expense (allocated between program and administrative expenses, reduces net assets without donor restrictions) Accumulated depreciation 9. Facilities Cash No change in net assets.

75,000

800,000 800,000

5,000,000 5,000,000

E13.17 Contributions Received on Behalf of Others 1. Cash—custodial Liability to unaffiliated organizations Liability to unaffiliated organizations Cash—custodial 2. Cash

5,000,000 5,000,000 3,000,000 3,000,000

2,000,000 Contribution revenue—unrestricted

Donor advised giving (program expense, reduces net assets without donor restrictions) Cash 3. Cash

2,000,000

1,800,000 1,800,000

1,000,000 Contribution revenue—restricted

Net assets released from use restrictions—restricted Net assets released from use restrictions— unrestricted Donor advised giving (program expense, reduces net assets without donor restrictions) Cash

1,000,000 900,000 900,000

900,000 900,000

PROBLEMS P13.1 Journal Entries and Financial Statements a. Restricted cash Cash Contributions revenue—use restricted Contributions revenue—unrestricted

1,000,000 1,500,000

Cash Restricted cash Contributions receivable Allowance for uncollectibles Contributions revenue—unrestricted Contributions revenue—use restricted (1) Contributions revenue—time restricted (2)

1,290,000 50,000 60,000

1,750,000 750,000

9,000 1,270,000 70,000 51,000

(1) $70,000 = $20,000 + $50,000; (2) $51,000 = $60,000 – (15% x $60,000).

Program expenses Administrative expenses Fund-raising expenses Accounts payable Cash

950,000 350,000 100,000

Investments Cash Investment income—unrestricted

800,000

100,000 1,300,000

770,000 30,000

Net assets released from use restrictions—restricted Net assets released from use restrictions— unrestricted

1,000,000

Building and equipment, net Note payable Restricted cash Mortgage payable

3,700,000

1,000,000

300,000 1,000,000 2,400,000

Administrative expenses Cash

140,000

Program expenses Building and equipment, net

190,000

140,000

190,000

b. Southside Counseling Center Statement of Activities For the Year Ended December 31, 2020 Net Assets Without Donor Restrictions Revenues, gains, and other support: Contributions—General $ 1,270,000 Contributions—Grant 750,000 Contributions—Parolee program -Contributions—Building fund -Investment income 30,000 Net assets released from use restrictions 1,000,000 Total revenues, gains and other support 3,050,000 Expenses: Program expenses 1,140,000 Administrative expenses 490,000 Fund-raising expenses 100,000 Total expenses 1,730,000 Change in net assets 1,320,000 Net assets, January 1, 2020 -Net assets, December 31, 2020 $ 1,320,000 Southside Counseling Center Statement of Financial Position December 31, 2020 Assets Cash Contributions receivable, net Investments Restricted cash Building and equipment, net Total assets Liabilities and net assets Liabilities: Accounts payable Note payable Mortgage payable Net assets: Without donor restrictions With donor restrictions Total liabilities and net assets

580,000 51,000 800,000 50,000 3,510,000 $ 4,991,000

100,000 300,000 2,400,000 2,800,000

1,320,000 871,000 2,191,000 $ 4,991,000

Net Assets With Donor Restrictions $

51,000 -770,000 1,050,000 -(1,000,000) 871,000

----871,000 -871,000

P13.2 Recognition of Contributions (a) Recorded?

(b) Classification and Amount

No; intention, not documented

No; conditional promise

Yes; unconditional portion

Net assets without donor restrictions, $40,000

No; services not otherwise purchased

Yes; unconditional promise

Net assets without donor restrictions, $15,000; net assets with donor restrictions, $55,757 (present value of a 4-payment $15,000 ordinary annuity discounted at 3%) Note: Answers may vary due to rounding.

Yes; unconditional contribution

Net assets with donor restrictions, $200,000; ($100,000 becomes unrestricted in the current year when used as donor intends)

Yes; unconditional contribution

Net assets with donor restrictions; $4,000,000; Each year $200,000 (= $4,000,000/20) is recategorized from net assets with donor restrictions to net assets without donor restrictions, and $200,000 in depreciation expense is recorded as a reduction in net assets without donor restrictions.

Yes; skilled services otherwise purchased

Net assets without donor restrictions, $5,000. Assumes value of services is capitalized as part of the cost of the houses.

10.

Yes, unconditional contribution

Net assets with donor restrictions (use restriction), $25,000; fair value of bonds, $1,035,000 (= $1,060,000 - $25,000) increases net assets with donor restrictions in perpetuity.

P13.3 Journal Entries and Financial Statements a. Cash

102,000 Dues revenue—unrestricted

Cash

102,000 210,000

Contributions revenue—unrestricted Cash

210,000 270,000

Grants—restricted

270,000

Expense—Tutoring programs Expense—After-school programs Expense—Fund-raising Cash

245,000 310,000 36,000

Expense—Tutoring programs Expense—After-school programs Building, net Equipment, net

30,000 30,000

Net assets released from use restrictions—restricted Net assets released from use restrictions— unrestricted

150,000

591,000

25,000 35,000

150,000

Expense—Tutoring programs Supplies

9,000

Dues receivable Dues revenue—unrestricted To record the $3,000 increase in dues receivable.

3,000

9,000

3,000

Net assets released from use restrictions—restricted Net assets released from use restrictions— unrestricted

195,000

Accounts payable Cash

35,000

Expense—Tutoring programs Expense—After-school programs Accounts payable

45,000 15,000

195,000

35,000

60,000

b. Learning Circle Statement of Activities For the Year Ended June 30, 2020 Without Donor Restrictions Revenues, gains, and other support: Dues $ 105,000 Contributions 210,000 Grants -Net assets released from program restrictions 345,000 Total revenues, gains and other support 660,000 Expenses and losses: Tutoring programs 329,000 After-school programs 355,000 Fund-raising 36,000 Total expenses 720,000 Change in net assets (60,000) Net assets, July 1, 2019 820,000 Net assets, June 30, 2020 $ 760,000

With Donor Restrictions

Learning Circle Statement of Financial Position As of June 30, 2020 Assets Cash Dues receivable Supplies Land Building, net Equipment, net Total assets

$ 16,000 8,000 16,000 200,000 475,000 225,000 $ 940,000

Liabilities and net assets Accounts payable Net assets without donor restrictions Net assets with donor restrictions Total liabilities and net assets

$ 60,000 760,000 120,000 $ 940,000

--270,000 (345,000) (75,000)

----(75,000) 195,000 $ 120,000

P13.4 Presentation of Corrected Financial Statements a. Correcting journal entries 1. Contributions receivable 50,000,000 Contributions—restricted 40,554,500 Discount on contributions receivable 9,445,500 To record the documented pledge. $40,554,500 = $5,000,000 x present value of an annuity of $1 for ten years at 4% = $5,000,000 x 8.1109. Note: Answers may vary due to rounding. 2. Discount on contributions receivable 1,780,700 Contributions—unrestricted 10,000,000 Contributions receivable 10,000,000 Contributions—restricted 1,780,700 To record the increase in time value of the pledge and the collection of the first installment. The pledge was originally recorded at $44,518,000 (= $10,000,000 x present value of an annuity of $1 for five years at 4%; $10,000,000 x 4.4518). The increase in time value in fiscal 2020 is $44,518,000 x 4% = $1,780,700, which is recorded as an increase in restricted contributions. Note: Answers may vary due to rounding. Net assets released from time restrictions— restricted 10,000,000 Net assets released from time restrictions—unrestricted 10,000,000 To record net assets released from time restrictions when installment of pledge is received. 3. Contributions—unrestricted Refundable contributions To reclassify conditional contributions as a liability.

2,500,000

Cash

27,500,000

2,500,000

4. Assets restricted to investment in plant assets To reclassify cash spent for construction. Net assets released from use restrictions— restricted Net assets released from use restrictions—unrestricted To record net assets released from use restrictions; $31,500,000 = $27,500,000 + $4,000,000.

27,500,000

31,500,000 31,500,000

5. Expenses—administrative 500,000 Land, buildings and equipment, net 10,000,000 Contributions of services—unrestricted To record donations of specialized and nonfinancial services.

10,500,000

6. Investments 2,500,000 Investment gains—restricted To record restricted unrealized gains on investments.

2,500,000

b. Corrected financial statements The Chicago History Museum Statement of Activities For the Year Ended June 30, 2020 Without Donor Restrictions

With Donor Restrictions

Revenues and gains: Contributions—cash and promises Contributions—services Investment income and gains Net assets released from time restrictions Net assets released from use restrictions Total revenues and gains

$ 47,500,000 10,500,000 300,000 10,000,000 31,500,000 99,800,000

$ 87,035,200 -2,500,000 (10,000,000) (31,500,000) 48,035,200

Expenses: Expenses—exhibitions and programs Expenses—membership and development Expenses—administrative Expenses—building operations Total expenses Change in net assets Net assets, beginning Net assets, ending

39,000,000 1,000,000 8,500,000 14,000,000 62,500,000 37,300,000 17,600,000 $ 54,900,000

-----48,035,200 35,000,000 $ 83,035,200

The Chicago History Museum Statement of Financial Position June 30, 2020 Assets Cash Contributions receivable, net Supplies Assets restricted to investment in plant assets Land, buildings, and equipment, net Investments Total assets

$ 30,300,000 85,335,200 4,500,000 12,500,000 75,000,000 15,000,000 $222,635,200

Liabilities and net assets Liabilities: Accounts payable Refundable contributions Notes payable Total liabilities Net assets: Without donor restrictions With donor restrictions Total net assets Total liabilities and net assets

2,200,000 2,500,000 80,000,000 84,700,000

54,900,000 83,035,200 137,935,200 $222,635,200

P13.5 Hospital Transactions 1. Cash Accounts receivable Patient service revenue—unrestricted Auxiliary revenue—unrestricted

74,000,000 59,500,000 132,000,000 1,500,000

2. Patient service revenue adjustments 1,900,000 Patient service revenue 1,800,000 Accounts receivable 3,700,000 The adjustments account is contra to the patient service revenue account; the charitable services are recorded at cost. Bad debt expense 1,320,000 Allowance for uncollectible accounts 1,320,000 $1,320,000 = 1% x ($70,000,000 + $35,000,000 + $20,000,000 + $3,000,000 + $4,000,000). Allowance for uncollectible accounts 900,000

Accounts receivable

900,000

3. Supplies Inventory Cash Accounts payable Contributions revenue—unrestricted

7,600,000

Equipment Contributions revenue—unrestricted

8,000,000

Nursing services expense General health care services expense Professional services expense Auxiliary services expense Supplies inventory Cash Salaries and wages payable Accounts payable

6,300,000 5,200,000 4,100,000 4,400,000

Cash

5,000,000

3,000,000 3,000,000 1,600,000

8,000,000

5,400,000 13,500,000 200,000 900,000

5. Contributions—restricted

5,000,000

Net assets released from use restrictions—restricted Net assets released from use restrictions— unrestricted

2,800,000

Research program expense Cash

2,800,000

Investments Cash

2,000,000

Cash

2,800,000

2,000,000 100,000

Investment income—restricted

100,000

6. Investments Contributions—restricted in perpetuity

25,000,000

Cash

1,900,000

25,000,000

Investment income—restricted Investment income—unrestricted

1,425,000 475,000

Net assets released from use restrictions—restricted Net assets released from use restrictions— unrestricted

1,500,000

Research program expense Cash

1,500,000

Restricted cash Contributions revenue—restricted

18,000,000

Net assets released from use restrictions—restricted Net assets released from use restrictions— unrestricted

18,000,000

Equipment, net Restricted cash Loan payable

50,000,000

Cash Loss on sale—unrestricted Equipment, net

1,650,000 350,000

1,500,000

7. 18,000,000

18,000,000

18,000,000 32,000,000

2,000,000

P13.6 Hospital Statement of Activities Montclair Hospital Statement of Activities For the Year Ended December 31, 2020 Net assets without donor restrictions Operating revenue, gains and other support Gross patient service revenue Less: contractual discounts Net patient service revenue Other revenue: Donated supplies Educational program fees Cafeteria/gift shop sales Unrestricted bequest Net assets released from restrictions for operations: Satisfaction of program restrictions Total operating revenue, gains and other support Operating expenses: Professional patient care General services Nursing services Administrative services Total operating expenses Operating income Investment income Performance income Unrealized loss on non-trading securities Change in net assets without donor restrictions

33,000,000 9,500,000 10,000,000 6,600,000 59,100,000 3,820,000 165,000 3,985,000 (230,000) $ 3,755,000

Net assets with donor restrictions Contributions Net assets released from use restrictions Change in net assets with donor restrictions

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

$60,000,000 (5,000,000) 55,000,000 800,000 500,000 1,320,000 1,500,000

3,800,000 62,920,000

Note: Hospitals are required to display a performance indicator, which in this solution is labeled “performance income.” This solution also displays an intermediate operating income subtotal. Other formats and labels may be used, but the amount for the performance indicator is defined by GAAP.

P13.7 Transactions and Financial Statements Journal entries (not required): Cash Contributions revenue—restricted Contributions revenue—unrestricted

450,000 200,000 250,000

Contributions receivable Contributions revenue—restricted Allowance for uncollectibles

290,000

Investments Contributions revenue—restricted

150,000

Cash

10,000

261,000 29,000

150,000

Investment income—unrestricted Unrealized losses—restricted Investments

10,000 4,000 4,000

Net assets released from use restrictions—restricted Net assets released from use restrictions— unrestricted

360,000

General service expenses Program service expenses Fund-raising expenses Cash

30,000 480,000 90,000

360,000

600,000

General service expenses Contributions of services—unrestricted

6,000

Building Contributions of services—unrestricted

50,000

6,000

50,000

Irvine Services Statement of Activities For the Year 2020 Without Donor Restrictions

With Donor Restrictions

Revenue, gains, and other support: Contributions revenue Contributions of services Investment income Unrealized losses Net assets released from program restrictions Total revenue, gains and other support

$ 250,000 56,000 10,000 -360,000 676,000

$ 611,000 --(4,000) (360,000) 247,000

Expenses and losses: General service expenses Program service expenses Fund-raising expenses Total expenses Change in net assets Beginning net assets Ending net assets

36,000 480,000 90,000 606,000 70,000 230,000 $ 300,000

----247,000 740,000 $ 987,000

P13.8 Accounting for Investments American Hereditary Disease Association Statement of Activities For the Year 2020

Investment income—mortgage bonds Investment income—debt securities Investment income—equity securities Unrealized losses—mortgage bonds Unrealized gains—debt securities Unrealized gains—equity securities

Net Assets Without Donor Restrictions -$ 60,000 --200,000 --

Net Assets With Donor Restrictions $ 45,000 -325,000 (8,000) -1,000,000

P13.9 Statement of Activities

Milwaukee Art Museum, Inc. Statement of Activities For the Year 2020 Net Assets Without Donor Restrictions Revenue, gains, and other support: Contributions revenue Investment income Unrealized gains Net assets released from restrictions: From program restrictions From building restrictions From time restrictions Total revenue, gains, and other support Expenses and losses: Administrative expenses Membership development expenses Fund-raising expenses Educational programs expenses Research expenses Total expenses Change in net assets Net assets, beginning of year Net assets, end of year (1) $51,400,000 = $52,600,000 - $1,200,000 (2) $2,000,000 = $1,500,000 + $500,000 (3) $11,400,000 = $9,200,000 + $2,200,000 (4) $600,000 = $400,000 + $200,000

Net Assets With Donor Restrictions

(1) $51,400,000 (3) $ 11,400,000 (2) 2,000,000 2,500,000 300,000 (4) 600,000 3,500,000 4,000,000 1,200,000 62,400,000

(3,500,000) (4,000,000) (1,200,000) 5,800,000

3,900,000 6,000,000 1,500,000 40,000,000 15,000,000 66,400,000 (4,000,000) 22,000,000 $18,000,000

------5,800,000 30,000,000 $ 35,800,000

P13.10 Complete Financial Statements Journal entries (not required): Contributions receivable Cash Contribution revenue—unrestricted Contribution revenue—restricted To record 2020 pledges and cash collections for the year.

50,000 4,200,000

Net assets released from time restrictions—restricted Net assets released from time restrictions— unrestricted

152,000

Cash

152,000

4,200,000 50,000

152,000

Contributions receivable To record cash collections of 2019 pledges.

152,000

State grant receivable Cash State grant—restricted To record state grant.

400,000 600,000

Program services expense Equipment and furnishings, net Cash To record expenditures for preschool program.

100,000 200,000

Net assets released from program restrictions—restricted Net assets released from program restrictions— unrestricted To record release from restrictions on state grant.

300,000

Cash

350,000

1,000,000

300,000

Contributions—restricted To record contributions for child development programs. Equipment and furnishings, net Program services expense Cash To record expenditures for child development programs.

350,000

350,000 50,000 400,000

Net assets released from program restrictions—restricted 400,000 Net assets released from program restrictions— unrestricted 400,000 To record release from restrictions on contributions for child development programs.

Administrative expenses ($3,330,000 x 20%) Program services expenses ($3,330,000 x 80%) Cash Salaries and wages payable To record salary and wage expenses for the year.

666,000 2,664,000

Program services expenses Accounts payable Cash To record expenses for utilities, food and supplies.

750,000 50,000

Program services expenses ($790,000 x 75%) Administrative expenses ($790,000 x 25%) Equipment and furnishings, net Building, net To record depreciation for the year.

592,500 197,500

Short-term investments Cash To record short-term investment of excess cash.

250,000

3,300,000 30,000

800,000

240,000 550,000

250,000

Greenvale Community Day Care Center Statement of Activities For the Year Ended December 31, 2020 Net Assets Without Donor Restrictions Revenues and gains: Contributions $ 4,200,000 State grant -Net assets released from time restrictions 152,000 Net assets released from use restrictions 700,000 Total revenues, gains, and other support 5,052,000 Expenses: Program services Administrative Total expenses Change in net assets Net assets, January 1 Net assets, December 31

4,156,500 863,500 5,020,000 32,000 5,010,000 $ 5,042,000

Net Assets With Donor Restrictions $

400,000 1,000,000 (152,000) (700,000) 548,000

---548,000 980,000 $1,528,000

Greenvale Community Day Care Center Statement of Financial Position at December 31, 2020 Assets Current assets Cash Short-term investments Contributions receivable State grant receivable Fixed assets Equipment and furnishings, net Building, net Total assets Liabilities and net assets Current liabilities Accounts payable Salaries and wages payable Net assets Without donor restrictions With donor restrictions Total liabilities and net assets

$ 352,000 250,000 50,000 400,000 2,810,000 2,950,000

$ 170,000 72,000 5,042,000 1,528,000

$ 1,052,000

5,760,000 $ 6,812,000

242,000

6,570,000 $ 6,812,000

Greenvale Community Day Care Center Statement of Cash Flows For the Year Ended December 31, 2020 Cash from operating activities: Unrestricted contributions ($4,200,000 + $152,000 + $350,000) State grant Program expenses paid [$100,000 + $50,000 + (0.8 x $3,300,000) + $800,000] Administrative expenses paid (.2 x $3,300,000) Cash from operating activities

$ 4,702,000 600,000 (3,590,000) (660,000) 1,052,000

Cash from investing activities: Equipment purchases ($200,000 + $350,000) Short-term investments acquired Cash from investing activities

(550,000) (250,000) (800,000)

Net increase in cash Beginning cash balance Ending cash balance

252,000 100,000 352,000

Cash from Operating Activities Indirect Method Change in net assets Adjustments: Depreciation expense Decrease in contributions receivable Increase in state grant receivable Increase in salaries and wages payable Decrease in accounts payable Cash from operating activities

580,000

790,000 102,000 (400,000) 30,000 (50,000) $ 1,052,000

P13.11 Buena Vista University Statement of Activities For the Year 2020 Net Assets Without Donor Restrictions Revenues and gains: Tuition, net of financial aid Grants Investment income Gifts Unrealized gains Net assets released from restrictions: From program restrictions From capital building restrictions Total revenues and gains Expenses: Instruction Research programs Student services Administration Total expenses Change in net assets Net assets, beginning Net assets, ending (1) $156,000,000 = $180,000,000 - $24,000,000 (2) $440,000 = $300,000 + $140,000 (3) $24,600,000 = $15,000,000 + $6,000,000 + $3,600,000 (4) $132,000,000 = $120,000,000 + $12,000,000

Net Assets With Donor Restrictions

(1) $156,000,000 $ -2,000,000 -(2) 440,000 280,000 -- (3) 24,600,000 -1,000,000 5,200,000 650,000 164,290,000

(5,200,000) (650,000) 20,030,000

(4) 132,000,000 24,000,000 6,000,000 12,000,000 174,000,000 (9,710,000) 3,800,000 $ (5,910,000)

-----20,030,000 26,000,000 $ 46,030,000

P13.12 Prepare Complete Financial Statements Journal entries (not required) (all numbers in thousands) Cash Contributions—unrestricted

150,000 150,000

Cash Restricted cash Grants—restricted Endowments—restricted Grants—unrestricted

950 5,050

Restricted cash Endowments—restricted

1,500

Discount on contributions receivable Contributions—restricted $1,000 = 5% x $20,000.

1,000

Cash

15,000

5,000 50 950

1,500

1,000

Contributions receivable

15,000

Net assets released from time restrictions—restricted Net assets released from time restrictions— unrestricted

15,000

Contributions receivable Contributions—restricted Discount on contributions receivable

8,000

Discount on contributions receivable Contributions—restricted $300 = 5% x $6,000. Cash

15,000

6,000 2,000 300 300

2,000 Contributions receivable

2,000

Net assets released from time restrictions—restricted Net assets released from time restrictions— unrestricted

2,000

Unrealized loss—restricted Unrealized loss—unrestricted Investments

3,000 5,500

Restricted cash

4,000

2,000

8,500

Endowments—restricted

4,000

Investments Restricted cash

4,000

Property and equipment, net Restricted cash Cash

12,000

Net assets released from use restrictions—restricted Net assets released from use restrictions— unrestricted

5,000

Cash

7,000

4,000

5,000 7,000

5,000

Investment income—unrestricted Investment income—restricted

5,000 2,000

Expenses—wish granting Expenses—chapter support Expenses—fund-raising Expenses—mgmt and general Property and equipment, net Accounts payable Cash

150,000 10,000 30,000 16,000

Net assets released from use restrictions—restricted Net assets released from use restrictions— unrestricted

20,000

Expenses—mgt and general Contributions of services—unrestricted

6,000

1,500 800 203,700

20,000

6,000

a. Make-A-Wish Foundation Statement of Activities For the Year Ended December 31, 2020

(in thousands) Revenues and gains and losses: Cash contributions Grants and endowments Contributions of services Investment income Unrealized losses on investments Promises of contributions Net assets released: From time restrictions (3) From use restrictions (4) Total revenues and gains Expenses: Wish granting Chapter support Fund-raising Management and general (5) Total expenses Change in net assets Net assets, beginning Net assets, ending (1) $10,550 = $5,000 + $50 + $1,500 + $4,000 (2) $7,300 = $1,000 + $6,000 + $300 (3) $17,000 = $15,000 + $2,000 (4) $25,000 = $5,000 + $20,000 (5) $22,000 = $16,000 + $6,000

Net Assets Without Donor Restrictions

Net Assets With Donor Restrictions

$ 150,000 950 6,000 5,000 (5,500) --

-(1) 10,550 -2,000 (3,000) (2) 7,300

17,000 25,000 198,450

(17,000) (25,000) (25,150)

150,000 10,000 30,000 22,000 212,000 (13,550) 135,000 $ 121,450

-----(25,150) 48,000 $ 22,850

Make-A-Wish Foundation Statement of Financial Position at December 31, 2020 (in thousands) Assets Cash Contributions receivable (net) Restricted cash Property and equipment (net) Investments Total assets Liabilities and net assets Liabilities: Accounts payable Notes payable Total liabilities Net assets Without donor restrictions With donor restrictions Total net assets Total liabilities and net assets

4,250 10,300 1,550 22,500 115,500 $ 154,100

8,800 1,000 _9,800

121,450 22,850 144,300 $ 154,100

b. Make-A-Wish Foundation Statement of Cash Flows For the Year Ended December 31, 2020 (in thousands) Cash for operating activities: Contributions (1) Investment income Operating expenditures Net cash used for operating activities

$ 167,950 7,000 (203,700) (28,750)

Cash for investing activities: Investments Property and equipment Net cash used for investing activities

(4,000) (12,000) (16,000)

Cash from financing activities: Endowments (2) Restricted to property and equipment Net cash provided from financing activities Net decrease in cash Beginning cash balance Ending cash balance ($4,250 + $1,550)

5,550 5,000 10,550 (34,200) 40,000 $ 5,800

(1) $167,950 = $150,000 + $950 + $15,000 + $2,000 (2) $5,550 = $50 + $1,500 + $4,000

Cash for Operating Activities Indirect Method Change in net assets (-$13,550 - $25,150) Adjustments: Endowment Restricted to property and equipment Depreciation expense Decrease in contributions receivable Unrealized investment losses Increase in accounts payable Net cash for operating activities

$ (38,700) (5,550) (5,000) 1,500 9,700 8,500 800 $ (28,750)

P13.13 Promised Contributions a. The discount rate used is the risk-adjusted rate appropriate to the promise. The more uncertainty connected with the promise, the higher the rate. The length of the period over which the promise will be collected, the financial viability of the contributor, and the organization’s willingness to use legal means to collect are factors to consider in determining collectability. b.

(in thousands) Net assets released from time restrictions— restricted Net assets released from time restrictions— unrestricted To record net assets released when cash is collected. Cash

75,000 75,000

75,000

Short-term contributions receivable To record collection of beginning balance of short-term promises.

75,000

Allowance for uncollectibles 4,074 Short-term contributions receivable 4,074 To write off remainder of beginning short-term promises to be collected within 1 year. Short-term contributions receivable 69,264 Contributions revenue—restricted 65,420 Allowance for uncollectibles 3,844 To record ending short-term promises; $3,844 = $2,834 + $4,074 - $3,064. Long-term contributions receivable Contributions revenue—restricted Discount on contributions receivable To record new long-term promises. Net assets released from time restrictions— restricted Net assets released from time restrictions— unrestricted To record net assets released when cash is collected. Cash

6,500 5,960 540

6,149 6,149

6,149 Long-term contributions receivable 6,149 To record collections of promises; $6,149 = $9,092 + $6,500 - $9,443.

Discount on contributions receivable 110 Contributions revenue—restricted 110 To record increase in value of long-term promises; $110 = $341 + $540 - $771.

P13.14 Prepare Complete Financial Statements Journal entries for 2020 (not required): Cash (operating) Contributions revenue—unrestricted

5,200

Contributions receivable, net Contribution promises—restricted

350

Contributions receivable, net Contribution promises—restricted $14 = 4% x $350.

Contributions receivable, net Contribution promises—restricted $6 = 3% x $200.

Net assets released from time restrictions—restricted Net assets released from time restrictions— unrestricted

Cash (operating) Contributions receivable, net

Restricted cash (financing) Endowment contributions—restricted

250

Investments Restricted cash (investing)

250

Cash (operating) Grant revenue—restricted

500

Program expenses Cash (operating)

400

Net assets released from use restrictions—restricted Net assets released from use restrictions— unrestricted

400

5,200

350

250

500

400

Program expenses Buildings and equipment, net Cash (operating) Cash (investing) Net assets released from use restrictions—restricted Net assets released from use restrictions— unrestricted Program expenses Administrative expenses Fund-raising expenses Accounts payable Cash (operating)

100 100 100 100 200 200 3,000 1,500 500 20 5,020

Program expenses Administrative expenses Fund-raising expenses Buildings and equipment, net

480 280 40

Buildings and equipment, net Administrative expenses Contribution of services—unrestricted

160 75

Cash (operating) Investment income—unrestricted

Investments Unrealized losses—restricted Unrealized gains—unrestricted

5 15

800

235

a. International Society of Accounting Professionals Statement of Activities Year Ended December 31, 2020 Net Assets Without Donor (in thousands) Restrictions Revenues and gains and losses: Cash contributions and grants $ 5,200 Endowment contributions -Contributions of services 235 Investment income 25 Unrealized gains (losses) 20 Promises of contributions -Net assets released: From time restrictions 75 From use restrictions 600 Total revenues and gains 6,155 Expenses: Programs 3,980 Administrative 1,855 Fund-raising 540 Total expenses 6,375 Change in net assets (220) Net assets, beginning 2,300 Net assets, ending $ 2,080

Net Assets With Donor Restrictions $

500 250 --(15) 370 (75) (600) 430

----430 2,675 $ 3,105

b. International Society of Accounting Professionals Statement of Financial Position December 31, 2020 (in thousands) Assets Cash Investments Contributions receivable Buildings and equipment, net Total assets Liabilities and net assets Liabilities: Accounts payable Net assets: Without donor restrictions With donor restrictions Total net assets Total liabilities and net assets

405 1,105 495 3,460 $ 5,465

280

2,080 3,105 5,185 $ 5,465

c. International Society of Accounting Professionals Statement of Cash Flows For the Year Ended December 31, 2017 (in thousands) Cash from operating activities: Change in net assets Reconciliation items: Increase in contributions receivable Endowment contributions Decrease in accounts payable Depreciation expense Contractor services Unrealized gains on investments Unrealized losses on investments Cash from operating activities

210 (295) (250) (20) 800 (160) (20) 15 280

Cash for investing activities: Investments Buildings and equipment Cash for investing activities

(250) (100) (350)

Cash from financing activities: Endowment Increase in cash Beginning cash balance Ending cash balance

250 180 225 405

P13.15 NFP Financial Statements a. Cash

211,000 Contributions—unrestricted Contributions—restricted

113,000 98,000

Contributions receivable, net Contribution promises—restricted

8,000

Contributions receivable, net Contribution promises—restricted

3,000

Net assets released from time restrictions—restricted Net assets released from time restrictions— unrestricted

12,000

Cash

12,000

8,000

3,000

12,000

Contributions receivable, net Cash

12,000 55,000

Investments Realized gain on investments—unrestricted

50,000 5,000

Investments Unrealized gain on investments—restricted

15,000

Investments Unrealized gain on investments—unrestricted

6,000

Net assets released from use restrictions—restricted Net assets released from use restrictions— unrestricted

94,000

Program expenses Cash

94,000

Program expenses Administrative expenses Fund-raising expenses Accounts payable Cash

90,000 45,000 15,000 2,000

15,000

6,000

94,000

152,000

Plant and equipment, net Administrative expense Contributed services—unrestricted Program expenses Administrative expenses Plant and equipment, net

5,000 3,000 8,000 14,000 21,000 35,000

Cash Loss on sale of plant and equipment—unrestricted Plant and equipment, net

18,000 4,000

Administrative expenses Loan payable Cash

15,000 8,000

22,000

23,000

b. (1) American Museum of Natural History Statement of Activities Year Ended June 30, 2020 (in thousands) Change in net assets without donor restrictions Operating revenues and support: Contributions and grants Contributions of services ($5,000 + $3,000) Net assets released from use restrictions Net assets released from time restrictions Total revenues and other support Operating expenses: Programs ($94,000 + $90,000 + $14,000) Administrative ($45,000 + $3,000 + $21,000 + $15,000) Fund-raising Total expenses Excess of operating expenses over operating revenues and support Nonoperating items: Gain on sale of investments Unrealized gains on securities Loss on sale of P&E Total nonoperating items Change in net assets without donor restrictions Beginning net assets without donor restrictions Ending net assets without donor restrictions

$ 113,000 8,000 94,000 12,000 227,000 198,000 84,000 15,000 297,000 (70,000) 5,000 6,000 (4,000) 7,000 (63,000) 330,000 $ 267,000

Change in net assets with donor restrictions Contributions and grants Contribution promises Unrealized gains on securities Net assets released from use restrictions Net assets released from time restrictions Change in net assets with donor restrictions Beginning net assets with donor restrictions Ending net assets with donor restrictions

$98,000 11,000 15,000 (94,000) (12,000) 18,000 410,000 $ 428,000

(2) American Museum of Natural History Statement of Financial Position June 30, 2020 (in thousands) Assets

Liabilities

Cash Contributions receivable, net

Investments Plant and equipment, net

511,000 418,000 ________ $1,018,000

Total assets

67,000

Accounts payable

22,000

Loans payable

21,000 302,000

Net assets Net assets without donor restrictions Net assets with donor restrictions Total liabilities and net assets

267,000 428,000 $1,018,000

P13.16 Statement of Activities

Denton County Historical Museum Statement of Activities For Fiscal 2020 Operating revenues and other support Admissions revenues Membership revenues Gift shop revenues Grants and contributions Total operating revenues and other support Net assets released from restrictions to fund operations: From program restrictions From time restrictions Total net assets released from restrictions to fund operations Total operating revenues and other support and reclassifications Operating expenses Circulating exhibition fees Curatorial and support expenses Gift shop cost of sales Membership development Facilities and security expenses Exhibition expenses Total operating expenses Excess of operating revenues and other support over operating expenses Nonoperating revenues, expenses, and other support Acquisition of works of art Net assets released from restrictions for art acquisitions Net gain on disposal of assets Board-designated contributions Defined benefit plan change costs other than net periodic benefit cost Interest expense Investment income Unrealized losses on hedging swap agreements Unrealized gains on investments in equity securities Total nonoperating revenues, expenses, and other support Change in net assets without donor restrictions Net assets without donor restrictions, beginning balance Net assets without donor restrictions, ending balance

Net assets without donor restrictions $ 405,000 270,000 335,000 720,000 1,730,000 195,000 15,000 210,000 1,940,000 112,000 362,000 265,000 225,000 450,000 522,000 1,936,000 4,000 (45,000) 45,000 7,000 3,000 (6,000) (35,000) 18,000 (2,000) 8,000 (7,000) (3,000) 329,000 $ 326,000

Note: The format of this statement of activities is taken from the actual statement of activities of The Museum of Modern Art.

P13.17 NFP Combinations a. Identifiable assets Goodwill (asset) Liabilities Cash

6,000 1,300

Identifiable assets Excess paid over fair value of identifiable net assets acquired (charge on statement of activities) Liabilities Cash

6,000

3,500 3,800

1,300 3,500 3,800

Identifiable assets Liabilities Inherent contribution received—unrestricted Inherent contribution received—restricted

6,000

Identifiable assets ($4,000 + $9,000) Liabilities ($3,500 + $7,500) Net assets without donor restrictions ($200 + $1,000) Net assets with donor restrictions ($300 + $500)

13,000

3,500 1,600 900

11,000 1,200 800

CHAPTER 14 SOLUTIONS TO MULTIPLE CHOICE QUESTIONS, EXERCISES AND PROBLEMS

MULTIPLE CHOICE QUESTIONS 1.

b Total invested capital equals $100,000. Each partner has an equal capital interest, thus $50,000 is credited to each partner.

d Since the two partners have equal capital interests, Bemus is assumed to bring intangibles to the partnership, making his/her investment equal to Amos’s. Thus Bemus is credited with $75,000, consisting of $25,000 cash and $50,000 goodwill.

b Partnership income is $140,000. After allocating salaries of $40,000 to Dawn and $60,000 to Lorrie, $40,000 remains for allocation by the percentage formula. Adam’s share is 30 percent, or $12,000.

c Partnership capital before Zeke’s investment is $400,000; Zeke’s $150,000 investment brings it to $550,000. There are now five equal partners. Zeke’s share of capital is $110,000 (= $550,000/5). Since Zeke invested $150,000, there is a $40,000 bonus to the old partners, which they share equally, $10,000 each.

d Zeke invests $150,000 for a 20 percent interest. This implies that the partnership is worth $750,000 (= $150,000/0.2). The old capital of $400,000 plus Zeke’s investment accounts for $550,000. $200,000 of goodwill is recorded, and attributed equally to the four old partners.

c Renee’s capital account was $120,000, and she is paid $300,000. This implies a bonus to Renee of $180,000, which is shared equally by the three remaining partners.

10.

a Renee’s capital account was $120,000 and she was paid $300,000. Under the partial goodwill approach, the $180,000 difference is recorded as goodwill, and is attributed to Renee. The capital accounts of the other partners are unaffected

11.

Initial capital Allocate $108,000 loss on sale Balance Assumed loss on $208,000 of remaining assets Balance Allocate Yvonne’s deficiency Balance Allocate Oscar’s deficiency Safe payment

12.

Thomas

Renee

Oscar

Yvonne

$160,000 (27,000) 133,000 (52,000) 81,000 (13,000) 68,000 (6,000) $62,000

$120,000 (27,000) 93,000 (52,000) 41,000 (13,000) 28,000 (6,000) $22,000

$80,000 (27,000) 53,000 (52,000) 1,000 (13,000) (12,000) 12,000 $ 0

$40,000 (27,000) 13,000 (52,000) (39,000) 39,000 0 _____ $ 0

d Because the partners share losses equally, there is no need to standardize the capital accounts. Calculations for cash distribution plan:

Initial capital Equalize Thomas with Renee Balance Equalize Thomas and Renee with Oscar Balance Equalize Thomas, Renee, and Oscar with Yvonne Balance

Thomas

Renee

Oscar

Yvonne

$160,000 (40,000) 120,000 (40,000) $80,000

$120,000 _____ 120,000 (40,000) $80,000

$80,000 _____ 80,000 ______ $80,000

$40,000 ______ 40,000 ______ $40,000

(40,000) $40,000

______ $40,000

Thus the cash distribution plan would show: • • • • •

First $100,000 to creditors Next $40,000 to Thomas Next $80,000 equally to Thomas and Renee Next $120,000 equally to Thomas, Renee, and Oscar Any additional cash equally to all four partners

EXERCISES E14.1 Partnership Formation a. Capital balances are equal to fair market value of contributed assets.

Cash Computer equipment Building Liability

Cheng $ 5,000 100,000 0 (25,000) $80,000

Morales $ 0 0 150,000 (35,000) $115,000

The entry to record the formation of the partnership is: Cash Computer equipment Building Loan payable Mortgage payable Capital, Cheng Capital, Morales

5,000 100,000 150,000 25,000 35,000 80,000 115,000

b. Investment by Cheng Investment by Morales Total capital

$ 80,000 115,000 $195,000

Capital account of Cheng ($195,000/2) Capital account of Morales ($195,000/2)

$ 97,500 $ 97,500

There is a bonus of $17,500 from Morales to Cheng. The entry to record the formation of the partnership, reflecting that bonus, is: Cash Computer equipment Building Loan payable Mortgage payable Capital, Cheng (= $80,000 + $17,500) Capital, Morales (= $115,000 - $17,500)

5,000 100,000 150,000 25,000 35,000 97,500 97,500

c. Since the partners are to have equal capital and Morales has invested $115,000, Cheng is presumed to have invested a similar amount. Specific net assets account for $80,000 of Cheng's investment; goodwill of $35,000 must therefore be recorded to bring Cheng's investment to $115,000. The entry to record the formation of the partnership is: Cash Computer equipment Building Goodwill Loan payable Mortgage payable Capital, Cheng (= $80,000 + $35,000) Capital, Morales

5,000 100,000 150,000 35,000 25,000 35,000 115,000 115,000

E14.2 Partnership Formation a. Because Roberta is the only partner not contributing expertise that would support goodwill recognition, we base the apparent total value of the firm on her investment. Total value = $475,000 = $95,000/0.2 Total tangible assets invested amount to $315,000 (= $25,000 + $180,000 + $15,000 + $20,000 + $75,000), implying goodwill of $160,000 (= $475,000 - $315,000). The following entry is needed to record formation of the partnership under the goodwill approach. Cash Note receivable Equipment Goodwill Capital – Max (= 0.5 x $475,000) Capital – Nat (= 0.3 x $475,000) Capital – Roberta (= 0.2 x $475,000)

60,000 75,000 180,000 160,000 237,500 142,500 95,000

b. Total tangible assets invested amount to $315,000, consisting of $205,000 from Max, $15,000 from Nat, and $95,000 from Roberta. Max's share of partnership capital (0.5) is $157,500, Nat's share (0.3) is $94,500 and Roberta's share (0.2) is $63,000. To bring the respective amounts invested into this alignment, bonuses will flow from Max ($205,000 - $157,500) and Roberta ($95,000 - $63,000) to Nat. The entry to record the formation under the bonus method is: Cash Note receivable Equipment Capital – Max Capital – Nat Capital – Roberta

60,000 75,000 180,000 157,500 94,500 63,000

E14.3 Partnership Income Allocation a. Original balance Salary Withdrawal of salary Loss distribution* Ending balance * Income Less salary Balance of income

Whitman $ 200,000 100,000 (100,000) (10,000) $ 190,000

Greene $ 245,000 0 0 (15,000) $ 230,000

Whitman $ 200,000 100,000 (100,000) 20,000 $ 220,000

Greene $ 245,000 0 0 30,000 $ 275,000

$ 75,000 100,000 $(25,000)

b. Original balance Salary Withdrawal of salary Income distribution**

** Income Less salary Balance of income

$150,000 100,000 $ 50,000

E14.4 Partnership Income Allocation – Various Options Income of partnership: Revenues Expenses Income

$80,000 55,000 $25,000

a. Capital, January 1 Investment Allocation of income (assumed equal) Capital, December 31

Kingston $ 56,000 8,000 12,500 $ 76,500

Allen $ 84,000

Kingston $ 56,000 8,000

Allen $ 84,000

12,500 $ 96,500

b. Capital, January 1 Investment Allocation of income: Kingston, 65% x $25,000 Allen, 35% x $25,000 Capital, December 31

16,250 _______ $ 80,250

8,750 $ 92,750

c. Capital, January 1 Investment Allocation of income: Interest on average capital: Kingston, 10% x $60,000* Allen, 10% x $84,000 Balance is $10,600 ($25,000-$14,400) divided equally Capital, December 31 * $60,000 = ($56,000 + $64,000)/2

Kingston $ 56,000 8,000

Allen $ 84,000

6,000 5,300 $ 75,300

8,400 5,300 $ 97,700

d. Capital, January 1 Investment Allocation of income: Salaries Interest on beginning capital: Kingston, 5% x $56,000 Allen, 5% x $84,000 Balance is ($2,000), divided equally** Capital, December 31

Kingston $ 56,000 8,000

Allen $ 84,000

12,000

8,000

2,800 (1,000) $ 77,800

4,200 (1,000) $ 95,200

** ($2,000) = $25,000 – ($12,000 + $8,000 + $2,800 + $4,200)

E14.5 Multiple Income Allocation Provisions a. Salaries Interest Residual Total Share

Johnson (.6) $ 75,000 10,000 22,920 $107,920

Kane (.3) $ 55,000 12,000 11,460 $ 78,460

Lehman (.1) $ 80,000 4,800 3,820 $ 88,620

Total $ 210,000 26,800 38,200 $ 275,000

Salaries Interest Residual Total Share

Johnson (.6) $ 75,000 10,000 (22,080) $ 62,920

Kane (.3) $ 55,000 12,000 (11,040) $ 55,960

Lehman (.1) $ 80,000 4,800 (3,680) $ 81,120

Total $ 210,000 26,800 (36,800) $ 200,000

c. Johnson’s bonus (B) amounts to $55,000, calculated as follows: B = 0.25($275,000 - B) 1.25B = $68,750 B = $55,000

Salaries Interest Bonus Residual Total Share

Johnson (.6) $ 75,000 10,000 55,000 (10,080) $ 129,920

Kane (.3) $ 55,000 12,000 -(5,040) $ 61,960

Lehman (.1) $ 80,000 4,800 -(1,680) $ 83,120

Total $ 210,000 26,800 55,000 (16,800) $ 275,000

E14.6 Bonus Calculations a.

Sherif’s bonus = 20% x $300,000 = $60,000

Rafik’s bonus = 20% x [$300,000 - $100,000 - $120,000 – (4% x $525,000) – (4% x $425,000)] = $8,400

Sherif’s bonus = 20% x [$300,000 - $100,000 - $120,000 – (4% x $525,000) – (4% x $425,000) - bonus] 1.2 bonus = $42,000 bonus = $35,000

E14.7 New Partner Admission: Purchase of Existing Interest a. Capital—Ajeet Capital, Harish

400,000 400,000

Ajeet’s entire capital balance is transferred to Harish. New capital balances: Capital—Harish Capital—Rahul Capital—Suresh

$400,000 350,000 500,000

b. Capital—Ajeet Capital—Rahul Capital—Suresh Capital—Harish

80,000 70,000 100,000 250,000

20% of each partner’s capital balance is transferred to Harish. New capital balances: Capital—Ajeet Capital—Rahul Capital—Suresh Capital—Harish

$320,000 280,000 400,000 250,000

c. Goodwill Capital—Ajeet Capital—Rahul Capital—Suresh

850,000 255,000 170,000 425,000

Harish is willing to pay $420,000 for a 20% interest in the partnership, implying that the entire partnership is worth $420,000/.2 = $2,100,000. Currently partnership net assets total $1,250,000. Therefore goodwill of $850,000 (= $2,100,000 - $1,250,000) is recognized and allocated to the current partners in a 3:2:5 ratio. The capital balances of the existing partners are now: Capital—Ajeet. Capital—Rahul Capital—Suresh

$655,000 520,000 925,000

20% of each partner’s capital is transferred to Harish: Capital—Ajeet Capital—Rahul Capital—Suresh Capital, Harish

131,000 104,000 185,000 420,000

The capital balances after the transfer are: Capital—Ajeet. Capital—Rahul Capital—Suresh Capital—Harish

$524,000 416,000 740,000 420,000

E14.8 New Partner Admission: Investment of New Capital a. New total capital = $50,000 + $250,000 + $140,000 + $60,000 = $500,000 Gao’s share of new capital = 12% x $500,000 = $60,000, which is equal to Gao’s cash contribution. Cash

60,000 Capital—Gao

60,000

b. Gao’s share of new capital = ($440,000 + $50,000) x 12% = $58,800. The bonus total is $58,800 - $50,000 = $8,800, shared among the existing partners in a 1:6:3 ratio. Cash Capital—Liang Capital—Tan Capital—Wu Capital—Gao

50,000 880 5,280 2,640 58,800

c. Gao’s investment of $72,000 for a 12% interest implies that the fair value of the partnership is $72,000/0.12 = $600,000. Partnership net assets are understated by $600,000 – ($440,000 + $72,000) = $88,000. The $88,000 revaluation is allocated to goodwill and the capital accounts of the existing partners, in a 1:6:3 ratio. Cash Goodwill Capital—Liang Capital—Tan Capital—Wu Capital—Gao

72,000 88,000 8,800 52,800 26,400 72,000

E14.9 Admission of New Partner a. Jeter should contribute $600,000. Capital - Martinez Capital – O’Neill Capital - Clemens Total capital

$ 100,000 300,000 500,000 $ 900,000

This capital will represent 60 percent of the partnership after Jeter's admission. The total capital will be $1,500,000 (= $900,000/.6). Hence, Jeter must invest $600,000 (= $1,500,000 - $900,000). b. Jeter's payment of $480,000 for a 40 percent interest implies that the total value of the partnership is $1,200,000 (= $480,000/.4). First record implied goodwill of $300,000 (= $1,200,000 - $900,000), and then transfer 40 percent of each partner's capital to Jeter. The resulting capital balances are: Original Capital

Implied Goodwill

Total

Transfer To Jeter

Balances After Acquisition

Martinez

$100,000

$ 60,000 (.2)

$ 160,000

$ (64,000)

O’Neill

300,000

90,000 (.3)

390,000

(156,000)

234,000

Clemens

500,000

150,000 (.5)

650,000

(260,000)

390,000

480,000

$1,200,000

Jeter

Total

$900,000

$300,000

$1,200,000

96,000

E14.10 Partner Retirement: Various Cases a. Capital—Nelson Capital—Diaz Capital—Isidro

600,000

Capital—Diaz Capital—Isidro Capital—Nelson

50,000 100,000

Capital—Nelson Cash

750,000

Goodwill Capital—Nelson

150,000

Capital—Nelson Cash

750,000

200,000 400,000

150,000

750,000

c. 150,000

750,000

d. The excess payment is $150,000 (= $750,000 - $600,000), so total goodwill is $150,000/0.4 = $375,000. Goodwill Capital—Diaz Capital—Isidro Capital—Nelson

375,000

Capital—Nelson Cash

750,000

75,000 150,000 150,000

750,000

e. The payment is $150,000 lower than Nelson’s capital balance. Using the total goodwill approach, the asset overvaluation is $150,000/.4 = $375,000. Capital—Diaz Capital—Isidro

75,000 150,000

Capital—Nelson Plant and equipment

150,000

Capital—Nelson Cash

450,000

375,000

450,000

E14.11 Post-Retirement Capital Balances

Capital balances before Atkins' retirement Write-up of assets Bonus to Bodkins and Calkins Capital balances after Atkins' retirement

Bodkins $300,000 67,500 7,500 $375,000

Calkins $150,000 112,500 12,500 $275,000

Following are the journal entries (not required) leading to these capital balances: 1. Adjust capital accounts to reflect write-up of assets from $750,000 to $975,000. Assets

225,000 Atkins, Capital Bodkins, Capital Calkins, Capital

45,000 67,500 112,500

2. Record Atkins’ retirement under the bonus method. Atkins, Capital Bodkins, Capital (3/8) Calkins, Capital (5/8) Cash

145,000 7,500 12,500 125,000

E14.12 Retirement: Bonus and Goodwill Calculations a. Stevens' bonus is $120,000 (= $300,000 - $180,000). Once Stevens' retirement is recorded, total capital is $500,000 (= ($800,000 - $300,000). b. Partial goodwill is $120,000 (= $300,000 - $180,000). Entries are as follows: Goodwill Stevens, Capital

120,000

Stevens, Capital Cash

300,000

120,000

300,000

c. Total goodwill is $480,000 [= ($300,000 - $180,000)/.25]. Entries are as follows: Goodwill Stevens, Capital Other partners, Capital

480,000

Stevens, Capital Cash

300,000

120,000 360,000

300,000

E14.13 Partnership Balance Sheets After Retirement a.

Journal entries (not required): Warner, Capital Xavier, Capital Yollen, Capital Yollen, Capital Cash

Current assets……………. Equipment………………..

$115,000 600,000 _______ Total assets……………….. $715,000 b.

Journal entries (not required): Equipment Goodwill Yollen, Capital Yollen, Capital Cash

20,000 40,000 60,000 150,000 150,000 Payables……………............. $200,000 Warner, Capital……………. 305,000 Xavier, Capital…………….. 210,000 Total liabilities and capital… $715,000

25,000 35,000 60,000 150,000 150,000

Current assets……………. $115,000 Equipment……………….. 625,000 Goodwill…………………. 35,000 Total assets……………….. $775,000 c.

Payables……………............. $200,000 Warner, Capital……………. 325,000 Xavier, Capital…………….. 250,000 Total liabilities and capital… $775,000

Journal entries (not required): Equipment Goodwill Warner, Capital Xavier, Capital Yollen, Capital

25,000 575,000 180,000 360,000 60,000

Yollen, Capital Cash

150,000 150,000

Current assets……………. $ 115,000 Payables……………............. $ 200,000 Equipment……………….. 625,000 Warner, Capital……………. 505,000 Goodwill…………………. 575,000 Xavier, Capital…………….. 610,000 Total assets……………….. $1,315,000 Total liabilities and capital… $1,315,000

E14.14 Lump-Sum Liquidation Cho receives zero. Kenney receives $18,000. Martinez receives $45,000. Cash from sale of assets Cash on hand Total cash available Less: Payments to creditors Cash available to partners

$117,000 6,000 $123,000 (60,000) $ 63,000

If assets are sold for $117,000, there is a loss of $48,000 (= $117,000 - $25,000 $140,000) which the partners must share in their income-sharing ratio.

Original capital balance Offsets Adjusted capital balance Loss of $48,000 divided (7:5:4) Allocation of Cho’s deficit, divided (5:4) Cash distribution

Cho $ 27,000 (15,000) 12,000 (21,000) (9,000) 9,000 $ 0

Kenney $ 28,000 10,000 38,000 (15,000) 23,000 (5,000) $ 18,000

Martinez $ 61,000 -61,000 (12,000) 49,000 (4,000) $ 45,000

E14.15 Rights of Creditors Distribution of cash of AB Partnership: Partnership creditors Creditors of Partner A Partner B Distribution of cash of Partner A: Creditors of Partner A Partnership creditors Distribution of cash of Partner B: Creditors of Partner B

Case 1 $42,000 3,000 3,000 $48,000

Case 2 $31,000

$10,000 _____ $10,000

$17,000 13,000 $30,000

$ 9,000

$15,000

______ $31,000

Case 1 • The partnership is solvent, all liabilities are paid, and $6,000 is left over. • Partner A gets $3,000 of partnership cash, which goes to A’s creditors. Combined with A’s cash, A’s creditors collect $13,000. • Partner B gets $3,000 of partnership cash, for total cash of $53,000, of which only $9,000 is needed to pay B’s creditors. • Final result: partnership creditors are paid in full; Partner A’s creditors collect $13,000 out of $17,000; Partner B’s creditors are paid in full. Case 2 • The partnership is insolvent, and $20,000 in liabilities cannot be paid by partnership cash • Partner A has $13,000 in cash available after paying A’s creditors, which goes to partnership creditors. • Partner B is insolvent, with $1,000 in liabilities unpaid by personal cash. • Final result: partnership creditors collect $44,000 of the $51,000 owed them; Partner A’s creditors are paid in full; Partner B’s creditors collect $15,000 of the $16,000 owed them.

E14.16 Safe Payment Calculation Rane Snow Hale

Cash from sale of assets Cash on hand Total cash available Less: Payments to creditors Cash available to partners

$ 125,000 45,000 $ 170,000 (140,000) $ 30,000

Original capital balances Loss of $75,000 on sale of assets Assume total loss on remaining assets of $550,000 Allocate Rane’s deficit (3:2)

0 26,000 4,000

Rane (.5) $210,000 (37,500)

Snow (.3) $275,000 (22,500)

Hale (.2) $170,000 (15,000)

(275,000) $ (102,500) 102,500 $ 0

(165,000) $ 87,500 (61,500) $ 26,000

(110,000) $ 45,000 (41,000) $ 4,000

Whitehead (.5) $ 65,000 ______ $ 65,000 .5 130,000 ______ $130,000 (80,000) $ 50,000

Ellis (.3) $ 45,000 (30,000) $ 15,000 .3 50,000 ______ $ 50,000 ______ $ 50,000

Riley (.2) $ 80,000 ______ $ 80,000 .2 400,000 (270,000) $130,000 (80,000) $ 50,000

E14.17 Cash Distribution Plan

Capital balances per books Deduct loan receivable Pre-liquidation balances Divide by income-sharing % Standardized capital balances Equalize Whitehead and Riley Equalize Whitehead, Ellis & Riley Convert equalization adjustments Convert equalization adjustments

$ $

40,000

Cash Distribution Plan First $50,000 to creditors; Next $54,000 to Riley; Next $56,000 to Whitehead and Riley in a 5:2 ratio; Cash over $160,000 to Whitehead, Ellis and Riley in a 5:3:2 ratio

54,000 16,000

PROBLEMS P14.1 Partnership Formation: Working Backward a. Tangible net assets invested amount to $180,000 (= $50,000 cash + $30,000 equipment + $40,000 cash + $60,000 note). Because the capital balances in Scenario #2 add up to $180,000, Scenario #2 must reflect the bonus approach. The flow of bonuses is as follows:

Brian Jennifer Eric

Tangible Investment $80,000 40,000 60,000

Capital Balance $100,000 25,000 55,000

Bonus To (From) $20,000 (15,000) (5,000)

In Scenario #1, total capital of $360,000 (= $120,000 + $40,000 + $80,000) and goodwill of $180,000 (= $360,000 - $180,000) were recorded, based on Eric’s investment of $60,000 for a 1/6 interest. Goodwill is allocated as follows:

Brian Jennifer Eric

Tangible Investment $80,000 40,000 60,000

Capital Balance $152,000 148,000 60,000

Goodwill To $ 72,000 108,000 --

In Scenario #3, total capital of $260,000 (= $125,000 + $50,000 + $85,000) and goodwill of $80,000 (= $260,000 - $180,000) were recorded. Because these amounts cannot be calculated from the problem data, the partners apparently decided that their various skills have a total value of $80,000, and goodwill is allocated as follows:

Brian Jennifer Eric

Tangible Investment $80,000 40,000 60,000

Capital Balance $125,000 50,000 85,000

Goodwill To $45,000 10,000 25,000

b. First, as to profitability, the fact that goodwill is subject to annual impairment testing means that its presence in the accounts may result in lower earnings than under the bonus method in Scenario #2, other things being equal. The larger amount of goodwill recognized in Scenario #1 may depress earnings more than in Scenario #3. Moreover, conventional return-on-assets measures will be further reduced because the firm's asset base is inflated by the presence of goodwill (the numerator could be smaller and the denominator is always larger).

Second, as to leverage, if one takes the account balances without adjustment, the presence of goodwill results in lower leverage measures because total assets and equity are higher than in the bonus case. And, any interest coverage ratio (or times interest earned) will be reduced by the effect of any goodwill impairment losses on earnings. The presence of goodwill will weaken some profitability measures but has mixed effects on credit-worthiness. Recognizing the "softness" inherent in goodwill, particularly in the non-purchased goodwill here, an analyst may remove its effects.

P14.2 Partnership Formation a. Partnership Balance Sheet Date of Partnership Formation Assets Cash (a) Accounts receivable (net) Equity securities Inventory Equipment (b) Building Land

Total assets

$ 40,000 42,000 60,000 65,000 20,000 45,000 80,000 _______ $352,000

Liabilities Accounts payable Mortgage payable Total liabilities Invested capital Capital, Berrini (d) Capital, Fiedler (e) Capital, Wade (e) Total invested capital (c) Total liabilities and invested capital

$ 45,000 60,000 105,000 123,500 61,750 61,750 247,000 $352,000

Supporting computations: (a) $5,000 (Berrini) + $20,000 (Fiedler) + $15,000 (Wade) = $40,000. (b) Original cost of equipment = $28,000 + $12,000 (depreciation) = $40,000. One half of $40,000 = $20,000. (c) Note that Berrini's investment = $152,000, the fair market value of net assets of Berrini Company: Cash Accounts receivable Inventory Equipment Building Land Accounts payable Mortgage payable

5,000 42,000 65,000 20,000 45,000 80,000 (45,000) (60,000) $152,000

Fiedler's investment = $20,000. Wade's investment = $15,000 + $60,000 (securities) = $75,000. Total investment = $152,000 + $20,000 + $75,000 = $247,000. (d) $247,000 (total investment) x 50% = $123,500 (e) $247,000 (total investment) x 25% = $ 61,750

b. Partnership Balance Sheet Date of Partnership Formation Assets Liabilities Cash $ 40,000 Accounts payable Accounts receivable (net) 42,000 Mortgage payable Equity securities 60,000 Total liabilities Inventory 65,000 Invested capital Land 80,000 Capital, Berrini (a) Equipment 20,000 Capital, Fiedler (b) Building 45,000 Capital, Wade (a) Goodwill (c) 57,000 Total invested capital Total liabilities and Total assets $409,000 invested capital

$ 45,000 60,000 105,000 152,000 76,000 76,000 304,000 $409,000

Supporting calculations: (a) Berrini contributed more than his fair share, whereas Fiedler and Wade contributed less, and will be credited with the goodwill. Berrini is credited with capital of $152,000 = 50% of the total investment of $304,000 including goodwill. Berrini's investment is in the proper ratio ($152,000 = 50% of $304,000). Goodwill of $56,000 is attributed to Fiedler's admission (= $76,000 $20,000), and goodwill of $1,000 is attributed to Wade’s admission (= $76,000 - $75,000), to bring capital balances into the correct relationship. (b) $76,000 = 25% (total capital of $304,000 including goodwill) (c) Total partnership value (= $152,000/0.5) $304,000 Less identifiable net assets contributed (247,000) Goodwill $ 57,000

P14.3 Partners’ Disputes Over Income Allocation a. The basic problem seems to be that the actual workload of the three partners differs from that originally contemplated. Although the existing provisions allow ample opportunity for a nice share of the income to flow to Kaitlyn, the lower income along with the partial implementation provision* shut her out in 2020 and almost shut her out in 2019. In contrast, Nathan and Daniel continue to receive almost all of the partnership income despite the declining value of their efforts in the firm. * Salaries to Nathan and Daniel absorbed all of the 2020 income and Kaitlyn's share of the 2019 income amounted to only her interest on capital of $36,000. After salaries and interest, there was no income available for percentage distribution [income after salaries and interest = $205,400 - ($90,000 + $75,000) - .04($40,000 + $70,000)- .20($180,000) = $0].

b. The proposed bonus provision ought to ameliorate Kaitlyn's discontent; in 2020 and 2019 she would have received $35,000 and $51,350, respectively, off the top. Daniel, however, would have seen his share reduced to $47,775 [= .455($140,000 - $35,000)] in 2020 and to $70,093 [= .455($205,400 - $51,350)] in 2019. Note: When income is insufficient to cover both salaries, Nathan and Daniel share proportionately. Daniel's share of the total salary allocation is .455 [= $75,000/($90,000 + $75,000)].

c. Under the new bonus provision, Kaitlyn's 2021 bonus (B), based on income of $220,000, is $44,000 [B = .25($220,000 - B) = $55,000/1.25]. The comparative income allocation is therefore:

Bonus Salary Interest** Residual Total

Nathan New Old $ -$ -90,000 90,000 436 1,600 -2,920 $90,436 $94,520

Daniel New Old $ -$ -75,000 75,000 762 2,800 -4,380 $75,762 $82,180

Kaitlyn New Old $44,000 $ ---9,802 36,000 -7,300 $53,802 $43,300

** Under the new bonus provision, only $11,000 (= $220,000 - $44,000 - $90,000 - $75,000) of income remains to be allocated via interest on capital balances. The maximum amount to be allocated via interest is $40,400 [= (.04 x $40,000) + (.04 x $70,000) + (.2 x $180,000) = $1,600 + $2,800 + $36,000], Nathan's share of the $11,000 is therefore $436 [= $11,000 x ($1,600/$40,400)], Daniel's is $762 [= $11,000 x ($2,800/$40,400)] and Kaitlyn's is $9,802 [= $11,000 ($36,000/$40,400)].

This approach leads to a shift in income away from Nathan and Daniel and toward Kaitlyn. Although the shifts shown in the above table may not seem very large, Kaitlyn's income share rises by 24% in 2021.

P14.4 Income Allocations: Schedule of Changes in Capital Accounts a. Capital balances at beginning of year Added to Sills' capital account during the year was the income share (interest + salary + bonus + share of residual). Withdrawn from Sills' account was the income share plus $40,000. Thus, the net withdrawal from Sills' account was $40,000. By using the end of year balance in the account, we can compute the beginning balance. The same logic applies to calculating Reeves’ beginning capital account balance. Sills: End of year balance Plus net withdrawal Beginning balance Reeves: End of year balance Less net addition Beginning balance Burstein: Total capital balance at beginning of year Less other partners= balances ($100,000 + $220,000) Beginning balance

$ 60,000 40,000 $100,000 $ 250,000 (30,000) $ 220,000 $ 450,000 (320,000) $ 130,000

b. Greystone Partnership Schedule of Changes in Capital Accounts For the Year Ended December 31, 2020

Capital balances, January 1 Allocation of income: Interest (5% x beginning capital balances) Salaries Bonus (1) Residual profit (2) Balance after distributions Withdrawals (3) Ending Balance (1) Bonus to Sills: Income before salaries and bonus Plus interest ($6,500 + $11,000 + $5,000) Income before salaries, bonus and interest Bonus (2) Income after salaries, bonus, and interest: Income before salaries, bonus and interest Less interest Less salaries: Burstein Reeves Sills Less bonus to Sills Income after salaries, bonus, and interest

Burstein $ 130,000 6,500 70,000 30,975 237,475 (83,475) $154,000

Reeves Sills $ 220,000 $ 100,000 11,000 80,000

5,000 50,000 48,375 10,325 10,325 321,325 213,700 (71,325) (153,700) $250,000 $ 60,000

$300,000 22,500 322,500 x 15% $ 48,375

$322,500 (22,500) $70,000 80,000 50,000

(200,000) (48,375) $ 51,625

6:2:2 allocation is $30,975 to Burstein, $10,325 to Reeves, and $10,325 to Sills. (3) Drawings by partners: Burstein: (given) Reeves: Total distribution less $30,000 retained = $11,000 + $80,000 + $10,325 - $30,000 = Sills: Total distribution plus $40,000 = $5,000 + $50,000 + $48,375 + $10,325 + $40,000 =

$ 83,475 71,325 153,700

P14.5 Tax Consequences of Investments in MLPs a. Cash distribution (5,000 x per unit cash distribution) Tax on taxable income (5,000 x per unit taxable income x 35%) Net cash return

2018 $6,000

2019 $7,500

2020 $8,000

(700) $5,300

(630) $6,870

(875) $7,125

b. Calculation of basis: Original cost Less 2018 excess cash distribution = ($1.20 - $0.40) x 5,000 Less 2019 excess cash distribution = ($1.50 - $0.36) x 5,000 Less 2020 excess cash distribution = ($1.60 - $0.50) x 5,000 Total basis reduction Basis

$125,000 $(4,000) (5,700) (5,500) 15,200 $109,800

Selling price Basis Gain

$140,000 109,800 $ 30,200

Tax on gain taxed at personal tax rate $15,200 x 35% Tax on gain taxed at capital gains rate ($140,000 - $125,000) x 15% Total tax

$ $

5,320 2,250 7,570

c. Present value of tax on excess cash distribution, if paid yearly: ($4,000 x 35%)/1.1 + ($5,700 x 35%)/(1.1)2 + ($5,500 x 35%)/(1.1)3 = $4,367.77 Present value of tax on excess cash distribution if paid at time of sale: ($15,200 x 35%)/(1.1)3 = $3,996.99 Present value of delaying the tax = $4,367.77 - $3,996.99 = $370.78

P14.6 Bonus Calculations J = Jie’s bonus N = Nuan’s bonus a. $400,000 - $120,000 - $150,000 – (4% x $500,000) – (4% x $387,500) = $94,500 J = 20% x $94,500 = $18,900 N = 20% x ($94,500 - $18,900 – N) N = $12,600 b. J = N J = 20% x ($94,500 – J – N) J = 20% x ($94,500 – 2J) J = $13,500 N = $13,500 c. N = ½ J J = 20% x ($94,500 – J – N) J = 20% x ($94,500 – 1.5J) J = $14,538 N = ½ J = $7,269

P14.7 Financial Statement Effects of Partnership Expansion a. The alternatives affect the amounts of assets and equities, not liabilities. Alternatives 2 and 3 look good because debt is a small part of the capital structure (and total assets) and cash and the quick ratio [= (cash + receivables)/accounts payable] are highest. This may be offset by the presence of additional other assets (probably goodwill) which produce greater depreciation and possible impairment charges that exceed the additional earnings generated. The principal red flag involves the very large portion of total assets represented by other assets. What is the composition of other assets? To the extent that goodwill is included, as it undoubtedly is in alternatives 3 and 4, impairment losses can cause a drag on earnings without corresponding earning power. Remember, the partnership group is the same, with the same talents, whether or not goodwill is recorded. b. In each alternative, Ingalls has the same 20% of total capital. Ingalls' capital represents the greatest percentage of total assets in #3. Yet in #4, Ingalls acquires the 20% capital interest for $12,000 (rather than $40,000) cash. Either of these alternatives is probably preferred to the other two although we cannot determine how much cash was paid in the personal transaction #1.

c. Dr (Cr) Cash Other assets Capital—Graham Capital—Hyde Capital—Ingalls

#1 $ --10,000 6,000 (16,000)

#2 $40,000 -(12,000) (4,000) (24,000)

#3 $40,000 80,000 (60,000) (20,000) (40,000)

#4 $12,000 8,000 --(20,000)

#1: Personal transaction between Ingalls, Graham and Hyde. #2: Bonus to old partners. #3: Goodwill to old partners [$80,000 = $40,000/0.2- ($50,000 + $30,000 + $40,000)] #4: Goodwill to new partner [$8,000 = ($50,000 + $30,000)/0.8 - ($50,000 + $30,000 + $12,000)]

P14.8 Investment Club: Admission and Income Allocation a. Grant and Lee must each invest $7,000, as shown below: Current value of Club equity: Cash Fair market value of securities Total

3,200 122,800 $126,000

Equity value per partner = $126,000/18 = $7,000 b. Allocation of 2020 income to partners:

Interest and dividends Gain on Security A: Prior to January 1, 2020 After January 1, 2020 Loss on Security B: Prior to January 1, 2020 After January 1, 2020 Total

Total $4,200

Grant $210

Lee $210

18 Old Partners $3,780

3,600 2,000

0 100

3,600 1,800

(1,800) (1,000) $7,000

0 (50) $260

(1,800) (900) $6,480

Gains and losses that occurred prior to January 1, 2020 are attributable to the 18 old partners. Gains and losses since January 1, 2020 are attributable to all 20 partners; $260 = ($4,200 + $2,000 - $1,000)/20. c. To answer this question, we calculate the capital accounts of the partners after the

sale of the portfolio. Certain other calculations are required first. 1. Cost of portfolio at time of sale: Cost at January 1, 2020 Less cost of securities sold in 2020 Plus cost of securities bought in 2020 Cost of portfolio at time of sale in January 2021

$ 78,300 (14,000) 40,000 $104,300

2. Gain on sale of portfolio: Selling price Cost (per (1) above) Gain

$ 228,000 104,300 $123,700

3. Amount of unrealized gain prior to January 1, 2020: Fair value of portfolio at January 1, 2020 Less: January 1, 2020 value of securities sold in 2020 Remaining fair value at December 31, 2020 Cost of portfolio at January 1, 2020 Less: Cost of securities sold in 2020 Remaining cost at December 31, 2020 Remaining pre-January 1, 2020 gain

$122,800 15,800 $107,000 78,300 14,000 64,300 $ 42,700

4. Amount of gain accrued after January 1, 2020: Total gain, per (2) above Gain accrued prior to January 1, 2020, per (3) Gain accrued after January 1, 2020

$123,700 42,700 $ 81,000

5. Total assets of Club at dissolution: Cash: Balance at January 1, 2020 Invested by Grant and Lee Invested during 2020 (20 x $500) Proceeds from 2020 sale of securities Received from 2020 interest and dividends Invested in new securities during 2020 Cash balance at December 31, 2020 Proceeds from 2021 sale of securities Total assets at dissolution

3,200 14,000 10,000 16,800 4,200 (40,000) 8,200 228,000 $236,200

Partners’ capital accounts at time of dissolution: Total Capital at January 1, 2020 Invested by Grant and Lee

Grant

Lee

18 Old Partners

$ 81,500 14,000

$ 7,000

$ 81,500 0

Invested during 2020

10,000

500

9,000

2020 income allocation (see b.) Capital at December 31, 2020

7,000 112,500

260 7,760

6,480 96,980

Allocation of remaining pre-2020 gain

42,700 81,000

0 4,050

42,700 72,900

$236,200

$11,810

$212,580

Allocation of Post-January 1, 2020 gain Capital at time of dissolution

Thus, Grant and Lee each received $11,810 and the 18 old partners as a group received $212,580.

P14.9 Admission of New Partner Xavier must pay $1,895,400 to be admitted to the partnership. Under the proposed arrangements, Blackman, Coulter, and Xavier would be equal partners. The annual amount available for income sharing is the $2,250,000 currently earned by Blackman ($1,000,000), Coulter ($1,000,000), and Xavier ($250,000). Thus each partner would receive $750,000 annually (= $2,250,000/3). Xavier's increased earnings would be $500,000 annually (= $750,000 - $250,000). The present value of this amount, discounted at 10% over five years, is $1,895,400 (= $500,000 x present value of annuity factor, 5 years, 10% = $500,000 x 3.7908). NOTE: Answers will vary with the use of a financial calculator or a more precise present value factor. P14.10 Retirement of Two Partners a. Capital—Decker 250,000 Capital—Groth 150,000 Capital—Farmer 25,000 Capital—Wang 25,000 Capital—Lux 25,000 Cash and other assets To record retirement of Decker and Groth under the bonus method. Total paid $475,000 Less total capital of retirees (400,000) Total bonus $ 75,000 Shared equally among the remaining partners.

475,000

b. Goodwill 75,000 Capital—Decker Capital—Groth To record partial goodwill prior to retirement of Decker and Groth.

Payment Capital balance Goodwill attributable to retiree

Decker $287,500 250,000 $ 37,500

37,500 37,500

Groth $187,500 150,000 $ 37,500

Capital—Decker 287,500 Capital—Groth 187,500 Cash and other assets 475,000 To record retirement of Decker and Groth under the partial goodwill approach. c. Under the bonus method of accounting for retirement, Wang's capital balance is reduced to zero. This is likely his objection to the procedure. d. In either case, the firm does not have sufficient cash to pay the retirees. Certainly some cash is also needed for operating expenses so that depleting the cash account would be unwise. A simple solution would be to pay retirees in installments over a period of several years.

P14.11

Financial Statement Effects of Retirement/Admission Note: Mills and Sinclair each have a 20% share of partnership income. Therefore the other partners have a 60% share. a. Goodwill is about 39% of the partnership’s total assets (= $800,000/$2,068,000), and is often considered a “soft” asset by lenders as it represents unspecified intangible assets with unknown future cash-generating potential. Partnership leverage (debt/assets) is about 51% (= $47,000 + $209,000 + $600,000 + $200,000)/$2,068,000 if goodwill is included, and is about 83% (= $47,000 + $209,000 + $600,000 + $200,000)/($2,068,000 - $800,000) if goodwill is excluded. As a result, a lender may conclude that the partnership is less likely to make additional debt payments.

b. Because the $350,000 exceeds Mills' capital balance of $270,000, total goodwill is $400,000 (= 80,000/.2). The following entries record the goodwill and Mills' retirement. Goodwill 400,000 Capital—Mills 80,000 Capital—Sinclair 80,000 Capital—Other partners 240,000 To record goodwill of $400,000, assigning it to the partners in accordance with their income-sharing percentages. Cash

350,000 Notes payable

Capital—Mills Cash

350,000 350,000 350,000

At this point, total capital amounts to $1,062,000 (= $195,000 + $80,000 + $547,000 + $240,000); it will be $1,112,000 after Luh's $50,000 investment. Thus, Luh invests $50,000 for a 10% interest in $1,112,000, or $111,200. Under the bonus method of admission, Luh's bonus is $61,200 (= $111,200 - $50,000), charged in a 20:60 or 1:3 ratio between Sinclair and the other partners, or $15,300 to Sinclair and $45,900 to the other partners. The admission entry is as follows: Cash 50,000 Capital—Sinclair 15,300 Capital—Other partners 45,900 Capital—Luh To record admission of Luh under the bonus method of admission.

111,200

Under the goodwill method of admission, we have goodwill to the new partner ($50,000 < $111,200) of $68,000 [= ($1,062,000/.9) - ($1,062,000 + $50,000)]. The admission entry is as follows: Cash 50,000 Goodwill 68,000 Capital—Luh To record admission of Luh under the goodwill method of admission.

118,000

The pro-forma balance sheets appear next. Moore, Mills, Sinclair & Co. Pro-forma Balance Sheets After Mills' Retirement and Luh's Admission

Cash and cash equivalents (1) Accounts receivable--clients Notes receivable--Sinclair Prepayments Fixed assets, net Goodwill, net

Trade payables Accrued liabilities Notes payable--1st National Bank Notes payable—Moore Capital—Luh Capital—Sinclair Capital—other partners

Bonus Method $ 228,000 430,000 100,000 60,000 500,000 1,200,000 (2) $2,518,000

Goodwill Method $ 228,000 430,000 100,000 60,000 500,000 1,268,000 (5) $2,586,000

$ 47,000 209,000 950,000 200,000 111,200 259,700 (3) 741,100 (4) $2,518,000

$ 47,000 209,000 950,000 200,000 118,000 275,000 (6) 787,000 (7) $2,586,000

(1) $228,000 = $178,000 + $350,000 - $350,000 + $50,000 (2) $1,200,000 = $800,000 + $400,000 (3) $259,700 = $195,000 + $80,000 - $15,300 (4) $741,100 = $547,000 + $240,000 - $45,900 (5) $1,268,000 = $800,000 + $400,000 + $68,000 (6) $275,000 = $195,000 + $80,000 (7) $787,000 = $547,000 + $240,000

c. The resulting pro-forma balance sheets are not very different. Total assets and total capital are larger by the additional $68,000 of goodwill arising when Luh is admitted by the goodwill method. Using the comparisons made in Requirement b., we see that:

Goodwill/Total assets Total liabilities/Total assets

Bonus Method .477 .558

Goodwill Method .490 .544

Thus the two pro-forma balance sheets have about the same degree of strength (or weakness). Leverage is slightly worse under the bonus method whereas the soft goodwill is a slightly more significant component of total assets under the goodwill method.

P14.12 Retirement Effects on Partnership Balance Sheet and Income a. 1. Journal entries (not required): Martinez, capital Nunez, capital Lopez, capital Lopez, capital Cash

105,000 105,000 210,000 300,000 300,000

Cash………………………. $ 40,000 Accounts payable……………. $ 125,000 Receivables……………….. 100,000 Loans payable……………….. 500,000 Supplies…………………… 25,000 Martinez, capital…………….. 545,000 Equipment………………… 450,000 Nunez, capital……………….. 720,000 Building…………………… 975,000 Land…..………………….. 300,000 _______ Total assets……………….. $ 1,890,000 Total liabilities and capital….. $1,890,000 2. Journal entries (not required): Supplies Equipment Building Goodwill Land Lopez, capital Lopez, capital Cash

5,000 50,000 25,000 150,000 20,000 210,000 300,000 300,000

Cash………………………. $ 40,000 Accounts payable……………. $ 125,000 Receivables……………….. 100,000 Loans payable……………….. 500,000 Supplies…………………… 30,000 Martinez, capital…………….. 650,000 Equipment………………… 500,000 Nunez, capital……………….. 825,000 Building…………………… 1,000,000 Land…..………………….. 280,000 Goodwill…………………. 150,000 ________ Total assets……………….. $ 2,100,000 Total liabilities and capital….. $2,100,000

$210,000/.2 = $1,050,000 total value increase

Journal entries (not required): Supplies Equipment Building Goodwill Land Lopez, capital Martinez, capital Nunez, capital Lopez, capital Cash

5,000 50,000 25,000 990,000 20,000 210,000 420,000 420,000 300,000 300,000

Cash………………………. $ 40,000 Accounts payable……………. $ 125,000 Receivables……………….. 100,000 Loans payable……………….. 500,000 Supplies…………………… 30,000 Martinez, capital…………….. 1,070,000 Equipment………………… 500,000 Nunez, capital……………….. 1,245,000 Building…………………… 1,000,000 Land…..………………….. 280,000 Goodwill…………………. 990,000 ________ Total assets……………….. $ 2,940,000 Total liabilities and capital….. $2,940,000 b. The bonus method does not affect next year’s income since no assets are revalued. The partial and full goodwill approaches revalue assets, which are written off next year as follows: Supplies expense Depreciation expense, equipment = $50,000/5 = Depreciation expense, building = $25,000/20 = Total expense

$ 5,000 higher 10,000 higher 1,250 higher $ 16,250 higher

Partnership income is $16,250 lower next year due to revaluation write-offs. If goodwill was impaired, this would reduce income further.

Partnership Liquidation – Safe Payments

P14.13

November Cash on hand Cash from sale (= $18,000 + $21,000) Payment of outside creditors Cash available for distribution

$25,000 39,000 (60,700) $ 3,300

Ingram's loan account is added to her capital balance.

Capital balance, Nov. 2 Loss realized in November* Capital November 30 Assumed loss on remaining assets** Allocate deficiencies Allocate deficiencies

Dennis $62,000

Edwards $54,000

Lacy $22,000

Ingram $71,300

(3,200) 58,800 (38,000) 20,800 (12,600) 8,200 (4,900) $ 3,300

(4,800) 49,200 (57,000) (7,800) 7,800 0 0 $ 0

(1,600) 20,400 (19,000) 1,400 (6,300) (4,900) 4,900 $ 0

(6,400) $64,900 (76,000) (11,100) 11,100 0 0 $ 0

Distribute $3,300 to Dennis. *

Loss of $7,000 on fixtures (= $18,000 - $25,000) and $9,000 on equipment (= $21,000 - $30,000), total $16,000. ** Book values of remaining assets = $20,000 supplies + $145,000 equipment + $25,000 fixtures = $190,000.

December Cash from sale of supplies (= 0.8 x $20,000) Cash from sale of fixtures Cash available for distribution

Capital balance before distribution November distribution Loss realized in December*** Capital balance, Dec. 31 Assumed loss on remaining assets**** Allocate deficiencies

Dennis $ 58,800 (3,300) 55,500 (4,200) 51,300 (29,000) 22,300 (1,400) $ 20,900

Distribute $20,900 to Dennis and $3,100 to Lacy.

$16,000 8,000 $24,000 Edwards $ 49,200 0 49,200 (6,300) 42,900 (43,500) (600) 600 $ 0

Lacy $ 20,400 0 20,400 (2,100) 18,300 (14,500) 3,800 (700) $ 3,100

Ingram $ 64,900 0 64,900 (8,400) 56,500 (58,000) (1,500) 1,500 $ 0

***

Loss of $4,000 (= $16,000 - $20,000) on supplies and $17,000 (= $8,000 - $25,000) on fixtures, total loss for December $21,000. **** Book value of remaining assets = $145,000 equipment.

January Cash available for distribution = $25,000

Capital balance before December distribution December cash distribution Loss realized in January***** Assumed loss on remaining equipment ($105,000)

Dennis $51,300 (20,900) 30,400 (3,000) 27,400

Edwards $42,900 ______ 42,900 (4,500) 38,400

Lacy $18,300 (3,100) 15,200 (1,500) 13,700

Ingram $56,500 _____ 56,500 (6,000) 50,500

(21,000) $ 6,400

(31,500) $ 6,900

(10,500) $ 3,200

(42,000) $ 8,500

Distribute $6,400 to Dennis, $6,900 to Edwards, $3,200 to Lacy, and $8,500 to Ingram. ***** Loss of $15,000 (= $25,000 - $40,000) on equipment in January.

P14.14 Partnership Liquidation – Safe Payments and Cash Distribution Plan a.

Cash distributions January Beginning cash balance Collections of receivables Sale of inventory Sale of equipment Liquidation expenses Payment of loan Payment of accounts payable Cash reserve Cash distribution—January

$ 32,000 45,000 30,000 80,000 (5,500) (75,000) (39,500) (20,000) $ 47,000

February Beginning cash balance Collections of receivables Liquidation expenses Cash reserve Cash distribution—February

$ 20,000 15,000 (3,000) (10,000) $ 22,000

March Beginning cash balance

$ 10,000

Sale of land Liquidation expenses Cash distribution—March b.

125,000 (8,000) $127,000

Safe payments January

Capital Partners’ loans Combined capital January transactions: Loss on inventory return Loss on inventory sale Loss on equipment sale Liquidation expenses January 31 capital Less: Reserved cash Potential loss on accounts receivable Potential loss on land Potential loss on truck Allocation of Edsel’s and Harley’s deficiencies January 31 safe payment

Dodge (40%)

Edsel (25%)

Ford (20%)

$ 71,000 80,000 151,000

$ 42,000 (25,000) 17,000

$ 53,000 -053,000

(600) (6,000) (12,800) (2,200) 129,400

(375) (3,750) (8,000) (1,375) 3,500

(8,000)

Harley (15%) $

Total

9,000 -09,000

$175,000 55,000 230,000

(300) (3,000) (6,400) (1,100) 42,200

(225) (2,250) (4,800) (825) 900

(1,500) (15,000) (32,000) (5,500) 176,000

(5,000)

(4,000)

(3,000)

(20,000)

(16,800) (12,000) (14,800) 77,800

(10,500) (7,500) (9,250) (28,750)

(8,400) (6,000) (7,400) 16,400

(6,300) (4,500) (5,550) (18,450)

(42,000) (30,000) (37,000) 47,000

(31,467) $ 46,333

28,750 $ -0-

(15,733) $ 667

18,450 $ 0

-0$ 47,000

February

January 31 Capital Less: payment to partners February transactions: Loss on truck Transfer of truck Accounts written off Liquidation expenses February 28 capital Less: Reserved cash Potential loss on land Allocation of Edsel’s and Harley’s deficiencies February 28 safe payment

Dodge (40%)

Edsel (25%)

Ford (20%)

$ 129,400 (46,333)

3,500 -0-

$ 42,200 (667)

(2,800) (30,000) (10,800) (1,200) 38,267

(1,750) -0(6,750) (750) (5,750)

(4,000) (12,000) 22,267

Harley (15%) $

Total

900 -0-

$ 176,000 (47,000)

(1,400) -0(5,400) (600) 34,133

(1,050) -0(4,050) (450) (4,650)

(7,000) (30,000) (27,000) (3,000) 62,000

(2,500) (7,500) (15,750)

(2,000) (6,000) 26,133

(1,500) (4,500) (10,650)

(10,000) (30,000) 22,000

(17,600) $ 4,667

15,750 $ -0-

(8,800) $ 17,333

10,650 $ -0-

-0$ 22,000

Dodge (40%)

Edsel (25%)

Ford (20%)

Harley (15%)

Total

38,267 (4,667)

$ (5,750) -0-

$ 34,133 (17,333)

$ (4,650) -0-

$ 62,000 (22,000)

38,000 (3,200)

23,750 (2,000)

19,000 (1,600)

14,250 (1,200)

95,000 (8,000)

68,400

$ 16,000

$ 34,200

8,400

$127,000

March

February 28 capital Less: payment to partners March transactions: Gain on land sale Liquidation expenses March 31 capital and safe payment

c. Cash distribution plan Capital Accounts Dodge Edsel Ford (.4) (.25) (.2) Preliquidation balances $ 151,000 $ 17,000 $ 53,000 Divide by income-sharing % 0.4 0.25 0.2 Standardized capital $377,500 $68,000 $265,000 Equalize Dodge and Ford (112,500) --$265,000 $68,000 $265,000 Equalize Dodge, Edsel and Ford (197,000) -(197,000) $ 68,000 $ 68,000 $ 68,000 Equalize Dodge, Edsel, Ford and Harley (8,000) (8,000) (8,000) $ 60,000 $ 60,000 $ 60,000

Harley (.15) $ 9,000 0.15 $60,000 -$60,000 -$60,000 -$60,000

Convert equalization adjustments Convert equalization adjustments Convert equalization adjustments

Dodge $45,000 78,800 3,200

Edsel

Ford

$2,000

$39,400 1,600

Cash distribution plan Step 1: First $45,000 to Dodge Step 2: Next $118,200 to Dodge and Ford in a 2:1 ratio Step 3: Next $6,800 to Dodge, Edsel and Ford in a 40:25:20 ratio Step 4: Remaining cash distributed to all four partners in income-sharing ratio January $47,000 cash distribution Step 1: First $45,000 to Dodge Step 2: $2,000 to Dodge and Ford in a 2:1 ratio Total distribution

Dodge $45,000

Edsel

1,333 $46,333

Ford

Harley

$667 $667

February $22,000 cash distribution plus $30,000 truck to Dodge Dodge Edsel Step 2 truck to Dodge $30,000 Step 2 cash distribution to Ford to get back on cash distribution plan $7,000 step 2 cash in 2:1 ratio 4,667 Total distribution (includes truck) $34,667

Ford

Harley

$15,000 2,333 $17,333

March $127,000 cash distribution Dodge Step 2: $64,200 to Dodge and Ford in a 2:1 ratio Step 3: $6,800 to Dodge, Edsel, and Ford in a 40:25:20 ratio Step 4: $56,000 to Dodge, Edsel, Ford and Harley in 40:25:20:15 ratio Total distribution

Edsel

$42,800

Ford

Harley

$21,400

3,200

$2,000

1,600

22,400 $68,400

14,000 $16,000

11,200 $34,200

$8,400 $8,400

P14.15 Close Books and Prepare Cash Distribution Plan a.

Preclosing balances per books Deduct drawings Income allocation: Salaries Residual Post-closing balances

Capital Accounts Arnold Bell Crane (.2) (.5) (.3) $ 85,000 $ 70,000 $ 40,000 (60,000) (27,000) (25,000)

Total $ 195,000 (112,000)

50,000 18,400 $ 93,400

120,000 92,000 $ 295,000

70,000 46,000 $ 159,000

-27,600 $ 42,600

Postclosing balances Add loan payable to Crane Preliquidation balances Divide by income-sharing % Standardized capital Equalize Arnold and Bell Equalize Arnold, Bell and Crane Convert equalization adjustments Convert equalization adjustments

Arnold (.2) $ 93,400 -93,400 0.2 467,000 (149,000) 318,000 (56,000) $262,000 $ 29,800 11,200

Capital Accounts Bell Crane (.5) (.3) $159,000 $ 42,600 -36,000 159,000 78,600 0.5 0.3 318,000 262,000 _______ -318,000 262,000 (56,000) -$262,000 $262,000 $ 28,000

Total $ 295,000 36,000 331,000

$ 29,800 39,200

Cash Distribution Plan First $114,000 to creditors Next $29,800 to Arnold Next $39,200 to Arnold and Bell in 2:5 ratio Any further amount Arnold, Bell and Crane in 2:5:3 ratio c. Because cash of $95,000 is already available, only $19,000 must be realized from the other assets to liquidate the liabilities. If $19,000 is realized, the loss on the other assets is $331,000 (= $350,000 – $19,000). As expected, this loss equals the total preliquidation capital of $331,000. When allocated to the partners in their 2:5:3 income-sharing ratio, and assuming no additional investments are made, each capital account will be driven to zero.

P14.16 Analysis of Liquidation Scenario a. There appears to be inadequate control over cash receipts. An opportunity to steal cash exists when a single individual is responsible for collecting the coins and depositing them. This opportunity, coupled with Green's worsening personal financial situation, may have presented a temptation that Green found difficult to resist. If so, this may explain the observed decrease in operating cash flow. b. Capital accounts per trial balance Income allocation Addition of loan payable to Blue Ending capital accounts To standardize, divide by income % Standardized capital balance Equalize Green and Blue

Green $ 5,000 3,600 0 8,600 .60 14,333 0 $14,333

Convert equalization adjustment ($31,292 x 0.4)

Blue $ 4,850 2,400 11,000 18,250 .40 45,625 (31,292) $14,333 $12,517

Total $ 9,850 6,000 11,000 26,850

Therefore, the cash distribution plan is: First $3,350 to creditors (includes $2,000 lease buyout). Next $12,517 to Blue. Any further amount to Green and Blue in a 3:2 ratio. c. Sale of the equipment, supplies and prepayments, with total net book value of $25,900 (= $900 + $42,000 - $17,000) must realize $13,567 (= $3,350 + $12,517 $2,300) before Green will receive any proceeds in liquidation. Prepayments generally do not generate significant cash, and the equipment and supplies, while valuable to partnership operations, are unlikely to be valued as highly by outside buyers. A sales price of over 50% of book value is possible but improbable.

P14.17 Evaluation of Partnership Opportunities a. The amount, in present value terms, to be received by each partner is as follows: Reitmyer ($200,000 + .4 x ($1,200,000 - $700,000)) Simon ($150,000 + .4 x ($1,200,000 - $700,000)) Trybus ($70,000 + .2 x ($1,200,000 - $700,000)) Total

$400,000 350,000 170,000 $920,000

In this situation, the properties are sold for $1,200,000. After paying the $300,000 of liabilities, there is $920,000 (= $900,000 from sale transaction plus $20,000 existing cash) to be divided by the partners. These transactions occur immediately, and no present value calculations are required. b. The amount, in present value terms, to be received by each partner is as follows: Reitmyer Simon Trybus Total

$266,170 266,170 256,170 $788,510

In this situation, $50,000 is received immediately and divided among the partners in a 4:4:2 ratio. The annual salary of $40,000 is received by each partner for ten years; this has a present value of $245,784 (= $40,000 x present value of annuity factor, 10 years, 10% = $40,000 x 6.1446). A final payment of $1,000 is made to each partner at the end of year 10, which has a present value of $386 (= $1,000 x present value factor, 10 years, 10% = $1,000 x .3855). Thus, the present values of the amounts received by each partner are:

Initial payment Present value of ten years’ salary Present value of final payment Total

Reitmyer $ 20,000 245,784 386 $ 266,170

Simon $ 20,000 245,784 386 $ 266,170

Trybus $ 10,000 245,784 386 $ 256,170

Because all partners receive the same salary, note that Trybus fares better under this arrangement than under the immediate sale, while the other two partners receive less. NOTE: Answers will vary with the use of a financial calculator, or more precise present value factors.

c. The amount, in present value terms, to be received by each partner is as follows: Reitmyer Simon Trybus Total

$239,680 239,680 154,550 $633,910

In this situation, $50,000 is received immediately and divided among the partners in a 4:4:2 ratio. The annual salary of $40,000 is received by each partner for two years; this has a present value of $69,420 (= $40,000 x present value of annuity factor, 2 years, 10% = $40,000 x 1.7355). The properties are sold for $950,000 at the end of the fourth year. After paying the $400,000 of liabilities, there is $550,000 to be divided by the partners. The present value of the net proceeds is $375,650 (= $550,000 x present value factor, 4 years, 10% = $550,000 x .6830). Thus, the present values of the amounts received by each partner are:

Initial payment Present value of two years’ salary Present value of sale proceeds Total

Reitmyer $ 20,000 69,420 150,260 $ 239,680

Simon $ 20,000 69,420 150,260 $ 239,680

Trybus $ 10,000 69,420 75,130 $ 154,550

NOTE: Answers will vary with the use of a financial calculator, or more precise present value factors. d. The amount, in present value terms, to be received by each partner is as follows: Reitmyer Simon Trybus Total

$266,166 266,166 256,166 $788,498

In this situation, $50,000 is received immediately and divided among the partners in a 4:4:2 ratio. The annual salary of $40,000 is received by each partner for five years; this has a present value of $151,632 (= $40,000 x present value of annuity factor, 5 years, 10% = $40,000 x 3.7908). The remaining five years of salary are then prepaid, at the end of year 5. The discounted value of these payments is $151,632 per partner (= $40,000 x present value of annuity factor, 5 years, 10% = $40,000 x 3.7908), and the present value is $94,148 (= $151,632 x present value factor, 5 years, 10% = $151,632 x .6209). The final payment of $1,000 is also prepaid to each partner at the end of year 5, which has a present value of $386 (= $1,000 x present value factor, 5 years, 10% = $1,000 x .6209 = $621; this amount discounted to the present is $386 = $621 x present value factor, 5 years, 10% = $621 x .6209). Thus the present values of the amounts received by each partner are:

Initial payment Present value of five years’ salary Prepayment of five years’ salary Prepayment of final payment Total

Reitmyer $ 20,000 151,632 94,148 386 $ 266,166

Simon $ 20,000 151,632 94,148 386 $ 266,166

Trybus $ 10,000 151,632 94,148 386 $ 256,166

Note that, except for a small rounding error in the discount factors, this outcome is identical to requirement b. The acceleration of the payments makes no difference in present value terms. NOTE: Answers will vary with the use of a financial calculator, or more precise present value factors. e. The amount, in present value terms, to be received by each partner is as follows: Reitmyer Simon Trybus Total

$ 444,828 444,828 298,230 $1,187,886

In this situation, $50,000 is received immediately and divided among the partners in a 4:4:2 ratio. The annual salary of $40,000 is received by each partner for five years; this has a present value of $151,632 (= $40,000 x present value of annuity factor, 5 years, 10% = $40,000 x 3.7908). The election of the buyout requires the partners to pay the Ushers $250,000 (= $50,000 x 5). The present value of this payment is $155,225 (= $250,000 x present value factor, 5 years, 10% = $250,000 x 0.6209). This payment would be divided among the partners in a 4:4:2 ratio. The properties are sold for $2,000,000 at the end of the fifth year. After paying the $650,000 of liabilities, there is $1,350,000 to be divided by the partners. The present value of the net proceeds is $838,215 (= $1,350,000 x present value factor, 5 years, 10% = $1,350,000 x 0.6209). Thus the present values of the amounts received by each partner are:

Initial payment Present value of five years’ salary Buyout payment made to Ushers* Present value of sale proceeds** Total

Reitmyer $ 20,000 151,632 (62,090) 335,286 $444,828

Simon $ 20,000 151,632 (62,090) 335,286 $444,828

Trybus $ 10,000 151,632 (31,045) 167,643 $298,230

* Total is $155,225 = 5 x $50,000 x 0.6209. ** Total is $838,215 = ($2,000,000 - $650,000) x 0.6209.

NOTE: Answers will vary with the use of a financial calculator, or more precise present value factors.

CHAPTER 15 SOLUTIONS TO MULTIPLE CHOICE QUESTIONS, EXERCISES AND PROBLEMS

MULTIPLE CHOICE QUESTIONS 1.

a $120,000 + $25,000 - $180,000 = $(35,000)

d Net free assets = $1,000,000 realizable value of assets, less $300,000 pledged to fully secured creditors, less $250,000 unsecured liabilities with priority, equals $450,000.

a Total unsecured liabilities of $1,500,000 less $250,000 unsecured liabilities with priority equals $1,250,000 unsecured liabilities without priority. Subtracting net free assets of $450,000 gives the deficiency to unsecured creditors of $800,000.

d Inventory of $650,000 was sold for $290,000, giving a loss on realization of $360,000. There is no gain on liquidation. Assets not realized are $775,000 equipment. Initial assets to be realized do not include the cash balance.

c Cash of $420,000 is paid to creditors ($130,000 initially on hand plus $290,000 from sale of inventory). It is to be distributed proportionately to unsecured creditors, which total $2,100,000. Thus there is a 20% distribution and the bank receives $100,000 (= 20% x $500,000).

a Reorganization value is defined as expected proceeds from sale of excess assets (which is zero) plus the present value of future cash flows from the new entity’s operating assets ($2,370,000).

10.

d Reorganization value ($2,370,000) equals postpetition liabilities in full ($820,000) plus fully secured prepetition liabilities ($400,000) plus the compromised amount of other prepetition liabilities (?) plus the valuation of new equity interests ($160,000). Hence the compromised amount of prepetition liabilities is $990,000 (= $2,370,000 – $820,000 – $400,000 – $160,000).

11.

c Enough additional paid-in capital must be created to offset the deficit in retained earnings of $2,240,000 (original balance of $1,440,000 plus $800,000 loss on asset write-down). Additional paid-in capital has an initial balance of $200,000, hence $2,040,000 must be transferred from common stock to additional paid-in capital.

12.

a In a troubled debt restructuring, the difference between the carrying value of the asset surrendered and its fair value is a gain or loss on asset disposition and the difference between the fair value of the asset surrendered and the carrying value of the debt settled is a gain on restructuring. Here there is a $540,000 gain on asset disposition (= $1,460,000 – $920,000) and a $340,000 gain on restructuring (= $1,800,000 – $1,460,000).

EXERCISES E15.1 Liquidation Basis of Accounting a.

Book value of net assets = $400,000 - $360,000 = $40,000 Liquidation value of net assets = $10,000 + $30,000 + $70,000 + $175,000 - $360,000 - $25,000 = $(100,000) $40,000 – (-$100,000) = $140,000 cumulative reduction in net assets

b. Farmworth Company Statement of Net Assets in Liquidation March 1, 2020 Assets Cash Receivables Inventory Plant and equipment Total assets Liabilities Reported liabilities Accrued liquidation cost Total liabilities Net assets

$ 10,000 30,000 70,000 175,000 285,000 360,000 25,000 385,000 $(100,000)

E15.2 Liquidation Basis of Accounting (see related E15.1) a. Farmworth Company Statement of Changes in Net Assets in Liquidation For the 3 Months Ending June 1, 2020 Net assets, March 1, 2020 $(100,000) Remeasurement adjustments on assets: Receivables ($10,000 + $22,000 - $30,000) 2,000 Inventory ($30,000 + $20,000 - $70,000) (20,000) Plant and equipment ($160,000 - $175,000) (15,000) Items previously not recognized 8,000 Remeasurement of liabilities ($25,000 - $15,000) 10,000 Adjustment for accrued liquidation costs ($18,000 + $12,000 - $25,000) (5,000) Net assets, June 1, 2020 $(120,000)

b. Farmworth Company Statement of Net Assets in Liquidation June 1, 2020 Assets Cash ($10,000 + $10,000 + $30,000 - $12,000 - $30,000) Receivables Inventory Plant and equipment Items not previously reported Total assets Liabilities Reported liabilities (360,000 - $10,000 - $30,000) Accrued liquidation costs Total liabilities Net assets

$ 8,000 22,000 20,000 160,000 8,000 218,000 320,000 18,000 338,000 $(120,000)

E15.3 Statement of Affairs Dennison Company Statement of Affairs Estimated Realizable Value Assets pledged to fully-secured creditors: Equipment Less: Liabilities to fully-secured creditors

$ 90,000 (60,000)

Assets pledged to partially-secured creditors: Equipment

25,000

Free assets: Cash Accounts receivable Inventory Equipment (1) Total free assets Less: Priority liabilities Net free assets Estimated deficiency to unsecured creditors Total unsecured liabilities

5,000 12,000 40,000 10,000

Creditors’

Free Assets

$ 30,000

67,000 97,000 (20,000) 77,000 48,000 $125,000

Unsecured

Claims Fully-secured creditors: Note payable

$ 60,000

Partially-secured creditors: Loan payable Less: Value of pledged assets

100,000 (25,000)

Priority liabilities

20,000

Unsecured creditors: Accounts payable Total unsecured liabilities (1)

Liabilities

$ 75,000

50,000 $125,000

$10,000 = $125,000 - $90,000 - $25,000

E15.4 Deficiency to Unsecured Creditors The estimated deficiency is the difference between net free assets and unsecured liabilities. First, calculate net free assets: Assets pledged to fully-secured creditors: Inventory Less notes payable Unsecured assets: Cash Accounts receivable Inventory ($200,000 – $175,000) Buildings Total free assets Less priority liabilities: Wages payable Taxes payable Net free assets

$ 175,000 (145,000)

$ 30,000

31,700 300,000 25,000 250,000

606,700 $ 636,700

77,300 30,900

(108,200) $ 528,500

Next, calculate unsecured liabilities: Partially secured liabilities: Notes payable ($205,400 – $145,000) Less realizable value of equipment Unsecured liabilities without priority: Accounts payable Total unsecured liabilities

$ 60,400 (40,000)

20,400

967,300 $ 987,700

The estimated deficiency to unsecured creditors = $987,700 – $528,500 = $459,200.

E15.5

Statement of Affairs Dellwood Corporation Statement of Affairs September 30, 2020

Assets pledged to fully-secured creditors: Land and building Less: Liabilities to fully-secured creditors Assets pledged to partially-secured creditors: Accounts receivable Inventory – finished goods Truck Free assets: Cash Accounts receivable Inventory – materials Trucks Equipment Total free assets Less: Unsecured liabilities with priority Net free assets Estimated deficiency to unsecured creditors Total unsecured liabilities

Estimated Realizable Value

Free Assets

$ 1,150,000 600,000

$ 550,000

240,000 400,000 30,000 670,000 20,000 60,000 90,000 40,000 200,000

410,000 960,000 (210,000) 750,000 960,000 $ 1,710,000

Creditors’ Claims Fully-secured creditors: Mortgage payable

Unsecured Liabilities

$ 600,000

Partially-secured creditors: Bank loan Loan payable Truck loan

275,000 480,000 85,000 840,000

Less: Value of pledged assets ($240,000 + $400,000 + $30,000) Unsecured creditors with priority: Wages payable Taxes payable

670,000

$ 170,000

160,000 50,000 210,000

Unsecured creditors: Accounts payable Note payable Total unsecured liabilities

740,000 800,000

1,540,000 $1,710,000

E15.6 Bankruptcy Calculations a. Estimated net loss on asset disposition = $89,760

Asset Accounts receivable Notes receivable Inventories Prepaid expenses Land and buildings Equipment Goodwill Estimated net loss

Book Value $71,000 50,000 108,600 17,200 172,000 113,500 28,000

Realizable Value $42,600 42,500 43,440 2,000 300,000 40,000 0

b. Priority claims = $164,700 (= wages $94,700 + taxes $70,000)

Gain (Loss) $(28,400) (7,500) (65,160) (15,200) 128,000 (73,500) (28,000) $(89,760)

c. Estimated payments to secured creditors = $237,500. Bank loan Mortgage

$ 42,500 195,000 $237,500

d. Expected recovery percentage to unsecured creditors = 30.7% Calculate net free assets: Assets pledged to fully secured creditors ($300,000 – $195,000) Unsecured assets: Cash Accounts receivable Inventories Prepaid expenses Equipment Total free assets Less liabilities with priority Net free assets

$ 105,000 $

3,200 42,600 43,440 2,000 40,000

131,240 236,240 (164,700) $ 71,540

Calculate unsecured liabilities: Partially secured liabilities ($60,000 – $42,500) Accounts payable Notes payable Total unsecured liabilities

Expected recovery percentage = $71,540/$233,300 = 30.7%

$ 17,500 131,900 83,900 $ 233,300

E15.7 Statement of Realization and Liquidation Dong Company Statement of Realization and Liquidation Assets to be realized: Accounts receivable Inventories Bldgs & equipment Liabilities liquidated: Wages & taxes payable Administrative fees

$ 80,000 175,000 300,000

$555,000

$40,000 60,000 35,000

$135,000

40,000 75,000 220,000

335,000

Liabilities to be liquidated: Accounts payable 200,000 Wages & taxes payable 50,000 Loan payable 350,000

600,000

Assets not realized: 50,000 45,000

95,000

Liabilities not liquidated: Accounts payable 200,000 Loans payable 350,000

Combined total

Assets realized: Accounts receivable Inventories Equipment

550,000

_______ $1,200,000

Accounts receivable Inventories Bldgs & equipment

Liabilities incurred: Administrative fees Losses on realization ($40,000 + $45,000) Combined total

45,000 85,000 $1,200,000

Dong Company Receiver’s Balance Sheet Cash Accounts receivable Inventories Buildings & equipment Total assets

$ 65,000 40,000 75,000 220,000 $400,000

Accounts payable Loan payable Estate deficit Total liabilities and equity

$200,000 350,000 (150,000) _______ $400,000

Dong Company Receiver’s Statement of Estate Deficit Loss on realization of inventories Loss on realization of equipment Administrative expenses Net change in estate deficit Estate deficit, beginning Estate deficit, ending

$ 40,000 45,000 45,000 (130,000) (20,000) $(150,000)

E15.8 Journal Entries for Bankruptcy Trustee Journal Entries: (1) Cash Loss on realization Inventories To record sale of inventories at 60% of book value.

18,000 12,000 30,000

(2) Notes payable 15,000 Cash 15,000 To record payment to secured creditor. (Since inventory was sold at 60% of its book value, creditors received 60% of $25,000 on sale of inventory that secured the notes.) (3) Accrued wages Cash To record payment of wages. (4) Cash Loss on realization Accounts receivable To record collection and write-off of accounts receivable. (5) Taxes payable Cash To record payment of taxes.

7,000 7,000

8,000 2,000 10,000

8,000 8,000

(6) Notes payable 13,750 Accounts payable 10,000 Cash 23,750 To record payments to unsecured creditors (payments are proportionate to interest, 40/95 to unsecured notes payable and 55/95 to unsecured accounts payable.) (7) Cash

35,000

Land 15,000 Gain on realization 20,000 To record sale of land. The gain on sale of land is calculated by determining the cash received after all other transactions have been accounted for.

Closing entry: Gain on realization Loss on realization Estate deficit To close at December 31, 2020.

20,000 14,000 6,000

E15.9 Statement of Realization and Liquidation Davis Corporation Realization and Liquidation Statement For the Month of January 2020 Assets to be realized: Land Building Equipment Patents Liabilities liquidated: Accounts payable Loans payable Trustees fee Liabilities not liquidated: Accounts payable Loans payable Gain on realization ($30,000 - $15,000) Combined total Assets realized: Equipment Patents Assets not realized: Land Buildings Equipment Liabilities to be liquidated: Accounts payable Loans payable Liabilities incurred: Trustees fee Loss on realization ($35,000 - $10,000) Combined total

$ 60,000 250,000 75,000 15,000

$ 400,000

22,500 27,500 5,000

55,000

256,500 313,500

10,000 30,000

570,000 15,000 $1,040,000

40,000

60,000 250,000 40,000

350,000

279,000 341,000

620,000 5,000 25,000 $1,040,000

Davis Corporation Sharon Thomson, Trustee Balance Sheet January 31, 2020 Cash (1) Land Building Equipment

5,000 60,000 250,000 40,000 $355,000

Accounts payable (2) Loan payable (3) Estate deficit

$ 256,500 313,500 (215,000) _______ $ 355,000

(1) $5,000 = $20,000 + $10,000 + $30,000 - $5,000 - $50,000 (2) ($279/$620) x $50,000 = $22,500; $279,000 - $22,500 = $256,500 (3) ($341/$620) x $50,000 = $27,500; $341,000 - $27,500 = $313,500 Davis Corporation Sharon Thomson, Trustee Statement of Estate Deficit January 31, 2020 Gain on realization Loss on realization Administrative expenses Net change in estate deficit Estate deficit - January 1, 2020 Estate deficit - January 31, 2020

$ 15,000 $ 25,000 5,000

(30,000) (15,000) (200,000) $(215,000)

E15.10 Reconstruct Realization and Liquidation Transactions (1) Cash

9,000 Accounts receivable 9,000 Assets realized shows $9,000 was realized from receivables. The unrealized amount also decreased by $9,000, from $15,000 at the beginning of the period (assets to be realized) to $6,000 at the end of the period (assets not realized); thus there was no gain or loss. (2) Cash 18,000 Loss on realization of inventory 3,000 Inventory 21,000 Assets realized shows $18,000 was realized from sale of inventory. The unrealized amount decreased by $21,000, from $41,000 to $20,000, indicating a loss of $3,000.

(3) Cash

23,000

Equipment 16,000 Gain on realization of equipment 7,000 Assets realized shows $23,000 was realized from sale of equipment. The unrealized amount decreased by $16,000, from $88,000 to $72,000, indicating a gain of $7,000. (4) Notes payable 50,000 Cash 45,000 Gain on liquidation of notes 5,000 Liabilities liquidated indicates $45,000 was paid on notes payable. The balance of notes payable decreased by $50,000, from $160,000 at the beginning of the period (Liabilities to be liquidated) to $110,000 at the end of the period (Liabilities not liquidated). Thus, there was a gain of $5,000.

E15.11

Financial Statement Display of Items During Reorganization Transaction 1: Balance sheet: liabilities Liabilities subject to compromise (not classified as current/noncurrent)

$2,500,000

Transaction 2: Balance sheet: current liabilities Post petition liabilities

$275,000

Transaction 3: Income statement and the operating section of the statement of cash flows: Reorganization items: Legal expenses

$(100,000)

Transaction 4: Income statement: Reorganization items: Losses

$(5,000)

Statement of cash flows: investing activities Proceeds due to reorganization sales of assets

$30,000

Transaction 5: Balance sheet: Reduce prepaid expenses (deposits) by

$40,000

Income statement: Reorganization items: Loss due to cancellation of contract

$(40,000)

Transaction 6: Income statement: Reorganization items: Interest revenue Interest revenue (classified as usual)

$25,000 5,000

Statement of cash flows: operating section Reorganization items: Interest revenue Interest revenue (regular operating item)

$25,000 5,000

Transaction 7: Balance sheet: noncurrent liabilities Loans payable

$650,000

Transaction 8: Balance sheet: liabilities Notes payable subject to compromise (not categorized as current/noncurrent)

$100,000

E15.12 Calculation of Reorganization Value Expected proceeds from sale of excess assets Present value of future cash flows from new entity’s operating assets: $350,000 x present value of annuity, 5 years, 10% = $350,000 x 3.791 = Reorganization value NOTE: Answers may vary due to rounding.

460,000

1,326,850 $ 1,786,850

E15.13 Conditions for Fresh Start Reporting Yes, the company is entitled to adopt fresh start reporting. Both conditions are met: 1. Reorganization value ($8,000,000) is less than the total of postpetition liabilities ($1,500,000) plus allowed claims ($6,700,000) 2. The preconfirmation holders of voting shares (the common shareholders) receive less than 50 percent of the voting shares in the new entity (they receive 35 percent).

E15.14 Reorganization Entries and Balance Sheet Losses on asset revaluations Receivables Buildings and equipment Intangible assets To write down assets.

665,000 15,000 50,000 600,000

Accounts payable 300,000 Notes payable 100,000 Loan payable 500,000 Debt (new) 325,000 Capital stock (new) 94,500 Gain on restructuring 480,500 To record exchange of debts for new debt and stock; $94,500 = 70% x $135,000. Capital stock (old) 250,000 Gain on restructuring 480,500 Losses on asset revaluations 665,000 Retained deficit 25,000 Capital stock (new) 40,500 To record exchange of old for new stock, close the gains/losses on restructuring, and eliminate the retained deficit; $40,500 = 30% x $135,000.

AB Electronics Post-Reorganization Balance Sheet Cash Receivables Inventories Buildings and equipment

$ 10,000 100,000 200,000 150,000 $460,000

Debt Capital stock

$325,000 135,000 _______ $460,000

E15.15 Quasi-Reorganization a. Retained earnings Assets To write down assets.

400,000 400,000

Common stock ($10 par) 1,000,000 Common stock ($1 par) 10,000 Additional paid-in capital 990,000 To record exchange of equity interests; 100,000 shares @ $10 par are exchanged for 10,000 shares @ $1 par. Additional paid-in capital 1,200,000 Retained earnings To eliminate deficit; $1,200,000 = $800,000 + $400,000.

1,200,000

b. Common stock, $1 par value, 10,000 shares issued and outstanding Additional paid-in capital Retained earnings since (date) Total shareholders' equity

$ 10,000 390,000 0 $400,000

E15.16 Troubled Debt Restructuring Note payable and accrued interest 400,000 Land Gain on disposition of land To record transfer of land in partial settlement of obligation.

150,000 250,000

Note payable and accrued interest 300,000 Preferred stock 300,000 To record issuance of preferred stock in partial settlement of obligation. Note payable and accrued interest Gain on restructuring To record reduction in total obligation, as follows:

210,000

Principal of new note Future interest ($18,000 x 5 years) Total cash payments Remaining carrying value ($1,000,000 + $300,000 - $400,000 - $300,000) Gain

210,000 $300,000 90,000 390,000 600,000 $210,000

A gain is reported because the sum of the undiscounted new payments < carrying value of the note.

E15.17 Troubled Debt Restructuring a. Note and interest payable Gain on restructuring To record reduction in total obligation, as follows: Principal of new note Future interest ($200,000 x 5 years) Total cash payments Carrying value of old note plus interest Gain

2,250,000 2,250,000

$2,500,000 1,000,000 3,500,000 5,750,000 $2,250,000

b. The undiscounted sum of the future payments on the new note exceeds the carrying value of the current debt, as follows: $4,500,000 + (5 x $360,000) = $6,300,000 > $5,750,000 Therefore there is no adjustment to the carrying value of the debt; it remains at $5,750,000.

PROBLEMS P15.1 Liquidation Basis of Accounting a. Evergreen Company Statement of Changes in Net Assets in Liquidation For the 2 Months Ending June 30, 2020 Net assets, May 1, 2020 (1) Remeasurement adjustments on assets: Accounts receivable ($25,000 + $80,000 - $120,000) Inventories ($172,000 - $170,000) Property and equipment ($100,000 + $505,000 - $600,000) Intangible assets ($23,000 - $25,000) Accrued income receivable ($5,000 + $19,000 - $20,000) Adjustment for accrued liquidation costs ($18,500 - $11,600 - $7,000) Adjustment for accrued compensation ($35,000 - $13,600 - $20,000) Net assets, June 30, 2020

$ 16,500 (15,000) 2,000 5,000 (2,000) 4,000 (100) 1,400 $ 11,800

(1) $16,500 = $30,000 + $120,000 + $170,000 + $600,000 + $25,000 - $18,500 $35,000 + $20,000 - $245,000 - $650,000 b. Evergreen Company Statement of Net Assets in Liquidation June 30, 2020 Assets Cash ($30,000 + $25,000 + $100,000 - $7,000 - $20,000 + $5,000 – $25,000 - $95,000) Accounts receivable Inventories Property and equipment Intangible assets Accrued income receivable Total assets Liabilities Accounts payable ($245,000 - $25,000) Loans payable ($650,000 - $95,000) Accrued liquidation costs Accrued compensation costs Total liabilities Net assets

P15.2 Statement of Affairs

$ 13,000 80,000 172,000 505,000 23,000 19,000 812,000 220,000 555,000 11,600 13,600 800,200 $ 11,800

Shaw Corporation Statement of Affairs

Assets pledged to fully-secured creditors Less: Liabilities to fully-secured creditors Assets pledged to partially-secured creditors (1)

Estimated Realizable Value $250,000 (190,000)

200,000 260,000 (40,000) 220,000 80,000 $300,000 Creditors’ Claims $190,000

Partially-secured creditors Less: Value of pledged assets

95,000 (50,000)

Priority liabilities

40,000

Unsecured creditors (2) Total unsecured liabilities (1) (2)

$50,000 = $500,000 - $250,000 - $200,000 $255,000 = $300,000 - $45,000

$ 60,000

50,000

Free assets Total free assets Less: Priority liabilities Net free assets Estimated deficiency to unsecured creditors Total unsecured liabilities

Fully-secured creditors

Free Assets

Unsecured Liabilities

$ 45,000

255,000 $300,000

P15.3 Calculation of Expected Distributions a. Total estimated realizable values of assets = $4,000 + $65,000 + $90,000 + $220,000 = $379,000 b. Net free assets = $54,000, calculated as follows: Assets pledged to fully secured creditors Less note payable Assets available to unsecured creditors Unsecured assets: Cash Accounts receivable Total free assets Less priority claims: Wages and taxes payable Customer deposits Net free assets

$90,000 (50,000) $ 40,000

4,000 65,000

35,000 20,000

69,000 $109,000

(55,000) $ 54,000

Unsecured liabilities = $230,000, calculated as follows: Partially secured liabilities Less buildings and equipment

$350,000 (220,000)

Unsecured liabilities: accounts payable Total unsecured liabilities

$130,000 100,000 $230,000

The expected recovery rate for unsecured creditors is $54,000/$230,000 = 23.48% c. Fully secured Partially secured $220,000 + (54/230) x $130,000 = Priority Unsecured $100,000 x (54/230) = Total paid out to creditors d. $250,522/$350,000 = 71.58%

$ 50,000 250,522 55,000 23,478 $379,000

P15.4 Statement of Affairs a. The Janes Corporation Statement of Affairs March 10, 2020

Assets pledged to fully-secured creditors: Land and building Less: Liabilities to fully-secured creditors: Assets pledged to partially-secured creditors: Accounts receivablea Inventory of finished goodsb Free assets: Cash Equity securities Inventory of raw materialc Machinery and equipment Total free assets Less: Unsecured liabilities with priorityd Net free assets Estimated deficiency to unsecured creditors Total unsecured liabilities

Estimated Realizable Value

Free Assets

$675,000 (422,000)

$253,000

57,000 137,500 $194,500 9,000 17,000 65,000 100,000 444,000 (365,000) 79,000 619,500 $698,500

The Janes Corporation Statement of Affairs March 10, 2020 Creditors’ Claims Fully-secured creditors: Mortgage payable Partially-secured creditors: Notes payable Less: Value of pledged accts rec. Less: Value of pledged finished goods Unsecured creditors with priority: Accrued federal taxes payable Accrued salaries and wages Legal, accounting and administrative Customer deposits Unsecured creditors: Accounts payable Bank loan payable Lawsuit, net of insurance Lease obligatione

Unsecured Liabilities

$422,000 250,000 (57,000) (137,500)

$ 55,500

150,000 60,000 150,000 5,000 $365,000 370,000 113,000 40,000 120,000 $698,500

Notes: a. Estimated realizable value of the accounts receivable = $82,000 book value plus $5,000 credit balances, for total gross receivables of $87,000. Of this amount, $30,000 is expected to be uncollectible. b. Estimated realizable value of inventory of finished goods = $250,000 x 0.55 = $137,500. c. If the inventory of raw materials were completed, it would have an expected realizable value of $110,000 (= $200,000 x 0.55). Subtracting the cost to complete of $45,000 yields a net estimated realizable value of $65,000. This is more than the estimated realizable value of the inventory in its present form ($60,000), so completion is indicated and the realizable value of the inventory is $65,000. d. Priority claims = $150,000 taxes + $60,000 salaries and wages + $150,000 administrative costs + $5,000 customer deposits = $365,000. e. While the lease liability could be settled for $60,000, by including the entire amount as an unsecured liability, the expected payment to the lessor is 11.31% x $120,000, or $13,572 (see answer to part b). Thus, the trustee would not choose to pay the early termination fee.

b. Computation of estimated settlement per dollar of unsecured liabilities: Estimated amount available for unsecured liabilities, $79,000, divided by total unsecured liabilities, $698,500, equals estimated amount payable on claims, 11.31% or $.1131 on the dollar.

P15.5 Statement of Affairs a. Bridges Furniture Store Statement of Affairs September 30, 2020 Estimated Realizable Value Assets pledged to fully-secured creditors: Installment receivables Less bank loan Land and buildings Less mortgage (plus $1,470 accrued interest) Assets pledged to partially-secured creditors: Autos and trucks Furniture and equipment Free assets: Cash Accounts receivable Inventories Prepaid insurance Total free assets Less: Unsecured liabilities with priority Net free assets Estimated deficiency to unsecured creditors Total unsecured liabilities

$525,000 483,750 225,000 148,470

Free Assets

$ 41,250 76,530

24,000 15,000 39,000 6,360 49,500 300,000 2,970 476,610 (71,700) 404,910 331,290 $736,200

Bridges Furniture Store Statement of Affairs September 30, 2020 Creditors’ Unsecured Claims Liabilities Fully-secured creditors: Bank loan Mortgage (including 2 months interest at 6% = $1,470) Partially-secured creditors: Installment loan (auto and trucks) Less: Value of pledged assets Furniture and equipment loan payable Less: Value of pledged assets Unsecured creditors with priority: Taxes payable Estimated administrative costs of liquidation Accrued salaries and wages Total unsecured creditors with priority Unsecured creditors: Trade accounts payable Notes payable to shareholders plus accrued interest of $31,500 Total unsecured liabilities

$483,750 148,470 632,220 30,000 24,000 17,400 15,000

6,000 2,400

42,660 15,000 14,040 71,700 396,300 331,500 $736,200

b. Percentage of recovery by unsecured creditors is 55% ($404,910 divided by $736,200). Fully-secured creditors and unsecured creditors with priority receive 100% recovery. For the partially-secured creditors, the installment loan holder receives 91% (= [$24,000 + (0.55 x $6,000)]/$30,000) and the furniture and equipment lender receives 93.8% (= [$15,000 + (0.55 x $2,400)]/$17,400).

P15.6 Statement of Realization and Liquidation Barnwell Corporation Statement of Realization and Liquidation January 31, 2021 Assets to be realized: Accounts receivable Raw material inventory Work in progress inventory Finished goods Equipment Assets acquired: Accounts receivable Raw material inventory Work in process inventory (1) Finished goods Equipment

6,093 24,000 51,600 8,550 50,076

113,523 9,450 86,182 137,782 1,125

Liabilities liquidated: Accounts payable Liabilities not liquidated: Accounts payable Advances by creditors Gain on realization: Inventory ($113,523$101,332)

$140,319

133 9,000

Assets realized: Accounts receivable Raw material inventory Work in process inventory Finished goods Equipment

$113,973 30,450 137,782 113,523 1,500

Assets not realized: Accounts receivable Raw material inventory

5,073 3,000

Finished goods Equipment (2)

45,000 49,701

$397,228

102,774

348,062

69,750

Liabilities to be liquidated: Accounts payable

9,133

Liabilities incurred: Advance by creditors Accounts payable (3)

37,933

9,000 31,950

40,950

Loss on realization: 12,191 $579,455

Accounts receivable

570 $579,455

(1) $86,182 = $54,232 + $1,500 + $30,450 (2) $49,701 = $50,076 + $1,125 - $1,500 (3) $31,950 = $9,450 + $22,500 NOTE: This problem is complex and requires many calculations, particularly with the three manufacturing inventories. The problem is also a review of management accounting concepts. The raw materials are realized when they enter work-in-process; the amount is the credit needed to reconcile the beginning balance and purchases with the ending balance. Work-in-process is realized when it enters finished goods, and the credit to finished goods determines cost of goods sold and the margin on sales, reported as a gain on finished goods realization. Journal entries for all transactions clarify the numbers:

Cash

9,000

Advance from creditors To record advance from creditors. Raw materials inventory

9,000

9,450

Accounts payable To record purchase of raw materials on account. Work-in-process inventory

9,450

54,232

Accounts payable Cash To record expenses charged to work-in-process. Equipment

22,500 31,732

1,125

Cash To record acquisition of new equipment, paid in cash. Cash Loss on receivables

1,125

5,523 570

Accounts receivable To record collection of beginning receivables balance. Work-in-process inventory

6,093

1,500

Equipment To record depreciation on equipment, charged to work-in-process. Cash

1,500

108,450

Accounts receivable To record collections of sales made on account.

108,450

Accounts receivable

113,523 Sales revenue 113,523 To record sales on account; $113,523 = $5,073 ending receivables balance + $108,450 collections. Accounts payable

69,750

Cash 69,750 To record payment of accounts payable; $69,750 = $37,933 beginning balance of payables + $9,450 raw materials purchased on account + $22,500 work-in-process costs purchased on account - $133 ending balance of payables.

Work-in-process inventory

30,450 Raw materials inventory 30,450 To record materials transferred to work-in-process; $30,450 = $24,000 beginning balance of raw materials + $9,450 materials purchases - $3,000 ending balance of raw materials. Finished goods inventory

137,782

Work-in-process inventory 137,782 To record completion of work-in-process; $137,782 = $51,600 beginning balance of work-in-process + $54,232 costs charged to work-in-process + $1,500 depreciation charged to work-in-process + $30,450 materials charged to work-in-process. There is no ending balance of work-in-process. Cost of goods sold

101,332

Finished goods inventory 101,332 To record sale of inventory; $101,332 = $8,550 beginning balance of finished goods + $137,782 transferred from work-in-process - $45,000 ending balance of finished goods.

P15.7 Statement of Realization and Liquidation a. Comfort Mattress Corporation Statement of Realization and Liquidation For the period March 17 through June 30, 2020 Assets to be realized: Accounts receivable Inventory Store fixtures Liabilities liquidated: Loan payable Note payable

$140,000 600,000 200,000

300,000 75,000

Liabilities not liquidated: Accounts payable 550,000 Note payable 25,000 Lease termination 35,000 Receiver’s fee 50,000

$ 940,000

375,000

660,000

________ $ 1,975,000 (1) $320,000 = $400,000 - $80,000

Assets realized: Accounts receivable Inventory (1) Store fixtures

$ 100,000 320,000 75,000

$495,000

Liabilities to be liquidated: Loan payable 300,000 Note payable 100,000 Accounts payable 550,000

950,000

Liabilities incurred: Lease termination Receiver’s fee

35,000 50,000

85,000

Loss on realization: Accounts receivable Inventory Store fixtures

40,000 280,000 125,000

445,000 $1,975,000

b. Balance of cash available: Balance, March 17 Increases: Collections of receivables Sales of inventory (2) Auction of store fixtures Decreases: Expenses of sale Payment of loan Payment of note Balance, June 30

$ $ 100,000 400,000 75,000

575,000

80,000 300,000 75,000

Cash available Less liabilities with priority: Receiver's fee Available for unsecured creditors

5,000

(455,000) 125,000 125,000 (50,000) $ 75,000

(2) $400,000 = $350,000 + $50,000

Unsecured creditors: Accounts payable Note payable Lease termination

Amount

Expected Recovery

$550,000 25,000 35,000 $610,000

$ 67,623 3,074 4,303 $75,000

Note: Expected recovery is the amount of the unsecured liability x ($75,000/$610,000).

P15.8 Statement of Realization and Liquidation a. Cognitech Corporation Statement of Realization and Liquidation Assets to be realized: Receivable Supplies Prepaid expenses Equipment Intangibles Liabilities liquidated: Wages & taxes payable Customer deposits

Assets realized: Accounts receivable Supplies Prepaid expenses Equipment

$ 45,000 15,000 4,000 150,000 200,000

$72,000

15,000 9,000 90,000

114,000

35,000 20,000 150,000 225,000

430,000

$414,000

35,000 20,000

55,000

Liabilities not liquidated: Accounts payable 150,000 Loans payable 225,000

375,000

Assets not realized: Accounts receivable Supplies Equipment Liabilities to be liquidated: Wages & taxes payable Customer deposits Accounts payable Loans payable

_____ $844,000

Combined total (1) Losses: Supplies Prepaid expenses Equipment Intangibles Total

$ 30,000 4,000 3,000 35,000

Losses on realization (1) Combined total

2,000 1,000 25,000 200,000 $228,000

b. Remaining assets, at estimated realizable value: Cash (2) Receivables Supplies Equipment Total available

$18,000 13,500 4,500 36,000 $72,000

(2) $18,000 = $1,000 + $30,000 + $4,000 + $3,000 - $35,000 - $20,000 + $35,000 Remaining liabilities, all unsecured: Accounts payable Loans payable Total liabilities

$150,000 225,000 $375,000

Estimated recovery percentage: $72,000/$375,000 = 19.2%

228,000 $844,000

P15.9 Accounting and Reporting During Reorganization Axell Corporation (Debtor in Possession) Balance Sheet December 31, 2021 Current assets: Cash (1) Accounts receivable (2) Property, plant and equipment, net: Land and building ($1,600,000 - $75,000) Equipment ($500,000 - $50,000) Total assets Current liabilities (post-petition): Accounts payable (3) Income taxes payable Accrued legal and accounting fees Long-term liabilities (fully-secured): Mortgage payable Liabilities subject to compromise Shareholders' equity* Total liabilities and shareholders' equity

871,200 600,000 1,525,000 450,000

275,000 5,000 125,000

$1,471,200

1,975,000 $3,446,200

$ 405,000 900,000 2,088,500 52,700 $3,446,200

(1) $871,200 = $50,000 + $1,500,000 - $900,000 - $40,000 + $1,200 + $260,000 (2) $600,000 = $400,000 + $1,700,000 - $1,500,000 (3) $275,000 = $1,300,000 - $900,000 - $50,000 - $75,000

The liabilities subject to compromise are: Accounts payable ($1,200,000 – ($120,000/2)) Loan payable Notes payable Accrued interest, mortgage ($135,000 + $20,000/2)) Accrued interest, loan and note (($5,000 + $2,000)/2) Deferred compensation payable * $52,700 = ($2,800,000 - $2,835,000) beginning balance + $87,700 net income.

$ 1,140,000 400,000 200,000 145,000 3,500 200,000 $2,088,500

Axell Corporation (Debtor-in-Possession) Income Statement for the Nine Months Ended December 31, 2021 Revenues Expenses: Operating expenses Interest expense Income before reorganization items and taxes Reorganization items: Legal and accounting fees Settlement of employment contract Gain on sale of investment Interest revenue Adjustment of disputed payable Income before taxes Income tax expense Net income

$1,700,000 $1,300,000 13,500

(1,313,500) 386,500

(125,000) (200,000) 10,000 1,200 60,000

(253,800) 132,700 (45,000) $ 87,700

Axell Corporation (Debtor-in-Possession) Statement of Cash Flows) For the Nine Months Ended December 31, 2021 Cash flows from operating activities: Collections of receivables Payment of operating expenses Payment of income taxes Cash from operating activities Operating cash flows from reorganization items: Interest revenue Total cash from operating activities Cash flows from investing activities: Proceeds from sale of investment due to reorganization Net increase in cash Cash balance - April 1 Cash balance - December 31

$ 1,500,000 (900,000) (40,000) 560,000 1,200 561,200

260,000 821,200 50,000 871,200

Journal entries for transactions (not required): Transaction 1 Cash Accounts receivable Revenues To record sales for the period. Transaction 2 Operating expenses Cash Equipment, net Building, net Accounts payable (postpetition) To record operating expenses for the period.

1,500,000 200,000 1,700,000

1,300,000 900,000 50,000 75,000 275,000

Transaction 3 Interest expense 13,500 Accrued interest, mortgage 10,000 Accrued interest, loan 2,500 Accrued interest, note 1,000 To accrue interest on prepetition liabilities, at amounts expected to be allowed as a claim. Transaction 4: Income tax expense Cash Income taxes payable To record income taxes for the period. Transaction 5 Cash Interest revenue To record interest earned during reorganization. Transaction 6 Legal and accounting fees (expense) Accrued legal and accounting fees To record fees connected with reorganization.

45,000 40,000 5,000

1,200 1,200

125,000 125,000

Transaction 7 Accounts payable (prepetition) 60,000 Adjustment of payable (gain) 60,000 To record reorganization item from adjustment of disputed payable to amount expected to be allowed.

Transaction 8 Cash Investment Gain on sale of investment To record sale of investment during reorganization.

260,000 250,000 10,000

Transaction 9 Settlement of employment contract 200,000 Deferred compensation payable (prepetition) To establish prepetition liability to settle employment contract.

P15.10

200,000

Classification of Liabilities in Reorganization Classification of liabilities at December 31, 2020:

Item 1

2 3

4 5

6 7 8

Description

Liabilities Current Subject to Liabilities Compromise (Post-petition)

Long-term Liabilities (Prepetition, Fully Secured)

Accounts payable to suppliers: Balance at March 19 During reorganization Lease termination penalty Accrued legal fees: Balance at March 19 During reorganization Notes payable (not fully secured) Accrued interest Unsecured short-term loan existing at March 19 Accrued interest Short-term loan during reorganization Mortgage payable (fully secured) Accrued interest Cancellation charge on maintenance contracts Totals

$435,000 $215,000 50,000 10,000 80,000 60,000 4,000 200,000 8,000 100,000 $400,000 15,000 18,000 $785,000

_______ $395,000

_______ $415,000

Spring Hill Corporation Liability Section of Balance Sheet in Reorganization December 31, 2020 Liabilities Current liabilities Accounts payable Accrued legal fees Short-term loan Total current liabilities Noncurrent liabilities Mortgage payable Mortgage interest payable Total noncurrent liabilities Liabilities subject to compromise Total liabilities

$ 215,000 80,000 100,000 $ 395,000 400,000 15,000 415,000 785,000 $1,595,000

P15.11 Fresh Start Reporting a. Expected proceeds from excess assets Present value of future cash flows from new entity's operating assets Reorganization value

500,000

7,900,000 $ 8,400,000

b. Reorganization value must equal: Postpetition liabilities Fully secured prepetition liabilities Compromised amount of other prepetition liabilities (plug) Valuation of new equity interests Reorganization value

$ 1,000,000 2,000,000 ? 950,000 $ 8,400,000

Compromised amount of other prepetition liabilities thus equals:

$ 4,450,000

c. Gain on restructuring of debt = $8,000,000 - $4,450,000 = $3,550,000

d. Summary balance sheet after reorganization: Lopez Corporation Balance Sheet After Implementation of Reorganization Plan Total assets Liabilities* Shareholders’ equity

$8,400,000 $7,450,000 950,000 $8,400,000

* $7,450,000 = $1,000,000 + $2,000,000 + $4,450,000

P15.12 Emerging from Reorganization a. The company meets the two conditions for fresh start reporting. 1. Reorganization value of the entity’s assets ($3,400,000) is less than the total of all postpetition liabilities ($900,000) plus all allowed claims ($3,800,000), and 2. Preconfirmation holders of existing voting shares receive 40% of the voting shares in the new entity, which is less than 50%. b. Liabilities subject to compromise 3,800,000 Cash 500,000 Senior secured debt 1,600,000 Subordinated debt 350,000 Common stock 30,000 Gain on discharge of debt 1,320,000 To record settlement of prepetition liabilities according to terms of the plan of reorganization. Shareholders' equity 20,000 Common stock To record creation of new equity interests; $20,000 = $50,000 x 40%. Shareholders' equity Total assets To write down excess assets to estimated realizable value; $20,000 = $120,000 - $100,000.

20,000

20,000 20,000

Gain on discharge of debt 1,320,000 Total assets 580,000 Shareholders’ equity 740,000 To adjust asset values to reorganization value and eliminate deficit. $740,000 = original deficit of $700,000 (= $4,000,000 - $3,800,000 - $900,000) + further reductions in entries above of $20,000 + $20,000. c. Total assets (includes $100,000 net realizable value of excess assets available for distribution) (1)

$2,900,000

Postpetition liabilities Senior secured debt Subordinated debt Common stock Total liabilities and equity

$ 900,000 1,600,000 350,000 50,000 $2,900,000

(1) $2,900,000 = $4,000,000 - $500,000 - $20,000 - $580,000

P15.13 Fresh Start Reporting a. The company meets the two conditions for fresh start reporting. 1. Reorganization value of the entity’s assets ($3,000,000) is less than the total of all postpetition liabilities ($450,000) plus all allowed claims ($4,650,000), and 2. Preconfirmation holders of existing voting shares receive 20% of the voting shares in the new entity, which is less than 50%. b. Current liabilities (postpetition) Notes payable (new) Loans payable (new) Common stock Reorganization value

$ 450,000 1,000,000 1,500,000 50,000 $3,000,000

Reorganization value less total liabilities equals the value of common stock. c. Discharge debt: Liabilities subject to compromise Notes payable (new) Loans payable (new) Common stock (80% x $50,000) Gain on discharge of debt To record settlement of prepetition liabilities.

4,650,000 1,000,000 1,500,000 40,000 2,110,000

Restructure prior shareholders’ interests: Common stock (old) Common stock (new) (20% x $50,000) Additional paid-in capital To record creation of new equity interests.

100,000 10,000 90,000

Revalue assets: Loss on revaluation 1,600,000 Goodwill 650,000 Identifiable intangibles 150,000 Current assets 100,000 Property and equipment 2,300,000 To revalue assets. Loss on revaluation = $3,000,000 - $4,600,000. Goodwill = $650,000 = $3,000,000 – ($200,000 + $2,000,000 + $150,000). Close gains and losses and eliminate the retained deficit: Gain on discharge of debt 2,110,000 Additional paid-in capital 90,000 Loss on revaluation Retained earnings To close gains and losses and eliminate the retained deficit.

1,600,000 600,000

Assets Current assets Property and equipment Identifiable intangibles Goodwill Total assets

Benson Industries Balance Sheet Following Reorganization Liabilities and equity $ 200,000 Current liabilities 2,000,000 Notes payable 150,000 Loans payable 650,000 Common stock $3,000,000 Total liabilities and equity

$ 450,000 1,000,000 1,500,000 50,000 $3,000,000

P15.14 Quasi-Reorganization a. Retained earnings Noncurrent assets To write down assets to fair value.

1,000,000

Common stock (no par) Common stock ($1 par) Additional paid-in capital To restructure common stock equity.

2,500,000

1,000,000

100,000 2,400,000

Additional paid-in capital Retained earnings To eliminate deficit.

2,200,000 2,200,000

b. Hassani Corporation Balance Sheet Following Quasi-Reorganization Current assets Noncurrent assets

$ 500,000 3,000,000 $3,500,000

Current liabilities Long-term liabilities Common stock ($1 par) Additional paid-in capital Retained earnings since (date)

$ 400,000 2,800,000 100,000 200,000 0 $3,500,000

P15.15 Quasi-Reorganization a. After the buildings and equipment are written down, the retained earnings deficit is $40,000 + $200,000 + $50,000 = $290,000. To eliminate the deficit, $290,000 must be transferred from additional paid-in capital to retained earnings. Therefore $150,000 (= $290,000 - $140,000) must be added to additional paid-in capital. To reduce the common stock account by $150,000, the par value must decline from $5 to $3.50: Current common stock account: After reorganization:

100,000 shares x $5 = $500,000 100,000 shares x $3.50 = $350,000

b. The common stock account declines from $500,000 to $100,000 (= $2 x 50,000), adding $400,000 to additional paid-in capital, and bringing the balance to $540,000. Therefore a retained deficit of $540,000 can be eliminated. The balance is currently a $40,000 deficit, so the buildings and equipment could be written off as much as $500,000 total.

c. Entries (not required): Retained deficit Buildings Equipment To write down the buildings and equipment.

225,000

Common stock, $5 par Common stock, $2.50 par Additional paid-in capital To revise the par value of the common stock.

500,000

Additional paid-in capital Retained deficit To eliminate the retained deficit.

265,000

125,000 100,000

250,000 250,000

265,000

Gordon Company Balance Sheet After Quasi-Reorganization Current assets Buildings Equipment

$ 40,000 375,000 300,000 $715,000

Current liabilities Long-term liabilities Common stock, $2.50 par Additional paid-in capital Retained earnings (quasi-reorganization date)

$100,000 240,000 250,000 125,000 0 $715,000

P15.16 Troubled Debt Restructuring (1) Notes payable Investment in debt securities Gain on asset disposition Gain on restructuring To record settlement of note. (2) Loan payable Investment in debt securities Gain on asset disposition Gain on restructuring To record settlement of loan. (3) Accounts payable Trade note payable To record conversion of accounts payable to notes payable. (4) Income tax expense Income taxes payable To accrue taxes on gains; $150,000 = .3 x $500,000; $500,000 = $180,000 + $20,000 + $250,000 + $50,000.

500,000 300,000 180,000 20,000

900,000 600,000 250,000 50,000

1,200,000 1,200,000

150,000 150,000

Herbert Company Balance Sheet After Restructuring Operating assets Land Investment in debt securities

$2,000,000 700,000 300,000 $3,000,000

Accounts payable Income taxes payable Trade note payable Shareholders' equity*

$ 600,000 150,000 1,200,000 1,050,000 $3,000,000

* $1,050,000 = $700,000 beginning balance + $500,000 gains - $150,000 tax expense

P15.17 Troubled Debt Restructuring a. The original loan carries an interest rate of 5%. $432,950/$100,000 = 4.3295, which is the present value of an annuity of 1 per year for 5 years, at 5%. b. The carrying amount of the loan at January 1, 2020, is $272,328.

Date January 1, 2018 December 31, 2018 December 31, 2019

Principal payment $78,352 82,270

Interest payment (5%)

Balance $432,950 $21,648 354,598 17,730 272,328

c. No. The sum of the undiscounted future payments is $283,290 (= $94,430 x 3), which is greater than the carrying value of the loan ($272,328). d. The renegotiated loan carries an interest rate of 2%. $272,328/$94,430 = 2.8839, which is the present value of an annuity of 1 per year for 3 years, at 2%. e. December 31, 2020 Interest expense (2% x $272,328) Loan payable Cash To record payment at December 31, 2020.

5,447 88,983 94,430

CHAPTER 16 SOLUTIONS TO MULTIPLE CHOICE QUESTIONS, EXERCISES AND PROBLEMS

MULTIPLE CHOICE QUESTIONS 1.

10.

EXERCISES E16.1 Multiple Choice—Securities Laws and SEC Functions a. b. c. d.

2 3 4 3

E16.2 Multiple Choice—SEC Reporting Requirements a. b. c. d.

1 4 3 3

E16.3 Multiple Choice—SEC Reporting Requirements a. b. c. d.

4 2 4 3

E16.4 Multiple Choice—SEC Reporting Requirements a. b. c. d.

4 1 4 3

E16.5 Multiple Choice—Corporate Governance a. b. c. d.

3 4 2 2

E16.6 Multiple Choice—SEC and Accounting Standards a. b. c. d.

3 1 3 2

E16.7 Multiple Choice—Registration of Securities a. b. c. d.

4 1 4 2

E16.8 Risk Factors Ford lists many risk factors in its 2016 10-K. Here is a sampling: •

Decline in industry sales volume, particularly in the United States or Europe, due to financial crisis, recession, geopolitical events, or other factors.

•

Market shift away from sales of larger, more profitable vehicles beyond Ford’s current planning assumption, particularly in the United States.

•

Continued or increased price competition resulting from industry excess capacity, currency fluctuations, or other factors.

•

Fluctuations in foreign currency exchange rates, commodity prices, and interest rates.

•

Single-source supply of components or materials.

•

Work stoppages at Ford or supplier facilities or other limitations on production (whether as a result of labor disputes, natural or man-made disasters, tight credit markets or other financial distress, production constraints or difficulties, or other factors).

•

Substantial pension and postretirement liabilities impairing liquidity or financial condition.

•

Cybersecurity risks to operational systems, security systems, or infrastructure owned by Ford, Ford Credit, or a third-party vendor or supplier.

•

The discovery of defects in vehicles resulting in delays in new model launches, recall campaigns, or increased warranty costs.

E16.9 Possible Effect of SOX on SEC's Designation of Standard-Setting Bodies The SEC has traditionally relied on the FASB to set accounting standards. However, Section 108 of the Sarbanes-Oxley Act of 2002 (SOX) establishes general criteria for the standard setter of a comprehensive set of accounting standards, including being a private entity governed by a board of trustees that are mostly removed from the practice of public accounting, operating with a due process, an independent funding mechanism, and the like. These criteria are currently satisfied by the FASB. The International Accounting Standards Board (IASB) satisfies most of these criteria, and the criteria could conceivably be satisfied by other standard setters. Because the SOX legislation that acknowledged the possibility of the SEC accepting the work of other standard-setters also established the PCAOB, alternative sets of comprehensive accounting standards cannot be summarily dismissed. The SEC clearly has the right, maybe even the obligation, to consider, and adopt, other accounting standards. Moreover, how the PCAOB will develop over time remains to be seen; it may absorb some of SEC's standard-setting prerogatives or find in its review of audits enough evidence of serious shortcomings in FASB standards. In our view, Section 108 of SOX presents a clear challenge to the FASB and a warning against complacency.

E16.10 Reporting of Significant Ownership a. Ownership of over five percent of the publicly traded shares of a company is considered “significant.” A person or organization holding the shares may exert influence over the company’s activities, and knowledge of this ownership informs other investors of potential risks involved. b. Warren E. Buffett, 8.5%, 81,241,303 shares Berkshire Hathaway Inc., 8.5%, 81,232,303 shares National Indemnity Company, 8.3%, 78,894,582 shares

E16.11 Use of Form 8-K a. The restaurant had an E. coli incident in 2015, with a subsequent decline in consumer opinion concerning the quality of their food products. b. The forecasted effect of this incident on Chipotle’s 2015 fourth quarter results will be an 8-11% drop in comparable restaurant sales, and costs of $6 - $8 million to replace food, perform testing, and retain advisory services. 2016 comparable restaurant sales cannot be estimated due to the high level of uncertainty related to the incident. c. The most common 8.01 event reported by Chipotle in 2016 and 2017 was the planned repurchase of shares. Repurchases increase share price by reducing the number of outstanding shares. Chipotle’s shares dropped substantially during this period, and repurchases are a way to restore shareholder value.

E16.12 Form 10-K Item 7A a. Market risk disclosures about financial instruments can be in the form of: (1) tabular presentation of estimated fair values and expected cash flows, (2) sensitivity analysis of potential losses from changes in prices, rates, etc., or (3) value at risk analysis, estimating the maximum loss expected to occur over a period of time at a particular likelihood. b. Coca-Cola uses a sensitivity analysis of the estimated loss from each type of risk, if prices or rates change by a particular amount. c. Coca-Cola lists risk from changing FX rates, interest rates, and commodity prices. To hedge its FX risk, it uses forwards, options and collars to lock in the value of future cash flows denominated in other currencies, and to lock in the value of net monetary assets and investments in foreign operations. An estimated 10% weakening of the U.S. dollar would change a net unrealized gain on hedges of $366 million to a net unrealized loss of $364 million. An estimated 10% weakening of the U.S. dollar would change a net unrealized gain on investments not qualifying as hedges of $208 million to a net unrealized gain of $244 million. Coca-Cola uses interest rate swaps to manage its mix of fixed-rate and variable-rate debt. A one percentage point increase in interest rates would increase interest expense by $227 million. A one percentage point increase in interest rates would reduce the value of its investments in liquid securities by $71 million. Coca-Cola uses derivatives to lock in commodity prices on sweeteners, metals, juices, PET (polyethylene terephthalate, used in bottles). and fuels. For commodity derivatives qualifying for hedge accounting, a 10% decrease in underlying commodity prices would change an actual $1 million unrealized loss to a $2 million unrealized loss. For commodity derivatives not qualifying for hedge accounting, a 10% decrease in underlying commodity prices would change an actual $11 million unrealized gain into a $28 million unrealized loss.

E16.13 Effects of Sarbanes-Oxley Act on Financial Reporting Requirements SOX's principal objective is to restore confidence in the veracity of publicly-reported financial information and reduce related uncertainty in the capital markets. Several specific requirements of the Act that bear on these issues are: 1. Personal top management (CEO/CFO) certifications of financial statements filed with the SEC 2. Increased auditing of and reporting on internal controls, particularly companies' systems of internal controls relating to financial reporting 3. Establishment of the Public Company Accounting Oversight Board (PCAOB) to set auditing standards and monitor the qualifications and performance of auditing firms 4. Limitations on the nonaudit services that CPA firms can provide to audit clients

E16.14 Comment Letters on Periodic Filings a. The SEC identifies three issues: (1) Exclusion of depreciation and amortization from cost of sales, in determining gross margin. (2) Lack of disclosure of the nature of international earnings assumed to be indefinitely invested outside the U.S. and therefore not subject to U.S. tax, and the tax implications of international cash and short-term investments if repatriated. (3) Lack of disclosure of revenues and long-lived assets attributable to non-U.S. countries, and policy for allocating revenues from customers. b. (1) After rounds of negotiation lasting two months, Target agreed to include depreciation and amortization in determining gross margin, in order to be able to label gross margin as a GAAP measure, but also will present a line separating out depreciation and amortization. (2) Target supplied details of its international earnings, stating the earnings are reinvested to finance operations in other countries. It identified a tax liability recorded on Target India operations. It also stated that any tax on repatriation would be immaterial. It agreed to disclose in its MD&A the cash and short-term investments held outside the U.S. for which there would be tax implications if repatriated to the United States. (3) Revenues and long-lived assets attributable to non-U.S. countries are immaterial, as virtually all revenues are generated in the U.S. Target will add a note to this effect in future filings. It has no allocation policy since the amounts are immaterial.

E16.15 Item 9A Controls and Procedures

a. Item 9A provides the evaluation of the effectiveness of internal controls and procedures, and management’s evaluation of the effectiveness of internal controls over financial reporting. Oracle’s item 9A is more extensive than most companies. There are four sections: evaluation of disclosure controls and procedures, management’s report on controls over financial reporting, changes in controls, and inherent limitations. Evaluation of Disclosure Controls and Procedures •

The evaluation process involved the Disclosure Committee and management, including the CEO and CFO.

•

Steps included a review of objectives and design, implementation, and the effect on information used in the 10-K.

•

Data errors and control problems were reviewed, and corrective actions were evaluated for effectiveness.

•

The review is done on a quarterly basis.

•

The CEO and CFO concluded that disclosure controls and procedures were effective.

Management’s Report on Internal Control over Financial Reporting •

The review was done in accordance with established guidelines.

•

The CEO and CFO concluded that disclosure controls and procedures were effective.

•

The assessment was reviewed with the Finance and Audit Committee.

•

Internal control effectiveness was audited by Ernst & Young LLP.

Changes in Internal Control over Financial Reporting •

There were no material changes in internal control

Inherent Limitations on Effectiveness of Controls •

Management believes disclosure controls and procedures and internal control over financial reporting are effective at a reasonable assurance level.

•

Controls will not prevent all errors or fraud.

•

Resource constraints and the benefits of controls must be considered relative to their costs.

•

Misstatements due to error or fraud may still occur, even with effective controls, for these reasons: faulty judgments in decision making, simple errors, collusion to override controls, wrong assumptions about the likelihood of future events, deterioration in compliance with policies or procedures.

b. The information is an outline of who was included in the evaluation, general steps involved, and limitations on the results. There is no detail on any weaknesses or steps taken. Readers can be assured that the evaluation followed the rules, but it is difficult to determine if the review was effective.

PROBLEMS P16.1 Origins and Objectives of Securities Legislation a. Investment practices of the 1920s that contributed to the erosion of the stock market include the following: •

The prices of securities were manipulated through the use of "wash sales" or "matched orders." Brokers or dealers engaged in prearranged buy and sell orders that created the impression of activity and drove up prices. When the public began buying, driving prices up even higher, the brokers and dealers would sell, making huge profits before prices fell back to market level.

•

False or misleading financial statements were issued to lure unwary investors.

•

The excessive use of credit to finance speculative activities served to undermine the market. There was no limit to the amount of credit or "margin" that a broker could extend to a customer. As a result, a slight decline in market prices often caused overextended customers to sell when margins could not be covered, thus further reducing prices.

•

Corporate officials and other "insiders" misused information about corporate activities to take advantage of fluctuations in stock prices.

b. 1. The objectives of the Securities Act of 1933 are to: •

provide investors with financial and other information concerning the initial offering of securities for sale, thus ensuring full and fair disclosure. Companies were required to file a registration statement and a prospectus for review.

•

prohibit misrepresentation, deceit, and other fraudulent acts and practices in the sale of securities.

b. 2. The objectives of the Securities Exchange Act of 1934 are to: •

regulate the trading of securities on secondary markets by requiring the registration of securities traded on any national exchange.

•

create a regulatory agency, the Securities and Exchange Commission, to administer the requirements of both the 1933 and 1934 acts.

c. 1. The provisions of the Foreign Corrupt Practices Act of 1977 include the requirement for public companies to devise and maintain a system of internal accounting controls to provide reasonable assurance that transactions are properly authorized, recorded, and accounted for. c. 2. The provisions of the Insider Trader Sanctions Act of 1984 include increased penalties against persons who profit from illegal use of insider information. Fines of up to three times the profits gained or losses avoided can be imposed on those who misuse nonpublic information.

P16.2 Annual Reports to Stockholders and Form 10-K a. Form 10-K is an annual report companies are required to file with the SEC. This report is required under the Securities and Exchange Act of 1934. b. Possible additional information which might be ascertained from a firm's 10-K and which might not be in the company's annual report is: •

Remuneration of directors and officers

•

Indemnification arrangements for directors and officers

•

Principal holders of equity securities and holdings by directors and officers

•

Interest of management in certain transactions

•

Number of equity security holders

•

Management analysis of material changes in revenues and expenses.

c. Financial information which might be included in a firm's annual report but not required for the 10-K includes: •

Financial charts (bar graphs, pie charts, etc.)

•

Ratio analysis of operations and financial position

•

Ten-year summary of financial data

•

Market price by quarter for common stock for the current year

•

Analysis of operations and future prospects in president's letter.

P16.3 Quarterly Reports to the SEC a. 1. Form 10-Q is the quarterly report to the SEC required under the Securities Exchange Act of 1934. It includes condensed financial statements, management's discussion and analysis, and other information as applicable. Registrants must file a Form 10-Q for each of the first three quarters of each fiscal year within 40 days of the end of the quarter (45 days for non-accelerated filers). a. 2. The SEC is empowered under the 1934 Act to require that registrants provide timely, current information to the trading markets. The Form 10-K annual report is the Commission's basic continuous reporting document. Form 10-Q serves to update the latest 10-K information for events of the current fiscal year. b. 1. Balance sheet. Form 10-Q must include a balance sheet as of the end of the most recent fiscal quarter and a balance sheet as of the end of the preceding fiscal year in the same degree of detail (same major captions) as the interim balance sheet. Inclusion of a balance sheet for the same period of the previous year is optional (e.g., necessary for understanding the impact of seasonal fluctuations). b. 2. Statements of income and comprehensive income for the most recent fiscal quarter, current cumulative fiscal year-to-date and for corresponding periods of the preceding fiscal year, are required. Only major captions, with material amounts, need be disclosed separately. b. 3. Statements of cash flows for the current fiscal year-to-date (most recent quarter-end) and for the corresponding period of the preceding fiscal year are required. These may include a single amount for cash provided by operations, with other items disclosed only if material relative to operating cash flow. b. 4. Management's discussion and analysis of interim periods include discussion of material changes in financial position and material changes in the results of operations with particular reference to liquidity, capital resources, and operating results. b. 5. Footnote disclosures should be sufficient to make the interim financial statements not misleading, under the presumption that users have access to the latest audited annual financial statements. Thus, only material current year-to-date events that would significantly alter the latest annual report footnotes need to be disclosed.

P16.4 Special Reports to the SEC a. 1. The purpose of Form 8-K is to ensure that any significant event affecting a firm's policies or financial position is immediately reported to the SEC. Covering the period since the filing of the latest annual or quarterly report, Form 8-K provides a continuous stream of material information concerning specified events between filings. a. 2. Form 8-K must be filed with the SEC within 4 days after the occurrence of a reportable event. Violation of the 8-K filing requirement may jeopardize a registrant's status.

a. 3. The inclusion of audited and pro forma financial statements is only required when reporting the acquisition of a business. Financial statements may be included in a Form 8-K in order to clarify the effect of any event on the corporation. In general practice, financial statements are included if an event is deemed to have a material financial impact. b. Five circumstances under which the Securities and Exchange Commission requires the filing of Form 8-K include: Note: Answers may vary. See Exhibit 16.3 in the text. •

changes in the control of the registrant

•

acquisitions or dispositions of assets

•

material legal proceedings

•

bankruptcy or receivership

•

changes in the registrant's certifying accountants

c. The role of the SEC is to regulate the issuance and trading of securities. By requiring the disclosure of adequate information, it enables investors to make informed judgments about securities. Form 8-K fosters this purpose by requiring firms to report significant events as they occur to the investing public. d. The purpose of the securities laws is not to have the SEC judge the merits of securities offered for sale. Through its strict disclosure and reporting requirements, the SEC attempts to make certain that the investor has the opportunity to judge the merits of securities on the basis of full disclosure of the pertinent facts. The SEC does have the power to suspend trading in securities of companies that fail to make full and accurate reports; however, these actions are not based on the merits of the securities but on the companies' failure to comply with reporting regulations.

P16.5 Audit Committees a. The audit committee acts as an intermediary or communication link between the external auditor and management during the external audit process. In addition, the audit committee reviews the arrangements for the audit, the scope of the audit, the progress and findings of the audit, and any investigative matters related to financial reporting and internal control. b. Duties which may be assigned to the audit committee by the board of directors other than those associated with the annual audit, may include: •

monitoring the activities of the internal audit staff

•

seeing that any recommendations made by the external auditor are acted upon by the internal auditors

•

reviewing the design of the company's control systems

c. The audit committee should act as an overseer of the company's internal audit staff. The audit committee is concerned with such matters as the scope of internal audits, the completion of assignments, and discussion of the results of reviews conducted by the internal audit staff. d. Members appointed to serve on the audit committee should be outside board members (independent of management) because the NYSE specifies that members be independent of management, outside members would be free from bias or conflicts of interest, and outside members would be more objective in settling disputes between management and the external auditor.

P16.6 Proxy Statements a. The purpose of proxy statements is to provide full and fair disclosure of significant events in order to allow shareholders to exercise a more informed judgment before voting on corporate matters. b. Events or actions for which proxy statements are normally solicited include election of directors, change in corporate charters or by-laws, appointment of auditors, issuance of securities or modification of outstanding securities, or plans to merge, acquire, or dispose of property.

c. Conditions which must be met in order to have a shareholder proposal in opposition to management incorporated in a proxy statement include: •

eligibility; the proponent must own a security with voting privileges.

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attendance; the proponent or his designated alternate shall agree to be present at the annual meeting to present the proposal.

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timeliness; the proposal shall be received at least 90 days in advance of the proxy statement mailing date.

P16.7 Registration of New Securities a. The Securities Act of 1933 requires a filing by any firm that raises capital in the primary capital market through the initial sale of a new security, whether by a public offering made directly by the firm or through an underwriter. The registration applies only to the specific quantity of the specific security being offered. The Securities Act of 1934 requires a filing by any firm whose securities are being traded publicly in the secondary capital market. These securities are registered as an entire class with no amount specified. A secondary offering of a firm's securities also requires the filing of a registration statement. b. An objective of the 1933 Act is to provide investors with material information concerning the issuing firm, its management, the securities offered for public sale. The SEC does not evaluate the creditworthiness of the investment. The 1933 Act is an attempt to ensure that investors are given full and fair disclosure of all pertinent information about the issuing firm, including audited financial statements. c. SEC Publication

Explanation

Regulation S-X

Instruction as to the form and content of the required financial statements.

Regulation S-K

Instructions as to the form and content of required disclosures other than the required financial statements, i.e., supplementary financial information, summary financial data, and non-financial information.

Financial Reporting Releases (formerly Accounting Series Releases)

Constitute part of Regulation S-X in the determination of the form and content of the required financial statements.

Staff Accounting Bulletins

Interpretations and practices followed by the Division of Corporation Finance and the Office of the Chief Accountant in administering the disclosure requirements of the federal securities laws.

P16.8 Role of the SEC in Standard Setting a. The Securities and Exchange Commission (SEC) was created through the Securities and Exchange Act of 1934. As a result of this act, the SEC has legal authority relative to accounting practices. The U.S. Congress has given the SEC broad regulatory power to control accounting principles and procedures in order to fulfill its goal of full and fair disclosure. Specific responsibilities of the SEC include: •

regulating the sale of securities on secondary markets.

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regulating the initial offerings and actual sales of stock in interstate commerce.

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prescribing the forms and reports to be used.

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prescribing the items or details to be shown in the financial statements and the methods to be followed in preparing the accounts.

b. The SEC was created by Congress, and the FASB was created by the private sector; therefore, no direct relationship exists. However, SEC recognizes the FASB as authoritative, and has historically followed a policy of relying on the FASB to establish financial accounting and reporting standards. There has been cooperation between the SEC and FASB, but at times the relations between these bodies have become strained. In cases of unresolved differences the SEC rules takes precedence over FASB rules for the companies within SEC jurisdiction.

P16.9 Role of the PCAOB a. Per SOX Section 101, the PCAOB oversees “the audit of public companies that are subject to the securities laws.” Therefore all auditors of companies accessing U.S. capital markets are subject to PCAOB governance. This also applies to audit firms that are not the main auditor, but only participate in the audit. Non-U.S. auditors are also subject to PCAOB governance, if they have any role in the audit of a company listed in the U.S. b. The PCAOB registers audit firms, establishes or adopts auditing standards, conducts inspections of registered firms, and follows up with investigations and disciplinary actions, including sanctions, as appropriate. c. Prior to the formation of the PCAOB, the AICPA was responsible for developing auditing standards. Now the PCAOB has the ultimate authority to establish standards of auditing, governance, control, and ethics, as necessary to protect the interests of investors. Initially the PCAOB adopted most AICPA standards. However, it also has issued its own standards. AICPA standards still apply to audits of nonpublic companies.

P16.10 Comment Letters on Periodic Filings a. When the machine vision operations were sold, the entire consideration received was recorded as a gain. This implies that the book value of the machine vision operations was zero. The SEC questioned why none of the cost of Misfit was allocated to the machine vision operations. If the negotiations to sell the machine vision operations occurred within a year of the acquisition, why didn’t Fossil do a measurement period adjustment to allocate some of the acquisition cost to the machine vision operations, representing its value at the date of acquisition, based on the new information about its value? b. Fossil justified allocating zero acquisition cost to the machine vision operations because it was not relevant to Fossil’s strategic plan (and therefore had no value if retained), and Fossil believed the operations had no market value (if sold) since its optical image recognition and processing software was its only project and it was in very early stages. Their position is that at the date of acquisition the machine vision operations had no value, and even if they did a measurement period adjustment to try to measure the value as of the date of acquisition (as opposed to value changes after acquisition), it would be immaterial. If these facts are accurate, it can be argued that Fossil made reasonable reporting choices in this case. The SEC accepted their arguments.

P16.11 PCAOB Inspections a. Part I contains a description of inspection procedures and observations for the audit form. Part IA includes the scope of the inspections, inferences from the engagement reviews, and, for each engagement for which deficiencies were identified, a detailed description of the deficiency. Part IB contains a description of the auditing standards with which PwC failed to comply. Part IC describes general characteristics (industries, size of revenues) of issuer audits selected for the inspection. Part ID contains general information on PCAOB inspections (reviews of audit work, quality control, management structure and processes, partner management, assessment of client risk, use of audit work from international affiliates, procedures for assessing audit quality). Several parts of the report are not available to the public. Appendix C is a letter from PwC, responding to the report. Appendix D is a list and brief description of audit standards referenced in the report.

b. Pages 3-4 of the report say the following: “Certain of the deficiencies identified were of such significance that it appeared to the inspection team that the Firm, at the time it issued its audit report, had not obtained sufficient appropriate audit evidence to support its opinion that the financial statements were presented fairly, in all material respects, in accordance with the applicable financial reporting framework and/or its opinion about whether the issuer had maintained, in all material respects, effective internal control over financial reporting ("ICFR"). In other words, in these audits, the auditor issued an opinion without satisfying its fundamental obligation to obtain reasonable assurance about whether the financial statements were free of material misstatement and/or the issuer maintained effective ICFR…. The audit deficiencies that reached this level of significance are described in Part I.A.1 through I.A.12, below.”

Therefore, deficiencies not meeting this level of significance were omitted from the report. c. The three major issue categories are: 1. Failure to sufficiently test the design and/or operating effectiveness of controls that the Firm selected for testing (8 audits). 2. Failure to sufficiently test significant assumptions or data that the issuer used in developing an estimate (7 audits). 3. Failure to test controls over or test the accuracy and completeness of issuerproduced data or reports (6 audits). d. Major items for which audit deficiencies were found include: •

Goodwill impairment testing

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Valuation of acquired identifiable intangibles

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Identifiable intangibles impairment testing

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Revenue recognition for long-term contracts

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Divisional reporting of revenues and inventory costs

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Allowance for loan losses

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Appraisals of real estate assets

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Loan delinquencies and write-offs

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Valuation of patient-service revenues and receivables

e. The PCAOB specifically addresses this issue as follows: “The fact that one or more deficiencies in an audit reach this level of significance does not necessarily indicate that the financial statements are misstated or that there are undisclosed material weaknesses in ICFR. It is often not possible for the inspection team, based only on the information available from the auditor, to reach a conclusion on those points.”

However, the report goes on to say: “Whether or not associated with a disclosed financial reporting misstatement, an auditor's failure to obtain the reasonable assurance that the auditor is required to obtain is a serious matter. It is a failure to accomplish the essential purpose of the audit, and it means that, based on the audit work performed, the audit opinion should not have been issued.”

P16.12 Registration Statement a. “The principal purposes of this offering are to increase our capitalization and financial flexibility and create a public market for our Class A common stock. We intend to use the net proceeds from this offering primarily for general corporate purposes, including working capital, research and development, business development, sales and marketing activities and capital expenditures. We may also use a portion of the net proceeds from this offering for acquisitions of, or investments in, technologies or businesses that complement our business, although we have no commitments or agreements to enter into such acquisitions or investments.” b. $100,000,000 $11,590/$100,000,000 = approximately 0.01% c. Each Class A share has one vote, while each Class B share has ten votes. d. Roku is a non-accelerated filer, and an emerging growth company. Non-accelerated filers have extra time to file their 10-K and 10-Qs, and as an emerging growth company they are not required to meet certain SOX requirements concerning audits and compliance with standards. e. Roku’s auditor is Deloitte and Touche, LLP. They provided a clean audit opinion for the annual financial statements covering 2015 and 2016, that are included in the registration statement. They did not provide an opinion on Roku’s internal control over financial reporting, and are not required to do so since Roku is an emerging growth company. The interim financial statements for the six months ended June 30, 2017 and interim reports re-issued September 1, 2017, are unaudited, but Deloitte evaluated subsequent events through September 1, 2017.

P16.13 JOBS Act Exemptions a. An emerging growth company is a company with annual gross revenues of less than $1,070,000,000 (adjusted for inflation; amount is current as of April 2017) during its most recent fiscal year. b. SOX exemptions: 1. 2. 3. 4.

Auditor is not required to attest to management’s report the effectiveness of internal controls. Companies are not required to comply with new accounting standards until private companies must comply (if private companies are required to comply). Rules on mandatory audit firm rotation or auditor discussion and analysis do not apply. Compliance with new audit standards is not required unless the SEC determines compliance is appropriate.

P16.14 Audit Committee Responsibilities Major duties include: 1. Hiring and oversight of the external independent auditor. 2. Approval of compensation for audit and nonaudit services. 3. Interaction with management, the internal audit department, and the external auditor on reporting and control issues. 4. Review of new reporting regulations and standards and their effect on company reporting. 5. Monitoring and evaluation of the company’s internal control over financial reporting.

P16.15 Audit Committees and Non-GAAP Disclosures a. A non-GAAP performance measure is a measure of income that does not comply with GAAP, but which management feels better measures the company’s performance. Most measures are some form of EBITDA, where noncash expenses and select nonoperating items are excluded. Some may also omit additional items of a “one-time” nature or which do not represent results of the company’s main mission. b. The SEC is concerned that a company may mislead investors by excluding items they need to evaluate performance and company value. Each company uses its discretion in determining which items to exclude from its performance measure; there are no standards against which to judge the accuracy of the measure. Non-GAAP measures may also be computed differently over time, increasing the confusion.

c. The audit committee should review all earnings releases and disclosures, and be satisfied that they comply with all regulations and laws. For example, in its filings, the SEC requires a reconciliation of non-GAAP measures with the comparable GAAP performance measure. Other audit committee considerations include: • • • •

Investigation of the process by which non-GAAP measures are calculated. Benchmarking data on measures used by industry peers. Are there motivations to meet internal or analyst targets that may influence the performance measure used? Does the non-GAAP measure reflect the key drivers of company value?